Innovative Industrial Properties, Inc. — 2016 Form 10-K
Reporting period: June 15, 2016 (incorporation) through December 31, 2016. The company began active real estate operations on December 19, 2016. This is its first reporting period; the filing says comparable company operating results are not meaningful. The company is a newly formed REIT focused on acquiring specialized industrial properties leased to state-licensed medical-use cannabis operators. It intended to elect REIT status beginning in 2017.
Financial performance and position
| Metric | 2016 reporting period |
|---|---|
| Total revenue | $321,000, including $180,000 rental revenue, $87,000 tenant reimbursements and $54,000 other revenue |
| Total expenses | $4.713 million, including $3.707 million of noncash expense for forfeited founder Class B shares |
| Net loss | $4.392 million; basic and diluted loss per share was $4.56 |
| FFO / AFFO | FFO loss of $4.365 million; AFFO loss of $600,000. These supplemental non-GAAP measures are not cash available for distributions. |
| Cash flow | $1.693 million provided by operating activities; $30.032 million used in investing activities, primarily for the property acquisition; $61.342 million provided by financing activities, primarily the IPO |
| Year-end balance sheet | Total assets $63.327 million, including $33.003 million cash and cash equivalents; total liabilities $2.888 million; stockholders’ equity $60.439 million |
| Debt and liquidity | The company reported no debt outstanding. It said liquidity and capital resources were adequate, while noting future capital-market access was not assured. |
Operating cash flow included contractual rent and tenant security deposits; it should not be read as evidence of a full year of recurring operating cash generation. The company recorded rent from its sole tenant on a cash basis because collectability was uncertain.
Property, lease and material changes
- At year-end, the company owned one 127,000-square-foot property in New York, acquired from PharmaCann for approximately $30.0 million in a sale-leaseback.
- The triple-net lease has a 15-year initial term and two five-year renewal options. Initial base rent is approximately $319,580 monthly, with annual increases at the higher of 4% or 75% of CPI. The lease also provides a 1.5% property-management fee and $105,477 monthly supplemental rent for its first five years. The company estimates these amounts together at an annualized initial yield of approximately 17.2% of purchase price.
- Contractual minimum rent, including base rent, supplemental rent and management fees, totals $83.623 million over the remaining lease term; $5.172 million is scheduled for 2017.
- The IPO generated approximately $61.1 million net proceeds. Approximately $30.0 million funded the initial property; the balance was intended for further acquisitions and general corporate purposes.
- As of March 22, 2017, management had identified approximately $120 million of potential properties under review, with no assurance any would be acquired.
There is no meaningful company year-over-year comparison. As a separate indicator of tenant risk, PharmaCann’s audited 2016 statements reported $3.623 million sales and a $13.239 million net loss, compared with $250,000 sales and a $4.168 million net loss in 2015. The company states PharmaCann was not profitable and might initially fund rent from sale proceeds or cash on hand rather than operating cash flow.
Outlook, risks and unusual items
- No formal earnings or distribution guidance is provided. Management expects revenue and expenses to rise as properties are acquired. The company had not declared or paid a distribution as of March 22, 2017; future distributions are not assured.
- The principal business and legal risk is that cannabis remains illegal under U.S. federal law despite state authorization. Changes in federal enforcement, state laws, licensing rules or banking access could impair tenants, leases, property values and the company’s ability to execute its strategy.
- The portfolio was entirely concentrated in one property, one state and one startup tenant. Tenant default, license loss, weak market development or inability to re-lease a specialized facility could materially affect results.
- PharmaCann’s lease payments are subject to collection uncertainty. The company recorded its lease revenue on a cash basis and disclosed that the tenant expected to continue incurring losses during 2017.
- Other risks include limited access to financing and banking services, REIT qualification and tax uncertainty (including possible Section 280E issues), environmental and property liabilities, and difficulty obtaining insurance.
- The $3.707 million forfeited-share charge was noncash: founders’ Class B shares were redeemed for par value before the IPO, and the filing says the founders received no value from those shares. The company also recorded $566,000 in consulting fees for IPO services from IGP Advisers, an entity owned by certain officers, and disclosed related reimbursements.
- Management disclosed a material weakness involving valuation and accounting for founder restricted shares, which led to a restatement of interim 2016 financial statements. The company reported remediation completed by December 31, 2016; disclosure controls were assessed as effective at year-end.
Important facts for investors to verify
- Whether PharmaCann is paying rent from sustainable operating cash flow, and its latest liquidity, profitability and debt position.
- Whether the approximately $120 million acquisition pipeline converts into completed, diversified investments and at what returns and financing cost.
- How much of future cash flow and distributions is recurring rent versus tenant deposits, advance rent, IPO proceeds or other capital sources.
- Developments in federal enforcement, state cannabis regulation, banking access and the company’s ability to maintain REIT status.
- Progress in sustaining internal controls after the reported interim restatement and material weakness remediation.