Q3 2024 Innovative Industrial Properties Inc Earnings Call
Good day, and welcome to the Innovative Industrial Properties 3rd Quarter 2024 Earnings Call. All participants will be in listen-only mode. Should you need assistance, please signal a conference specialist by pressing the star key, followed by zero.
After today's presentation, there will be an opportunity to ask questions.
Speaker Change: To ask a question, you may press star, then 1 on your telephone keypad. To withdraw your question, please press star, then 2. Please note, this event is being recorded. I would now like to turn the conference over to Brian Wolfe, General Counsel. Please go ahead.
Speaker Change: and Ken Kueh, which identify important risk factors that could cause actual results to differ from those contained in the forward-looking statements. We are not obligated to publicly update or revise any forward-looking statements, whether as a result of new information, future events, or otherwise. In addition, on today's call, we will discuss certain non-GAAP financial information such as FFO, normalized FFO, and adjusted FFO. You can find this information, together with reconciliations to the most directly comparable GAAP financial measure in our earnings release issued yesterday, as well as in our 8K filed with the SEC. I will now hand the call over to Alan.
Alan?
Alan: Thank you, Brian, and thanks to all of you for joining us this morning on our third quarter 2024 earnings call. We had a solid third quarter where we generated 76.5 million in total revenues and $2.25 in AFFO per share. In light of the crosswinds that the regulated cannabis industry has been experiencing for a number of years now, which we have discussed in detail in past quarters, we are pleased overall with how our tenants and portfolio have performed. As noted on prior calls, we achieved these results without the full impact of the rents for new leases that we executed in 2023 and year to date.
Speaker Change: David will provide more detail as well on our financial results for the quarter
and Capital Position.
Speaker Change: From a regulatory perspective, there's a fair amount to talk about as we digest the results of the most recent election cycle and additional state program developments, in addition to the continued progress on potential rescheduling of cannabis from Schedule I to Schedule III. I will now turn the call over to Paul to discuss our thoughts on election results, regulatory developments, and market dynamics. Paul?
Paul: Thanks, Alan. First off, with regard to the presidential and congressional election results, we would note that this is the first election cycle in U.S. history where both presidential candidates have supported cannabis reform.
Speaker Change: While tentative results of the presidential election indicate that Donald Trump has received the necessary electoral votes, as well as a Republican Senate and a House that is skewing Republican,
Speaker Change: We note, of course, the continuing strong and growing bipartisan support for cannabis reform at the federal level and remain optimistic on that front.
Speaker Change: Resumed, President-elect Trump's recent remarks in September on federal cannabis reform are also encouraging.
Speaker Change: with a focus on safe banking for state-authorized companies and supporting states' rights for passing and operating regulated cannabis programs.
Speaker Change: That said, the path forward on meaningful cannabis reform at the federal level does narrow, in our view, in the near term, assuming the current expected results hold.
Speaker Change: Looking at state voting results, four states had cannabis legalization matters on their ballots in this election cycle, including adult use programs for Florida, South Dakota, and North Dakota, and medical use for Nebraska.
Speaker Change: It failed to receive the requisite 60% voter support to legalize adult use cannabis, despite the previous support from Donald Trump. Both North Dakota and South Dakota also failed to pass their adult use cannabis referendums. Finally, Nebraska voters approved the adoption of a medical use cannabis program with more than two-thirds support.
Speaker Change: reflecting again the large majority support for medical cannabis shown in polls of Nebraska residents. Assuming the ongoing legal challenges regarding signature for ballot access are rejected, Nebraska will join the overwhelming majority of states that have adopted a medical use cannabis program.
Speaker Change: Regarding the DEA's progress on rescheduling cannabis from Schedule 1 to Schedule 3, we will of course be closely watching the administrative hearing on the matter, which was recently postponed from December 2nd to a date likely in early 2025.
Speaker Change: Visibility on rescheduling continues to be murky, factoring in the administrative hearing and the tens of thousands of comments received from the public.
Speaker Change: Nonetheless, we remain cautiously optimistic that rescheduling will continue to make forward progress.
Speaker Change: Looking to the general market dynamics, while we continue to see positive incremental steps.
toward additional state programs coming online.
Speaker Change: and more efforts to combat illicit markets, we do see continued financial pressure on licensed cannabis markets having to compete with the untaxed, unregulated, and historically unchecked illicit market, especially since inflationary pressures have made consumers all the more cost-conscious.
