Innovative Industrial Properties, Inc. — 2023 Form 10-K
Reporting period: Fiscal year ended December 31, 2023. The filing is an annual report, not a standalone fourth-quarter filing. IIP is a REIT that owns specialized properties leased mainly to state-licensed cannabis operators under triple-net leases.
Business context
At year-end, IIP owned 108 properties across 19 states, totaling approximately 8.9 million rentable square feet, including approximately 1.4 million square feet under development or redevelopment. Its 103-property operating portfolio was 95.8% leased, with a weighted-average remaining lease term of approximately 14.6 years. IIP reported approximately $2.4 billion invested in its property portfolio.
Financial and operating metrics
| Metric | 2023 | 2022 | Change |
|---|---|---|---|
| Rental revenue, including tenant reimbursements | $307.3 million | $274.4 million | +12% |
| Total revenue | $309.5 million | $276.4 million | +$33.1 million |
| Net income attributable to common stockholders | $164.2 million | $153.0 million | +7% |
| Diluted earnings per common share | $5.77 | $5.52 | +5% |
| AFFO | $256.5 million | $233.6 million | +10% |
| AFFO per diluted share | $9.08 | $8.45 | +7% |
| Common dividends declared per share | $7.22 | $7.10 | +2% |
| Net cash provided by operating activities | $255.5 million | $234.1 million | +$21.4 million |
Operating income was $174.6 million on total revenue of $309.5 million. Property expenses rose to $24.9 million from $10.5 million, mainly because IIP began paying property taxes directly and billing tenants for reimbursement; most such costs are reimbursable under leases. General and administrative expense was $42.8 million, including $19.6 million of non-cash stock-based compensation.
Year-end cash and cash equivalents were $140.2 million, restricted cash was $1.5 million, and investments were $21.9 million. Total assets were $2.39 billion and total liabilities were $438.1 million. Debt principal at year-end was $300.0 million of 5.50% senior notes due May 2026 and $4.4 million of 3.75% exchangeable notes due February 2024. No revolving-facility borrowings were outstanding at year-end. The $30 million revolving facility was increased to $45 million after year-end. The filing reports no debt maturity until May 2026 after the exchangeable notes were settled in February 2024.
Material changes versus the prior year
- Revenue, net income, AFFO, and operating cash flow increased. Rental revenue growth included $13.3 million of additional tenant reimbursements following the change in property-tax payment practice; therefore, the reported increase was not solely growth in base rent.
- Rental revenue also benefited from acquisitions and contractual rent escalations, but was affected by approximately $4.8 million of non-collection from operating-portfolio properties and the termination of leases with certain defaulting tenants.
- Property investment activity slowed: IIP acquired two properties in 2023, compared with nine in 2022. Cash used for real estate purchases, improvement funding, construction, and related investments was approximately $189 million in 2023, versus approximately $546 million in 2022.
- Cash and cash equivalents increased from $87.1 million to $140.2 million, while investments declined from $200.9 million to $21.9 million. Investing cash outflow was only $6.8 million in 2023, largely reflecting net maturities of short-term investments; financing cash outflow was $195.6 million, primarily due to dividends.
- Several tenants defaulted, and IIP regained possession of properties leased to Kings Garden, Parallel, and Green Peak. The company also provided rent deferrals or other lease accommodations to several tenants.
Outlook, risks, contingencies, and unusual items
- Outlook and liquidity: No numerical earnings or acquisition guidance is provided. Management expects to meet liquidity needs through cash and short-term investments, operating cash flow, and potential equity or debt issuance and facility borrowings; it believes available sources are adequate, while warning that capital may not be available on acceptable terms. Future growth depends on investment opportunities and access to capital.
- Tenant and concentration risk: The top ten tenants represented 76% of contractual rent collected. PharmaCann represented 15% of rental revenue, Ascend 10%, and Green Thumb 8%. Management noted that some tenants are not profitable and may fund rent from cash on hand, property-sale proceeds, or debt rather than operating cash flow. The reported 98% operating-portfolio rent collection for 2023 included approximately $8.7 million of security deposits applied to rent; fourth-quarter collection was reported at 100%, including approximately $767,000 of security deposits.
- Industry and regulatory risk: Cannabis remains illegal under federal law despite state programs. Federal enforcement, changes to state laws, banking restrictions, licensing, taxation, declining cannabis prices, and reduced tenant access to capital could impair rent collection, property values, and reletting prospects. HHS recommended rescheduling cannabis to Schedule III in August 2023, but DEA action and the effect of any change remained uncertain. The filing said the congressional medical-cannabis enforcement-spending restriction was extended only through March 8, 2024.
- Legal matters: A securities class action and several derivative actions were pending; IIP said it could not predict their outcome and had not accrued amounts for them. The class action’s amended complaint was dismissed without prejudice, and a second amended complaint was pending. Tenant-related litigation includes a Pennsylvania consent judgment of approximately $15.5 million, of which IIP received approximately $1.7 million in 2023, and a Kings Garden settlement and related property recovery matters.
- Sale accounting: IIP transferred four California properties for $16.2 million in March 2023 and provided a $16.1 million secured loan to the buyer, but the transaction did not qualify as a completed sale under GAAP. The properties remained on the balance sheet, proceeds and future payments were recorded as a deposit liability, and the buildings continued to be depreciated. Approximately $1.3 million of cash interest received was recorded as a liability.
- Commitments and development: At year-end, IIP had approximately $40.1 million committed for property improvements, of which approximately $9.6 million was incurred but unfunded; it had funded $22.0 million of a $23.0 million California construction-loan commitment. Inflation, labor and supply constraints have caused project delays and cost overruns. Three California properties were being evaluated for non-cannabis uses in part because zoning changes no longer permit cannabis operations.
- Controls and audit: Management reported that a previously identified material weakness involving review and approval of property-improvement funding requests had been remediated. The auditor gave unqualified opinions on the financial statements and internal control over financial reporting.
Important facts for investors to verify
- Whether rent collection remains strong after excluding security deposits, deferrals, settlements, and other non-recurring or non-operating support.
- Tenant financial condition and exposure to the largest tenants, including the performance of properties recovered from defaulting operators and the timing and cost of reletting or redevelopment.
- Whether improvement commitments and development projects are completed on schedule and within budget, and whether vacant or rezoned assets require impairment or additional capital.
- Current debt balances, covenant compliance, the May 2026 notes maturity, and the availability and terms of the expanded revolving credit facility.
- Developments in the pending securities and derivative litigation, tenant disputes, and the accounting and ultimate outcome of the California property transfer and seller-financed loan.
- Dividend coverage using operating cash flow and AFFO, while distinguishing declared dividends from taxable distributions and checking the effect of security-deposit applications and other adjustments.