Innovative Industrial Properties Keeps Creating Opportunities
Summary

The management team at IIPR continues to make acquisitions nationwide, now controlling 21 different properties.

Its long-term contracts, high yield on assets, and attractive AFFO conversion are all reasons to like the firm.

Shares are pricey right now, but if management can deploy its extra capital wisely, the numbers will come back down to earth.

Add to this the prospect of using its pricey shares to grow, and there could be some nice upside for shareholders long term.

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One of the more interesting prospects in the cannabis space right now happens to be Innovative Industrial Properties (IIPR). Unlike the other players in the space, which tend to focus largely on the cultivation and production of cannabis and cannabis-related products and services, IIPR is unique in that it serves as a REIT whereby cannabis companies will sell their properties to it and then lease them back under long-term arrangements. On the whole, this company might be the go-to player for investors who appreciate a company that pays out a dividend, plus for those who like the stability inherent in long-term rental agreements.

A look at its recent activities

The first (and only, other than this) time I wrote about IIPR was back in an article published on Seeking Alpha on March 5th of this year. Since then, shares in the firm have risen 11.7%, riding the wave of enthusiasm in the cannabis industry and driven by acquisition-related activities undertaken by management. Take, for instance, a look at the firm’s latest purchase. On May 20th, the company announced the acquisition of a 266,000 square foot industrial space, spread across two buildings, located in Saxton, Pennsylvania.

The purchase price for these assets came out to $13 million, and in exchange, the company landed a long-term contract structured under a triple-net lease. The occupant will be Green Leaf Medical, a company with extensive operations throughout Maryland (where sales alone in its first 11 months there totaled $9 million), Pennsylvania, Ohio, and Virginia. Having raised $24 million in funding since starting out in 2014, Green Leaf is working hard on becoming a meaningful player in the industry, and what better way than to raise $13 million without having to issue equity or assume any debt?

 

In all, Green Leaf is using 103,000 square feet of the facility for the cultivation and processing of cannabis for medical purposes, and the remaining 163,000 square feet is being set aside for future redevelopment. According to my calculations, annual management (if applicable) and rental fees associated with the facility that will be paid to IIPR come out to around $2.19 million. With the closing of this acquisition, IIPR will own 21 facilities, which collectively have a 100% occupancy rate.

Management has not provided much more in the way of details for this particular purchase, but what we do know is that it lengthens the weighted-average lease term of the business’s portfolio. In all, the weighted-average lease term on its 21 properties comes out to around 15.1 years. This is up from the 14.8 years reported the last time management announced the acquisition of some properties.

Speaking of acquisitions, this isn’t the only purchase made by management recently. The firm, on April 24th, acquired a 51,000 square foot facility in Pittsburgh, Pennsylvania in exchange for $6.3 million, plus a commitment for reimbursements of another $10 million associated with said facility’s development. On April 16th, meanwhile, the company purchased five other properties with a collective physical footprint of 102,000 square feet in California in exchange for $27.1 million.

Shares are pricey, but not as pricey as you think

One truly legitimate criticism regarding IIPR is that shares of the company are anything but cheap. Total AFFO (adjusted funds from operations) in the first quarter of the company’s 2019 fiscal year came out to $5.3 million. Annualized, and ignoring the impact of acquisitions brought on recently (since we don’t know exactly how profitable those will end up being), this translates to AFFO of $21.2 million. On the other hand, the firm’s market cap, as I type this, is $871.38 million, implying a market cap/AFFO trading multiple on the company of 41.1. That’s insanely high, not only by REIT standards but also by almost any standard imaginable.

 

Investors who point this out should not be dismissed, because there is a real possibility that if growth from the company is not significant enough, shares could eventually come back down to earth. That said, at the rate the company is going, and given the resources it has at its disposal, strong upside may be just around the corner. To see why I think this, we need only look back to February of this year.

Back in February, IIPR issued debt in the amount of $143.75 million, with an annualized interest rate of 3.75%. Net of costs, the company brought on proceeds of $138.4 million, implying an effective interest rate of 3.89% per annum. Not only is this debt low interest in nature, meaning that so long as the firm generates cash flows in excess of the 3.89%, that deals are value-accretive, there’s the fact that the debt may never come back to bite the company. This is due to the fact that the business has the right, upon redemption of the debt, to instead issue to the investors who gave them the cash, stock, cash, or a mix of the two. Depending on circumstances, management may elect to just issue shares.

Irrespective of the outcome, this issuance, combined with prior issuances of stock and the generation of cash flow, has allowed IIPR to amass cash on hand of $59.22 million, plus short-term investments of $197.73 million. In all, this brings the firm’s cash and cash equivalents to $256.95 million. If we assume that AFFO generated is enough to fund the firm’s cash needs, including reimbursement commitments over time, and if we account for the asset acquisitions subsequent to the first quarter this year, the business should have cash and cash equivalents that can be used toward acquisitions of around $200 million.

Assuming the company can get the same (or similar) yield on its future purchases as the 14.7% weighted average it has locked in right now, this $200 million could help to pump up revenue by $29.48 million on top of the implied $38.04 million annualized from all of its existing properties. Assuming the same AFFO/revenue conversion rate, I calculated forward AFFO of $52.45 million for the firm. This translates to a price/AFFO on the company of 16.6, which is still pricey but isn’t necessarily out of the question.

 

Another tool at the company’s disposal is the very issue naysayers in the business point out: its high share price. If management were to issue its high-priced stock, effectively diluting common shareholders, and utilize that toward growth, results could be supercharged even further. Of course, in the event of a major share issuance, or even many small ones over a period of time, there would be downward pressure on IIPR’s share price, all else being the same, but that could be a nice way to create a self-fulfilling prophecy whereby shares of the company might actually be worth what they’re trading for or higher.

Takeaway

Right now, IIPR is in a pretty good spot, but there are risks associated with the business. The real risk to keep in mind is that shares are not, as the firm stands, cheap. In fact, the opposite is true. Thankfully, though, with the cash it has on hand, plus the ability to issue not only additional debt but also to issue shares, and given its recent flurry of acquisition-based activities, there is a chance for management to grow into or even grow out of (by exceeding) the firm’s valuation. If this does come to pass, investors in the company will be in a nice spot.