Speaker Change: To give a sense of the magnitude of the illicit market in certain states, while difficult to measure, it is estimated that the California illicit market alone is a $10 billion industry. And while California authorities recently announced the seizures, or eradication of over $500 million of illicit cannabis year-to-date, that amounts to a mere 5% of the total estimated size of the illicit market. That said, we are seeing some progress in certain states and localities that have shifted priorities to more meaningful enforcement against illicit operators. In New York, for example, pursuant to legislation passed last year that increased civil and tax penalties for unlicensed sales of cannabis,
Speaker Change: and provided additional enforcement power to authorities, New York has seen a significant uptick.
Speaker Change: monitoring execution of refinancing plans for a number of MSOs that have debt maturities in the coming few years, with the bulk of those maturities coming in 2026.
Speaker Change: I'd like to now turn the call over to Ben to discuss our investment and leasing activity in Q3 and year-to-date. Ben? Thanks, Paul.
Ben: As we've noted on prior calls this year, we've made good progress in our execution on both new investment opportunities, as well as the releasing of our vacant assets.
Ben: Year-to-date, we have re-tenanted four properties covering $69 million in invested capital and selectively closed on new investments of just over $70 million.
Speaker Change: As we noted in our press release yesterday, we closed on a $5.6 million acquisition in Maryland of a cannabis processing facility and executed a long-term lease with MCP, one of our existing tenant partners.
Speaker Change: We continue to track an active pipeline across markets, evaluating opportunities, and look forward to executing on new investments on a very selective, disciplined basis.
Speaker Change: Within our portfolio, while the vast majority has continued to perform well despite the market headwinds, as we noted in our press release yesterday, we applied security deposits for the payments of rent from Forefront, Tilts, and Emerald Growth, where we collected partial rent from these three tenants in October.
Speaker Change: As we noted in prior calls, Forefront has experienced delays of well over a year in the development of their large-scale cultivation and processing facility in Illinois, primarily as a result of issues relating to delivery of power from the local utility.
Speaker Change: We were pleased to see the facility complete and operational during the first quarter this year. However, this delay was understandably impactful to their expected cash flows.
Speaker Change: Also in Q3, we successfully regained possession of a property in Massachusetts previously leased to Temescal Wellness, and will be looking to bring in another qualified cannabis operator to that asset.
With that, I'll turn it over to Catherine. Catherine?
Thanks, Ben.
Catherine: We've made strong progress in 2024 year-to-date on closing out or nearing completion on many of our tenants' remaining development projects. We've completed five leased projects during the year which are now operational for our tenants – Vireo's 325,000-square-foot expansion in New York, 4Front's 250,000-square-foot ground-up development in Illinois.
Speaker Change: Battle Green's 157,000 square foot ground-up development in Ohio, the 23,000 square foot Perez Road development project in California, and this quarter, completing the cultivation build-out of 104,000 square feet in our Summit building in Michigan, which is now 100% operational.
Speaker Change: We are pleased to see that these facilities are complete and are focused on bringing the success to our remaining assets under redevelopment.
Speaker Change: Regarding our portfolio, as of September 30th, we owned 108 properties across 19 states, comprising 9 million rentable square feet, including 618,000 square feet of development or redevelopment.
Speaker Change: Of these 108 properties, 105 properties are included in our operating portfolio, which was 95.7% leased at quarter end, with a weighted average remaining lease term of 14 years.
Speaker Change: Of the three properties under redevelopment, one was pre-leased at Quarter End, and the remaining two assets consist of 192,000 square feet of warehouse space in San Bernardino and a 12-acre parcel of land in Texas.
Speaker Change: Our portfolio continues to be well diversified with no one tenant representing more than 17% of our annualized base rent.
Speaker Change: and no state representing more than 15% of our annualized base rent.
Speaker Change: We have relationships with some of the largest and most experienced operators in the industry with our leased operating portfolio comprised of 91% multi-state operators and 62% leased to public company tenants.
Speaker Change: The total amount of capital invested and committed across our operating portfolio equates to $281 per square foot, which we believe remains significantly below replacement cost. And with that, I'll turn it over to David. David?
David: Thank you, Catherine. For the third quarter, we generated total revenues of $76.5 million compared to $77.8 million for the same period in 2023.
David: The decrease is primarily due to a $3 million loss in revenue.
David: For properties we took back possession of since the second quarter of 2023, $1.3 million in rent received during the quarter but not recognized in total revenues due to a reclassification of two leases as sales-type leases as of January 1, 2024.
David: and $1.3 million of contractually due rent, interest, and property management fees that were not collected during the quarter.
