Item 1.
Financial
Statements
Innovative Industrial Properties, Inc.
Condensed Consolidated Balance Sheets
(Unaudited)
(In thousands, except share and per
share amounts)
|
|
March 31,
2019
|
|
|
December 31,
2018
|
|
Assets
|
|
|
|
|
|
|
|
|
Real estate, at cost:
|
|
|
|
|
|
|
|
|
Land
|
|
$
|
22,563
|
|
|
$
|
20,475
|
|
Buildings and improvements
|
|
|
123,927
|
|
|
|
109,425
|
|
Tenant improvements
|
|
|
18,784
|
|
|
|
14,732
|
|
Construction in progress
|
|
|
666
|
|
|
|
6,298
|
|
Total real estate, at cost
|
|
|
165,940
|
|
|
|
150,930
|
|
Less accumulated depreciation
|
|
|
(4,789
|
)
|
|
|
(3,571
|
)
|
Net real estate held for investment
|
|
|
161,151
|
|
|
|
147,359
|
|
Cash and cash equivalents
|
|
|
59,224
|
|
|
|
13,050
|
|
Short-term investments, net
|
|
|
197,729
|
|
|
|
120,443
|
|
Other assets, net
|
|
|
2,304
|
|
|
|
614
|
|
Total assets
|
|
$
|
420,408
|
|
|
$
|
281,466
|
|
Liabilities and stockholders’ equity
|
|
|
|
|
|
|
|
|
Exchangeable senior notes
|
|
$
|
133,196
|
|
|
$
|
―
|
|
Tenant improvements and construction funding payable
|
|
|
3,201
|
|
|
|
2,433
|
|
Accounts payable and accrued expenses
|
|
|
1,224
|
|
|
|
1,968
|
|
Dividends payable
|
|
|
4,750
|
|
|
|
3,759
|
|
Rent received in advance and tenant security deposits
|
|
|
9,661
|
|
|
|
9,014
|
|
Total liabilities
|
|
|
152,032
|
|
|
|
17,174
|
|
Commitments and contingencies (Notes 6 and 11)
|
|
|
|
|
|
|
|
|
Stockholders’ equity:
|
|
|
|
|
|
|
|
|
Preferred stock, par value $0.001 per share, 50,000,000 shares authorized: 9.00% Series A cumulative redeemable preferred stock, $15,000 liquidation preference ($25.00 per share), 600,000 shares issued and outstanding at March 31, 2019 and December 31, 2018
|
|
|
14,009
|
|
|
|
14,009
|
|
Common stock, par value $0.001 per share, 50,000,000 shares authorized: 9,806,194 and 9,775,800 shares issued and outstanding at March 31, 2019 and December 31, 2018, respectively
|
|
|
10
|
|
|
|
10
|
|
Additional paid-in capital
|
|
|
265,733
|
|
|
|
260,540
|
|
Dividends in excess of earnings
|
|
|
(11,376
|
)
|
|
|
(10,267
|
)
|
Total stockholders’ equity
|
|
|
268,376
|
|
|
|
264,292
|
|
Total liabilities and stockholders’ equity
|
|
$
|
420,408
|
|
|
$
|
281,466
|
|
See the accompanying notes to the condensed
consolidated financial statements.
Innovative Industrial Properties, Inc.
Condensed Consolidated Statements of
Income
(Unaudited)
(In thousands, except share and per
share amounts)
|
|
For the Three Months Ended
March 31,
|
|
|
|
2019
|
|
|
2018
|
|
Revenues:
|
|
|
|
|
|
|
|
|
Rental
|
|
$
|
6,576
|
|
|
$
|
2,677
|
|
Tenant reimbursements
|
|
|
247
|
|
|
|
87
|
|
Total revenues
|
|
|
6,823
|
|
|
|
2,764
|
|
Expenses:
|
|
|
|
|
|
|
|
|
Property expenses
|
|
|
247
|
|
|
|
87
|
|
General and administrative expense
|
|
|
1,918
|
|
|
|
1,477
|
|
Depreciation expense
|
|
|
1,218
|
|
|
|
476
|
|
Total expenses
|
|
|
3,383
|
|
|
|
2,040
|
|
Income from operations
|
|
|
3,440
|
|
|
|
724
|
|
Interest income
|
|
|
993
|
|
|
|
221
|
|
Interest expense
|
|
|
(792
|
)
|
|
|
—
|
|
Net income
|
|
|
3,641
|
|
|
|
945
|
|
Preferred stock dividend
|
|
|
(338
|
)
|
|
|
(338
|
)
|
Net income available to common stockholders
|
|
$
|
3,303
|
|
|
$
|
607
|
|
Net income available to common stockholders per share (Note 8):
|
|
|
|
|
|
|
|
|
Basic
|
|
$
|
0.34
|
|
|
$
|
0.10
|
|
Diluted
|
|
$
|
0.33
|
|
|
$
|
0.09
|
|
Weighted average shares outstanding:
|
|
|
|
|
|
|
|
|
Basic
|
|
|
9,664,775
|
|
|
|
5,883,610
|
|
Diluted
|
|
|
9,797,676
|
|
|
|
6,025,067
|
|
See accompanying notes to the condensed
consolidated financial statements.
