Innovative Industrial Properties, Inc. — 2017 Form 10-K
Reporting period: Fiscal year ended December 31, 2017. The company, incorporated in June 2016, began real estate operations in December 2016; accordingly, the 2016 comparison covers only June 15 through December 31 and is not directly comparable to the full 2017 year. The filing was dated March 29, 2018.
Business context and portfolio
The company is a self-advised REIT focused on acquiring and leasing specialized properties to state-licensed medical-cannabis operators, primarily through long-term triple-net leases. At year-end it owned five properties in New York, Maryland, Arizona and Minnesota, totaling approximately 617,000 rentable square feet. All were leased, with a weighted-average remaining lease term of approximately 14.7 years. Invested capital was $68.3 million, excluding transaction costs; the company reported an estimated average initial yield of approximately 15.8%, including specified rent and management-fee components and potential tenant-improvement reimbursements.
Financial results and liquidity
| Metric | 2017 | 2016 comparison period |
|---|---|---|
| Total revenue | $6.420 million | $0.267 million |
| Rental revenue | $6.302 million | $0.180 million |
| Operating expenses | $6.643 million | $4.713 million |
| Loss from operations | $0.223 million | $4.446 million |
| Net loss | $0.072 million | $4.392 million |
| Net loss attributable to common stockholders | $0.395 million | $4.392 million |
| Operating cash flow | $5.015 million | $1.693 million |
The 2016 loss included $3.707 million of noncash expense for forfeited founder shares. 2017 net loss attributable to common stockholders includes a $0.323 million preferred dividend. Management’s supplemental measures were FFO of $0.520 million ($0.15 per common share) and AFFO of $2.352 million ($0.70 basic and $0.67 diluted per share); these non-GAAP measures are not cash available for dividends.
At December 31, 2017, cash and cash equivalents were $11.758 million, total assets $80.028 million, total liabilities $6.479 million and stockholders’ equity $73.549 million. The company reported no debt outstanding. 2017 cash flows included $38.645 million used in investing activities and $12.385 million provided by financing activities. The company said its liquidity was adequate, while cautioning that funding availability and terms were not assured.
Common dividends declared totaled $0.55 per share for 2017; the fourth-quarter rate rose to $0.25 per share from $0.15. The company also issued 600,000 shares of 9.00% Series A preferred stock in October 2017, receiving approximately $14.0 million net. After year-end, a January 2018 common-stock offering generated approximately $79.3 million net.
Material changes and outlook
- The portfolio expanded from one property at the end of 2016 to five at the end of 2017. Four properties acquired during 2017 represented approximately $38.3 million of investment, excluding transaction costs.
- Cash increased rental revenue as the portfolio grew, but the company remained slightly loss-making under GAAP. The prior-period loss was substantially affected by a one-time noncash founder-share charge.
- At March 28, 2018, the company reported agreements to buy two properties for a total investment of $10.5 million, non-binding letters of intent for two others representing approximately $25 million to $30 million, and roughly $100 million of additional potential acquisitions under review. These opportunities were subject to diligence and closing conditions.
- Management’s strategy is to grow rental income and distributions through acquisitions while maintaining financial flexibility. No specific earnings or acquisition guidance was provided.
Risks, contingencies and unusual items
- Tenant and portfolio concentration: PharmaCann generated approximately 82% of 2017 rental revenue and Holistic approximately 14%. All five tenants were described as start-ups with limited operating histories and not yet profitable; rent payments may depend on sale proceeds or available cash rather than operating cash flow. The company recorded lease revenue on a cash basis because collectability was uncertain.
- Federal cannabis law: Cannabis remained illegal under federal law. In January 2018, the Department of Justice rescinded the Cole Memo; the impact was unclear. The company warned that enforcement could impair tenants, property values, banking access and its business, and could expose the company to legal consequences.
- REIT and tax uncertainty: The company intended to qualify as a REIT beginning in tax year 2017. It identified potential risks involving REIT qualification and the possible application of Internal Revenue Code Section 280E to the company because of its tenants’ activities.
- Capital and distributions: REIT distribution requirements and reliance on external capital may constrain funds for growth. The company cautioned that dividends are not assured and may be funded from sources other than operating cash flow.
- Commitments and reporting: The company had committed an additional $5.0 million for tenant improvements at year-end, principally allowances for the Vireo and Arizona properties. No material company litigation was reported. Management reported effective disclosure controls and internal control over financial reporting; the auditor did not audit internal controls.
Important facts for investors to verify
- Whether tenants are generating sufficient operating cash to meet rent obligations, especially PharmaCann given its concentration of rental revenue.
- Whether the company’s cash-basis rent recognition, collection record and tenant financial condition support reported and expected rental income.
- Developments in federal enforcement, state licensing and cannabis-related banking, and their implications for tenants, property use and REIT tax status.
- How the January 2018 equity proceeds were deployed, and whether acquisitions close on terms consistent with management’s stated investment returns.
- Whether dividends are supported by recurring operating cash flow rather than offering proceeds, borrowing or other non-operating sources.