Shares of Innovative Industrial Properties (NYSE:IIPR) are currently attached to a massive dividend yield of 10.1%. However, one crucial question lingers: how sustainable is the yield of this cannabis-specialized REIT? While it’s not always true, a massive yield, especially one in the double-digits, could indicate the market’s expectation of a potential cut. With shares of Innovate Industrial Properties having lost roughly 3/4 of their value since their 2021 high of $288, it’s safe to say that investors don’t exactly feel confident about the company’s financial health.
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In my view, while there are valid risks attached to Innovative Industrial Properties’ investment case, including a low-quality tenant base, I don’t believe that its dividend is going to get a cut anytime soon. The dividend is by no means invulnerable, but the company’s continuous profitable growth appears to adequately support the underlying payouts. Precisely because of featuring such a massive yield and further growth potential ahead, I am bullish on IIPR stock.
How Well-Covered is IIPR’s Dividend?
To evaluate whether IIPR’s double-digit dividend is sustainable, it’s useful to see how well-covered the underlying payouts are. The company has increased its dividend for six consecutive years, with last September’s increase boosting the annualized dividend rate to $7.20. Last year, the company posted AFFO (adjusted funds from operations, a cash-flow metric used by REITs) per share of $8.45, up 26.9% compared to the previous year. This implies a payout ratio of 84%, meaning that payouts are adequately covered.
Of course, the market doesn’t really care about the company’s past performance relative to how much it cares about its future performance. While AFFO/share grew significantly last year, investors could fear that the ongoing rising-rates environment could have an adverse impact on the company’s bottom line, which could threaten the viability of the dividend.
That said, this doesn’t appear to be the case. In its most recent Q1 results, we saw Innovative Industrial Properties even lightly reducing its indebtedness, resulting in interest expenses falling by 5.1% to $4.52 million. In the meantime, the company posted robust revenue growth of 17.9% to another record of $76.1 million.
Most importantly, however, the company was able to grow its AFFO on a per-share basis. This is despite the higher expenses and the larger share count as a result of the issuance of common stock to fund the company’s acquisitions, as higher revenues more than offset these factors. Specifically, Innovative Industrial Properties’ AFFO per share grew by 10.9% year-over-year to $2.25. Not only is this a highly-commendable result in a rising-rates environment in which most REITs fail to sustain their profitability, let alone expand it, but also, it implies improved coverage of the $1.80 quarterly dividend.
Is Innovative Industrial’s Low-Quality Tenant Base a Threat to the Dividend?
While the company continues to grow profitably, even improving its dividend coverage, as we just discussed, some investors believe that its low-quality tenant base could eventually be a threat to the dividend.
To frame the picture here, the cannabis industry presents unique challenges for producers, making it arduous for them to achieve profitability. Given that cannabis functions as a commodity, akin to other agricultural products, generating substantial profits becomes an extremely daunting task for players in this sector.
While cultivating a strong brand can enhance sales to some degree, it becomes challenging to command premium prices in a competitive landscape, especially when legitimate businesses have to contend with illicit market participants. Consequently, certain tenants of the company have encountered difficulties in meeting their rent obligations.
In the latter part of the previous year, the company faced such challenges. Notably, during the third quarter, two tenants with deteriorating financial conditions failed to fulfill their contractual rent commitments, resulting in an accumulated amount of $5.7 million in unpaid rent. The company did manage to partially offset the impact by withholding $2.6 million from these tenants’ deposits. Nonetheless, it was not an ideal situation overall.
Moving into the fourth quarter of 2022, the company also experienced weakened rent collection, with only 94% of rent successfully received. This was largely due to a few tenants going out of business, signaling a potential gradual deterioration within the cannabis producer segment.
However, it is important to note that this does not yet indicate a worrisome trend. In the subsequent first quarter of this year, the company’s rent collection rate rebounded to 98%, with the remaining 2% reflecting the previously defaulted tenants in Q4 2022, namely Parallel and Green Peak. Notably, the company successfully collected rent from all tenants in April and May, with the exception of Parallel for the Pennsylvania property (where they continue to occupy) and the two small retail properties leased to Green Peak. Thus, the company’s core tenants have consistently paid on time, and the overall business remains unaffected by most issues.
Is IIPR Stock a Buy, According to Analysts?
Turning to Wall Street, Innovative Industrial Properties has a Moderate Buy consensus rating based on three Buys and two Holds assigned in the past three months. At $109.75, the average Innovative Industrial Properties stock forecast implies 51.05% upside potential.
The Takeaway
Innovative Industrial Properties stock has plummeted in recent months, with investors likely betting against the viability of the company’s hefty dividend. The truth is that the company does face risks, especially when it comes to its possibly more volatile tenant base due to its exposure to the cannabis industry. However, I believe the company’s dividend is secure.
With continuous profitable growth, healthy indebtedness, and accretive capital allocation, Innovative Industrial Properties shows resilience in a rising-rates environment. Hence, the stock could offer a compelling opportunity at its current levels, especially with the yield now hovering well into the double digits.
