Revolutionary Industrial Properties (NYSE:IIPR) stays a compelling funding on the expansion of the hashish trade. As a hashish actual property funding belief (‘REIT’), IIPR doesn’t immediately promote or course of the plant, but it surely earns high-quality rental earnings from its tenants. As hashish operators throughout the nation cope with worth compression amidst a troublesome macro backdrop, IIPR has seen some tenants default on their lease obligations. But with the inventory buying and selling under 2019 ranges, a lot of that pessimism has already been priced in. I anticipate IIPR to proceed providing above-sector progress charges and finally earn again a premium valuation a number of.
IIPR Inventory Value
Hashish shares had been all the fad in 2021, however your entire hashish sector has undergone a vicious crash as margins deteriorated and valuations had been reset. Being increased on the capital stack has not insulated IIPR from the ache, because the inventory is down 70% from highs.
I final coated IIPR in December the place I rated the inventory a purchase on account of the engaging 7% dividend yield and low valuation even underneath pessimistic assumptions. The inventory is down 25% since then, as extra troubled tenants have emerged. Whereas it might take a while to work via close to time period headwinds, IIPR stays a gorgeous progress story for the long run.
IIPR Inventory Key Metrics
IIPR owns 110 properties unfold throughout 19 states. The overwhelming majority of those properties are cultivation services and 85% of its tenant base function in multiple state. IIPR is arguably probably the most well-known hashish REIT within the nation and has been a vital supplier of capital for the hashish trade.
As a result of hashish has been and stays unlawful on the federal degree, hashish operators have very restricted entry to capital. This permits IIPR to earn above-market returns on its investments. For reference, whereas Realty Earnings (O) would possibly earn round a 6% cap fee with 1% annual lease escalators on its internet lease property, IIPR however earns a 13% cap fee with 3% annual lease escalators on its hashish property. That has big implications for each inner and exterior progress potential.
These engaging lease phrases plus excessive urge for food for actual property capital has helped IIPR ship unimaginable progress, with its dividend per share rising at a 40% CAGR over the previous 5 years.
But as seen above, the upper funding yields will not be with out threat, as lease assortment has lastly dipped under 100% in 2022. The newest quarter noticed IIPR ship $2.12 in AFFO per share, representing 14.6% YOY progress, however traders have justifiably targeted as a substitute on the rising checklist of troubled tenants. King’s Backyard was the troubled tenant of the prior quarters however administration has disclosed that the tenant was now paying lease and is within the technique of promoting off a few of its properties. It isn’t clear if King’s Backyard is paying its lease in full or if there was some markdown in lease.
However as the problems at King’s Backyard are kind of resolved, new tenant points have emerged. Hire assortment was 94% for the fourth quarter however dipped to 92% for the month of February. On the convention name, administration famous that it had utilized $413,000 in safety deposits in the direction of lease from tenant Holistic for its California and Michigan properties. Tenant Inexperienced Peak has defaulted on a property in Michigan and tenant Parallel has defaulted on a property in Pennsylvania, however IIPR has not but utilized these safety deposits. Administration famous that typically taking that safety deposit can get in the best way of the authorized course of however emphasised that it might and would take the safety deposit when it made sense to take action. Parallel additionally has defaulted on a property in development in Texas, of which IIPR has already funded $8.2 million of the $27.4 million unique dedication. An fascinating level concerning these two tenants is that whereas they’ve defaulted on these two properties, they’re present on lease on their leased properties in different states. IIPR had not added “cross-default” provisions on these leases, making it potential for these tenants to default on choose properties whereas nonetheless working different properties. Administration famous that simply round 38% of its revenues had been topic to cross-default provisions. Administration said that the authorized course of to resolve these circumstances could take so long as 2 years.