Innovative Industrial Properties, Inc.
Condensed Consolidated Statements of Stockholders’ Equity
(Unaudited)
(In thousands, except share amounts)
|
|
Three Months Ended
March 31, 2019
|
|
|
|
Series A
Preferred
Stock
|
|
|
Shares of
Common
Stock
|
|
|
Common
Stock
|
|
|
Additional
Paid-In-
Capital
|
|
|
Dividends in
Excess of
Earnings
|
|
|
Total
Stockholders’
Equity
|
|
Balance, December 31, 2018
|
|
$
|
14,009
|
|
|
|
9,775,800
|
|
|
$
|
10
|
|
|
$
|
260,540
|
|
|
$
|
(10,267
|
)
|
|
$
|
264,292
|
|
Net income
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
3,641
|
|
|
|
3,641
|
|
Equity component of exchangeable senior notes
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
5,569
|
|
|
|
—
|
|
|
|
5,569
|
|
Net issuance of unvested restricted stock
|
|
|
—
|
|
|
|
30,394
|
|
|
|
—
|
|
|
|
(939
|
)
|
|
|
—
|
|
|
|
(939
|
)
|
Preferred stock dividend
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
(338
|
)
|
|
|
(338
|
)
|
Common stock dividend
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
(4,412
|
)
|
|
|
(4,412
|
)
|
Stock-based compensation
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
563
|
|
|
|
—
|
|
|
|
563
|
|
Balance, March 31, 2019
|
|
$
|
14,009
|
|
|
|
9,806,194
|
|
|
$
|
10
|
|
|
$
|
265,733
|
|
|
$
|
(11,376
|
)
|
|
$
|
268,376
|
|
|
|
Three
Months Ended March 31, 2018
|
|
|
|
Series A
Preferred
Stock
|
|
|
Shares of
Common
Stock
|
|
|
Common
Stock
|
|
|
Additional
Paid-In-
Capital
|
|
|
Dividends in
Excess of
Earnings
|
|
|
Total
Stockholders’
Equity
|
|
Balance, December 31, 2017
|
|
$
|
14,009
|
|
|
|
3,501,147
|
|
|
$
|
4
|
|
|
$
|
66,248
|
|
|
$
|
(6,712
|
)
|
|
$
|
73,549
|
|
Net income
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
945
|
|
|
|
945
|
|
Net proceeds from sale of common stock
|
|
|
—
|
|
|
|
3,220,000
|
|
|
|
3
|
|
|
|
79,311
|
|
|
|
—
|
|
|
|
79,314
|
|
Net issuance of unvested restricted stock
|
|
|
—
|
|
|
|
60,932
|
|
|
|
—
|
|
|
|
(390
|
)
|
|
|
—
|
|
|
|
(390
|
)
|
Preferred stock dividend
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
(338
|
)
|
|
|
(338
|
)
|
Common stock dividend
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
(1,696
|
)
|
|
|
(1,696
|
)
|
Stock-based compensation
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
330
|
|
|
|
—
|
|
|
|
330
|
|
Balance, March 31, 2018
|
|
$
|
14,009
|
|
|
|
6,782,079
|
|
|
$
|
7
|
|
|
$
|
145,499
|
|
|
$
|
(7,801
|
)
|
|
$
|
151,714
|
|
See accompanying notes to the condensed
consolidated financial statements.
Innovative Industrial Properties, Inc.
