The authority when it comes to analyzing the cannabis industry

Marijuana Real Estate: Innovative Industrial Properties (NYSE: IIPR) Profile

We think it may be helpful to examine how some successful businesses are targeting niche areas of the marijuana industry, and how that may shed light on the business conditions for our readers. So we’re profiling Innovative Industrial Properties today (or “IIPR,” its stock ticker). IIPR, which focuses on acquiring undervalued and distressed properties (mainly large buildings, 25,000 to 150,000 sq ft in size) and leasing them to growers of medical marijuana, was the first publicly listed cannabis real estate business and raised about $67 million of cash when it debuted late last year.

What few have pointed out is that IIPR is founded by Alan D. Gold, a 30-year veteran of the real estate industry who successfully sold his last real estate company  (founded 20 years ago) for almost $8 billion. His last business, Biomed Realty, shares some similarities to IIPR:  Biomed specializes in real estate for the medical/life science industry (think labs and offices) and grew from 30 properties to over 196 properties and nearly 19 million sq ft of rentable space under his able guidance. Such life science real estate, like cannabis grow facilities, has unique and specialized uses and is outside the scope of many commercial developers.

Fast forward to today, IIPR is operating with almost no competition in its niche area of acquiring real estate for cannabis use. Both its scale (transactions in the size of $5-$30 million as stated in its prospectus) and management depth have no equals in the marijuana industry. Banks are unlikely to finance real estate purchases and so far a few private buyers and private pools of capital have provided real estate financing, with growers needing precious capital to build out other portions of their operations.

IIPR bought its first property in late December  paying $30 million for three new buildings constructed by PharmaCann, the licensed medical marijuana dispensary with 4 locations in New York State.  PharmaCann in turn owes IIPR more than $5 million of rent per year. PharmaCann will use the $30 million proceeds to build out its growth operations in the sold properties, fund loses (like paying such rent), and for other business needs. IIPR in turn has about $2 million of overhead salary costs per year (Mr. Gold’s annual salary is a whopping $600k, based on its latest government filing), which doesn’t factor in dead deal costs or other costs associated with due diligence and acquiring properties.

While we like the IIPR and what it’s doing, there are a few issues with actually investing in the stock. First, there is 1 million shares reserved for incentivizing the management team. While those shares have not been distributed, that is in relation to a total of 3.35 million shares outstanding, so anyone who buys could be substantially diluted by the company (~25% reduction). Second, because there are limited cannabis properties of this size, and there are other firms looking to also purchase real estate (albeit without as much capital as IIPR), IIPR may find itself chomping away at an even smaller pool of properties which we estimate to be not more than $200-$300 million of annual transactions. As IIPR notes: “we will be competing to acquire real estate with persons who have no interest in the cannabis industry, but have identified value in a piece of real estate that we may be interested in acquiring.” Now there are quite a few posers in the industry, but some of the competition is very real and have been quite acquisitive over the past year (such as MJ Real Estate). Third, as IIPR finds more properties, it will need to issue more stock to raise funds to purchase its targeted properties. After the IPO, IIPR has about $35 million of cash and realistically can deploy about $30-$35 million this year. IIPR has a pipeline of almost $90 million worth of identified properties. While it is unlikely IIPR will be able to close on all its targets in its present pipeline, IIPR’s market capitalization is $60 million so raising even $15 million of equity to fund these acquisitions could be quite dilute shareholders. Typically real estate transactions are financed with a mixture of debt and equity (Biomed’s purchase price included about 40% of debt), but given it is difficult for marijuana real estate businesses to borrow from banks (and one of the key reasons companies like IIPR exist), IIPR will have to tap the equity markets. With low interest rates, equity is rather expensive.

And lastly, New York State has been a notoriously difficult place to conduct business for dispensaries (recreational use has not been approved yet). There are 849 practitioners available in New York State to recommend marijuana and only 13,389 patients have been certified as of early February, which translates to less than an average of 20 patients per practitioner. In other states this ratio is considerably higher by several multiples. The existing five medical dispensaries are not profitable, so there is a degree of customer risk. Medical-use cannabis sales in New York were around $33 million in 2016. Several other restrictions abound such as the ban on edibles, a conservative state legislature which may not be the most receptive to working with established (and law abiding) cannabis firms, and lack of familiarity with the medical marijuana system. For the reasons above, New York is not a state we particularly like, or recommend, for new entrepreneurs; the biggest obstacle is the shift in attitude required from its medical community/practitioners to open up the door for patients in need. Even in states such as Colorado surveys have found doctors are still hesitant in recommending marijuana. Naturally, some of the sick in New York who are in the addressable market for PharmaCann might move to neighboring states like Massachusetts with bigger programs.

