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Intrinsic Value is all-important and is the only logical way to evaluate the relative attractiveness of investments and businesses.
Good day everyone and welcome to the Innovative Industrial Properties Incorporated Fourth Quarter 2017 Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions] After today’s presentation, there will be an opportunity to ask questions. [Operator Instructions] Please also note that today’s event is being recorded.
At this time, I would like to turn the conference call over to Brian Wolfe, General Counsel. Sir, please go ahead.
Thank you for joining the call. Presenting today are Alan Gold, Executive Chairman; Paul Smithers, President and Chief Executive Officer; and Catherine Hastings, Chief Financial Officer.
Before we begin, I would like to remind everyone that statements made during today’s conference call maybe 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.
For a detailed discussion of some of the ongoing risks and uncertainties of the Company’s business, I refer you to the news release issued yesterday and filed with the SEC on Form 8-K, as well as the Company’s reports filed periodically with the SEC. The Company disclaims any intention or obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.
Before I hand the call over to Alan, I want to mention that we have limited time for the call today, but we will answer as many questions as we can after our prepared remarks. Alan?
Thank you, Brian, and welcome everyone. Today, we get a chance to review and share our financial results for the fourth quarter and full year 2017, and provide our updated perspective on the business and the industry from our last call in August.
Overall, we are pleased with the execution on our business plan during our first full year of operations since going public and beginning real estate operations in December 2016. Having acquired four additional properties and committed substantially all of the capital we raised from our IPO and our subsequent Series A preferred stock offering in October of 2017.
At year end, we owned five properties in four states, totaling approximately 617,000 square feet, which were 100% leased on a long-term basis to high quality licensed, medical-use cannabis operators. Our initial blended yield on these properties is 15.8% with each lease providing minimum annual escalations ranging from 3.25% to 4% with a weighted average remaining lease term of nearly 15 years as of year-end.
Our fourth quarter was very active in terms of acquisitions. In December, we closed on a sale-leaseback transaction for a 358,000 square-foot medical-use cannabis cultivation and processing facility with the farm in Arizona and closed on two other sale-leaseback transactions with Vireo in the state of New York and Minnesota in October and November. Paul will provide more details regarding these transactions and the new additions to our tenant roster.
We also declared our third consecutive quarterly common stock dividend of $0.25 per share to stockholders of record as of December 29, 2017, representing a 67% increase over third quarter 2017 dividend of $0.15 per share. After having generated $0.67 per diluted share and adjusted funds from operations for the year, truly a remarkable achievement for such a young company. Now, Catherine will provide more detail regarding our financial results.
As we discussed in our last call, the medical-use cannabis industry is constantly evolving, including the strong growth of existing state markets and the rollout of new programs passed to numerous states by popular vote or legislation in recent years. Paul will provide further perspective on these changes and other industry trends in our call today in addition to discussing in further detail our properties, individual state markets, tenants and pipeline.
Now, this is still a nascent industry that is witnessing amazing growth with state regulated medical-use cannabis markets now comprising a large majority of the United States. We are very optimistic about the future of this industry and our ability to deliver results for our stakeholders and enduring value to our tenant partners, by providing tailored real estate solutions that meet key operational and capital needs.
With that, I’d like to turn the call over to Paul. Paul?
Thanks, Alan. As Alan alluded to this is a rapidly evolving industry and we’ll try to provide as effective an overview as we can with the short time we have today focusing on four main topics; one, the current regulatory environment; two, the growth and evolution of the medical-use cannabis market in the United States generally; three, an update on the New York, Arizona, Maryland, Minnesota markets and our tenants; and finally our pipeline.
First, regarding the current regulatory environment. As you all know there continues to be much discussion about a reevaluation of the federal government's enforcement posture as it relates to the Canada’s industry. To summarize the current status, cannabis remains a Schedule 1 Controlled Substance, which generally prohibits all cannabis use and cannabis related commercial activity in the United States.
That said Congress has enacted spending bills since 2014 with a provision that has been interpreted by courts as preventing the Department of Justice from using funds to interfere with the implementation of state medical-use cannabis laws. Their provision was again included in the congressional spending bill enacted on March 23rd, which carry through September 30 of this year.
While we are pleased to see the Congress has continued to move in the direction that clearly represents the will of the people as it serves, we continue to monitor federal government positions closely and are cautiously optimistic that the executive branch of the federal government will do the same.