Condensed Consolidated Statements of Cash Flows
(Unaudited)
(In thousands)
|
|
For the Three Months Ended
March 31,
|
|
|
|
2019
|
|
|
2018
|
|
Cash flows from operating activities
|
|
|
|
|
|
|
|
|
Net income
|
|
$
|
3,641
|
|
|
$
|
945
|
|
Adjustments to reconcile net income to net cash provided by operating activities
|
|
|
|
|
|
|
|
|
Depreciation
|
|
|
1,218
|
|
|
|
476
|
|
Stock-based compensation
|
|
|
563
|
|
|
|
330
|
|
Amortization of discounts on short-term investments
|
|
|
714
|
|
|
|
(93
|
)
|
Amortization of debt discounts and issuance costs
|
|
|
208
|
|
|
|
—
|
|
Changes in assets and liabilities
|
|
|
|
|
|
|
|
|
Other assets, net
|
|
|
(89
|
)
|
|
|
(213
|
)
|
Accounts payable and accrued expenses
|
|
|
(744
|
)
|
|
|
(531
|
)
|
Rent received in advance and tenant security deposits
|
|
|
647
|
|
|
|
441
|
|
Net cash provided by operating activities
|
|
|
6,158
|
|
|
|
1,355
|
|
Cash flows from investing activities
|
|
|
|
|
|
|
|
|
Purchases of investments in real estate
|
|
|
(7,410
|
)
|
|
|
—
|
|
Reimbursements of tenant improvements and construction funding
|
|
|
(6,832
|
)
|
|
|
—
|
|
Deposits to escrow for acquisitions
|
|
|
(1,601
|
)
|
|
|
—
|
|
Purchases of short-term investments
|
|
|
(118,500
|
)
|
|
|
(48,763
|
)
|
Maturities of short-term investments
|
|
|
40,500
|
|
|
|
—
|
|
Net cash used in investing activities
|
|
|
(93,843
|
)
|
|
|
(48,763
|
)
|
Cash flows from financing activities
|
|
|
|
|
|
|
|
|
Issuance of common stock, net of offering costs
|
|
|
—
|
|
|
|
79,314
|
|
Net proceeds from issuance of exchangeable senior notes
|
|
|
138,557
|
|
|
|
—
|
|
Dividends paid to common stockholders
|
|
|
(3,421
|
)
|
|
|
(875
|
)
|
Dividends paid to preferred stockholders
|
|
|
(338
|
)
|
|
|
(323
|
)
|
Taxes paid related to net share settlement of equity awards
|
|
|
(939
|
)
|
|
|
(390
|
)
|
Net cash provided by financing activities
|
|
|
133,859
|
|
|
|
77,726
|
|
Net increase in cash and cash equivalents
|
|
|
46,174
|
|
|
|
30,318
|
|
Cash and cash equivalents, beginning of period
|
|
|
13,050
|
|
|
|
11,758
|
|
Cash and cash equivalents, end of period
|
|
$
|
59,224
|
|
|
|
42,076
|
|
|
|
|
|
|
|
|
|
|
Supplemental disclosure of cash flow information:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Accrual for reimbursements of tenant improvements and construction funding
|
|
$
|
3,201
|
|
|
$
|
—
|
|
Accrual for common and preferred stock dividends declared
|
|
|
4,750
|
|
|
|
2,034
|
|
See accompanying notes to the condensed
consolidated financial statements.
Innovative Industrial Properties, Inc.
Notes to the Condensed Consolidated Financial Statements
March 31, 2019
(Unaudited)
1. Organization
As used herein, the terms “we”,
“us”, “our” or the “Company” refer to Innovative Industrial Properties, Inc., a Maryland corporation,
and any of our subsidiaries, including IIP Operating Partnership, LP, a Delaware limited partnership (our “Operating Partnership”).
We are an internally-managed real estate
investment trust (“REIT”) focused on the acquisition, ownership and management of specialized industrial properties
leased to experienced, state-licensed operators for their regulated medical-use cannabis facilities. We have acquired and intend
to continue to acquire our properties through sale-leaseback transactions and third-party purchases. We have leased and expect
to continue to lease our properties on a triple-net lease basis, where the tenant is responsible for all aspects of and costs related
to the property and its operation during the lease term, including structural repairs, maintenance, taxes and insurance.
We were incorporated in Maryland on June
15, 2016. We conduct our business through a traditional umbrella partnership real estate investment trust, or UPREIT structure,
in which our properties are owned by our Operating Partnership, directly or through subsidiaries. We are the sole general partner
of our Operating Partnership and own, directly or through subsidiaries, 100% of the limited partnership interests in our Operating
Partnership.
2. Summary of Significant Accounting Policies and Procedures
and Recent Accounting Pronouncements
Basis of Presentation.
The
condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the
United States (“GAAP”) for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation
S-X. They do not include all of the information and footnotes required by GAAP for complete financial statements.
This interim financial information should
be read in conjunction with the audited consolidated financial statements in the Company’s Annual Report on Form 10-K for the year
ended December 31, 2018.
Management believes that all adjustments
of a normal, recurring nature considered necessary for a fair presentation have been included. This interim financial information
does not necessarily represent or indicate what the operating results will be for the year ending December 31, 2019.
Federal Income Taxes.
