Progressive Industrial Properties: Not Your Ordinary REIT (NYSE:IIPR)

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Written by Nick Ackerman

Innovative Industrial Properties (IIPR) is not just your everyday industrial real estate REIT like STAG Industrial (STAG) which we also own. This REIT belongs to a specialized category of the warehouse and distribution center business. They describe themselves as “a leading provider of real estate capital to the medical cannabis industry.”

This puts the IIPR in a league of its own. For investors, the REIT branches out into all of the major investment categories of growth, income, dividend growth, and speculation. Typically, REITs are often associated with income games. The speculation part deserves special mention, since it’s not your run-of-the-mill, established REIT that’s been providing investors with returns for decades. They came onto the investment scene in 2016.

Growth, dividends and speculation

That speculation part is exactly why we’ve seen the returns we’ve seen so far. Below is a chart since the REIT’s inception on both a total return and price basis. The total return, of course, taking into account the dividends paid. When returns are this impressive, they generally grab investors’ attention.

diagram

Ycharts

Ycharts

Those dividends were also quite substantial. It might take a little longer to get that growth though as they recently announced they would be evaluating in Q1 and Q3. Previously, they had announced dividend increases almost every quarter.

Paid a quarterly dividend of $1.50 per share on October 15, 2021 to common shareholders of record as of September 30, 2021, an increase of approximately 28% from the third quarter 2020 dividend. As previously announced, IIP’s Board of Directors expects to evaluate adjustments to the amount of IIP’s quarterly common stock dividend every six months, with all adjustments expected to be announced in the first and third quarters of each year.

Another sign that the REIT has at least matured somewhat.

They remain committed to maintaining the payout ratio between 75% and 85% of AFFO, as noted in their second-quarter earnings call. That has resulted in a phenomenal growth trajectory fueled by the rapid growth of the REIT itself.

As we have indicated in the past, the Board continues to target a dividend payout ratio of 75% to 85% of AFFO based on a stabilized portfolio.

When they released their third quarter results in early November, we saw that AFFO was at $1.71. Over the past 9 months, AFFO was $4.81. Analysts had expected the name to continue growing at a rapid pace. Definitely a lot snappier than the rest of the REITs in my portfolio.

profit estimate

earnings estimates

Alpha wanted

Analysts expect IIPR to provide $8.66 in FFO next year and anticipate that they will provide $6.34 this year. That will mean nearly 37% growth if they deliver what’s expected in the fourth quarter to close out its fiscal year. Such growth could mean that we also see a roughly 37% increase in the dividend.

As shocking as that may seem, that’s slow compared to what we got when we look at the compound annual growth rate over the last three years. Unfortunately we don’t have a longer track record, but what we have is pretty impressive. The lack of a track record also fits into the speculative part of the equation.

dividend growth

dividend growth

Alpha wanted

They introduced a quarterly dividend of $0.15 when they launched, and the most recent dividend of $1.50 represents 900% growth. That wasn’t enough to keep up with their stock price growth, but I’d say it’s still pretty impressive. Currently, the REIT is yielding 2.82%, so we still look significantly better than the S&P 500.

dividend chart

dividend chart

Alpha wanted

This growth was fueled by the fact that it was a small operation at first. If you add 10 traits but only have 10 to start with, your size will double. If you’re Realty Income (O), you’ll need to make significant purchases to get your needle moving. That’s exactly what they did when they merged with VEREIT. The combined company has nearly 11,000 properties. That was more than the approximately 6,700 properties before the merger. That’s an extreme example, but hopefully the point is clear.

IIPR had just 76 total properties at the end of Q3 2021. Since then, they’ve continued to buy real estate to grow, as any good REIT should. This is how they generate appreciation and growth for their shareholders. A recent deal completed a particularly large 27 properties, bringing the total number of properties to 103 across 19 states.

Not only does it make sense that they should continue to buy properties, but we need to know that those properties will also be occupied. In the case of IIPR, they found that 100% of their 7.5 million rentable square feet were currently rented. Even more impressive, the weighted average remaining lease term was 16.7 years. That should provide their tenants with a steady income for years to come.

Risks

While that’s all impressive, it doesn’t mean IIPR is risk-free. There are risks here that are very specific to this particular business – alongside the general dangers we would expect with any investment.

The fact is, they still have a pretty massive runway to keep growing at a healthy pace. They’re by no means a big REIT with only 103 properties. However, as mentioned above, if you have 10 properties and buy 10 more, you double.

At this point, if IIPR adds 10 properties, we have an increase of less than 10%. It’s pretty impressive considering the more established REITs out there, but regardless of how they’re growing, they’re maturing, which means growth is slowing. In terms of market capitalization, they have reached the mid-cap level. In 2020 they made the transition from Small to Mid.

diagramData from YCharts

Not to mention, the REIT’s valuation here is on the high end, despite recent declines. The P/FFO stands at 33.60, which means that a lot of growth is already priced in. Even if they hit their FFO estimates, we see a P/FFO of around 30, which is still pretty high. If they miss, which is rare, the rating can quickly drop.

The financial strength of the underlying tenants should also be questioned. One of the reasons they don’t build their own facilities is that they lack the capital — and access to capital, which we’ll get to in a moment. Because medical marijuana is a newer industry overall (at least one that’s gaining acceptance), there’s no long-term history for most of these operators. In a burgeoning industry, there are concerns here. As they noted in their last quarterly report:

The properties we acquire are real estate assets that support the regulated cannabis industry. Changes in federal law and current favorable state or local laws in the cannabis industry can significantly affect our ability to renovate or re-let properties and our tenants’ ability to meet their rent obligations and our ability to maintain or increase rent and adversely affect prices for our properties.

Finally, one final key concern specific to this REIT. For those already familiar with IIPR, this is nothing new. However, for those considering a position, there is significant risk if marijuana is legalized at the federal level. The reason for this is that they enjoy high rental rates that they can charge to tenants.

If legalized, it will mean a flood of dollars and competition can rush into the space. Not to mention that tenants could fund themselves through the big banks that don’t or can’t fund such projects. That would rule out leasing, but a big enough company probably wouldn’t see that as a particularly attractive route.

Some counterpoint to that risk is the fact that they only operate in 19 states today. That would also give them more opportunities to diversify geographically, rather than being based in friendlier states with relatively lax marijuana laws.

Conclusion

IIPR is definitely not for everyone due to the speculative nature of the name. However, if you can handle a higher level of risk, it offers quite an attractive place to deploy capital. An investor can earn growth, income, and dividend growth in this REIT. That is, if they can continue to operate as successfully as they have done since 2016.

This is one of the best performers in my portfolio. The massive increase in price has put it on the expensive side, with growth impressive but much of it already priced in. Granted, every time I look at it too I tell myself it’s overpriced – then it seems to run even higher. The recent pullback could create an opportunity.

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