Recently I interviewed Innovative Industrial Properties (IIPR) CEO, Paul Smithers as well as the CFO, Catherine “Cat” Hastings. In this 23 minute interview we discuss a variety of topics related to the cannabis-focused REIT.
During the last 30 days IIPR shares have declined ~18% (and -4.4% YTD). We upgraded the company to a Strong Buy after the recent pullback and in this interview we discuss the Safe Banking Act, that has caused more volatility in the cannabis industry.
Keep in mind, IIPR shares now yield 3.0% and analysts are forecasting AFFO per share growth of 39% in 2021 (7 analysts included in the forecast). I hope you enjoy the interview and thank you for the opportunity to be of service.
Interview Transcript
Brad Thomas:
Hi everyone. This is Brad Thomas with The Ground Up. I’m back again with another C-suite interview. And today we’ve got two of the executives on the team here at Innovative Industrial, ticker symbol IIPR. I’m honored and pleased today to have Paul Smithers, the CEO, as well as Cat Hastings the CFO. So Paul and Cat, welcome to The Ground Up.
Paul Smithers:
Hey, thanks, Brad. Good to be back.
Brad Thomas:
You got it. There’s a lot that’s happening, especially in your sector. That’s the cannabis sector. So remind the audience. This is what Innovative IIPR invests in cannabis related properties. And not just industrial properties, but even you’ve got a few retail. So Paul, can you talk a little bit about just the portfolio in general and what you’re investing in today?
Paul Smithers:
Sure. We’ve got 68 properties now across 18 different states. So we’ve got a nice geographic dispersion. We do primarily invest in large grow and processing cannabis facilities. And these are large facilities often two, 300,000 square feet. We do have some retail. We have about 10 retail dispensaries as well, but the majority of the portfolio is in the larger grow and processing facilities.
Brad Thomas:
Okay. So I want to talk, I guess, cut to the chase a little bit in terms of, there’s been some news recently on the Safe Banking Act, which has obviously been a political piece of that coming down the tracks. Of course, it’s been around a while, but your business model, again, you’re able to acquire properties at low double digit cap rates.
Obviously you’re deploying that into those assets and then generating pretty significant investment spreads. You have no leverage per se on those properties. So can you talk a little bit about your business model? And I guess, the question that’s out there for everybody is, how sustainable are these investment spreads given the Safe Banking Act noise that we’re seeing here lately?
Paul Smithers:
Sure. And Brad, since we’ve started this company a little over four years ago, the federal government has always been a big factor in what’s the future going to look like. Because I really can’t think of another industry that is so reliant on what the federal government’s going to do or not do. So we’ve had a great run.
When we started the company, the threat was that the federal government with Attorney General Jeff Sessions under Donald Trump was going to come in and really be aggressive and really affect the industry in a negative way. That hasn’t happened, we certainly haven’t seen it. And we don’t think with the new AG Merrick Garland that we’re going to have any problem at the federal level.
So the question now is, what’s the legislation going to look like at the federal level? And you’re right. The Safe Banking Act has really gotten the most attention. And the Safe Banking Act is really focused on giving some coverage to those operators that want to bank and take the cash element out of the industry. And that’s why it’s really had bipartisan support in the past, because people understand we’ve got to get the cash out of the industry.
So what safe banking doesn’t do it doesn’t reschedule or de schedule cannabis or legalize it. So it’s really focused on just what the banks do. So it was reintroduced last week into the House, which everybody expected. And we get a lot of headlines about re-introducing a bill, but hundreds of bills are introduced every Congress. And that really was very expected. No new news. So the question is, how does it become law? What’s the path to get there? When’s it going to get there?
We are of the opinion that it’s going to be a much longer path than some other people might think. And the reason is a couple of reasons. One, we really have a divided democratic caucus right now. Half of the Democrats in the House want to do big reform. They want to reschedule, de schedule cannabis, legalize it. The other half say, no, that’s never going to get through the Senate. So let’s do some bits and pieces. Let’s do the Safe Banking Act. That is the easiest thing to get through. And we’re going to float that.
Not so fast. We get over the Senate, we still have a 50/50 divided Senate. And the new banking chair in the Senate, Sherrod Brown just came out this weekend with a very forceful statement that he said, I am not going to pass Safe Banking through my committee until it has some social equity, prison reform, some of those other things that are not attached to the bill. So you can think the Democrats have the House, have the Senate, have the White House, it’s going to be a smooth path. Now, it’s not.