We believe
that we have operated our business so as to qualify to be taxed as a REIT for U.S. federal income tax purposes. Under the REIT
operating structure, we are permitted to deduct dividends paid to our stockholders in determining our taxable income. Assuming
our dividends equal or exceed our taxable net income, we generally will not be required to pay federal corporate income taxes on
such income. The income taxes recorded on our consolidated statement of income represent amounts paid for city and state income
and franchise taxes and are included in general and administrative expenses in the accompanying condensed consolidated statements
of income.
Use of Estimates.
The
preparation of the condensed consolidated financial statements in conformity with GAAP requires management to make a number of
estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities
at the date of the condensed consolidated financial statements and reported amounts of revenues and expenses during the reporting
period. Actual results may differ materially from these estimates and assumptions.
Acquisition of Real Estate Properties.
Our
investment in real estate is recorded at historical cost, less accumulated depreciation. Upon acquisition of a property, the tangible
and intangible assets acquired and liabilities assumed are initially measured based upon their relative fair values. We estimate
the fair value of land by reviewing comparable sales within the same submarket and/or region and the fair value of buildings on
an as-if vacant basis. Acquisition costs are capitalized as incurred. All of our acquisitions to date were recorded as asset acquisitions.
Depreciation.
We are
required to make subjective assessments as to the estimated useful lives of our depreciable assets. We consider the period of future
benefit of the assets to determine the appropriate estimated useful lives. Depreciation of our assets is charged to expense on
a straight-line basis over the estimated useful lives. We depreciate each of our buildings and improvements over its estimated
remaining useful life, generally not to exceed 35 years. We depreciate tenant improvements at our buildings over the shorter of
the estimated useful lives or the terms of the related leases.
We depreciate office equipment and furniture
and fixtures over estimated useful lives ranging from three to six years.
Provision for Impairment.
On
a quarterly basis, we review current activities and changes in the business conditions of all of our properties prior to and subsequent
to the end of each quarter to determine the existence of any triggering events or impairment indicators requiring an impairment
analysis. If triggering events or impairment indicators are identified, we review an estimate of the future undiscounted cash flows
for the properties, including, if necessary, a probability-weighted approach if multiple outcomes are under consideration.
Long-lived assets to be held and used are
individually evaluated for impairment when conditions exist that may indicate that the carrying amount of a long-lived asset may
not be recoverable. The carrying amount of a long-lived asset to be held and used is not recoverable if it exceeds the sum of the
undiscounted cash flows expected to result from the use and eventual disposition of the asset. Impairment indicators or triggering
events for long-lived assets to be held and used are assessed by project and include significant fluctuations in estimated net
operating income, occupancy changes, significant near-term lease expirations, current and historical operating and/or cash flow
losses, construction costs, estimated completion dates, rental rates, and other market factors. We assess the expected undiscounted
cash flows based upon numerous factors, including, but not limited to, construction costs, available market information, current
and historical operating results, known trends, current market/economic conditions that may affect the property, and our assumptions
about the use of the asset, including, if necessary, a probability-weighted approach if multiple outcomes are under consideration.
Upon determination that an impairment has occurred, a write-down is recognized to reduce the carrying amount to its estimated fair
value. We may adjust depreciation of properties that are expected to be disposed of or redeveloped prior
to the end of their useful lives. As of March 31, 2019, no impairment losses were recognized.
Revenue
Recognition.
Our leases are and future tenant leases are expected to be triple-net leases, an arrangement
under which the tenant maintains the property while paying us rent and a property management fee. We account for our current
leases as operating leases and anticipate that future leases will be accounted for as operating leases. Under this method,
leases that have fixed and determinable rent increases are recognized on a straight-line basis over the lease term, unless
the collectability of minimum lease payments is not reasonably predictable. Rental increases based upon changes in the
consumer price index are recognized only after the changes in the indexes have occurred and are then applied according to the
lease agreements. Contractually obligated reimbursements from tenants for recoverable real estate taxes and operating
expenses are included in tenant reimbursements in the period when such costs are incurred. Contractually obligated real
estate taxes that are paid directly by the tenant to the tax authorities are not reflected in our consolidated
financial statements.
We record revenue for each of our properties
on a cash basis due to the uncertainty of collectability of lease payments from each tenant due to its limited operating history
and the uncertain regulatory environment in the United States relating to the medical-use cannabis industry.
