Could Cannabis Legalization Harm Innovative Industrial Properties Stock?

When it comes to real estate investment trusts (REITs) in the cannabis industry, Innovative Industrial Properties (IIPR) is the first among equals. IIP holds 76 marijuana-cultivation properties, and I like to joke that it’s the industry’s landlord. It’s also one of my…

highest-conviction stocks.

The prospect of marijuana legalization has profound impacts for every player in the business, and IIP is no exception. I’ve spoken with a few of the stock’s skeptics, and their refrain is always the same: Things are great right now, but legalization will wipe it out, so don’t touch it. As a shareholder, I don’t believe that this argument is true — but let’s break the issue down into bite-sized pieces to analyze it.

The bears might have a point

To appreciate how legalization might impact Innovative Industrial’s stock, it’s necessary to understand why it’s so successful under the current legal scheme. One of the persistent problems for cannabis companies in the U.S. is that it’s hard to raise money to expand, as major financial institutions are leery of the legality of working with the industry.

That’s why IIP is a lifesaver for those businesses. In case you aren’t familiar, Innovative Industrial’s business model is to run sale-leaseback transactions that result in cannabis companies getting liquid capital.

For the uninitiated, sale-leasebacks are a type of real estate deal in which a company with working property sells it to a buyer like Innovative Industrial, which then promptly rents it right back to the seller. Leasebacks are a win-win because the cannabis business gets cash up front without any disruption to their production floor, and IIP gets another piece of property in its portfolio, as well as a trickle of rental income. Thanks to its steady drumbeat of signing new leasebacks, IIP has grown its quarterly revenue by more than 1,000% over the last three years and expanded its dividend by 328.6%.

If the law eventually changes such that cannabis companies can get access to financing through traditional institutions like investment banks, they won’t need to raise funds by doing sale-leaseback transactions with IIP. Though the option will remain on the table, it’ll probably be easier to take on debt, which doesn’t entail sacrificing ownership of property.

In theory, that means IIP won’t be able to expand its holdings as rapidly as it has in the past. But that doesn’t spell disaster whatsoever, nor is it a guaranteed outcome.

Legalization could just as easily open the door to new customers

The thing about raising money as a business is that it’s extremely helpful to have more than one source of financing.

For example, many companies issue new shares of stock and then also take out debt to generate even more capital. The fact that they can issue stock doesn’t preclude taking out debt, or vice versa. Nonetheless, if a company’s stock is already diluted or its shares aren’t priced at an appealing level, that avenue might be off-limits. Likewise, eventually, a debt load can grow so large as to scare off new creditors.

In a nutshell, it’s highly unlikely for IIP to be without any new leaseback targets, even if marijuana is fully legalized. And if it needs to find a niche by working with indebted or highly diluted cannabis growers, there will still be an audience for its services.

Then there’s the prospect of the cannabis industry exploding nationwide when the legal floodgates are finally opened. In such a gold rush-like environment, it’s entirely possible that more companies than ever would be clamoring for funding from IIP to fuel their new operations. While some of these players would doubtlessly be poached by banks, it’s very hard to believe that…


Continue reading at THE MOTLEY FOOL