Despite the total return of its shares falling by 29% in the last 12 months, the analysts on Wall Street have high hopes for Innovative Industrial Properties (IIPR -0.17%), with their average forward price target of $109 implying an upside of about 50% before June 2024. But for that to happen, the cannabis landlord will need to weather the headwinds that are battering its industry, not to mention convince potential investors that its future will be better for shareholders than its past.
So is Wall Street's aggregate prediction a pipe dream, or is it a well-grounded projection? Let's work through some of the relevant details and find out.
What's going wrong
As a real estate investment trust (REIT) that rents space to cannabis companies so that they can cultivate their crops in dedicated facilities, Innovative Industrial is inextricably tied to the fortunes of the cannabis industry. Lately, those fortunes have been abysmal.
As marijuana prices remain depressed in North America due to an oversupply of legal cannabis, IIP's tenants have struggled to stay in business. In the first quarter, the company reported that it successfully collected 98% of its rents on time. But it also seized the security deposits for three of its properties where the tenants had defaulted on their rent.
Such defaults have been happening over the past year, and it's very likely that there will be more in the future, because that's the nature of being in business as a commercial landlord. But given that each announcement of defaults will be met with a sell-off of its stock, the grim conditions of the cannabis industry are doubtlessly going to be a big obstacle to Innovative reaching the price level specified by Wall Street.
Furthermore, cannabis legalization in the U.S. is probably not going to happen within the next 12 months, and even if it did, it's unclear exactly how positively the market would interpret legalization as being for IIP. Nor is there the possibility of a clear financial catalyst to spark a bull run; rental income is predictable, and investments in new properties only yield a trickle of new rents in any given period relative to their cost. So at first glance, Wall Street's estimates are improbable.
The stars are starting to align for a rally
Regardless of the above, there are still two paths for Innovative Industrial's stock to rise.
First, the SAFE Banking Act, which would ease the marijuana industry's access to institutional sources of capital, is being considered by the U.S. Congress once again. Senate Majority Leader Chuck Schumer said informally on June 21 that he believes that the bill will pass before the recess in early July. If it passes, the effect on Innovative Industrial could be significant, and positive.
While easier access to financing from big national banks would technically give potential tenants fewer reasons to consider accepting IIP's sale-leasebacks to raise capital in exchange for their real estate, it would generally be seen as a boon for the marijuana industry, which could ultimately lead to more opportunities.
The other path for the stock to take off involves its low valuation and its steady growth in a relatively pessimistic and difficult operating environment. Over the past three years, the more recent two of which saw the cannabis industry in dire straits, the company's quarterly funds from operations (FFO) -- an important metric of REIT performance -- rose by an impressive 188%, totaling $57.8 million. In the same period, its dividend grew by nearly 70%.
Regarding its valuation, its price-to-funds from operations (P/FFO) ratio is 9.3, which is dramatically lower than the average P/FFO of U.S. REITs, at 17.7. In other words, compared to similar businesses, Innovative Industrial is starting to look cheap, and it's fully possible that the market will eventually notice the discrepancy and bid up its shares.
If the SAFE Banking Act doesn't pass, it will be tough for this stock to rise by as much as the analysts are calling for, even with good earnings and inexpensive shares. But if the legislation passes, Wall Street will likely be proven right, and the price target might even be exceeded. So it looks like the analysts might not be too far off the mark, even if there's not much to offer in terms of guarantees that things will play out like they're hoping.