Future contractual minimum rent (including
base rent, supplemental base rent (for one of our properties in New York) and property management fees) under the operating leases
as of March 31, 2019 for future periods is summarized as follows (in thousands):
Year
|
|
Contractual Minimum Rent
|
|
2019 (nine months ending December 31)
|
|
$
|
22,360
|
|
2020
|
|
|
31,114
|
|
2021
|
|
|
32,063
|
|
2022
|
|
|
31,869
|
|
2023
|
|
|
32,931
|
|
Thereafter
|
|
|
388,385
|
|
Total
|
|
$
|
538,722
|
|
Cash and Cash Equivalents
. We consider
all highly-liquid investments with original maturities of three months or less to be cash equivalents. As of March 31, 2019, approximately
$55.9 million were invested in short-term obligations of the U.S. government and money market funds. As of December 31, 2018, approximately
$8.9 million were invested in short-term money market funds and certificates of deposit.
Short-Term Investments
. Short-term
investments consist of obligations of the U.S. government with an original maturity at the time of purchase of greater than three
months. Investments are classified as held-to-maturity and stated at amortized cost.
Exchangeable Notes.
The
“Debt with Conversion and Other Options” Topic of the Financial Accounting Standards Board (“FASB”)
Accounting Standards Codification requires the liability and equity components of exchangeable debt instruments that may
be settled in cash upon exchange, including partial cash settlement, to be separately accounted for in a manner that
reflects the issuer’s nonexchangeable debt borrowing rate. The initial proceeds from the sale of exchangeable notes
are allocated between a liability component and an equity component in a manner that reflects interest expense at the rate
of similar nonexchangeable debt that could have been issued at such time. The equity component represents the excess
initial proceeds received over the fair value of the liability component of the notes as of the date of issuance. We measured
the estimated fair value of the debt component of our Exchangeable Senior Notes (as defined below) as of the respective
issuance dates based on our nonexchangeable debt borrowing rate. The equity component of our Exchangeable Senior Notes is
reflected within additional paid-in capital on our condensed consolidated balance sheets, and the resulting debt discount is
amortized over the period during which the Exchangeable Senior Notes are expected to be outstanding (through the maturity
date) as additional non-cash interest expense. The additional non-cash interest expense attributable to our Exchangeable
Senior Notes will increase in subsequent periods through the maturity date as the Exchangeable Senior Notes accrete to the
par value over the same period.
Deferred Financing Costs.
The
deferred financing costs that are included as a reduction in the net book value of the related liability on our condensed consolidated
balance sheets reflect issuance and other costs related to our Exchangeable Senior Notes. These costs are amortized as interest
expense using the effective interest method over the life of the Exchangeable Senior Notes.
Stock-Based Compensation.
Stock-based
compensation for equity awards is based on the grant date fair value of the equity investment and is recognized over the requisite
service period. If awards are forfeited prior to vesting, we reverse any previously recognized expense related to such awards in
the period during which the forfeiture occurs and reclassify any nonforfeitable dividends previously paid on these awards from
retained earnings to compensation expense.
Recent Accounting Pronouncements.
In March 2016, the FASB issued
ASU 2016-09, Compensation — Stock Compensation; Improvements to Employee Share-Based Payment Accounting ("ASU 2016-09").
The FASB issued ASU 2016-09 to simplify several aspects of the accounting for share-based payment transactions, including classification
of awards as either equity or liabilities, estimation of forfeitures, and classification on the statement of cash flows. The Company’s
adoption of ASU 2016-09 beginning on January 1, 2018 did not have a material impact on our consolidated financial statements.
In May 2014, the FASB issued ASU 2014-09,
Revenue from Contracts with Customers (“ASU 2014-09”). ASU 2014-09 outlines a comprehensive model for companies to use
in accounting for revenue arising from contracts with customers, and will apply to transactions such as the sale of real estate.
The Company’s adoption of ASU 2014-09 beginning on January 1, 2019 did not have a material impact on our consolidated financial
statements.
In February 2016, the FASB issued
ASU 2016-02, Leases; in July 2018, the FASB issued ASU 2018-10, Codification Improvements to Topic 842, Leases, and ASU
2018-11, Leases — Targeted Improvements; and in December 2018, the FASB issued ASU 2018-20, Narrow-Scope Improvements
for Lessors. This group of ASUs is collectively referred to as Topic 842 and is expected to be effective for the Company
beginning January 1, 2020 as a result of the Company’s election as an emerging growth company. Topic 842 supersedes the
existing standards for lease accounting (Topic 840, Leases).
The Company expects to elect the practical
expedients provided by Topic 842, including: the package of practical expedients that allows an entity not to reassess upon adoption
(i) whether an expired or existing contract contains a lease, (ii) whether a lease classification related to expired or existing
lease arrangements, and (iii) whether costs incurred on expired or existing leases qualify as initial direct costs, and as a lessor,
the practical expedient not to separate certain non-lease components, such as common area maintenance, from the lease component
if (i) the timing and pattern of transfer are the same for the non-lease component and associated lease component, and (ii) the
lease component would be classified as an operating lease if accounted for separately.