Speaker Change: The decrease is partially offset by a $4.6 million increase in contractual rent and property management fees, primarily due to contractual rent escalations, amendments to leases for additional improvement allowances at existing properties.
and new leases entered into since June 2023.
Speaker Change: Revenues for the quarter were also down sequentially versus the second quarter of this year, primarily as a result of a one-time disposition lease termination fee of 3.9 million earned in the second quarter relating to the sale of our Esperanza property in Los Angeles.
Speaker Change: As we noted in our press release last night, our third quarter results also included $1.4 million of security deposits applied for contractually due rent, and we applied the remainder of Forefront's security deposits totaling $0.5 million per payment of rent owed for October.
Speaker Change: We are closely monitoring Forefront's progress, and at this point expect rent collection for Forefront well below what is contractually due for the fourth quarter.
Speaker Change: AFFO for the third quarter was $64.3 million or $2.25 per share, a 2% decrease versus the second quarter of 2024.
Speaker Change: driven primarily by one-time interest payments of $1,000,000 or $0.04 per share received on a secured construction loan in the second quarter and a lease termination with Temescula, MA during the third quarter.
As we've noted on prior calls,
Speaker Change: While we expect the releasing activity we achieved this year to contribute meaningfully to our long-term earnings, the timeline to rent stabilization may differ between the properties as there are state and local approvals needed for these transitions.
Speaker Change: Additional regulatory requirements to be completed at certain assets and some level of rent abatement is negotiated to allow for a ramping of our new tenants operations.
Speaker Change: That being said, we are seeing continued progress on this front, with Loom receiving approvals for operation of the Harvest Park facility and completion of the cultivation space for our Summit project, both in Michigan, with rent expected to ramp up in the next three to six months.
Speaker Change: Since our IPO in 2016, we have maintained one of the most conservative balance sheets in the REIT industry, and that continued this quarter.
Speaker Change: With only $300 million of debt on gross assets of $2.6 billion, our debt to gross assets was a low 11% and our debt service coverage ratio was a strong 17 times.
Speaker Change: We expect to continue to run the business with a conservative balance sheet and maintain strong liquidity.
Speaker Change: Regarding liquidity, we finished the third quarter with over 220 million of total liquidity, which is slightly higher than the second quarter and is comprised of our cash, short-term investments, and availability under our revolving credit facility.
Speaker Change: And just this week, we added two banks to our revolving line of credit, bringing it to four in total, and expanded capacity by another 37.5 million.
Speaker Change: Our total capacity on our revolver now stands at 87.5 million, all of which is undrawn as of today.
Speaker Change: We are pleased that we have nearly tripled the size of this revolver since a year ago and appreciate the increasing support from our banking relationships. We are continuing to have dialogue with numerous banks regarding their interest in joining our credit facility to continue to increase the overall capacity.
Thank you for watching!
Speaker Change: Finally, we opportunistically issued shares of our Series A preferred stock under our ATM program in the third quarter totaling $9.6 million in net proceeds.
Speaker Change: As we noted previously, we entered into a new ATM program in the second quarter to provide additional flexibility in the offering of common stock on a forward basis and issuance of shares of our Series A preferred stock from time to time, and we're excited with the demand we saw for our preferred stock during the quarter.
Speaker Change: Overall we are pleased with where we are positioned as our balance sheet remains strong with leverage amongst the lowest in the read industry and we have continued to demonstrate access to many capital markets.
With that, I will turn it back to Alan.
Alan: Thanks David. I'd like to note the following in closing. I'm proud of what our team has accomplished year to date and especially in light of some of the enduring challenges faced by the regulated cannabis industry. We continue to be laser focused on maximizing the value of each property in our portfolio for the benefit of our stockholders and I see our company as exceptionally well positioned from overall capitalization and liquidity perspectives to continue to execute on additional investments where we see the potential for exceptional risk-adjusted returns. As long-term owners of our company, thank you as always for your continued support.
Speaker Change: With that, I'd like to open it up to questions. Operator, could you please open the call up for questions?
Speaker Change: We will now begin the question and answer session. To ask a question, you may press star, then 1 on your telephone keypad. If you are using a speakerphone, please pick up your handset before pressing the keys.
Speaker Change: If at any time your question has been addressed and you would like to withdraw your question, please press star, then 2. At this time, we will pause momentarily to assemble our roster.
and many more. Thank you. Thank you.
**Cough**
Speaker Change: And their first question comes from Tom Catherwood with BTIG. Please go ahead.