So we’ve seen a lot of pushing back between both the Senate Democrats and the House Democrats. The Senate is going to have their own version of Safe Banking, probably introduced this week. But then of course, whatever that bill is going to finally look like, it has to get to a Senate vote and, in absence of filibuster reform, they still need 60 votes, 10 Republican votes. That’s not a sure bet. So when is it going to happen? Not this year, maybe next year, maybe with this Congress.
And then I think, Brad, what you asked about what, when we do have Safe Banking, how’s it going to affect the business? We don’t think it’s going to affect us that much. And the reason why is with Safe Banking, it does not, as I mentioned, does not change the federal prohibition against cannabis. And we’re told that the big banks, the Wells Fargos, the Citis, the B of A’s are not going to come rushing into this space while cannabis is still federally illegal. So we don’t think there’s going to be a ton of capital coming in. We might see some localized lenders, some lending from the regional banks, the SNLs, the credits might come in and do some lending, but we don’t think anything is going to significantly move the needle.
Brad Thomas:
Yeah. And I think we talked about this last time, but a lot of your business model is really predicated on your core portfolio. So you’ve got existing customers that are in place and you’re transacting additional opportunities for expansions, for new facilities. So can you talk a little bit about that? Because what I don’t see is a mad rush this year or next year from your customers over to the banks. I think you appear to have built a pretty sticky business model with customers that are going to follow you into the future. So can you touch on that a little bit?
Paul Smithers:
Sure. So, yeah, and you’re right. It’s been great. The industry itself has had just tremendous growth. We had 50% growth year over year in 2020. It’s expected to double that in excess of 40 billion by 2025. So you’re right. Our operators understand that, they need the growth capital. And they’ve come back to us on many occasions for expansion dollars in the existing facilities, or they’re in an M&A mode and they’re out there acquiring assets and they come to us for that capital.
We have that great relationship with these MSOs that we’ve developed over the years. And we think that’s … we’re partners and they come to us for their capital needs. And we just see that going forward as this industry just continues to grow. And Cat, I know you’ve had some ideas on that as well.
Catherine Hastings:
Yeah, I think that there’s a lot of education that the big banks would need to understand about the industry. Obviously a cultivation facility has some specialized infrastructure that goes into the building. We understand that, we can value that. And working with those operators, they’re appreciative of the fact that we understand this asset class very well and are able to fund much of that infrastructure into those assets that we own.
I think it’s important for the operators also that they know that we can raise capital and partner with us into the future when they do have these expansion needs. Adding square footage to an existing building that we already own with them, or continuing to build out existing structures, as well as Paul was saying, partnering with them as they enter new states. All of that relationship I think becomes really important for when the operators are looking at different alternatives and certainly see us as a leader in helping them expand to where they have been today.
Brad Thomas:
Right. Now I want to talk about that, if we could, that expansion. So currently, do you see any states that have opened up? That are appealing for your expansion? And can you touch on that pipeline? I don’t know if you provide a guidance for 2021, if so, what is that? Or what does your pipeline look like for this year?
Paul Smithers:
We haven’t specifically offered any guidance, but I can tell you that from the election last year with New Jersey, Arizona going recreational, with Mississippi doing medical, it’s really had a domino effect, and as we thought it would. New York is this close to getting their medical, or pardon me, their recreational use through.
Obviously Governor Cuomo has some other issues dealing with, but maybe that gets through this week. We’re really looking at 11 new states coming on with both medical and rec in the next 12 to 24 months. Some really interesting states. So we’ve got Texas, South Carolina. Alabama’s coming in then New York on the rec side, Connecticut, Rhode Island, New Mexico, Virginia. It’s expanding and it’s fun to watch.
Brad Thomas:
Have the cap rates been fairly consistent up through the fourth quarter of 2020? I know it seems that last year we saw ranges of around 10, 11, 12%. Is that fairly consistent today with what you’re seeing in the market?
Paul Smithers:
I think so. And we’re really looking at some of the MSOs, the top four, if you will, top five or six. They’re doing real well. And they’re public and they’ve announced their earnings, and they’re in a position now where they can demand a little better money. They’re a better credit risk and they’re taking advantage of that. But there’s many operators that aren’t there yet, that we still are enjoying those low teens, 11 to 14s type numbers with those operators. So we’re seeing that in the pipeline. It’s great.
Brad Thomas:
If we could touch on the capital, how are you growing the business? Again, we touched on the fact that your company has very little debt. So are you primarily funding this through equity? Do you any other sources of capital that you are looking to? And at some point do you look at increasing your leverage in the future?