Topic 842 requires lessees to record
most leases on their balance sheet through a right-of-use (“ROU”) model, in which a lessee records a ROU asset
and a lease liability on their balance sheet. Leases that are less than 12 months do not need to be accounted for under the
ROU model. Lessees will account for leases as financing or operating leases, with the classification affecting the timing and
pattern of expense recognition in the income statement. Lease expense will be recognized based on the effective interest
method for leases accounted for as finance leases and on a straight-line basis over the term of the lease for leases
accounted for as operating leases. At March 31, 2019, the Company is the lessee under one office lease that would require
accounting under the ROU model. Upon adoption of Topic 842 expected in January 2020, the ROU asset and lease liability to be
recognized on the balance sheet relating to this lease is not expected to have a material impact on our consolidated
financial statements.
The accounting by a lessor under Topic
842 is largely unchanged from that of Topic 840. Under Topic 842, lessors will continue to account for leases as a sales-type,
direct-financing, or operating. A lease will be treated as a sale if it is considered to transfer control of the underlying asset
to the lessee. A lease will be classified as direct-financing if risks and rewards are conveyed without the transfer of control.
Otherwise, the lease is treated as an operating lease. Topic 842 requires accounting for a transaction as a financing in a sale
leaseback in certain circumstances, including when the seller-lessee is provided an option to purchase the property from the landlord
at the tenant’s option. The Company expects that this provision could change the accounting for these types of leases in the future.
Topic 842 also includes the concept of separating lease and non-lease components. Under Topic 842, non-lease components, such as
common area maintenance, would be accounted for under Topic 606 and separated from the lease payments. However, the Company will
elect the lessor practical expedient allowing the Company to not separate these components when certain conditions are met. Upon
adoption of Topic 842, the Company expects to combine tenant reimbursements with rental revenues on its consolidated statements
of income. Further, the Company has historically capitalized allocated payroll cost incurred as part of the leasing process, which
will no longer qualify for classification as initial direct costs under Topic 842. The Company will elect the lessor practical
expedient, allowing the Company to continue to amortize previously capitalized initial direct leasing costs incurred prior to the
adoption and Topic 842 and does not expect a material impact to its consolidated financial statements related to the capitalization
of leasing costs. Also, the Narrow-Scope Improvements for Lessors under ASU 2018-20 allows the Company to continue to exclude from
revenue, costs paid by our tenants on our behalf directly to third parties, such as property taxes.
Topic 842 provides two transition alternatives.
The Company expects to apply this standard based on the prospective optional transition method, in which comparative periods will
continue to be reported in accordance with Topic 840. The Company also anticipates expanded disclosures upon adoption, as the new
standard requires more extensive quantitative and qualitative disclosures as compared to Topic 840 for both lessees and lessors.
In June 2016, the FASB issued ASU
2016-13, Financial Instruments — Credit Losses, which changes the impairment model for most financial assets and
certain other instruments. For trade and other receivables, held-to-maturity debt securities, loans and other instruments,
companies will be required to use a new forward-looking “expected loss” model that generally will result in the
earlier recognition of allowances for losses. In November 2018, the FASB issued ASU 2018-19, Codification Improvements to
Topic 326, Financial Instruments — Credit Losses, which among other updates, clarifies that receivables arising from
operating leases are not within the scope of this guidance and should be evaluated in accordance with Topic 842. For
available-for-sale debt securities with unrealized losses, companies will measure credit losses in a manner similar to what
they do today, except that the losses will be recognized as allowances rather than as reductions in the amortized cost of the
securities. Companies will have to disclose significantly more information, including information they use to track credit
quality by year of origination for most financing receivables. Companies will apply the standard’s provisions as a
cumulative-effect adjustment to retained earnings as of the beginning of the first reporting period in which the guidance is
adopted. This standard is expected to be effective for years beginning after December 15, 2020 as a result of the
Company’s election as an emerging growth company with early adoption permitted. We do not expect this amendment to have
an effect on our consolidated financial statements.
In August 2016, the FASB issued ASU
2016-15, Statement of Cash Flows (Topic 230) Classification of Certain Cash Receipts and Cash Payments (“ASU 2016-15”), which clarifies or
provides guidance relating to eight specific cash flow classification issues. The standard should be applied retrospectively
for each period presented, as appropriate. The Company’s adoption of ASU 2016-15 beginning on January 1, 2019 did not
have a material impact on our consolidated financial statements.