Tom Catherwood: Thanks and good morning everyone. Maybe starting with Alan or Paul, in the past you've worked with tenants that faced operating challenges usually by doing short-term lease amendments.
Speaker Change: For the tenants that paid partial or no rent in Q3, did they just stop paying out of the blue or did they come to you ahead of time looking for some kind of amendment or work out and you declined?
Speaker Change: Well, first, we have worked and we continue to work with all of our tenants on understanding their businesses and making sure that we are
Speaker Change: know what they're doing and how things are going. So we're aware of what's going on with our tenants. So that's number one. Number two, you know, we,
Speaker Change: want to work with our tenants when they're experiencing unusual or unforeseen issues such as what we've done with
Speaker Change: our shareholders and ourselves in addition to themselves. So that's what we do.
Speaker Change: Yeah, I think, you know, Tom, you've seen how we've dealt with
these issues in the past, and we do take...
[inaudible]
supply chain issues. We work with that tenant.
Speaker Change: But, on the other hand, if the situation, as we've seen in the past, is with a tenant that just stops paying rent, and we don't see a reasonable path.
for them to restart paying rent.
Speaker Change: and get back to even, we take a very aggressive stance in regaining possession of the property. So there's two paths that we take, and it's really dependent on the situation.
Thank you.
Speaker Change: I appreciate those those thoughts and then maybe going over to acquisitions last quarter it sounded like operators were almost in a wait-and-see kind of mode waiting for the election waiting to see what would happen with rescheduling before making any investment decisions
Speaker Change: What worries us is a scenario where the addressable market for cultivation acquisitions with high-quality operators is just more limited than once thought. How do you think of the potential to scale acquisitions and grow your portfolio without having to go further out on the risk curve with less experienced operators?
Speaker Change: So, I mean, I can turn it over to Ben to kind of talk about a pipeline where we still have, you know, I think a strong pipeline. But before we do that, I mean, I think we're...
Speaker Change: You know, your presumption is that the industry is, you know, stalled all of a sudden because of, you know, some political outcome or something that, you know, the election, you know, perhaps that's weighing on many people's thoughts. But the...
Ben: This industry has been around for a period of time, and it's going to be around for a long period of time. And it's not going anywhere, and revenue sales are expected to increase 9% year over year. The industry is definitely growing.
Ben: Our largest growers are constantly looking at opportunistic ways of expanding their businesses.
Ben: resurgence of interest in the industry, in addition to the continued growth of sales.
I think we've been cautiously optimistic about our pipeline.
Ben: looking at transactions very, very carefully given the uncertainties that we've seen.
Speaker Change: Just to reiterate, Tom, what Alan's talking about is we're continuing to see that growth in the industry. To highlight again, we're expecting north of a 9% CAGR through 2028 in the industry overall.
Ben: We're very happy with what we're seeing in the pipeline and the quality of the transactions and we will you know execute on those in 2025 on a very disciplined and selective basis.
Thank you. Thank you.
Speaker Change: Got it. Thank you for that color. And then last one for me, if I can, Ben, sticking with you, for the asset that you took back in North Adams, Massachusetts. I know it's early, but what is the outlook for backfilling that space? And is any incremental investment needed to get the building market ready?
Tom Catherwood: Tom, I can handle that. We just took back that facility.
Tom Catherwood: But the facility is a fully built out cannabis cultivation and processing facility and we believe that we should have the same general reusability that we've seen on other built out assets that we've re-tenanted.
Understood, that's it for me. Thanks everyone. Thanks Tom.
Speaker Change: And the next question comes from Alexander Goldfarb with Piper Sandler. Please go ahead.
Alexander Goldfarb: Hey, morning out there. Maybe just continuing on Tom's question on the tenant credit, a two-parter in the tenant credit, one is you guys made an additional investment in forefront in the second quarter, they have four properties.
Tom Catherwood: four properties, and then a power issue on one of the properties. And then regarding the other two tenants.
Tom Catherwood: You know is this I years ago we used to talk or I used to talk it was my words my words
Tom Catherwood: you know, sort of a whack-a-mole where there'd be a tenant issue, that would get resolved, there'd be another one. So I just want to understand if, you know, if that maybe is in fact how the business works, that there's always going to be, you know, a few tenants.
Speaker Change: Yeah, not necessarily the same but a few that are always surfacing and therefore this isn't a bad thing It's just part of the business
Well, I mean, certainly,
Tom Catherwood: You know there's We would love to be fully 100% leased and not have any tenants ever you know have
a bad situation. That would be the ideal.
