Either way, I can certainly recommend this fast growing REIT to anyone who is comfortable with its rather unique risk profile.

 

Risks To Consider

There are four main risks to IIPR’s extremely bullish growth thesis. The first stems from the fact that cannabis remains illegal at the Federal level (schedule 1 narcotic, the same classification as Heroine). This has important implications for both this REIT and all US cannabis companies.

Specifically, that, should the Feds ever decide to crack down on cannabis in states where it’s legal (as is technically DC’s right) then many cannabis companies, including IIPR’s tenants, might go bankrupt. Due to being illegal Federally, today cannabis companies are not able to access traditional financial markets or services. Most banks won’t even allow a cannabis business to have a checking account because they fear running afoul of drug money laundering laws.

This is likely why Innovative Industrial has no debt, because, simply put, no bank or financial institution will lend to them. As a result, the REIT is forced to fund 100% of its growth with retained cash flow or new equity. Now that’s fine, as long as the share price remains high and climbing (keeping the cost of equity low). As long as IIPR’s AFFO yield is lower than the sky-high cash yields on new properties it buys (15%) then it will be able to grow AFFO/share and its dividends.

And eventually, the REIT is expected to lower its payout ratio enough that it might be able to retain up to 33% of cash flow and buy its properties without issuing new shares (which dilutes investors and slows AFFO/share growth). However, that point is likely far off (four to five years). Until then IIPR’s hypergrowth story remains 100% dependent on remaining a Wall Street darling.

So far that hasn’t been a problem, with the stock easily crushing not just most REITs since its IPO but also blowing the S&P 500 out of the water. Just be aware that in the event of a market downturn, such as a recession-induced bear market, general market panic might cause the share price to fall, and thus cut off the REIT from its primary source of growth funding.

And it might not just be general market pessimism that threatens the stock price. Any negative cannabis news or even sentiment (say a popping of the cannabis stock bubble) might also send shares tanking. As would any negative IIPR news, such as one of its tenants defaulting on its rent. Remember that the REIT only has 10 properties so far, which means each one represents a significant percentage of its revenue. If one or two ends up getting into financial trouble, then IIPR’s hyper-growth might rapidly slow down or it might even report negative AFFO/share growth. While the current payout ratio is sustainable and expected to improve over time (down to 74% by the end of 2020), any tenant trouble might either force the REIT to slow its dividend growth (bad for the share price) or even potentially cut it (terrible for the share price).


About the Author: Adam Galas


Adam has spent years as a writer for The Motley Fool, Simply Safe Dividends, Seeking Alpha, and Dividend Sensei. His goal is to help people learn how to harness the power of dividend growth investing. Learn more about Adam’s background, along with links to his most recent articles. More...