In February 2017, the FASB issued
ASU 2017-05, Other Income — Gains and Losses from the Derecognition of Nonfinancial Assets (Subtopic 610-20):
Clarifying the Scope of Asset Derecognition Guidance and Accounting for Partial Sales of Nonfinancial Assets (“Subtopic
610-20”). A contract may involve the transfer of both nonfinancial assets and financial assets (e.g., cash and
receivables). The amendments clarify that a financial asset is within the scope of Subtopic 610-20 if it meets the definition
of an in substance nonfinancial asset. The amendments also define the term in substance nonfinancial asset. The amendments
clarify that nonfinancial assets within the scope of Subtopic 610-20 may include nonfinancial assets transferred within a
legal entity to a counterparty. For example, a parent may transfer control of nonfinancial assets by transferring ownership
interests in a consolidated subsidiary. A contract that includes the transfer of ownership interests in one or more
consolidated subsidiaries is within the scope of Subtopic 610-20 if substantially all of the fair value of the assets that
are promised to the counterparty in a contract is concentrated in nonfinancial assets. The amendments clarify that an entity
should identify each distinct nonfinancial asset or in substance nonfinancial asset promised to a counterparty and
derecognize each asset when a counterparty obtains control of it. The Company’s adoption of ASU 2017-05 beginning on
January 1, 2019 did not have a material impact on our consolidated financial statements.
Concentration of Credit Risk
. As
of March 31, 2019, we owned 13 properties located in Arizona, California, Colorado, Illinois, Maryland, Massachusetts, Michigan,
Minnesota, New York, Ohio and Pennsylvania. The ability of any of our tenants to honor the terms of its lease is dependent upon
the economic, regulatory, competition, natural and social factors affecting the community in which that tenant operates. During
the three months ended March 31, 2019, PharmaCann, LLC’s leases at one of our properties in New York and Massachusetts accounted
for approximately 31% of our rental revenues. During the three months ended March 31, 2018, PharmaCann, LLC leased one of our properties
in New York, which accounted for 50% of our rental revenues. In addition, the tenant at our property in Maryland accounted for
10% and 24% of our rental revenue for the three months ended March 31, 2019 and 2018, respectively. At March 31, 2019 and December
31, 2018, one of our properties in New York accounted for 18% and 20%, respectively, of our net real estate held for investment.
We have deposited cash with a financial
institution that is insured by the Federal Deposit Insurance Corporation (“FDIC”) up to $250,000. As of March 31, 2019,
we had cash accounts in excess of FDIC insured limits. We have not experienced any losses in such accounts.
Reclassifications.
Certain prior
period amounts have been reclassified for consistency with the current period presentation. These reclassifications had no effect
on the reported results of operations.
3. Common Stock
As of March 31, 2019, the Company was authorized
to issue up to 50,000,000 shares of common stock, par value $0.001 per share, and there were 9,806,194 shares of common stock issued
and outstanding.
4. Preferred Stock
As of
March 31, 2019, the Company was authorized to issue up to 50,000,000 shares of preferred stock, par value $0.001 per share, and
there were issued and outstanding 600,000 shares of 9.00% Series A Cumulative Redeemable Preferred Stock, $0.001 par value per
share (the “Series A Preferred Stock”). Generally, the Company is not permitted to redeem the Series A Preferred Stock
prior to October 19, 2022, except in limited circumstances relating to the Company’s ability to qualify as a REIT and in
certain other circumstances related to a change of control/delisting (as defined in the articles supplementary for the Series A
Preferred Stock). On or after October 19, 2022, the Company may, at its option, redeem the Series A Preferred Stock, in whole or
in part, at any time or from time to time, for cash at a redemption price of $25.00 per share, plus all accrued and unpaid dividends
on such Series A Preferred Stock up to, but excluding the redemption date. Holders of the Series A Preferred Stock generally have
no voting rights except for limited voting rights if the Company fails to pay dividends for six or more quarterly periods (whether
or not consecutive) and in certain other circumstances.
5. Dividends
The following table describes the dividends
declared by the Company during the three months ended March 31, 2019:
Declaration
Date
|
|
Security Class
|
|
Amount
Per
Share
|
|
|
Period Covered
|
|
Dividend
Paid Date
|
|
Dividend Amount
|
|
|
|
|
|
|
|
|
|
|
|
|
(In thousands)
|
|
March 12, 2019
|
|
Common Stock
|
|
$
|
0.45
|
|
|
January 1, 2019 to March 31, 2019
|
|
April 15, 2019
|
|
$
|
4,412
|
|
March 12, 2019
|
|
Series A preferred stock
|
|
$
|
0.5625
|
|
|
January 15, 2019 to April 14, 2019
|
|
April 15, 2019
|
|
$
|
338
|
|
6. Investments in Real Estate
The Company
acquired the following properties during the three months ended March 31, 2019 (dollars in thousands):
Property
|
|
Market
|
|
Closing Date
|
|
Rentable
Square
Feet (1)
|
|
|
Purchase
Price
|
|
|
Transaction
Costs
|
|
|
Total
|
|
Sacramento CA
|
|
California
|
|
February 8, 2019
|
|
|
43,000
|
|
|
$
|
6,664
|
|
|
$
|
35
|
|
|
$
|
6,699
|
(2)
|
PharmaCann OH
|
|
Ohio
|
|
March 13, 2019
|
|
|
58,000
|
|
|
|
700
|
|
|
|
11
|
|
|
|
711
|
(3)
|
Total
|
|
|
|
|
|
|
101,000
|
|
|
$
|
7,364
|
|
|
$
|
46
|
|
|
$
|
7,410
|
|
|
(1)
|
Includes expected rentable square feet at completion of construction.
