Innovative Industrial Properties, Inc. — Q2 2017 Form 10-Q
Reporting period: Three and six months ended June 30, 2017. The company is an early-stage REIT-focused owner of specialized industrial properties leased primarily to state-licensed medical-cannabis operators. It owned two properties at quarter-end. Management intends to qualify as a REIT beginning with tax year 2017. The company says comparisons with prior periods are not meaningful because it began active real estate operations in December 2016; the filing provides no comparable 2016 operating results.
Financial results and position
| Metric | Three months ended June 30, 2017 | Six months ended June 30, 2017 |
|---|---|---|
| Rental revenue | $1.289 million | $2.579 million |
| General and administrative expense | $1.466 million | $3.221 million |
| Severance expense | $113,000 | $113,000 |
| Depreciation | $175,000 | $336,000 |
| Net loss | $422,000 | $1.013 million |
| Net loss per share, basic and diluted | $0.13 | $0.31 |
| FFO / AFFO | FFO: $(247,000); AFFO: $471,000 | FFO: $(677,000); AFFO: $811,000 |
FFO and AFFO are non-GAAP supplemental measures and should not be treated as cash available for dividends or as substitutes for GAAP results or operating cash flow. AFFO adds stock-based compensation and severance to FFO.
- Cash flow: Six-month operating cash flow was $1.499 million; investing cash outflow was $8.172 million, primarily for the Maryland property; financing cash outflow was $574,000. Cash decreased $7.247 million to $25.756 million.
- Assets and liquidity: Total assets were $63.912 million at June 30, 2017, including $37.903 million of net real estate and $25.756 million of cash and cash equivalents. Management said cash on hand, operating cash flow and potential capital raises should meet expected needs, but availability and terms of future funding are not assured.
- Debt and liabilities: The company reported no debt outstanding. Total liabilities were $3.934 million; stockholders’ equity was $59.978 million.
- Dividend: A $0.15-per-share quarterly dividend ($525,000 total) was declared, payable July 14, 2017. Management described an annualized rate of $0.60 per share, but future dividends are at the board’s discretion.
Portfolio, changes and unusual items
- The New York property is a 127,000-square-foot facility leased to PharmaCann under a 15-year triple-net lease, with two five-year extension options. Its initial base rent is about $319,580 per month, with annual increases based on the higher of 4% or 75% of CPI, plus supplemental rent during the first five years. The New York tenant generated 100% of annualized base rent at quarter-end.
- The Maryland property, acquired in May for an initial approximately $8.2 million including transaction costs, is under development and expected to comprise about 72,000 square feet. The company committed up to $3 million of additional seller payments and up to $4 million for tenant improvements; it also agreed to fund a $1.9 million rent reserve. The additional $3 million seller payment was made August 1, 2017. Assuming the full development and improvement funding, the property investment would total about $15 million, apart from the rent reserve.
- The Maryland tenant, Holistic Industries, has a 16-year triple-net lease, subject to three five-year extension options. Rent is subject to a three-month abatement; no Maryland rental revenue was recognized in the quarter or first half. The lease’s initial annualized base rent is based on 15% of specified property costs, with 3.25% annual escalations.
- Second-quarter expenses included $113,000 of severance relating to an executive officer’s departure. Six-month G&A included approximately $1.4 million of non-cash stock-based compensation; the comparable second-quarter amount was approximately $605,000. No real estate impairment was recorded.
- Common-stock classes were reclassified into a single common-stock class effective January 26, 2017. Shares outstanding were 3,501,147 as of August 10, 2017.
Outlook, risks and contingencies
Management expects revenue and expenses to grow as the company acquires properties, but provided no specific earnings or revenue guidance. It expects to use remaining IPO proceeds for property investments and general corporate purposes, and may seek equity or debt financing. Its investment guidelines generally cap aggregate borrowings at 50% of tangible-asset cost at the time of a new borrowing, subject to board discretion. The company said it had no current plans to issue debt.
- Regulatory and tenant risk: Cannabis remains illegal under U.S. federal law. The filing warns of possible federal asset forfeiture involving properties used by cannabis businesses and risks to tenants’ financing, operations and lease payments.
- Maryland-specific risk: Holistic was a start-up that had not commenced operations and had experienced losses. As of August 10, it had not received final state cultivation-license approval; approval depended in part on facility inspection. Pending litigation over Maryland’s licensing process could affect the license and tenant’s ability to pay rent.
- Concentration: One New York tenant accounted for all annualized base rent at quarter-end, and the portfolio consisted of just two properties. Tenant default, regulatory action or local-market conditions could therefore materially affect results.
- Other risks: The filing discusses competition for suitable properties, access to capital, real-estate and credit-market conditions, REIT qualification, collectability of rent and the uncertainty of future operating results. It reported no material pending litigation known to management, no off-balance-sheet arrangements and no material change in internal control over financial reporting.
- Contingencies: Office-lease commitments were approximately $265,000 at quarter-end. Management reported no known environmental liability expected to have a material adverse effect.
Key facts for investors to verify
- Whether Holistic receives final Maryland licensing approval, completes facility development and tenant improvements, and begins paying rent after the abatement and rent-reserve arrangements.
- The timing and amount of remaining Maryland funding, including the tenant-improvement reimbursement and $1.9 million rent reserve, and the resulting effect on liquidity.
- Whether the company maintains rental collections from PharmaCann and reduces its 100% tenant concentration through additional acquisitions.
- Whether the company qualifies as a REIT for 2017 and can support future dividends with taxable income and cash flow.
- How federal and state cannabis enforcement, forfeiture policy and Maryland licensing litigation affect tenants, property values and lease obligations.