Today I’m doing something a little different — this ad from The Wealth Advisory about “The Only Pot Stock I Will Ever Own” has been getting a lot of attention from readers and driven a lot of questions our way, so here I’m re-posting for all readers a Friday File piece that I wrote about this one when I first saw the ad a little over a month ago.
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This stock has been in my portfolio since January, and I have not adjusted my position since the below was written…
–from the 7/20/18 Friday File–
The Wealth Advisory is pitching “The Only Pot Stock I Will Ever Own” … and since that newsletter has been touting various REITs for quite some time, including CoreSite (COR), a stock I’ve owned for years and wrote about a few times when they were pitching it as a way to profit from Netflix and other tech giants, it probably won’t surprise you to learn that they’re again pitching a REIT to play a growth sector… and it’s again a stock I’ve also been buying, Innovative Industrial Properties (IIPR).
So I’ve gone and let the cat out of the bag there, but here’s a bit of the ad to give you a taste:
“5 Reasons This is the Profit Opportunity of the Decade
- It’s the Fastest-Growing Industry on the Planet
- It’s the Biggest Untapped Market in the World
- It Has No Competition
… there is not a single other stock exclusively dealing in cannabis real estate.
This company already provides more than half a million square feet of real estate to cannabis companies around the country, and that is steadily growing.
- It Has First-Mover Advantage
- Real Estate ALWAYS Pays
“At this point, we know pot companies will make us money.
“But there are so many ways to play it, it’s hard to say which avenue will yield the greatest profits.
“But if there is one thing I’ve learned from Briton in the last decade, it’s that real estate ALWAYS pays.”
So that’s their basic argument for this “only pot stock I will ever own” — and it’s similar to past newsletters who have touted this stock, calling it the “safest pot stock” and a way for the wimpy to play this scary sector.
Which I won’t argue too much about, though it’s still a small company, still could easily face lots of competition, and is reliant for its high-profit niche on a somewhat uneasy balance between marijuana being semi-legal and fast-growing.
If marijuana were a legal business at the federal level, marijuana growers would be able to borrow cheap from banks just like everyone else, and they wouldn’t have to make deals with folks like IIPR that include above-market rents and high returns… and if other folks come into this business because risk goes down, competition could absolutely eat into those returns as marijuana growers scale up.
I don’t know what value their “first mover” status will have in the future, but they are not doing anything unique or proprietary that other REITs couldn’t eventually mimic, and there are lots of competing companies pursuing similar “alternative financing” models for marijuana companies — including lots of unlisted privately-backed pools of capital — so we shouldn’t assume that IIPR gets to automatically “win” in the end… though they’re doing quite well so far.
Here’s some background on the company, and my current thinking on IIPR, for those who are curious…
Innovative Industrial Properties (IIPR) is a REIT that does financing deals and sale/leaseback transactions with medical marijuana growers in states where medical marijuana is legal.
They effectively pay above-market prices for the properties owned or being developed by these companies, building in enough cash in the deal to get those properties expanded or otherwise finance the operation, and in return they get a very high rent. The bargain is essentially based on the fact that marijuana companies have very little access to traditional bank or debt financing, so real estate-based financing is one of the more appealing ways to get expansion capital without issuing shares and diluting shareholders — and since it’s a risky business without a lot of capital suppliers, and with projections for appealing economics for early license-holders in medical marijuana, IIPR can demand a pretty strong return.
Real estate companies use the term “cap rate” to describe the cash return on properties — it’s basically a simplified annual cash flow return, and an industrial property might earn a “cap rate” of 6-7% or so, while a prime office building that people are bidding up to crazy prices might have a cap rate of only 4% or less during hot times, the numbers vary widely. IIPR is making deals with marijuana growers that have 15% cap rates, in addition to other fees, and that’s extraordinary.
These are also triple-net leases, which means the tenants are responsible for taxes, insurance and maintenance, so if IIPR buys a grow facility for $10 million, they get $1.5 million back in rent per year (keeping in mind that if it weren’t a marijuana grow facility, that property might only be worth $5 million… which is just a wild estimate on my part , one I use to keep some perspective).
