When investing in dividend stocks, opting for high yields can be a seductive strategy. However, a high yield means little if a company cannot sustain it and is, eventually, forced to slash its payouts. That's why income-seeking investors should focus first and foremost on a corporation's underlying business.
That brings us to Innovative Industrial Properties (IIPR 3.30%), a real estate investment trust (REIT) focused on the medical cannabis sector. The company's forward yield of about 11% looks attractive, but is it sustainable?
Problems with a key tenant
Innovative Industrial Properties (IIP) buys properties from cannabis growers and leases them back to those same companies, allowing them to free up cash. The company's business model works, at least somewhat, for one key reason. Since marijuana remains illegal at the federal level in the U.S. and is still classified as a Schedule I substance, it can be challenging for cannabis companies to access banking-related services.
NYSE: IIPR
Key Data Points
However, the pot industry has struggled in the past few years, as has IIP. Consider the company's third-quarter financial results. IIP's revenue dropped by about 2% year over year to $76.5 million, which the company blamed on a $3 million decline in contractural rent.
On the bottom line, the REIT's earnings per share came in at $1.37, down from the $1.45 reported in the year-ago period. Investors shouldn't expect IIP's financial results to get much better soon -- quite the opposite.
Last month, the company announced that one of its tenants, PharmaCann, failed to pay rent for six of the 11 properties it leases. Although it did so for the remaining five, because of a cross-default provision in each of the leases, PharmaCann has essentially defaulted on its obligations for all 11. The amount PharmaCann failed to pay (not including late penalties and interest) amounts to $4.2 million.
Note that this sole company accounted for 17% of IIP's rental revenue through September 2024. The REIT will seek to resolve this issue, but it is an important headwind that investors should keep monitoring.
Looking beyond the yield
IIP's stock performance has been terrible over the past three years, resulting in a much higher yield. The company's dividend has increased through this period, though not by a considerable amount.
The issues that IIP was already facing -- including a legal and regulatory landscape that significantly slowed the progress of marijuana companies -- were already challenging enough. The PharmaCann-related problem only makes things more complicated. Furthermore, it isn't the first time one of the company's tenants failed to pay rent. That also happened in 2023. That does not bode well for the company. Some might argue that IIP still has plenty of room to grow in the U.S. cannabis market.
The company does business in just 19 states out of 38 (not including several other U.S. territories) where medical cannabis is legal. However, IIP might encounter similar issues as it expands into new regions. There is no reason to think its expansion efforts will necessarily lead to much stronger financial results.
Here's the bottom line. IIP's prospects largely hinge on the progress and the health of the cannabis industry. As long as marijuana companies continue to struggle, there will be significant risks with IIP, and the very real possibility that it will slash its payouts.
Legalization -- or at least a much friendlier regulatory regime -- might help, though it could also make IIP's business model obsolete since it would allow cannabis companies to access banking services much more easily. However, a less stringent regulatory landscape would also attract many more players in the industry, including some eager to avoid dealing with the downsides of traditional banking, such as high interest rates and strict loan requirements.
In my view, IIP should look forward to lawmakers easing up on cannabis-related laws, but there is no guarantee that this will happen anytime soon. In the meantime, IIP's headwinds could drag on for several quarters or longer. The company won't suspend its income program, since REITs must distribute at least 90% of their taxable income as dividends. But IIP's juicy yield looks anything but secure.
Dividend-seeking investors can find much better options.
