Innovative Industrial Properties, Inc. — 2018 Form 10-K
Reporting period: Fiscal year ended December 31, 2018. This is an annual report, not a standalone fourth-quarter report. The company is a REIT that owns specialized industrial properties leased, generally on a triple-net basis, to state-licensed cannabis operators.
Financial and operating performance
| Metric | 2018 | 2017 |
|---|---|---|
| Total revenue | $14.787 million | $6.420 million |
| Rental revenue | $14.342 million | $6.302 million |
| Operating income (loss) | $5.338 million | ($0.223 million) |
| Net income (loss) | $6.985 million | ($0.072 million) |
| Net income (loss) attributable to common stockholders | $5.633 million | ($0.395 million) |
| Diluted earnings (loss) per common share | $0.75 | ($0.13) |
| Net cash provided by operating activities | $15.693 million | $5.015 million |
Revenue increased approximately 130% year over year, principally from properties acquired in 2017 and 2018 and contractual rent increases. Operating margin was approximately 36% of revenue. Net income also included $1.647 million of interest and other income, compared with $0.151 million in 2017.
- REIT supplemental measures: FFO available to common stockholders was $8.262 million ($1.16 basic per share); AFFO was $9.727 million ($1.36 basic per share). These are non-GAAP measures and are not substitutes for GAAP earnings or operating cash flow.
- Cash and liquidity: Year-end cash and cash equivalents were $13.050 million, and short-term investments were $120.443 million. Together these totaled approximately $133.5 million. Total assets were $281.466 million; total liabilities were $17.174 million.
- Debt: The company reported no debt outstanding at December 31, 2018. In February 2019, its Operating Partnership issued $143.75 million of 3.75% exchangeable senior notes due 2024; net proceeds were approximately $138.4 million.
- Cash flows: Investing activities used $199.255 million, largely for property purchases, tenant improvements and construction funding, plus short-term investments. Financing activities provided $184.854 million, primarily from common-stock offerings.
- Dividends: 2018 declared dividends were $1.20 per common share and $2.25 per Series A preferred share. The company cautions that distributions are not assured and may be funded from sources other than operating cash flow.
Portfolio, changes, and outlook
- At year-end, the company owned 11 properties across nine states, totaling approximately 1.027 million rentable square feet; all were reported 100% leased, with a weighted-average remaining lease term of about 14.7 years.
- During 2018, it acquired six properties in five new states, adding approximately 391,000 square feet. Reported investment in those acquisitions was approximately $75.8 million. Year-end aggregate investment in the portfolio was $147.9 million, with a further $19.5 million committed for tenant improvements and construction.
- Contractual minimum rent, including specified supplemental rent and management fees, was approximately $25.8 million for 2019 and $463.6 million in total over the disclosed lease schedule. These amounts depend on tenants performing under their leases.
- Management said liquidity and capital sources were adequate for expected requirements, while noting that financing may not be available on acceptable terms. Its strategy is to pursue further acquisitions, fund tenant improvements, and grow rental cash flow; the filing provides no quantitative earnings or acquisition guidance.
- After year-end, the company acquired a California property and an Ohio property under development agreements. It also declared a March 2019 quarterly dividend of $0.45 per common share and $0.5625 per preferred share.
Risks, contingencies, and notable items
- Federal cannabis-law exposure: Cannabis remained illegal under federal law. The Department of Justice rescinded prior enforcement guidance in January 2018, and the company described the resulting enforcement risk as uncertain. Some leases permit state-legal adult-use operations, which may carry additional federal risk.
- Tenant and revenue concentration: PharmaCann, Holistic MD, and The Pharm accounted for approximately 39%, 18%, and 16% of 2018 rental revenue, respectively. Tenants generally had limited operating histories; the company expected many to continue incurring losses and potentially to fund rent from sale proceeds or cash on hand.
- Revenue recognition: Because of tenant credit and regulatory uncertainty, the company recorded property revenue on a cash basis rather than recognizing rent on a straight-line basis when collectability was uncertain.
- Development commitments: Construction and improvement funding creates execution, cost, and timing risks. The filing disclosed approximately $19.5 million of additional year-end commitments, as well as subsequent California and Ohio development funding arrangements.
- Other material risks: The focused portfolio is exposed to state-level regulatory changes, tenant defaults, limited re-leasing options, restricted banking and capital access, environmental and water/power constraints, and the company’s ability to maintain REIT status. Management reported no material pending or threatened litigation and no recognized property impairment at year-end.
Investor verification priorities
- Verify tenant rent-payment capacity, license status, and the latest concentration of rental revenue by tenant and property.
- Confirm progress, remaining costs, and lease commencement or rent terms for properties under construction or redevelopment.
- Review the 2019 notes’ exchange, dilution, repayment, and covenant terms, and the company’s post-issuance liquidity and leverage.
- Assess whether operating cash flow supports the common and preferred dividends, rather than relying on financing proceeds or other non-operating sources.
- Track federal and state cannabis-law developments, including the renewal of the federal spending restriction discussed in the filing, and their potential effect on tenants, leases, and REIT qualification.