That means after six or seven years, IIPR has had all of its capital returned and still owns the building, without a mortgage or any other carrying costs to speak of beyond normal depreciation, and these leases tend to go for 15-20 years, with annual rent increases. Most REITs load up with debt to make their returns better, either mortgages or unsecured debt, but IIPR hasn’t had access to the debt markets at good prices yet so these are also almost entirely unlevered returns — if they are able to access the debt markets in a few years as laws or regulations adjust, the returns could look even better for shareholders.
So that’s why I own the stock — lots of potential upside as they have the ability, within a couple years, to pretty dramatically increase the size of the dividend (it’s $1 a year right now, so almost exactly a 3% yield), in what I’m hoping could be a repeat of the success that CoreSite had in the very different data center business (CoreSite also started out with very low leverage, and had high and rising returns as their centers were built out, which enabled massive dividend increases that were partly fueled, particularly in recent years, by adding debt to the balance sheet). Small growth REITs in niche sectors can really explode if they catch a wave.
It’s also why I bought the preferred shares a while back, since those are effectively the senior debt (there is no other borrowing), which means they get first call on the assets — and since IIPR has a lot of cash and properties, arguably worth more than 5-10X the value of the preferred shares even if things turn ugly, they are pretty much as guaranteed as you can get outside of the debt markets.
There is a real calculus to deciding how much the preferreds should be worth, though, because the company can call those preferreds back in October, 2022 for $25 per share. So at $28.75, the preferreds actually have an annual yield of less than 5% to the call date. That’s perhaps not terrible for a really secure preferred yield, but it’s also not good enough for me anymore now that I’ve gotten a couple of the preferred dividends and the preferred share price has bumped up to this level… so this week I sold my preferreds and bought a bit more of the common stock, which means that IIPR is growing to become a meaningful player in my portfolio, with about a 1.5% allocation now.
If you value safety over long-term gains, as is perfectly reasonable if your situation is different than mine, your calculus might well be different — the effective cash yield on those preferreds is 8% now, if you ignore the fact that they can get bought back at $25 in four years, and that’s not without its appeal… and a 5% “guaranteed” return is also nothing to sneeze at. Just don’t expect the preferreds to rise much above this level, there shouldn’t be any assumption that the total return from this point will be much more than $6 per preferred share between now and the call date (~$9 in dividends between now and then, then shares should be redeemed at $25 if the company has the capital to do that at the time, so you effectively give back $3-4).
If the preferreds drop in price, especially if they trade below $25 at some point because of some kind of panic, it would be worth taking a much closer look again — having preferred shares of a company that has real assets and no debt is generally very comforting. The upside is limited and impacted by interest rates, as with pretty much all preferreds, but the downside of the preferreds should be limited to 10% or so… while the downside on the common is more likely to be at least 50% in the worst case scenario (where marijuana is fully recriminalized, their tenants go bankrupt, and they have to find other tenants for their properties — those properties are not worth nearly as much as IIPR paid if they’re used for non-marijuana businesses).
So yes, I have trouble with the economics of most of the marijuana companies… but as long as IIPR can keep threading that needle between “illegal” and “mainstream” by doing sale-leaseback deals with the safer end of the business (medical marijuana growers), they could book a lot of profit. Hopefully the uncertainty about marijuana continues at the federal level for long enough to give IIPR the chance to build a much larger portfolio of high-profit properties, because absent that regulatory uncertainty their little niche will probably become a lot more competitive and cut into their returns… but I like what I see so far.
Back to late August here…
The stock has surged again recently, whether because of this resurgent push from The Wealth Advisory or other newsletters, or just because marijuana stocks have had a bit of a comeback in recent weeks, so it’s again above my “buy below” price of $35… don’t know if it will get back down to that level or not, but given the volatility in the markets it seems pretty likely.
Any other favorite marijuana or REIT stocks you’d prefer to discuss? Have an opinion about IIPR or its competitors, or about Briton Ryle and The Wealth Advisory? Let us know with a comment below… thanks for reading!