Innovative Industrial Properties, Inc. — Q3 2019 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2019. Unless stated otherwise, financial amounts below are in millions of dollars. The company is a REIT that acquires and leases specialized properties to state-licensed cannabis operators, generally under triple-net leases.
Business context and portfolio
- At quarter-end, the company owned 31 properties in 12 states, totaling approximately 2.2 million rentable square feet, including approximately 687,000 square feet under development or redevelopment. Properties were 100% leased, with a weighted-average remaining lease term of approximately 16 years.
- During the first nine months, it acquired 13 properties for approximately $107.6 million and funded or capitalized substantial tenant improvements and construction. Aggregate investment in the portfolio was approximately $298.7 million, with a further $100.4 million committed for tenant and seller reimbursements.
- Rental revenue is recorded on a cash basis because of uncertainty about tenant collectability, including tenants’ limited operating histories and cannabis-related regulatory uncertainty.
Financial results and liquidity
| Metric | Q3 2019 | Q3 2018 | Nine months 2019 | Nine months 2018 |
|---|---|---|---|---|
| Total revenue | $11.6 | $3.9 | $27.0 | $10.0 |
| Operating income | $6.8 | $1.6 | $14.3 | $3.5 |
| Net income | $6.5 | $1.8 | $13.6 | $4.3 |
| Net income attributable to common stockholders | $6.2 | $1.5 | $12.6 | $3.3 |
| Basic / diluted EPS | $0.56 / $0.55 | $0.22 / $0.21 | $1.22 / $1.20 | $0.50 / $0.49 |
| FFO per diluted share | $0.76 | $0.32 | $1.72 | $0.77 |
| AFFO per diluted share | $0.86 | $0.38 | $2.02 | $0.93 |
- Q3 rental revenue rose 201% year over year; nine-month rental revenue increased 170%. Management attributed growth mainly to properties acquired in 2018 and 2019, lease escalations, and lease amendments. Operating income was approximately 59% of Q3 revenue, versus 40% in the prior-year quarter (calculated from reported figures).
- Nine-month operating cash flow was $25.1 million, compared with $9.6 million. Investing cash outflow was $237.4 million, primarily for real estate, tenant funding and short-term investments; financing cash inflow was $308.6 million, chiefly from stock issuance and the new notes. Cash, cash equivalents and restricted cash ended at $109.3 million.
- At September 30, total assets were $623.2 million, including $99.9 million cash, $9.4 million restricted cash and $208.8 million short-term investments. Total liabilities were $173.4 million and stockholders’ equity was $449.8 million.
- The Operating Partnership issued $143.75 million of 3.75% exchangeable senior notes due February 2024. Their net carrying value was $134.2 million; fair value was reported at $207.0 million. Nine-month interest expense was $4.5 million. The notes are unsecured and guaranteed by the company and certain subsidiaries.
- Funding included approximately $180.1 million net proceeds from a July common-stock offering and $5.6 million from September ATM sales. The ATM program authorized up to $250 million; approximately $201.9 million remained available as of November 7, 2019. In October, the company raised another $41.3 million through the ATM.
- The common dividend declared for Q3 was $0.78 per share, up from $0.60 for Q2 2019. The Series A preferred dividend was $0.5625 per share for the quarter.
Changes, outlook, risks and unusual items
- Results expanded alongside rapid portfolio growth and equity and debt issuance. General and administrative expense increased to $2.2 million in Q3 from $1.4 million, reflecting higher compensation, additional employees, public-company costs, travel and occupancy. Depreciation also rose as acquired properties and improvements entered service. Interest expense began in 2019 with the notes issuance.
- Management said liquidity and capital sources were adequate for expected needs, while noting funding may not be available in sufficient amounts or on acceptable terms. It expects to fund acquisitions through operating cash, cash on hand and equity or debt markets. No specific earnings or acquisition guidance was provided.
- Future contractual minimum rent was approximately $1.20 billion, including $13.9 million for the remainder of 2019 and $59.0 million for 2020. This is contractual rent, not a forecast of collections.
- Outstanding commitments included approximately $49.0 million for tenant improvement allowances and $36.6 million for specified construction funding, in addition to other smaller commitments. Subsequent to quarter-end, the company acquired six properties listed in the filing for approximately $105.1 million and committed approximately $45.0 million more for improvements and construction; certain funding could be reduced at tenants’ options.
- A significant tenant concentration remains: PharmaCann represented approximately 25% of Q3 rental revenue and 28% for the first nine months; Ascend Wellness represented 14% and 12%, respectively. The filing also disclosed that, on October 29, a court appointed a receiver over the assets of the tenant at the Los Angeles property, creating potential lease-default risk.
- Principal risks include cannabis remaining illegal under federal law, changing state licensing and regulatory frameworks, tenant financial weakness and limited banking access, tenant and property concentration, and difficulty re-leasing specialized facilities after a default. The filing also noted vaping-product restrictions, including a temporary Massachusetts ban, as a potential risk to tenants. No material litigation or environmental contingency was identified; no impairment losses were recorded.
- The company expected to cease being an emerging growth company on December 31, 2019. It expected to adopt the new lease-accounting standard for its 2019 annual report and was still evaluating the effects; it anticipated no material impact from the expected adoption of the credit-loss standard in 2020.
Important facts for investors to verify
- Tenant rent payment performance, especially the Los Angeles tenant subject to the October 29 receivership, and any resulting default, recovery or re-leasing costs.
- Exposure to major tenants and the financial health, licensing status and access to financing of cannabis operators, particularly PharmaCann and Ascend Wellness.
- Whether committed tenant-improvement and construction funding is drawn, completed on schedule and matched by rent increases; confirm the impact of tenant options to reduce funding.
- Cash generation and dividend coverage as acquisitions, development spending, debt service and the elevated common dividend continue.
- Future reliance on equity markets and the terms, dilution and remaining capacity of ATM issuance; monitor the 2024 notes and their exchange and settlement terms.
- Actual impact of cannabis regulation, banking constraints and lease-accounting adoption on collections, property values and reported results.