Why the Bad News of Innovative Industrial Properties Doesn’t Matter

Sometimes the market goes a bit too far when bad news hits, creating a profit opportunity for investors who see beyond the noise. On that note, shares of the cannabis cultivation real estate investment trust (REIT) Innovative industrial properties (IIPR 4.96%) collapsed more than 14.1% Friday at 2:24 p.m. ET after filing a document with the Securities and Exchange Commission (SEC) late July 13 outlining the default of one of its tenants, Kings Garden.

The company probably won’t get much compensation for its delinquent tenant, but the news is not a death knell for IIP. Let’s take a closer look at what happened and put it into context so you can decide whether or not to take advantage of the freshly discounted stock price.

The default won’t change much

Kings Garden leases grow space to IIP at six different locations and, according to the SEC filing, for the month of July, it missed $2.2 million in rent and property management fees. If we assume that the tenant is responsible for that $2.2 million each month, that equates to an annual sum of $26.4 million.

But IIP’s revenue over the past 12 months is more than $226.1 million. This means the tenant was worth just over 11.6% of the REIT’s revenue. Pointing to some accounting adjustments for expiring rent payment phases, management says it was worth an even smaller share, at 8% of the company’s stabilized revenue. It is therefore true that the defect will cause tangible damage to the top line for a while, but it is not as bad as it seems at first glance.

And it’s also true that nothing prevents the company from finding another tenant and renting the space to them, which they may already be doing. The only questions are whether he will be able to find another tenant willing to pay exactly as much as Kings Garden, and how long it will take to do so. Either way, IIP still retains full control of the space, and with the cannabis industry expected to expand over time, its facilities won’t sit idle forever.

Additionally, IIP’s quarterly revenue is up 50.4% year-over-year since its last earnings report, so the company is growing rapidly. It is also very profitable and its funds from operations (FFO) over the last 12 months have jumped 665.2% over the past three years. A tenant in default is a roadblock that is fully expected over a long enough period, not an existential crisis. It probably won’t even affect the company’s revenue much after a few quarters.

What is the next step ?

Regardless of the situation with Kings Garden, Innovative Industrial continues to expand its roster of tenants and make enhancements to its holdings so they command higher rental prices in the future beyond annual rent increases. which it includes in its leases. IIP will release its results during the week of August 2, and investors should expect to hear a bit more about how management is handling the Kings Garden default. In particular, be on the lookout for planned revisions to its underwriting and monitoring guidelines, which determine the terms it offers to its sale-leaseback targets and therefore to its future tenants.

Finally, don’t be too surprised if management chooses to tone down its expectations of generating $258 million in revenue in fiscal 2022. As such, there are likely a few more chops on the way for shareholders as the market digests news of the default. But the company’s long-term prospects are stronger than ever, so it’s probably not a good idea to sell your shares. In fact, now might be a good time to grab a few more.

Alex Carchidi holds positions in Innovative Industrial Properties. The Motley Fool fills positions and recommends innovative industrial properties. The Motley Fool has a disclosure policy.