Innovative Industrial Properties, Inc. (NYSE:IIPR) Q4 2023 Earnings Call Transcript
Innovative Industrial Properties, Inc. (NYSE:IIPR) Q4 2023 Earnings Call Transcript February 27, 2024
Innovative Industrial Properties, Inc. isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).
Operator: Good day. And welcome to the Innovative Industrial Properties Incorporated Fourth Quarter and Full Year 2023 Earnings Call. All participants will be in listen-only mode. [Operator Instructions] After today’s remarks, there will be an opportunity to ask questions. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Brian Wolfe, General Counsel. Please go ahead.
Brian Wolfe: Thank you for joining the call. Presenting today are Alan Gold, Executive Chairman; Paul Smithers, President and Chief Executive Officer; David Smith, Chief Financial Officer; Catherine Hastings, Chief Operating Officer; and Ben Regin, Chief Investment Officer. Before we begin, I’d like to remind everyone that statements made during today’s conference call may be deemed forward-looking statements within the meaning of the Safe Harbor of the Private Securities Litigation Reform Act of 1995 and actual results may differ materially due to a variety of risks, uncertainties and other factors. Please refer to the documents filed by the company with the SEC, specifically the most recent reports on Forms 10-K and 10-Q, which identify important risk factors that could cause actual results to differ from those contained in the forward-looking statements.
We are not obligated to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. In addition, on today’s call, we will discuss certain non-GAAP financial information, such as FFO, normalized FFO and adjusted FFO. You can find this information together with reconciliations to the most directly comparable GAAP financial measure in our earnings release issued yesterday, as well as in our 8-K filed with the SEC. I will now hand the call over to Alan. Alan?
Alan Gold: Thank you, Brian, and welcome, everyone. We are pleased to discuss our results for the full year 2023 and recent activity as we enter into our eighth full year of operations. The company performed well in 2023 and has continued to execute year-to-date, demonstrated by one, annual AFFO per share growth of 7%. Two, increasing our annual dividends declared each year since inception in 2016; three, committing capital totaling $119.5 million during 2023. Four, executing new leases and LOIs to release five properties, representing over $140 million of invested capital and five, further enhancing our liquidity position and strong balance sheet with the closing of a new $45 million revolving credit facility. For the year, IIP generated total revenues of $310 million and adjusted funds from operations of $256 million, increases of 12% and 10% over 2022, respectively.
I would note that these growth results were achieved during a time when we strategically determined to reduce our investigate increase cost of capital. That financial performance allowed us to continue to grow our dividend. With $7.22 of common stock dividends declared over the course of 2023. Annual dividends increasing each year since inception. Our most recent dividend declared in Q4 of $1.82 per share was at the midpoint of our Board's target dividend payout range of 75% to 85% of AFFO. We have one of the strongest and most experienced teams of real estate professionals in the cannabis industry, a high-quality portfolio and a conservative and flexible balance sheet with a 12% debt to total gross assets. No variable rate debt, no debt maturities until May 2026.
We further enhanced our balance sheet position during Q4 with introduction of a revolving credit facility and then recently upsized that facility earlier this month, which David will touch on further. On the investments front, we are very pleased with our execution on releasing initiatives as well as the opportunities we are seeing to selectively close on new investments, which Ben will discuss in more detail. From a regulatory perspective, as we noted in our prior call, we continue to follow closely the potential rescheduling of cannabis from Schedule 1 to Schedule 3 under the Controlled Substance Act. Of course, there are significant benefits to this, the most important of which, from our perspective, is the potential lifting of the confiscatory 280e federal taxes imposed on regulated cannabis operators, and Paul will discuss our thoughts in more detail.
I will now turn the call over to Paul to discuss licensing, regulatory and industry dynamics. Paul?
Paul Smithers: Thanks, Alan. Licensing. Before discussing overall market developments, I'd like to provide an update on the properties leased or previously leased to Parallel, Green Peak and Kings Garden. As we have noted in the past, and I think it is worth repeating here, we are of course first and foremost focused on maximizing the value of each of our properties and having tenants with strong teams that can manage their businesses successfully through the inevitable ups and downs with the industry. As we discussed in detail previously, Green Peak was placed into receivership in March of last year, and we subsequently regained possession of the Summit Building, a cultivation and processing facility under redevelopment, and three small retail locations.
