Is Innovative Industrial Properties’ 7.3% Dividend Yield Safe?

Innovative Industrial Properties (NYSE: IIPR) stock has been struggling mightily this year. Down 64%, it has done badly even for a marijuana stock — the Horizons Marijuana Life Sciences ETF‘s losses of 44% look modest by comparison. But the real estate investment trust (REIT) still pays its shareholders a generous quarterly dividend of $1.75 per share. At a share price of around $96, that means investors who buy now would be collecting a yield of 7.3%. That’s more than four times the 1.6% that the S&P 500 averages today.

Investing less than $14,000 into the stock would be enough to collect a dividend of $1,000 over the course of a year if the current rate holds up. But is this a safe dividend that investors can count on, or are you better off shopping around for other dividend stocks?

The company’s aggressive rate hikes haven’t left much of a buffer

Innovative Industrial Properties (IIP) has been an attractive dividend stock to own in the past because the company has been incredibly aggressive with respect to growing its payouts. The $1.75 quarterly payment it makes today is seven times the $0.25 that IIP was paying its shareholders back in July 2018.

The reason that strategy has worked thus far is because the dividend has soared along with the company’s top and bottom lines:

IIPR FFO Per Share (Quarterly) data by YCharts

And so while IIP’s dividend growth has been rapid, it has been sustainable as long as the company has been able to continue expanding its business. But as you’ll note from the bottom chart, that means that dividend payments per share have reflected a high percentage of its funds from operations per share (which is standard for REITs). That means there’s not much breathing room should IIP struggle. It could, of course, raise money through offerings, but that’s not a sustainable way to pay the dividend.

Recent tenant default raises questions about the company’s stability

Up until recently, it has been a relatively smooth ride for IIP as the company has been adding to its list of properties as more states have legalized marijuana. In the process, its profits have grown and the company has raised its dividend payments. It has been a win-win scenario for the company and its shareholders.

However, last month, the company noted that one of its key tenants defaulted on its monthly payment. To make matters worse, it was one of the tenants that a short-seller had warned investors about. That doesn’t mean the whole short-seller report is correct or that the business is in trouble. But it does show a crack in IIP’s business, and it does raise questions about how strong its tenants are, particularly the ones that aren’t publicly traded and that investors can’t readily obtain financials on. The company said it would be looking at re-leasing the impacted properties. Last year, the tenant in question, Kings Garden, accounted for 8% of IIP’s total rental revenue and was one of its top five tenants.

The REIT has a big job on its hands to address the issue and ensure that its financials remain sound.

Can investors rely on the dividend?

Anytime there’s news of a default involving a REIT and one of its major tenants, that’s cause for concern for investors. That’s no exception here, especially with IIP focused on a cannabis industry where many businesses are struggling to make money and often rely on share issues to fund their growth. Whether the current yield is safe depends on the actions management takes from here on out (i.e., if they can find another tenant to replace Kings Garden or prove to investors that they’re still a safe tenant, which would be difficult to do after a default).

I could see the company stopping its aggressive rate hikes if the situation doesn’t improve. And at worst, it may cut the payout. Although, given the high rate that it’s at today, investors could still collect a high yield even after a reduction. If you have a high-risk tolerance, Innovative Industrial Properties may be worth hanging on to and taking a contrarian stance on. But if you’re risk-averse, this isn’t a stock I’d suggest owning, as this year could get even tougher for marijuana companies with inflation still being a big problem for the economy.

David Jagielski has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Innovative Industrial Properties. The Motley Fool has a disclosure policy.

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