As a result, a worst case scenario would be that IIPR gets stuck with a property that doesn’t generate rent and one that probably cannot be easily sold either.

Disclaimer: The opinions stated are Cannabis Analysts’ only. We do not hold any securities nor do we have any business relationship with the companies mentioned in this article and are not being paid by any party for the words stated herein.  

How to Start A Dispensary Series Part I: Capex and Equipment Costs

This is part of an ongoing series where we explore detailed costs for starting a dispensary, from the equipment costs you should expect to the financial metrics that go into the income statement.

We base this analysis on information we collect across a variety of business plans and dispensary applications as well as public information. Today, we explore capital expenses necessary for building a vertically integrated dispensary (with cultivation/processing), which will be more costly than having only a dispensary or only providing cultivation. Controlling your supply chain is important because you also control your quality and quantity, and states like California allow for such vertical integration. Leasing a bigger area may also be beneficial given the possibility for expansion. In terms of assumptions, this analysis assumes that the dispensary portion is roughly ~3,000 sq ft and the cultivation and processing area is roughly ~15,000 sq ft for a total of 18,000 sq ft (we have seen spaces ranging from as low as 3,000 sq ft to a monstrous 60,000 sq ft retail/growth/processing area). The estimates below are split out into three sections: A) Permits/Inspections and Business Incorporation: these are all the necessary legal and regulatory legwork you have to do, from getting proper permits/zoning in place as well as properly designing your facilities; B) Capex for Build-Out: includes start up costs related to new construction, renovations, installing security systems, and other space improvements; C) Equipment Costs: everything you need to grow, process and sell your product.

While the following items are estimates, they are based on actual figures coming from business plans and dispensary expenditure information.

A) Permits/Inspections and Business Incorporation

  • Proof of liquid funds in a bank account (varies based on state/application process)
  • Architectural design of cultivation/processing facility ($30k-$60k)
  • Building permit for build-out of facilities ($5k-$10k), mostly zoning and engineering related, and/or environmental survey (~$5k). Will need to survey and measure location perimeter to ensure building lots are beyond minimal clearances to schools/residences based on state laws
  • Public health review of architecture (for medical)
  • Security audit/inspection and design for site grounds, perimeters and facilities ($2k-$5k)
  • Legal incorporation of business ($15k-$50k); includes preparing governing documents, applications, operations manuals, employee handbooks, interfacing with zoning and engineering firms, preparing employment agreements and navigating banking relationships
  • Site clean-up and preparation if using existing facility ($0k-$30k;, this includes removing interior offices/walls, gutting, and preparing space for dispensary/cultivation
  • All in total of ~$65k-$180k. On average these pre-build-out planning associated costs have been in the $100k range (at minimum).

B) Capital Expenditures for Build-Out

  • Build-out of dispensary and cultivation/processing spaces ($150k-$400k). Includes all dispensary, cultivation, processing, vault and storage rooms. The large variation is due to how extensive, and intensive, the build-out will be and whether one is targeting a dispensary operation by itself or a vertically integrated business with growth and processing
  • Space improvements including finishing/painting, kitchen, office space, bathrooms, etc. ($50k-$225k)
  • Additional construction costs including painting and finishes ($50k-$375k)
  • Security system including multiple camera feeds and metal/weapons detectors ($50k-$120k)
  • Parking facility ($10k-$25k), include resurfacing and lighting of patient and staff parking areas
  • Guardhouse/gate facility and/or perimeter boundary fencing, if necessary ($50k-$95k)
  • Also potential upgrade cost the electricity usage requires an increase in the power supply from nearby substation. We have seen a handful of dispensaries budget such a cost and would require working with the local utility and an engineering firm
  • All in built-out cost of ~$360k-$1.1MM; on average, costs have come in around $450k-$775k from what we have seen

