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Is Innovative Industrial Properties a Buy?

Innovative Industrial Properties (NYSE: IIPR) is an intriguing stock. The real estate investment trust (REIT) has a price-to-sales valuation of 23 and a price-to-earnings valuation of 60. That is far more expensive than the average 12 times earnings of its REIT peers.

Yet investors don't seem to care at all. Over the past year the stock is up a stunning 242%, far outpacing the S&P500's 69% return over the same period. Just what is behind the hype for such a seemingly overvalued stock?

Image source: Getty Images.

The nation's leading marijuana landlord

The answer is cannabis. Innovative Industrial owns 67 marijuana dispensaries across 17 states. The company has invested $1.42 billion into these properties. Last year its rental income amounted to $117 million, representing a massive increase over the $45 million it had in 2019. The average length of its leases was 17 years.

Stunningly, the company has leased 100% of its dispensaries and collected 100% of its rent due. Its tenants include many notable marijuana growers, like Cresco Labs (OTC: CRLBF), Trulieve (OTC: TCNNF), and Green Thumb Industries (OTC: GTBIF). What's more, the company accumulated very little leverage in accomplishing its spectacular results. Its debt-to-asset ratio stands at less than 10%. As icing on the cake, Innovative Industrial stock also posts an annual dividend yield of 2.3%.

The company is poised to benefit from a Wild West-esque marijuana market. Thirty-six U.S. states (plus Washington, D.C.) have already legalized medical cannabis, while another 15 have given the green light to recreational cannabis. In the past two years, the REIT has increased its net income by more than tenfold to $64.4 million.

The typical REIT has only grown earnings by 12% per year in the past five years, so one can see why Innovative Industrial stock is trading at such premiums. By simply sitting back and collecting rent, the company essentially frees itself from commodity-cycle fluctuations. In addition, it does not have to invest anything into materials and labor to actually grow any cannabis. That is why the company's net margin stands so high at 55%.

What's the verdict?

The exciting thing about Innovative Industrial is that it will remain the largest financing source for wannabe marijuana dispensaries in the nation for quite a while. Right now, banks cannot issue loans to cannabis companies, as the drug is still illegal under federal law. Since the Biden administration only supports decriminalization of the drug -- but not federal legalization -- this basically guarantees Innovative Industrial's monopoly status.

Each investment in a dispensary costs the company roughly $30 million, generating steady yields and a perfect rent collection rate. By 2025, the U.S. cannabis market could double to $41 billion from $20.1 billion today. For these reasons, I think Innovative Industrial is on a fierce path to growth, and would highly recommend marijuana investors add it to their watchlists.

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Zhiyuan Sun has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Cresco Labs Inc., Green Thumb Industries, and Innovative Industrial Properties. The Motley Fool has a disclosure policy.


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