The receiver also decided to turn back the Harvest Park cultivation and processing facility to us, but we expect the buyer of the remaining Green Peak receivership estate to assume the leases for the other three retail locations with no changes to terms. As you also know, we filed actions against Parallel for possession and damages at our Texas and Pennsylvania properties and regained possession of those two properties in March and October of last year, respectively. We are actively exploring all options for these properties. With respect to the Pennsylvania property, a consent order was issued in October awarding us damages of $15.5 million, of which we collected $1.7 million in Q4. And in late September, as we previously disclosed, we regained possession of the remaining four properties previously occupied by Kings Garden.
As Alan noted, we are pleased with our releasing efforts to date for these properties, and Ben will provide further detail in his prepared remarks. Market Developments. Growth of the overall cannabis industry in the US continues to remain strong, with BDSA projecting cannabis sales to increase approximately 10% in 2024. BDSA estimates US cannabis sales were $29.5 billion in 2023, representing approximately a 12% growth from 2022. Although unit pricing for regulated cannabis products has been under pressure in certain states at the wholesale level for some time now, indoor cannabis cultivation continues to command significant, sustained premiums versus greenhouse and outdoor counterparts. Several factors affect unit pricing, including basic supply-demand dynamics, lack of meaningful enforcement in certain states on illicit non-licensed cannabis sales by state and local law enforcement authorities, taxation and general macroeconomic conditions.
From a state market perspective, we continue to see divergence in performance and dynamics with new markets experiencing high growth, while some mature markets become increasingly competitive, especially after an extended period of price compression and the aforementioned challenges in competing with the illicit markets. For example, 2023 saw strong rollouts for adult-use sales in Missouri and Maryland and Ohio legalized adult-use in November. With sales expected to commence this year in Ohio expected to be one of the fastest-growing markets in the near future. On the flip side, while New York introduced its adult-use program more than a year ago, it remains constrained by limited retail availability and a thriving illicit market, though there are efforts in the state to ramp up enforcement efforts.
For additional perspective, BDSA put out recent estimates that illicit competition drives more than three quarters of total sales in the New York market, and that there were roughly 50 active adult-use retailers in the state earlier this month versus over 2,000 illicit retailers. Capital availability. Another continuing theme from our prior calls is the impact that the tightening of financial conditions has had on capital availability for the cannabis industry. As with other industries, the cost of capital and capital availability have fundamentally changed for cannabis operators over the course of the past few years. With Viridian Capital Advisors reporting that both U.S. operator, capital raising, and mergers and acquisitions activity in 2023, were at their lowest levels since before 2018, the funding environment continues to be challenged right now.
That said, we've seen a significant balance in many publicly traded MSO stock prices since the announcement by the Department of Health & Human Services that are recommended to the DEA a reclassification of cannabis from Schedule I to Schedule III. Federal legislation. On the Federal legislation front, we are closely watching for progress on the DEA's evaluation of the HHS recommendation to reschedule cannabis to Schedule III. Most importantly, such a reclassification is expected to end the 280E tax treatment, which has imposed an extreme unsustainable tax burden on regulated operators for years. We expect such a change to be a great win and potentially significant positive catalysts for the industry, immediately providing meaningful improvement in many operators' financials.
To give you a sense of the magnitude for this potential adjustment, a recent Viridian analysis estimated that removal of 280E earns could reduce the 12 largest publicly-traded operators collective tax burden by $700 million annually, providing for a rational tax structure for these operations, many of which faced effective tax rates of well over 100% under the 280E regime. I'd like to now turn the call over to Ben to discuss our portfolio and leasing activity in the fourth quarter and into 2024. Ben?
Ben Regin: Thanks Paul. For my prepared remarks, I plan to highlight our leasing progress for our vacant and under-development assets. We took back possession of our Summit property in Michigan in March of 2023, while it was under redevelopment. We signed an LOI for the asset in Q3, less than six months after repossession and executed a lease in Q4. We anticipate completing redevelopment of the 201,000 square foot project in Q4 of this year and are looking forward to our new tenant moving in and activating the building. In addition to the lease for the Summit building, we've also executed LOIs for both our McLane and 19th Avenue properties in Southern California. We are working diligently through lease negotiations on these assets and will provide updates as we progress.
