Innovative Industrial Properties’ (NYSE: IIPR) stock has lost almost half of its value since hitting a 52-week high in October 2024. Wall Street is increasingly worried about the real estate investment trust’s (REIT’s) strategy. A large tenant default at the end of 2024 hasn’t helped. Although there are reasons to be worried, the default and its quick resolution may actually highlight one of the strengths of Innovative Industrial’s approach.
From a big-picture perspective, Innovative Industrial is an industrial landlord. It makes use of net leases, which require tenants to pay for most property-level operating costs and taxes. This isn’t unique in the REIT sector. What is unique about Innovative Industrial is its focus on the marijuana sector.
Because of the murky legal status of marijuana, with conflicts between state and federal regulations, many banks refuse to offer services to marijuana companies. Innovative Industrial has stepped into that void, providing financing to pot cultivators by purchasing their properties and leasing them back to the growers. The trick is that Innovative will also finance the highly specific upgrades needed to turn an industrial property into a grow house. In return, Innovative Industrial generally gets long lease terms with generous rental rates. The downside is that its tenants have hefty rent bills to cover, which isn’t ideal considering how many businesses in the pot market are struggling.
Marijuana has been a growing industry for a number of years. However, it hasn’t grown in the way that many of the early entrants had hoped. Competition has been fierce among the legal growers, and, at the same time, illegal marijuana sales have remained a material portion of the industry. As such, profits haven’t been quite as robust as expected.
It is still early in the industry’s development and growing pains are to be expected. That said, the company expects the legal U.S. cannabis market to reach $46 billion by 2028. That will make it larger than wine ($14 billion), beer ($37 billion), and spirits ($38 billion). So, there is plenty of potential for the industry as a whole. However, after an early land grab, individual players are likely to experience a shakeout. And that is what appears to be taking shape.
The latest example within Innovative Industrial’s portfolio is PharmaCann, the REIT’s biggest tenant. This grower occupies 11 properties and represents 17% of rent roll. This is a big hit, and investors are right to be worried. But it may not be as bad as it at first seems, a fact borne out by the fairly quick resolution of the default.
