REITs Expect To See Their Money Grow Along With Marijuana

Rows of cannabis plants grow in the twenty thousand square foot greenhouse at Vireo Health's medical marijuana cultivation facility, August 19, 2016 in Johnstown, New York.  (Photo by Drew Angerer/Getty Images)

Marijuana industry insiders agree that it isn't easy to make money on the cultivation side of the business anymore, but that isn't stopping the money that is flooding into the real estate side of the business. According to New Frontier Data and Viridian Capital Partners, cultivation and retail was the top sector for capital raises with $478 million of private cannabis investment.

Marijuana REITs are multiplying as real estate professionals believe it is easy money to build a grow facility, use the latest technology to make the crop yield as efficient as possible, bring in someone else to actually grow the marijuana (so they don't run afoul of the law) and then collect a nice rent from the cultivator that is selling tons of pot.

The problem with this equation is that marijuana is now trading like a commodity with prices mostly falling as supply has outpaced demand. Indoor grow facilities are expensive to operate compared to greenhouses (a combination of indoor and outdoor) or outdoor grows. However, in some local markets, the weather doesn't cooperate and indoor grows are the only solution.

Innovative Industrial Properties (IIP) was first to list on the NYSE and the stock is down 7% year-to-date since going public in December. Shares were priced at $20 and have pretty much stayed below that price since then and were recently trading at $16.89. The stock does pay a dividend and is currently yielding 1.7%. Part of the reason for this success is that IIP had already signed its first client as a part of the deal. PharmaCann is paying IIP $319,580 a month in rent and a property management fee of $105,477 per month. Yet, they are located in the challenging New York market where the program is growing but still struggling.

They also made an acquisition in the Maryland market in May for $8 million, with an additional $3 million owed upon completion of certain milestones. The tenant, Holistic Industries, will pay $1.2 million per month to lease the facility and has only just started to grow its plants. IIP now has a market cap of $58 million.

Last month, Atlantic Alliance Partnership (AAP) merged with Kalyx Development in a deal valued at $60 million. The company will focus on owning and operating real estate facilities that will lease to cultivators. The new company will be called Kalyx Properties. Kalyx had been a private real estate company that is a pioneer in the cannabis industry. They own and operate approximately 653,000 square feet of properties in Arizona, Colorado, Oregon and Washington and they have top tenants like Medicine Man, Dixie Brands and Golden Leaf. Yet, a review of their properties shows that there is still plenty of space for rent in Oregon and Washington. By merging with AAP, they have become a publicly traded company like IIP.

The latest entry to the green field is Pacific Century Holdings, which announced a $50 million real estate investment fund that will pursue the same strategy. It is billed as being an “investment vehicle capitalizing on the scarcity of real estate for the cannabis industry.” But actually, there seems to be plenty of real estate. While certain locations for dispensaries may be challenging, most states that have legalized medical marijuana usually have some economically stressed area that is willing to accommodate a grow facility.

There is another new player called Doyen Elements, which initially filed as AdvantaMeds Solutions Fund I and has hopes of being listed on the New York Stock Exchange. They too plan to lease real estate properties and enter into joint ventures with established legal cannabis companies. They say they have gone above and beyond IIP with more experience in real estate and cannabis management. They don't have any revenue just yet but have entered an agreement to acquire controlling interests in 16 business entities. They do not plan to touch the plant.

They did acquire a 104,000-square foot industrial space in Pueblo, CO, in a former Pepsi Bottling plant. The plan is to build out the facility into a 234,000-square-foot cultivation site to lease to a cannabis tenant. It could potentially produce up to 600,000 pounds a year. They are planning on marijuana being priced at around $700-$750 a pound when the facility is live and they hope to earn $450 million per year in gross. Chief Executive Officer Geoff Thompson said they are projecting it will actually bring in $110 million-$120 million per year to the company. The current average price per pound per cannabis benchmarks for the first quarter of this year is $1,613.

One of the biggest problems with these new REITs is that the cost of the big build-out is high. Speaking of pending deals in Rhode Island and Massachusetts, Thompson said, “They have the licenses, but they don't have the ability to finance anything large scale on a regional basis.” He says his group has brought this expense down and can do a complete build-out of 100,000 sq. ft. at between $7 million-$8 million, while IIP is spending $15 million.

However, the big processors that are buying their pot in large quantities are getting discounts when they buy their product. They are sometimes paying $300-$500 a pound, which is a far cry from the spot index price. The cultivators generally say they can break even at $500-$700 a square foot cost but below $500, they lose money. This dynamic can't continue for long periods of time before the cultivators either go out of business or sell to another large well-funded party.

In fact, many cultivators are already selling their properties because they are finding they aren't making the money they thought they would. Or they are finding that there are better places within the industry to make money. According to Viridian Capital Advisors, the average number of deals in cultivation and retail at this time were between four and six in 2016 and they have mushroomed to between 17 and 21 deals in 2017.

The current administration is very unfriendly towards the cannabis industry and while some have taken the stance of “the genie's already out of the bottle,” it hasn't curtailed the pressure the Department of Justice is putting on anyone associated with cannabis. Stories are growing of long-time bank accounts being closed and ancillary businesses coming under pressure. The REITs seem like a great place for wary investors, but they may find that they will need to be very patient as the market gets flooded with cultivators.

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