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.