These two assets, along with Summit, represent over $120 million of invested capital and we are very pleased with the demand we saw for the space and the speed in which we were able to get each asset under LOI or lease. Also, as Paul noted, Green Peak is expected to move out of our Harvest Park property on March 1. We saw significant interest in the asset since the announcement of Green Peak's departure and executed a letter of intent earlier this month ahead of Green Peak's move out date. Lastly, we signed a lease last month for one of our three vacant retail assets in Michigan. We are continuing to market to lease the remaining two retail assets, as well as our North Anza and Del Sol assets in Southern California, a total of which is less than 1% of our total invested capital.
Regarding our San Bernardino property, as noted on previous calls, we are exploring a potential mixed-use development of the property, and we'll continue to provide updates on progress on future calls. For our land site in San Marcos, Texas, we continue to explore options for that site, where vertical construction has not yet commenced. And at our Pittsburgh, Pennsylvania asset, Parallel wound down its operations in late October, and we were awarded a consent judgment for possession and damages at that time, as Paul noted, and collected about $1.7 million on that judgment in December. As we now have control of the asset, we are actively exploring leasing options for the property. Regarding new investment activity, we have continued to selectively close on new opportunities, supporting our tenant partners and their growth initiatives in key markets.
As we previously reported, we amended our lease with Goodness Growth in New York in Q4, providing additional funding to complete the development of the expanded cultivation and processing facility and increasing rent accordingly. As Goodness Growth previously disclosed, and we noted in our last call, the company is exploring the sale of its New York operations, including the operations at this facility. We also executed a lease amendment with PharmaCann to provide additional construction funding of $16 million for our New York asset as PharmaCann executes on its strategy to expand production capacity after being awarded an adult-use production license late last year. We are pleased with the demand we are seeing for our assets across markets and the significant leasing progress we have made in the last year, while also continuing to source attractive new investment opportunities, which we will continue to pursue on a very selective, disciplined basis.
With that, I'll turn it over to Catherine. Catherine?
Catherine Hastings: Thanks, Ben. For this call, I'll describe our property portfolio and tenant roster in addition to a rent collection statistics and updates on our development projects. As of December 31, we owned 108 properties across 19 states, comprising 8.9 million rentable square feet, including 1.4 million square feet under development or redevelopment. Of these 108 net properties, 103 properties are included in our operating portfolio, which was 96% leased at year-end with a weighted average remaining lease term of approximately 14.6 years. Our portfolio continues to be well diversified with no one tenant representing more than 16% of our annualized base rent and no state representing more than 15% of our annualized base rent.
We have relationships with some of the largest and most experienced operators in the industry, with our leased operating portfolio comprised of 90% multistate operators and 62% leased to public company tenants. The total amount of capital invested and committed across our operating portfolio equates to $275 per square foot, which we believe remains significantly below replacement cost. Moving on to rent collection. We collected 100% of contractually due base rent and property management fees from our operating portfolio in Q4. Rent collected for the quarter included approximately $800,000 of security deposits applied for the payment of rent in connection with an amendment with forefront at one of our Illinois properties. As we indicated in the past, this property has been under development since August of 2021 and has experienced significant delays to get permanent power delivered to the building, which is needed to get it operational.
We recognized this hardship. And in January this year, restructured 4Front Illinois rental obligation to reduce the base rent due through September 2024 and increase their obligation thereafter, allowing for better alignment of 4Front’s future Illinois rental obligations with their ability to generate revenue from the property, while also extending the term of all four leases we have with 4Front. We're also pleased to report that the building did finally get permanent power in January, and we look forward to this project's completion in the near future. Q4 rent collection included approximately $700,000 of the $1.7 million collected in December 2023 from Parallel pursuant to a consent judgment awarded in our favor, and applied to rent due from Parallel for October 2023 at one of our Pennsylvania properties, which Parallel vacated on October 31st.
