Innovative Industrial Properties, Inc. — Q2 2023 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2023. Dollar amounts are in millions unless otherwise noted. The company is an internally managed REIT that owns specialized properties leased on a triple-net basis to state-licensed cannabis operators.
Business context and portfolio
- Owned 108 properties in 19 states, with approximately 8.9 million square feet, including approximately 1.6 million square feet under development or redevelopment. The 103-property operating portfolio was 99.9% leased, with a 14.9-year weighted-average remaining lease term.
- Reported rent collection of approximately 97% for Q2 and 98% for the first half of 2023. These figures include application of security deposits; collection excluding those applications is not clearly stated.
- Five tenants accounted for about 47% of Q2 rental revenue. PharmaCann was the largest at 15%.
Financial performance
| Metric | Q2 2023 | Q2 2022 | First half 2023 | First half 2022 |
|---|---|---|---|---|
| Total revenue | $76.5 | $70.5 | $152.5 | $135.0 |
| Operating income | $43.4 | $44.1 | $86.8 | $84.0 |
| Net income | $41.3 | $40.2 | $82.4 | $75.3 |
| Net income attributable to common stockholders | $40.9 | $39.9 | $81.7 | $74.6 |
| Diluted EPS | $1.44 | $1.42 | $2.87 | $2.75 |
| Operating cash flow | Not provided for quarter | Not provided for quarter | $126.4 | $122.0 |
| FFO per diluted share | $2.04 | $1.97 | $4.08 | $3.83 |
| Normalized FFO per diluted share | $2.07 | $1.98 | $4.12 | $3.85 |
| AFFO per diluted share | $2.26 | $2.15 | $4.51 | $4.19 |
- Q2 operating margin was approximately 56.8%, versus 62.6% a year earlier; net margin was approximately 54.0%, versus 57.0%. For the first half, operating margin was approximately 56.9% versus 62.2%, and net margin was approximately 54.0% versus 55.7%.
- At June 30, cash and cash equivalents were $92.6; restricted cash was $1.5; and investments were $72.7. Total assets were $2,396.3 and stockholders’ equity was $1,953.2.
- Debt carrying value was $300.2: $295.8 for the 5.50% notes due 2026 and $4.4 for 3.75% exchangeable notes due February 2024. Total principal was $304.4. Management said the company complied with the 2026 notes’ financial covenants.
- First-half investing cash outflow was $18.4 and financing cash outflow was $102.5. Cash, cash equivalents and restricted cash increased $5.5 to $94.1. Common dividends declared were $1.80 per share in each quarter; the company paid $101.2 of common dividends and $0.7 of preferred dividends during the first half.
Material changes versus comparable periods
- Revenue rose 8% in Q2 and 13% in the first half. Growth primarily came from previously acquired properties, rent escalations and lease amendments; first-half acquisitions contributed approximately $1.9 of rental revenue growth.
- Q2 operating income fell about $0.7 despite higher revenue, as total expenses increased 25% to $33.0. Property expense rose $3.3, G&A rose $1.9, and depreciation and amortization rose $1.5. First-half operating income increased 3% while total expenses rose 29%.
- First-half net income increased 9%. Higher interest and other income, largely from higher rates on investments and construction-loan interest, helped offset higher operating costs.
- First-half operating cash flow increased $4.4. Investing outflow was substantially lower than in 2022, when real estate investment funding was greater. The 2023 financing outflow reflects dividends; the prior-year period included $352.0 of net common-stock proceeds.
- Real estate at cost increased to $2,341.7 from $2,204.7 at year-end 2022, while net real estate held for investment rose to $2,172.0. The company acquired two properties for $35.2 and funded approximately $111.5 of construction and improvement draws in the first half.
Outlook, risks, contingencies and unusual items
- The filing provides no specific earnings or investment guidance. Management said cash on hand, operating cash flow and potential capital-market funding were expected to meet liquidity needs, but cautioned that funding may not be available on acceptable terms. The company had not sold shares under its $500 million ATM program as of June 30.
- Management cited tenant pressure from inflation, labor and supply constraints, falling cannabis product prices, limited operator financing, and weaker capital-market access. Cannabis remains illegal under federal law, creating regulatory and tenant-credit uncertainty.
- Rent collection and reported revenue were supported by security-deposit applications and rent amendments. Non-collected rent during Q2 was approximately $2.2, primarily associated with Parallel and Green Peak; first-half non-collection was approximately $3.6, including Green Peak, Vertical affiliates and Parallel.
- Kings Garden defaulted in 2022. The company received $15.6 in partial settlement payments and was investigating approximately $9.6 of project costs for potential overpayments; it said a possible loss could not yet be estimated. Arbitration related to the settlement was scheduled for August 2023.
- Parallel and Green Peak defaults led to litigation and property-possession proceedings; a receiver was appointed over substantially all of Green Peak’s assets. A federal securities class action and several derivative actions were also pending. The company could not predict their outcomes and had not accrued amounts for these lawsuits.
- A March 2023 transfer of four California properties to a buyer, alongside a $16.1 secured loan, did not qualify as a completed sale under GAAP. The properties remained on the balance sheet, and related receipts, including $0.5 of interest received, were recorded as a liability pending sale-recognition criteria.
- Disclosure controls were deemed ineffective because of a material weakness in review and approval of funding disbursements for property improvements. Management reported remediation efforts underway; the weakness was not yet considered remediated. Management stated that the filed financial statements had no material misstatements.
- No impairment losses were recognized in the first half. The company noted that its leases generally have fixed rent increases, which may not keep pace with inflation.
Important facts for investors to verify
- Whether tenant rent collections improve without continued reliance on security deposits, and the financial condition and lease status of Parallel, Green Peak, Kings Garden and other challenged tenants.
- Progress and cost exposure for redevelopment projects, improvement allowances, and the disputed Kings Garden construction costs.
- Whether the material weakness in funding-disbursement controls is remediated and operating effectively after testing.
- Outcomes and potential costs of the class action, derivative actions, tenant disputes and other litigation.
- Ability to fund dividends, investment commitments and the February 2024 exchangeable-note maturity while preserving liquidity and covenant compliance.
- How the $16.1 seller-financed loan and property transfer are ultimately accounted for, and whether sale-recognition conditions are met.