Innovative Industrial Properties Or NewLake Capital: Which Is The Better Cannabis REIT?

The bull case underpinning cannabis REITs Innovative Industrial Properties (NYSE:IIPR) and NewLake Capital Partners (OTCQX:NLCP) is of an oases of tranquility in a desert of chaos. The US recreational cannabis industry was kickstarted in 2012 when Washington and Colorado became the first states to legalize cannabis for recreational use. The recreational use of cannabis has since been legalized in 24 states, with medical use legalized in 40 states. This has come as cannabis remains a DEA Schedule I substance, defined as drugs with a high potential for abuse and no currently accepted medical use. Both REITs have acquired their properties through sale-leaseback transactions and third-party purchases. These properties are then leased on a triple-net lease basis.

The appeal of both REITs is income and lower price volatility in a sector extremely privy to wide swings in investor sentiment. Cannabis multi-state operators are barred from listing on official stock exchanges like the NASDAQ and NYSE, their access to standard banking services is heavily curtailed, and their profitability is heavily dampened due to punitive taxation and a high cost of capital. The top-5 cannabis MSOs by sales have all collectively lost more than 70% of their value over the last three years.

In California, cannabis retailers have to pay a 15% excise tax on sales, with additional taxes also applied by some local governments. The impact on multi-state operators of the high-burden regulatory and taxation regime across the US has been chaos, even as the industry is forecast to grow to $71 billion in sales by 2030 even without federal legalization.

Portfolio, AFFO, And Dividends

San Diego-based and internally managed IIPR concentrates on the acquisition and ownership of properties leased to state-licensed operators. The $2.60 billion market cap REIT owned 103 properties across 8.9 million square feet in 19 states as of the end of its last reported fiscal 2023 third quarter. There are roughly 1.4 million rentable square feet under development, with the portfolio 98.5% leased. Industrial cannabis properties form around 91% of IIPR’s portfolio, with 62% of the portfolio leased to publicly listed MSOs. The REIT’s largest tenant, PharmaCann, is a private company.

IIPR last paid a quarterly cash dividend of $1.82 per share, a 1.2% sequential increase for what’s currently a 7.92% annualized forward dividend yield. This was driven by revenue that at $77.82 million was up 9.8% over its year-ago comp and beat consensus estimates by $1.26 million. Illinois constituted 14.9% of annualized base rent with Pennsylvania and Massachusetts forming the second and third-largest markets.

Internally managed, NLCP operates out of New Canaan, Connecticut with a portfolio of 32 properties spread across 12 states and 1.7 million square feet that was 100% leased. Public listed MSOs Curaleaf (OTCPK:CURLF) at 22% of annualized base rent is NLCP’s largest tenant, with Cresco Labs (OTCQX:CRLBF) and Revolutionary Clinics the next two largest tenants. The REIT has a 64% to 36% split between public and private tenant companies. The REIT last paid a quarterly cash dividend of $0.40 per share, a larger 2.6% increase from its prior distribution for what’s a 9.68% annualized forward dividend yield.

NLCP’s dividend yield is roughly 176 basis points higher than IIPR for several reasons. Firstly, its portfolio and market cap at $360 million is significantly smaller than IIPR which commands a higher risk premium. Further, IIPR was listed on the NYSE in 2016 during a now-closed loophole period. Subsequent cannabis equity REITs will have to trade over the counter with NLCP trading on the OTCQX, the highest quality tier of the OTC markets. NLCP is also significantly cheaper than IIPR. The Connecticut REIT generated an adjusted FFO of $10.1 million, around $0.47 per share, during its third quarter. This was down $0.02 per share from its year-ago comp and meant the REIT is currently covering its dividend by 118%. NLCP is changing hands for an 8.8x price to annualized AFFO.

Valuation, Balance Sheet, And Risks

IIPR’s third-quarter AFFO at $64.8 million was $2.29 per share, up 16 cents from its year-ago quarter. This was $9.16 annualized for a 10x price to annualized AFFO. IIPR’s dividend coverage at 126% is also higher than NLCP. However, IIPR is currently growing, whilst NLCP recorded a year-over-year revenue decline of 4.8% to $11.5 million during its third quarter. Hence, whilst IIPR is more expensive and comes with a marginally lower dividend yield, the REIT currently faces fewer revenue headwinds. NLCP’s revenue decline during the third quarter was driven by Revolutionary Clinics, its third-largest tenant, not paying rent. The rent default of roughly $1.3 million was offset by NLCP tapping 25% of the defaulter’s security deposit, around $315,000. Historical revenue growth for NLCP has been higher.

NLCP came to a forbearance agreement with Revolutionary Clinics post-period end with a lease amendment that provides a 5-year extension, but with reduced contractual rent payments. The terms of the new rent payments were not disclosed during the third-quarter earnings call, but NLCP received $480,000 of previously unpaid rent and also applied $315,000 of security deposit to rent to be recognized in the fourth quarter. IIPR also faced some tenant issues with rent collection for its operating portfolio coming in at 97% during the third quarter on the back of headwinds faced on properties leased to Temescal Wellness, 4Front Ventures, and Holistic Industries. IIPR’s rent during the third quarter included tapping $2.2 million in security deposits from the relevant properties leased to these tenants.

The debt-to-equity ratios of both REITs are also materially below the equity REIT average. NLCP essentially has zero debt on its balance sheet, with IIPR faced with $304.4 million of debt coming due through to 2026. Around $4.4 million of this is due in 2024 with the remainder 5.5% senior notes due in 2026. IIPR also has outstanding 9% preferred shares (NYSE:IIPR.PR.A) that are currently trading for $1.35 above their $25 liquidation value.

The core risks facing both REITs are concentrated around a continued deterioration of MSOs. These have heavily depended on their equity to raise cash through new stock offerings. Hence, we’ve seen liquidity across the space wane as a direct consequence of the pullback of their stock prices. The top five US MSOs have seen their cash and equivalents fall by an average of 30% over the last three years.

Sentiment changes also pose an issue to the industry, with previous rallies driven by perceived progress with federal US legalization. There has been positive stock momentum building in recent weeks, with the US Department of Health and Human Services publishing a document recommending Marijuana to be rescheduled as a Schedule III drug. Critically, positive movement on this would likely catalyze continued positive momentum but runs the risk of a wide selloff in the opposite scenario. I’m neutral on both tickers and rate them as a hold.

Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.