In addition, there are numerous other initiatives taken by Congress, including the establishment of the bipartisan Congressional Cannabis Caucus in 2017 and the introduction of a number of bills in Congress in favor of various forms of cannabis legalization at the federal level. Onto a general update of the medical-use cannabis markets nationwide, the industry continues to move forward with tremendous velocity.
States that have legalized medical-use cannabis by popular through vote or legislative process now comprised a majority of U.S. with over 200 million residents, including an estimated 2.5 million people having used or being registered to use legalized medical cannabis.
Medical-use cannabis continues to pull with 90% plus popular support in the United States and the cannabis industry is expected to continue to be a leading driver for U.S. Jobs and Tax Revenues. In fact, New Frontier Data propjets that the state legal cannabis industry could create over 280,000 jobs and generate $2.3 billion in cannabis specific state taxes by 2020 and states which have already legalized medical-or adult-use cannabis.
Drilling down a bit on current markets in New York, Arizona, Maryland, and Minnesota where our five properties are located, we see tremendous potential in each. As you may recall, we purchased our first New York property in December 2016 and a sale-leaseback transaction with PharmaCann for a 15-year initial term and are all in initial yield of about 17% on a triple net basis.
PharmaCann is a multistate operator with two cultivation facilities and four medical-use cannabis dispensers in Illinois and our cultivation facility in four medical-use cannabis dispensaries in New York. PharmaCann has also been awarded licenses in Massachusetts, Maryland and Pennsylvania. Our New York property is about 127,000 square feet and construction of the facility was completed in mid 2016.
We acquired our second New York property in October of 2017 and a sale-leaseback transaction with Vireo Health for a 15-year initial term at an annual base rent equal to 15% of the sum of the purchase price and available tenant improvement allowances with a 1.5% property management fee and annual basement increases of 3.5% for the term.
Vireo Health is also a multistate operator conducting cultivation, processing and dispensing operations in New York and Minnesota as well as cultivation and processing operations in Pennsylvania. As discussed on our last call, the New York medical-use cannabis program as initially rolled out has been described by many as one of the most restricted and highly regulated.
In response and in order to enable broader access to treatment, New York has taken several positive steps including expansion of the pool of potential recommending health professionals to include nurse practitioners and physician assistants allowing for home delivery of the medicine, the streamlining of the registration process for practitioners and certification process for patients and perhaps most importantly the introduction of chronic pain and PTSD as additional qualifying condition.
Our few market research in consideration of the changes made in the program, the market potential and the estimated overall size of the illicit market in New York of nearly $3 billion has estimated $254 million of sales in New York's legal market by 2021, representing a compounded annual growth rate from 2016 of 48%.
We’re seeing encouraging signs of that accelerating growth and the early stages of the impact of the regulatory changes in New York’s available state level data. Patient count has more than doubled since the addition of chronic pain as a qualifying medical condition a year ago with over 48,000 patients registered as of March 27th of this year.
Now, onto our Arizona property. In December 2017, we entered into a sale-leaseback transaction with the Pharma for a 358,000 square foot industrial and greenhouse facility in Arizona. The lease has a 15-year initial term at an annual base rent equal to 14% of the sum of the purchase price and available tenant improvement allowance subject to an initial partial base rent abatement that expires this month.
There is also 1.5% of property management fee and annual base rental increases of 3.25% for the term. The Pharma is one of the largest wholesalers of medical-used cannabis in the Arizona market, with the highly experienced multidisciplinary management team that is well positioned to grow the Pharma's market share in Arizona and facilitate expansion into other states. Arizona's medical-used cannabis program is further long and it's matured in New York, having commenced medical-use cannabis sales in 2010.
According to the Arizona Department of Health Services, there are over a 150,000 qualifying patients in the Arizona's medical cannabis program as of February 2018, representing an increase of over 30% year-over-year with over 85% of registered patients utilizing medical cannabis to treat chronic pain. Our view expects that growth to continue projecting a nearly 30% compound annual growth rate in total legal cannabis spending from 2016 to 2021 in Arizona.
Now, onto Maryland, in May of 2017, we purchased 9220 Alaking Court in Capitol Heights, a well located property under development at the time of our acquisition. Development was completed in August and the property comprised approximately 72,000 square feet. At the close of the acquisition, we entered into a pure triple net lease with Holistic Industries, one of the only handful of operators in the State of Maryland that have received final licenses for complete vertical integration meeting cultivation, processing and dispensing of medical-used cannabis.