Catherine Hastings:
No, that’s a great question. And it’s one, I think that’s evolved over the four years that we’ve been in business. Really starting out, we only had equity. We have an extremely small preferred stock out there. We added in in 2019 a convertible note, and we’ve been very active with our ATM program. Last year in November, we re-upped it for a $500 million capacity and used about half of that through the end of the year.
With the cannabis affiliation, it tends to limit somewhat what opportunities we have that are different from traditional [inaudible 00:12:44]. So we don’t have access to the large warehousing line of credit that a traditional [inaudible 00:12:48] would be able to acquire properties and then raise capital to pay it down. So when we have raised capital, we are obviously looking for every alternative that we can in trying to get the best cost of capital at that time.
We continue to really be thrilled with how common stock has reacted and to be able to grow this large with essentially no secure debt today, that strong balance sheet really sets us up well for the future. So today we have $250 million of cash available that we’ve raised, that we haven’t committed for future acquisitions. We have great opportunities with common stock, continuing to raise through the ATM convertible market. So we feel like having these alternatives to be able to address the pipeline and raise capital when we need sets us up for a great position.
Brad Thomas:
Great. And I think I was looking, it looks like the last deal that I saw that you announced was a deal in Florida, 295,000 square feet, or 23.8 million for a subsidiary of Harvest Help. Can you talk about that transaction? Was that an existing relationship you had or is that a new relationship?
Catherine Hastings:
So Harvest, we were actually thrilled for them to acquire one of our other operators. So we’ve been talking to them for quite a while, but adding them into the portfolio I think was extremely great to … We’re always looking to add new names to the portfolio. And so that was a great partnership for us to really start out in Florida as well. We’ve been tracking them for a long time, and with 22 operators in the portfolio today, finding strong names like that was really exciting for us.
Brad Thomas:
I see another one, holistic, I guess in LA. It’s about 24 million all in. So I know they’re fairly lumpy, but is that … I’m just kind of looking at your average acquisition, is that fairly consistent, roughly? It looks like 20 … at least those last couple I see are around $20 million each, is that what you’re seeing in the marketplace?
Catherine Hastings:
I think it depends. We’ve done amendments that are in excess of $30 million to existing portfolio properties. So it really depends on the state. It depends on the cultivation facility itself. What types of improvements have been added in. Many times, we’ll do an initial acquisition and then provide additional build out dollars for them that we tend to fund over six to 12 month timeframe as they’re building out the cultivation facility. So I think on average 20 to 30 million is usually what we’ll look at for the cultivation, but it really depends on the makeup of what the building looks like and the infrastructure that’s gone in.
Brad Thomas:
Great. And I guess the last question I want to ask you all is the, 2020 still had very strong growth, over 50% based on my data that I’m looking at. But also, analysts’ expectations are still 39% growth. I’m looking at an AFFO analyst growth number for 2021. So definitely strong pipeline or growth forecast, I guess I should say. Dividend yield right now is about 3%. So definitely a lot of total return opportunity. I guess my question would be, going back to, we’ve seen this in the prison sector where another very volatile sector that we’ve seen out there, one of the companies [inaudible 00:16:51] back to C Corp. The other one is still in a [inaudible 00:16:54] space.
But I’m just curious, if you were a private company, you’re paying out about a 3% yield right now. If obviously as a public company you’ve performed extremely well, we’re glad you’re in the public market, but I’m just curious how you would perform if you were not public, if you were private. Would you still, I guess still have those investors would we be interested in that platform if you weren’t so volatile and more of a private vehicle?
Paul Smithers:
I don’t know. That’s a tough one. I do know that if we were private, our G&A would come down significantly based on the cost of being a public company. I don’t know. It’s an interesting question. Would we still get the interest without the liquidity in the market? Investors can’t come in and out perhaps as easily. And certainly I think our New York Stock Exchange listing is one of our key elements to our success and really attracting institutional investors, as well as retail investors who have that liquidity and the ability to come in and out.
Catherine Hastings:
Yeah, I think being a public company and being listed has really allowed the retail component of investors, just individuals who want to come in and buy the stock. We’ve had a lot of organic growth with that. And it’s a great way for private investors to also participate in the story as well. I think our execution has been really amazing and having that public listing has allowed to certainly raise capital very quickly and allow us to grow even more so. But it’s a difficult thoughts to understand what it would have been like if we had just been private. I still think the management team and the ability to close the transaction certainly still would have attracted a lot of institutional interest. But yeah, I think being public has been a great part of the story as well.
