The past few months have been challenging for the cannabis REIT, Innovative Industrial Properties, Inc. IIPR, as it has faced every landlord's worst-case scenario. One of its top tenants defaulted on a set of its leases, resulting in IIPR shares plunging 49.1% over the past three months, significantly underperforming the Zacks REIT and Equity Trust - Other industry and the S&P 500 composite.

The stock has earlier been a favorite for investors in the cannabis sector for its solid dividend yield and long-term growth potential if the cannabis industry stabilizes. But the latest development has eroded the gains and investors remain skeptical.

Before making a quick decision to sell this stock or rushing to buy it after the recent decline, it is essential to thoroughly assess the underlying concern and evaluate its growth prospects. This approach will enable investors to determine the best strategy for navigating the stock's post-decline trajectory.

Three-Month Price Performance

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What Is Concerning for Innovative Industrial?

PharmaCann, one of the nation’s largest vertically integrated cannabis companies that accounts for 17% of Innovative Industrial’s rental revenues, defaulted on its obligations to pay rent for December under six of the 11 leases. The properties are located in Illinois, Massachusetts, Michigan, New York, Ohio and Pennsylvania. For these six properties, December rent totaled $4.2 million. 

While rent was paid in full under the remaining five leases, aggregating $90,000 for December, the cross-default provisions included in each of the leases triggered default on its obligations on the remaining five leases. IIPR utilized the security deposits associated with these leases to fully cover the defaulted rent, along with applicable late fees and interest. The two companies are still in negotiations, but IIPR has stated its intention to " enforce its rights under the Leases aggressively," which may result in eviction.

Naturally, this event introduces uncertainty about IIPR’s ability to recover lost revenues or quickly replace tenants in a struggling cannabis market. Cannabis growers face profitability challenges, making it difficult for IIPR to secure reliable and financially stable tenants within the industry.

The default of PharmaCann has also raised questions regarding the dividend sustainability of Innovative Industrial. While it is too early to predict, a potential dividend cut could undermine investor confidence, especially since the stock’s high dividend payout is one of its primary attractions.

Moreover, with IIPR focusing on cannabis-related properties, its performance is tied to the highly volatile cannabis industry. There are challenges such as aggressive taxation, lack of banking access and slow regulatory progress at the federal level.

What Can Keep Investors Interested in IIPR Stock?

However, despite the concerns, Innovative Industrial draws investors’ attention by offering an 11% dividend yield. For investors seeking income, the company remains a rare source of consistent profitability in the cannabis sector, making it an appealing choice if management can navigate through this challenge successfully.

Moreover, public support for cannabis legalization continues to grow, and federal decriminalization could create a more favorable environment for cannabis operators. As a result, tenants' financial health would improve, and there would be growing demand for IIPR’s specialized properties.

Particularly, IIPR being a leading cannabis-focused REIT, it benefits from a first-mover advantage and a unique position in an emerging market. Despite experiencing tenant defaults, its diversified portfolio across multiple states and experienced management provide resilience and long-term growth potential if the cannabis industry stabilizes.

IIPR’s Estimate Revisions and Valuation

Even the estimate revision trends echo similar sentiments. While the Zacks Consensus Estimates for both 2024 and 2025 adjusted funds from operations (AFFO) per share have climbed over the past three months, there has been no revision in recent times.

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Innovative Industrial stock is trading at a forward 12-month price-to-FFO of 7.38X, below the REIT industry average of 14.95X and lower than its one-year median of 12.50X. Although Innovative Industrial stock is currently trading at a discount compared to its industry peers, including Prologis, Inc. PLD and Terreno Realty Corporation TRNO, this valuation disparity might not be as favorable as it seems.

Forward 12 Month Price-to-FFO (P/FFO) Ratio

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Final Take on Innovative Industrial

Innovative Industrial faces challenges, including the recent default of its top tenant, PharmaCann, which jeopardizes 17% of its rental revenues and raises concerns about dividend sustainability. The REIT’s reliance on the volatile cannabis sector, plagued by lack of banking access and regulatory hurdles, adds further risk. However, IIPR remains attractive for its 11% dividend yield, leadership in a niche market and potential upside from federal cannabis reform, which could stabilize tenant operations and drive long-term growth.

The stock is currently trading at a discount compared to its peers, but it may be wise to hold off on any decisions to buy or sell the stock until there is more clarity. The developments are still unfolding, and the coming weeks could reveal the true extent of the challenges facing the REIT. For existing shareholders, staying invested could be a reasonable choice, given the company’s solid dividend yield and focus on a niche industry.

At present, Innovative Industrial carries a Zacks Rank #3 (Hold). You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

Note: Anything related to earnings presented in this write-up represents funds from operations (FFO) — a widely used metric to gauge the performance of REITs.

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