Our initial yield on our agreed investment of $16.9 million excluding closing cost is 15.4% with the three in a quarter fixed rental escalations on $15 million of our investment, over 16 year total initial leased term. The Holistic team brings with the significant years of experience working in the industry including as regulated medical-use cannabis operators in Washington D.C., Holistic secured financing commitments of $9 million in 2017 to support commencement of its operations in Maryland.
Although it's still in its very early stages with the first dispensary is open in late 2017, we’re optimistic regarding the development of the legal medical-use cannabis market in Maryland driven by Maryland's population size and anticipated demand, the inclusion of PTSD in chronic pain among the initial qualifying conditions and the general view from regulators and policymakers that the industry represents an economic development opportunity.
Lastly, on the Minnesota, we acquire the Minnesota property in November 2017 in a sale-leaseback transaction with Vireo Health for a 15 year initial term at an annual base rent equal to 15% of the sum of the purchase price and available tenant improvement allowance. The lease includes a 1.5% property management fee and annual base rental increases of 3.5% for the term.
Vireo is one of two licensed medical cannabis operators in the State of Minnesota, while smaller market that began medical cannabis sales in mid-2015, medical cannabis program in Minnesota has experienced significant and accelerating growth, increasing patient count by over 100% year-over-year to over 8000 actively enrolled patients as of year-end 2017.
Growth in healthcare practitioners has experienced a similar trajectory with over 1,000 healthcare practitioners now approved in the registry system. Similar to New York, Minnesota medical cannabis program was initially rolled out as a highly regulated and restricted program that is gradually expanded the program for treatment of additional medical conditions, including intractable pain and PTSD and most recently autism spectrum disorders and sleep apnea.
Now, onto our acquisition pipeline, we are intensely focused on investing the proceeds from our recent completed follow-on common stock offering in the best opportunities, high quality assets, top tiered tenants with strong balance sheet and management teams in a state where we have confidence in the regulatory environment. In the first quarter, we executed agreements to purchase two properties for a total investment of $10.5 million.
In addition, we executed two nonbinding letters of intent for two properties representing a total expected additional investment of approximately $25 million to $30 million with final amounts determined after we complete our review and improve the level of future tenant improvements at each property. We are also actively evaluate pipeline of approximately $100 million in additional acquisitions spanning numerous states have approved medical-use cannabis programs.
We are also closely monitoring developments in California and are engaged in numerous discussions with high-quality cultivators there. As with any emerging dynamic high growth industry, we're in getting acquisition strategy and criteria accordingly. We are seeing excellent opportunities and our pipeline includes both near-term opportunities and longer-dated investment opportunity.
I will now turn the call over to Catherine, who will walk you through our financial results for the fourth quarter and full year 2017. Catherine?
Thanks Paul, having completed our IPO in December 2016 and having begun real estate operations shortly thereafter with our initial property acquisition in New York, 2017 represents just our first full year of operation. We had total revenues of 2.3 million in the fourth quarter of 2017 and 6.4 million for 2017.
As we noted, rent for our property in Arizona which we acquired in December is subject to an initial partial rent abatement that ends this month, and we acquired both of the Vireo Health properties in the fourth quarter. So, we recognized only a partial quarter of rent from these three properties. We recognized rental revenue for all of our leases on a cash basis.
For the three months ended December 31, 2017, we recorded net income of $284,000. Funds from operations which adds back property depreciation to net loss was 646,000, and adjusted funds from operations which adds back non-cash stock-based compensation was 817,000. For the full year 2017, we recorded a net loss of $395,000, funds from operations of 520,000, and adjusted funds from operations of 2.4 million.
As Alan mentioned on January 16th, we paid our third consecutive quarterly dividend of $0.25 per share to common stockholders of record as of December 29th, which represents a 67% increase over the third quarter common stock dividend of $0.15 per share. And two weeks ago we declared our Q1 2018 dividend of $0.25 per common share, which is payable on April 16th to shareholders of record as of today.
On the capital raising side, in October we raised an additional 14 million in net proceeds through the issuance of 600,000 shares of Series A preferred stock in an underwritten public offering. We then completed an underwritten follow-on public offering of common stock in January raising 79.3 million in net proceeds through the issuance of 3,220,000 shares of common stock, which includes the exercise in fill of the overallotment option granted to the underwriters.