Brad Thomas:
Yeah. No, well, again, in fairness, the prison [inaudible 00:19:11] obviously, at least the one company we covered, CoreCivic, they didn’t have … They required leverage to operate their business model. And when the big banks pulled out, Wells Fargo and the others, that created a much larger layer of complexity for them to raise capital. The good thing is you don’t require those banks. You don’t need those banks and you’re able to operate and run a successful business without that leverage. In fact, that’s really, I think one of your competitive advantages in fact is the fact there.
And again, I agree with, Paul, what you said about, I think that there’s going to be eventually this day of reckoning in the banking sector. But you’re a first mover advantage, you’ve already built a very significant pipeline, and these underlying assets are very high quality. We’ve seen a number of these properties that you’ve invested in, and they’re essentially a lot of them are industrial type properties, which have considerable value, even if the laws do change or shift.
And you could, to your point, Cat, increase leverage. I think your investment spreads could continue to be at the same levels that you’re at today. And by the way, that forecast for 2021, it’s, as I said, it’s 39% potential growth in terms of on an AFFO basis. So I guess lastly, what are you seeing out there in terms of your … I know the pipelines out there, but are you seeing that deal flow? Again, I know you’re not trying to provide you with any guidance at anything, but I guess the key to that is, are you able to deploy this capital and do you feel pretty good about the opportunity set that you see right now?
Paul Smithers:
Yeah Brad, we feel real good about it. And what’s really encouraging is we’re getting interest from a lot of different sectors. As mentioned, with the existing portfolio, with the large MSOs, they’re expanding, they see what’s coming, especially in those states that are going to adopt a recreational program. They need expansion dollars. A lot of these guys are in M&A mode and they’re going to tap their real estate to get capital for the acquisitions.
And we don’t want to forget these single state operators that are coming up in the new states. And that’s really exciting for us. That’s what I love personally. I love talking to these new guys, getting comfortable with them. And this is how we started the business four years ago, there was really no such thing as an MSO really four years ago. So we were doing the single state operators. So with these new states coming on, we’re looking at those guys too. So we see a lot of different channels coming into the pipeline, which is really exciting for us.
Brad Thomas:
So we’re roughly in market capital around 4.3 billion, do you think you can get to 10 billion?
Paul Smithers:
I answer that, Brad, by looking at the growth in the industry. And we’d like to say if this was a baseball game we’re probably somewhere between the second and third inning as far as growth. So if you do the math, yeah. The opportunity is out there to just keep growing. And again, it depends what the federal is going to do. If the federal government legalizes cannabis tomorrow and opens up banking, that changes the landscape.
We don’t think that’s going to happen, if at all. We could have the states act, which actually President Biden favors, to come in and the federal government may just wash their hands of it and say, states, you do what you need to do without federal interference. And actually, we think that’s the most likely path to legalization if you will. And who knows what the national banks are going to do with that. So to your point, yeah. There’s tremendous growth still left in this industry and with our company.
Brad Thomas:
Great. Well, Paul and Cat, I want to thank you both for joining me. Very helpful here, I’m sure to the viewers as well. So look forward to circling back here again after first quarter.
Paul Smithers:
Our pleasure. Thanks, Brad.
Catherine Hastings:
Thanks, Brad.
Brad Thomas:
Thank you all. Bye-bye.
Paul Smithers:
Take care.
Happy Investing
Brad Thomas is Senior Research Analyst at iREIT and CEO of Wide Moat Research LLC. With over 30 years of real estate experience, he is also long-time Editor of Forbes Real Estate Investor, a monthly subscription-based newsletter that dives deep into the vast world of profitable properties, and since 2021, he has served as an adjunct professor at New York University.
Thomas has also been featured on or in Forbes magazine, Kiplinger's, U.S. News and World Report, Money, NPR, Institutional Investor, GlobeStreet, CNN, Newsmax, and Fox. And he was the #1 contributing analyst on Seeking Alpha in 2014, 2015, 2016, 2017, 2018, 2019, 2020 and 2021 based on both page views and number of followers.
Thomas is the recently-published author of The Intelligent REIT Investor Guide (2021), co-author of The Intelligent REIT Investor (2016), and he wrote The Trump Factor: Unlocking The Secrets Behind The Trump Empire (2016) - all available on Amazon.
Thomas received a bachelor of science in business/economics from Presbyterian College and is married with five wonderful kids.