Tom Catherwood: Operating Environment. But it would get kind of boring for you guys if we did that. You wouldn't have any questions to talk, to ask us about. So this really gives us opportunities to, obviously,
No, we appreciate the excitement.
a glib being, uh, but look.
Thank you.
Tom Catherwood: And so we're no different than all the others. The difference is we've been paid a very high adjusted rate of return for what we believe is a much lower risk profile.
Tom Catherwood: And we've been paid that for a long period of time, and we have a very long-weighted average lease length to continue to capitalize on that disparity in our favor.
Speaker Change: You know, with that, I'll turn it over to Ben to talk about this.
Ben: I just wanted to touch on your question on forefront. We did make an investment in the Illinois facility to round out construction there. We do have four individual leases with forefront, but that is by far the largest and there was significant...
Speaker Change: delays in construction, which understandably had an impact on their overall cash flow.
Speaker Change: You know, that asset is in Illinois, which is one of the top five markets in the U.S. We feel very confident.
Speaker Change: in the Illinois market. As Paul described, you know, we look at each of these situations individually and we're looking to maximize value of our portfolio and we feel very positive about the future resolution for these issues.
Speaker Change: So was it it was just the one asset that defaulted, the other three were still paying, is that that that's what I hear you saying?
and others. Thank you. Thank you.
Speaker Change: Again, just to talk generally, we do have cross default language on those. We look at each tenant overall with our parent company guarantees that we have on all of our leases.
Speaker Change: It would be a tremendous boost to their business once it's done.
What's that?
at the Illinois Building, and it's fully operational.
Speaker Change: Okay, and then Paul on the on the three ballot defeats. It's been a while since we've had that I don't know if that's the start of a trend or
is that maybe...
States are reflecting
Speaker Change: you know whether or not legalizing cannabis is a good thing or is it just they they've seen how the tax scheme has worked in other states and maybe people maybe everyone just buys from their guy and they don't need it legal just trying to understand why you know we had these three defeats versus you know a long string of of uh wins
Speaker Change: Sure. Well, let me chop it up a little. If you look at the Dakotas, North and South Dakota, that's always been a challenge.
Speaker Change: And, you know, we've had such tremendous momentum in the last 10 years, you know, starting with the West Coast.
Speaker Change: starting with Colorado, and those you might call with a low-hanging fruit.
Speaker Change: Now that we get to this part of the 50 states, now it's getting challenging. The Dakotas...
Speaker Change: It's always going to be a challenge. You know, Nebraska, past the medical, there might be a legal challenge. But that's a positive. But obviously the big issue is Florida.
And, you know, Florida got 56% approval.
Speaker Change: And there was a ton of opposition money spent, and Governor DeSantis got very aggressive.
So that...
Speaker Change: It was always going to be a challenge to hit the 60%. But while I think a lot of us in the industry are disappointed, by no means are we out in Florida. I think it's a learning lesson and I expect to see it again in two years on the ballot.
Speaker Change: And I would not look at that as a type of a momentum killer, if that's your question. I just think that, as I mentioned,
Speaker Change: The battles get a little tougher now because, you know, the states that were easier to get to have already been there and are performing beautifully, for the most part, and, you know, generating a lot of tax revenue and jobs for the public, you know.
Speaker Change: We, overall, you know, we continue to see cannabis as really becoming increasingly a bipartisan issue.
Speaker Change: and we're very encouraged about the election. We're very happy to see Donald Trump as president with regard to cannabis. We think that's a...
Very good development, you know, he's obviously on record supporting
the rescheduling, the support of safe banking.
and he looked at cannabis as a states' rights issue.
Speaker Change: We expect that to continue. We don't see no reason for them to change those positions. So we're very excited about what can happen in the next term at the federal level. We're very happy to see the Republican Senate.
Speaker Change: You know, we think with Mitch McCollum's departure, we have new life in the Senate for state banking. And we think that if...
Speaker Change: the House remains in Republican control, that does increase chances for safe banking, as well as rescheduling.
Speaker Change: kind of dovetailed into the election results, but I knew you were going to ask a question about that, so I got ahead of you. We're very happy with the election results and what it means for the industry.
Paul, as always, thank you. All right. Thanks, Alex.
Speaker Change: This concludes our question and answer session. I would like to turn the conference back over to Alan Gold for any closing remarks.
Alan Gold: Well, thank you. Thank you all for joining. I know there was a lot of activity in the quarter, and I really want to thank the team for their very strong and great work, and thank the shareholders for their continued support. With that, we can close.
finish the call. Thank you.
Speaker Change: The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.