It isn’t all bearish. IIPR ended the quarter with simply $295 million in debt, representing a debt to EBITDA ratio of simply over 1x, far decrease than the everyday 5.5x to six.0x leverage ratio sometimes employed within the NNN REIT sector. For the total 2022 12 months, IIPR invested $394 million throughout 9 properties and 12 go away amendments. These included lease amendments with tenants Ascend Wellness, PharmaCann, and Goodness Development to fund their enlargement initiatives in New York forward of the adult-use rollout. IIPR famous that it had added cross-default provisions on all leases for these 3 tenants.
Wanting forward, administration declined to difficulty steering concerning its acquisition pipeline, citing entry to capital as being the principle roadblock. Whereas IIPR’s stability sheet stays under-leveraged relative to friends, lenders is probably not so keen to increase extra capital given the pricing pressures seen within the trade. In the meantime, the inventory is buying and selling at low fairness valuations, making its fairness a dearer foreign money than prior to now (although arguably nonetheless a potential supply of capital).
Is IIPR Inventory A Purchase, Promote, or Maintain?
At latest costs, IIPR was buying and selling at solely 9.4x ahead AFFO. Between the three% annual lease escalators and excessive acquisition cap charges, I view consensus estimates for ahead progress to be too conservative.
In the meantime, IIPR is buying and selling at its highest dividend yield it has ever traded because it got here public in 2016.
As a result of excessive margin profile of the enterprise, reductions in income wouldn’t result in considerably higher drops in money move. IIPR had a 92% lease assortment fee in February. If we assume that IIPR will get no restoration on these defaulted leases and sees even higher losses at 15% in complete revenues misplaced, then AFFO would drop by a most of 17.8%. IIPR can be incomes $1.74 in AFFO per share. The corporate would possible have to cut back its $1.80 per share dividend payout, however the inventory can be buying and selling at simply 10.7x AFFO. That’s considerably decrease than the 15.2x FFO a number of at Realty Earnings. But IIPR provides superior progress potential than O, and thus deserves to commerce at a premium a number of. IIPR advantages from being agnostic to hashish legalization. The longer it takes for legalization to happen, the longer IIPR advantages from above-market financing phrases. Upon legalization, the credit score profile of its tenants improves, with the related a number of enlargement being greater than sufficient to offset any eventual reductions in lease (I be aware that IIPR maintains a 15.3 weighted common lease time period). I’m uncertain that IIPR will see 15% reductions in lease with none restoration, however the inventory appears low-cost even when that situation happens. I might see IIPR buying and selling at 15x ahead AFFO, representing a inventory worth of $120 per share – however be aware that there’s a big selection of truthful worth for the inventory contemplating the excessive progress potential and nagging notion of threat.
What are the important thing dangers? Probably the most vital threat is the long run viability of the US hashish enterprise mannequin. Normalization (broader acceptance of hashish) is taking longer than anticipated, as our legislators have taken their time in passing regulatory reform. Because of this authorized operators are having to compete towards illicit operators in an artificially small market. As a passionate hashish person myself, I’m amazed by the good potential for the plant to handle a wide range of medical purposes equivalent to ache, insomnia, and anxiousness. But when the broader public will not be but conscious or snug with the plant, then demand for the plant stays low relative to the availability. I don’t anticipate pricing pressures to resolve themselves till normalization takes maintain. Because of this many operators could not survive till then, as many hashish operators have taken on an excessive amount of debt to fund overconfident ambitions. IIPR is more likely to face important close to time period volatility as it really works via the storm, and sentiment for hashish operators and IIPR could not enhance so shortly. Within the meantime, shareholders would take pleasure in having the ability to reinvest dividends at low valuations, however the catalyst for a number of enlargement may be elusive. I proceed to search out IIPR extremely buyable for these searching for a worthwhile title within the hashish investor that provides publicity to the long run progress potential of hashish whereas paying dividends alongside the best way. I be aware that Hashish Development Portfolio favourite NewLake Capital (OTCQX:NLCP) can also be a aggressive selection, with the next 12% dividend yield and higher cross-default safety.