C) Equipment Costs

  • Delivery vehicles ($15k-$25k each) or $45k if using SUV
  • Cultivation and processing equipment including grow lights, CO2 generators ($10k each), trimming machine ($15k each), HVAC system (one of the largest equipment costs, ~$80k), control systems, irrigation, pots, nutrients and other supplies (total $120k-$200k). Non-safety upgrades, such as backup power capacity, fans, eye wash and cleaning station, and a reverse osmosis machine
  • Commercial kitchen, ventilation and extractors for processing cannabis or preparing infused products (total $100k-$250k). This includes stove tops/ovens and stainless steel countertops for processing sales and decarboxylation of cannabis flower beds (required pre-processing)
  • Computer equipment/tracking software, including $8k point-of-sale/inventory system with initial hardware for tracking plant, plant to weight, weight to inventory, sale to depleted inventory ratios (total $10k-$20k)
  • Furniture, flooring, safe, other misc. items (total $10k-$85k)
  • All in total of ~$255k-$585k with average equipment costs of around $500k. That said, some companies have chosen to lease this equipment (similar to taking out mortgage to buy a house) so you don’t pay the full amount in the case of buying.

As mentioned, these costs are associated with an 18,000 sq ft dispensary/cultivation and processing center, which is fairly sizable and probably bigger than what most entrepreneurs would want to start out with. And given the rough prices estimates, this might sound like an odd-against venture. But one may also not need the bells and whistles (such as a guardhouse) if one is only retail or plans to operate within a larger, protected space. Still the market is young, and having built out space to expand may end up proving highly beneficial.

Competitor Facing Strategies: Understanding Where You Stand

There are many attributes that go into planning a dispensary: ensuring product excellence, hiring the right people, increasing productivity, financial forecasts – but what about having the proper strategy to tackle your market? We don’t mean just any strategy, but a competitor-facing strategy to win market share. Your dispensary will be up against large, well-backed, deep-pocketed enterprises that are spending $2MM-$10MM to open retail and cultivation facilities (MMM in Massachusetts or this one in CT).There will most likely be several of these multi-million dollar dispensaries near yours. Some of your competitors will even have strong medical and political connections.

Just like with a strong army, a strong company can use its power to stay on top, with more resources devoted to developing products and keeping prices down. Playing the defensive position would also be insufficient as you stand vulnerable to being inundated by a much larger force, even if they are in a neighboring county.

You are in a creative industry that caters to the minds of medical patients and (eventually) consumers. There is no creativity in outspending your opponents; you need intelligence, imagination and nerve. Managers and entrepreneurs cannot become shortsighted, absorbed by finances and daily sales, while the competition thinks long term and stays focused on products. Here are a few thoughts you should keep in mind when formulating your strategy:

1) Determine Your Starting Point: A good strategy starts with an evaluation of the nature of the challenge, simplifying the complexity of reality, and identifying the most critical aspects of the current situation. Survey your competitors, the closest 3-4 dispensaries around you. Visit their stores. How large is their retail space? How many strains do they offer? What types of patients visit (gender, class, etc)? How inviting is the facade? How many pounds do you think they move each month? Is there room for them to expand? Local market intelligence is key– stay on top of changes– the more dynamic the situation the poorer your foresight will be. Visit dispensaries in another state and talk to their managers, if possible; learn about their experience.

2) Share Your Insights In A Blog: the industry is still young and thought leaders are needed; many tech startup founders have blogs that both explain and advertise their ideas and creations to the world. Running a business can be difficult and managing different strains tedious, but customers are now plugged in as ever to the web. It’s a white space out there, dictate the terms of the conversation and help fill it. Those with the knowledge but not the power to clearly express themselves might as well have no ideas.

3) Apple Store Appeal: remember how enticing and welcoming an Apple store is? Invest in cleanliness, sharp and able employees, and clear product display cases. Also, it may be unprofessional to let employees use marijuana on the job; think how you’d feel if all the Apple store employees were constantly texting on their iPhones.

We’ll return to the broader concept of strategy and marketing later on. Avoid fluff, muddled or sloppy thinking. Define the challenge to be addressed and don’t declare objectives while disregarding the means for achieving them. Any broader plan is determined by where you start, and many are unaware of just how much is going on in their current situations.