Finally, I would like to note that our financial results were achieved utilizing a very conservative overall capital structure funded entirely with preferred and common equity and no debt.
With that I’ll turn it back to Alan. Alan?
Thanks, Catherine. It has been a very eventful first year as a public company. And we are excited about the opportunities to come. I want to thank the stockholders for your continued support. And we look forward to continuing to execute on our exciting business model by servicing this very promising industry as a long-term real estate and capital provider and to creating sustainable long-term value for our stockholders.
And with that, I’d like to open it up for questions. Operator, could you please open the call up for questions?
Ladies and gentlemen at this we’ll begin the question-and-answer session. [Operator Instructions] And our first question today comes from John Massocca from Ladenburg Thalmann. Please go ahead with your question.
To the extent you can provide it, can you give some color on the $10.5 million of properties under acquisition agreement and the properties under LOI? What are the ballpark kind of numbers for cap rate, lease term, ramp bumps et cetera?
Sure, I mean I think we are very pleased that we were able to maintain our yield requirements on this transactions ranging in the mid teen numbers and with the same sort of lease term and lease structure that Paul described on the acquisitions we acquired in 2017. We continue to see a very strong pipeline of similar type transactions with the same mid-teen type deals with and people are understanding our investment criteria in structures.
I mean kind of that same vein, have you seen pricing maybe for alternative sources of capital for potential tenants, just going to i.e. private loans et cetera? Has that moved rates for that capital moved up giving your appeal of the Cole Memo, there have been a reduced the availability of capital for some of your potential tenants?
One, we are in that market looking for that type of product or sales. I mean we are talking to many of our growers and we are seeing an increased size of our pipeline, which leads us to believe that there is either a more constrained capital in the market in general, and anecdotally we are hearing of that very same thing. I think that also given the success of innovative industrial properties and the fact that we continue to have access to capital that growers are now looking to us as a primary source of growth capital. So, we are benefiting from I think those two situations.
Are there any new markets maybe that are coming into focus particularly as certain states to come to mind, Florida, Pennsylvania are getting farther along and point the other regulatory framework for the medical cannabis programs?
Sure, John this is Paul. So there is definitely five or six stage for looking at that or in the roll up part of the program. You mentioned Pennsylvania, Massachusetts we are looking at Michigan and Florida, Ohio, California. But it was also kind of fun to notice is, there is five states that we will probably have on this November ballot a medical cannabis programs. So, this time next year we will probably looking at these states and probably it’s going to be Oklahoma, Kentucky, South Dakota, Utah, Missouri have a real good chance of having medical programs on the ballot this year. So it’s looking very positive for the market growth.
And then within that your markets that already you are kind of mature from a -- or already have a medical cannabis program, have you seen a move to maybe relax the program? I know you have talked about New York becoming less restrictive, Minnesota has historically become less restrictive, New Jersey just recently announced it's becoming less restrictive it's opening up the program to more conditions in making easier for patients to get into the program. Is that a trend you are seeing kind of beyond maybe the markets I mentioned?
Yes, absolutely. So, with the 90% plus national approval medical cannabis really at the state level and the programs that you mentioned in some of the other states as well, the states we like and our interested in being business and are those states would they have a department of health for a regulatory scheme that really works with the individual market. So, there are hands on they give an idea if the patient count is not where it needs to be there are lot of additional medical conditions, they're add maybe home delivery, maybe they will add different delivery methods like flower or eatable or tropical. So, yes, we're looking at all these states are fully working with the programs and adjusting in it as needed to ensure the patient count. So, that is definitely the trend maybe it's definitely getting more forward looking.
And just to add to Paul's comment there, I think the primary reason for the states regulatory environments working with the growers is not only had to benefit the patients but also to increase tax revenues that these states does provide any.
[Operator Instructions] And ladies and gentlemen, at this time it is showing no additional questions. I would like to turn the conference call back over for any closing remarks.
Well, thank you, and once again I like to thank you all for joining us today on this call, and we look forward to greater success as we move forward.
With that, operator, the call is over. Thank you.
Ladies and gentlemen, that does conclude today's conference call. We do thank you for attending today's presentation. You may now disconnect your lines.