As David will describe next, the full $1.7 million from Parallel, increased our revenue for the fourth quarter, but only $700,000 impacted our Q4 rent collection statistics. Overall, for the full year 2023, we collected 98% of our contractual rent on our operating portfolio. As for the first two months of 2024, we collected 100% of contractually due base rent and property management fees from our operating portfolio. We also continued to fund draws for improvement allowances or construction development to our operators under our leases. As we previously noted on prior calls, these improvements are critical for the efficient production of quality cannabis products at scale. In Q4 of 2023, we funded $21 million for building improvements and construction activities at our properties.
Recently, several projects received their operational status, including Battle Green in Ohio, with several other projects projected to complete this next quarter. And with that, I'll turn it over to David. David?
David Smith: Thank you, Catherine. For the fourth quarter, we generated total revenues of $79 million, a 12% increase from Q4 of last year. The increase was driven primarily by an increase in tenant reimbursements versus the prior period, as well as activity in prior periods for the acquisition and leasing of new properties, additional funding of building improvements provided to tenants at certain properties that resulted in base rent increases and contractual rental escalations. The $79 million of revenue for the fourth quarter included approximately $0.8 million of secured deposits applied for payment of rents or $0.03 per share and $1.7 million or $0.06 per share received as partial payment from the consent judgment against Parallel for its failure to pay rent at one of our Pennsylvania properties previously leased to Parallel.
For the three months ended December 31, 2023, we recorded net income attributable to common stockholders of $41 million or $1.45 per share. Adjusted funds from operations for the fourth quarter was $64 million or $2.28 per share, an increase of 8% compared to the fourth quarter of 2022, driven by increased tenant reimbursements, revenue generated by properties acquired in prior periods, contractual rent escalations and revenue earned on additional CapEx investments at existing properties. AFFO for the fourth quarter was down $0.01 per share versus the third quarter AFFO of $2.29, with a decrease primarily due to our taking back the remaining four properties at Kings Garden occupied until late September. Regarding Kings Garden, as mentioned on last quarter's call, results in the third quarter included $1.7 million or $0.06 per share of rent from Kings Garden applicable to those four properties, which was partially offset by $0.4 million in payments made by Kings Garden in the fourth quarter, pursuant to a consent judgment issued in our favor.
On January 12, we paid a quarterly dividend of $1.82 per share to common stockholders of record as of December 29, an increase of $0.02 per share versus the third quarter dividend of $1.80. As Alan noted, our dividend remained covered by our AFFO during the quarter with a payout ratio of 80%, which is in line with the Board's targeted payout ratio of 75% to 85% of AFFO. Turning to the balance sheet. At year-end, we had approximately $2.6 billion in total gross assets and roughly $304 million in fixed rate debt. Our debt outstanding as of today consists solely of $300 million in unsecured bonds not maturing until May 2026 with the holders of the remaining $4 million of exchangeable senior notes, having exchange their notes in full, Earlier this month for a mix of cash and common stock or receive cash payment at maturity.
We continue to maintain credit metrics that are among the best in the entire publicly traded REIT industry with a debt-to-gross assets ratio of less than 12% and a debt service coverage ratio in excess of 16x. On the liquidity front, we ended the fourth quarter with over $175 million of total liquidity and comprised of our cash, short-term investments and availability under our revolving credit facility. We closed on this credit facility last October, which, at that time, was a $30 million three-year facility. I'm pleased to report that just this month, we were able to increase our capacity by $15 million to provide us $45 million in total availability. We are well positioned as we continue to maintain a conservative and low leverage balance sheet, generate positive free cash flow and have now added another liquidity option for the company with the closing of this credit facility in the fourth quarter.
Finally, as a result of the investment activity that Ben mentioned, we opportunistically tapped our ATM program on a limited basis, issuing 101,000 shares of common stock for $9.6 million in net proceeds. With that, I will turn it back to Alan. Alan?
Alan Gold: Thanks, David. I'd like to note the following and closing. Now, into our eighth year of operations. I'm proud of what our team of dedicated professionals has accomplished over that time. With our property footprint, team expertise balance sheet position and strategic focus, I believe we are well positioned for the journey ahead, serving a dynamic industry with a continued long-term growth trajectory. With that, I'd like to open it up to questions. Operator, could you please open the call up for questions.
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