Innovative Industrial Properties (NYSE:IIPR) stock is one of the most interesting marijuana stocks out there right now.
Innovative Industrial has a totally unique business model compared to most other cannabis companies. Thus, IIPR stock trades off different fundamental factors than its other industry peers. This makes Innovative Industrial an intriguing way to diversify or hedge one’s cannabis portfolio.
At the core of it, Innovative Industrial is different because it’s the largest real estate investment trust serving the marijuana space. Innovative Industrial owns land and greenhouses for marijuana cultivation. It, in turn, rents these facilities out to cannabis-growing operators.
In this way, Innovative Industrial doesn’t have the same risk that a cannabis producer has; it is just collecting the rent regardless of how the retail marijuana market is looking.
However, Innovative Industrial faces a different risk of its own. Its business model is built on something of a legal ambiguity, and future changes in marijuana legislation could render the business far less valuable.
Innovative Industrial’s Golden Opportunity
Innovative Industrial is one of the most unique companies in both the REIT and cannabis spaces. The company’s management team brilliantly saw a gap in the market and seized it.
Specifically, American cannabis companies have struggled to obtain financing. Most U.S. banks won’t deal with cannabis companies because the drug is illegal on a federal level. Doing business with a cannabis company, thus, would put the banks at risk of breaking the law as banks aren’t allowed to finance potentially prohibited activity. Furthermore, the major stock exchanges have avoided listing U.S. cannabis companies for similar reasons.
As a result, U.S. cannabis companies have had to pay a high price for access to capital. Innovative Industrial stepped into the breach with a clever solution. Innovative Industrial could raise capital on attractive terms. And it isn’t directly engaging in any legally questionable activity. After all, it merely owns land and greenhouses, it isn’t actively cultivating marijuana itself. Meanwhile, it can rent out those production facilities to cannabis growers at a high profit margin, thus capturing an attractive spread versus its own cost of capital.
Normally, banks would compete away this excess profit. But due to the legal issues, competition has largely stayed out of the arena. This has allowed IIPR stock to be one of the biggest winners in the cannabis industry so far. Shares are up from $20 a few years ago to $170, and IIPR stock has paid a generous dividend along the way as well.
First Risk: Marijuana Legalization
The good times probably won’t last forever, however. The most obvious risk to Innovative Industrial’s business model is potential federal legalization of marijuana. The thing that’s made IIPR stock special is that the company can effectively lend to cannabis companies.
Innovative Industrial secures capital from investors, buys greenhouses, and rents them out to cannabis-growing operations. In effect, it’s serving as a high-interest loan to the cannabis farmer, as it is charging seemingly above market rates for the leases. However, this offer is still much more attractive to a cannabis company than having to secure up-front financing on its own.
All that would change, however, if marijuana is legal. In that case, traditional banks could lend directly to cannabis growers. Innovative Industrial almost certainly couldn’t generate double-digit annual returns on its properties in a world where cannabis farmers could borrow money directly from normal financial institutions at low interest rates. Innovative Industrial’s big value-add is that it has created a unique conduit to help an under-banked portion of the economy get access to capital.
Second Risk: The SAFE Banking Act
Even if federal legalization efforts remain stalled, there is one more risk to consider. Congress is working on a bill that would protect banks that lend to marijuana companies in individual states where cannabis is legal. The House of Representatives approved similar legislation during the last Congress. However, it stalled out in the Republican-controlled Senate.
Now, however, the Democrats have the Senate and presidency as well and the House is trying to advance the bill again. So, in theory, this time, the SAFE Banking Act could actually become law.
However, with the Democrats having only a razor-thin majority in the Senate, there’s still a chance the SAFE Banking Act gets bogged down once again. If it becomes law, however, cannabis companies could borrow from banks directly, greatly reducing the need to rely on third-party intermediaries such as Innovative Industrial Properties.
IIPR Stock Verdict
If you share my view that the Biden administration isn’t in a rush to decriminalize marijuana on a federal level, there’s a lot to like about IIPR stock for now. Due to the legal uncertainty around lending to American marijuana companies, Innovative Industrial is making huge profit margins on its investments.
Someday that gravy train is going to end. It seems unlikely that marijuana will remain in legal limbo forever. That said, there may be no change in marijuana’s legal status federally for the next few years.
In that case, IIPR stock has more room to grow. Just be watching legal developments closely. If marijuana is legalized or other stopgap measures such as the SAFE Banking Act are passed, it’d likely put an end to the company’s unusually high levels of profitability.
On the date of publication, Ian Bezek did not have (either directly or indirectly) any positions in the securities mentioned in this article.
Ian Bezek has written more than 1,000 articles for InvestorPlace.com and Seeking Alpha. He also worked as a Junior Analyst for Kerrisdale Capital, a $300 million New York City-based hedge fund. You can reach him on Twitter at @irbezek.