|
|
(2)
|
The seller of the property is expected to complete redevelopment of the building, for which we have agreed to provide reimbursement
of up to approximately $4.8 million as additional purchase price. As of March 31, 2019, we incurred approximately $2.4 million
of the additional purchase price, of which we funded approximately $2.3 million.
|
|
(3)
|
Concurrent with the closing, we entered into a long-term lease
and development agreement with a subsidiary of PharmaCann, LLC, which is expected to construct two buildings at the
property, for which we have agreed to provide reimbursement
of up to $19.3 million. As of March 31, 2019, we incurred approximately $1.5 million of the development costs, of which no
amounts had
been funded.
|
Including
all of our properties, during the three months ended March 31, 2019, we capitalized costs of approximately $7.6 million relating
to tenant improvements and construction activities at our properties.
7. Exchangeable Senior Notes
In February 2019, our Operating Partnership
issued $143.75 million of 3.75% Exchangeable Senior Notes due 2024 (the "Exchangeable Senior Notes") in a private offering,
including the exercise in full of the initial purchasers' option to purchase additional Notes. The Exchangeable Senior Notes are
senior unsecured obligations of our Operating Partnership, are fully and unconditionally guaranteed by us and our Operating Partnership's
subsidiaries and are exchangeable for cash, shares of our common stock, or a combination of cash and shares of our common stock,
at our Operating Partnership's option, at any time prior to the close of business on the second scheduled trading day immediately
preceding the stated maturity date. The initial exchange rate for the Exchangeable Senior Notes is 14.37298 shares of our common
stock per $1,000 principal amount of Notes and the initial exchange price is approximately $69.575 per share of our common stock.
The initial exchange rate and initial exchange price are subject to adjustment in certain circumstances. The Exchangeable Senior
Notes will pay interest semiannually at a rate of 3.75% per annum and will mature on February 21, 2024, unless earlier exchanged
or repurchased in accordance with their terms. Our Operating Partnership will not have the right to redeem the Exchangeable Senior
Notes prior to maturity, but may be required to repurchase the Exchangeable Senior Notes from holders under certain circumstances.
As of March 31, 2019, we have the intent and ability to settle the Exchangeable Senior Notes in cash.
Upon our issuance of the Exchangeable Senior
Notes, we recorded an approximately $5.8 million discount based on the implied value of the exchange option and an assumed
effective interest rate of 4.65%, as well as approximately $5.2 million of initial issuance costs, of which approximately
$5.0 million and $200,000 were allocated to the liability and equity components, respectively, based on their relative fair values.
Issuance costs allocated to the liability component are being amortized using the effective interest method and recognized as non-cash
interest expense over the expected term of the Exchangeable Senior Notes.
The following table details our interest
expense related to the Exchangeable Senior Notes (in thousands):
|
|
Three Months Ended
March 31, 2019
|
|
Cash coupon
|
|
$
|
584
|
|
Amortization of debt discount
|
|
|
111
|
|
Amortization of issuance costs
|
|
|
97
|
|
Total interest expense
|
|
$
|
792
|
|
The following table details the carrying
value of our Exchangeable Senior Notes on our condensed consolidated balance sheets (in thousands):
|
|
March 31, 2019
|
|
Principal amount
|
|
$
|
143,750
|
|
Unamortized discount
|
|
|
(5,666
|
)
|
Unamortized issuance costs
|
|
|
(4,888
|
)
|
Carrying value
|
|
$
|
133,196
|
|
Accrued interest payable for the Exchangeable
Senior Notes was approximately $584,000 as of March 31, 2019.
8. Net Income Per Share
Grants of restricted stock of the Company
in share-based payment transactions are considered participating securities prior to vesting and, therefore, are considered in
computing basic earnings per share under the two-class method. The two-class method is an earnings allocation method for calculating
earnings per share when a company’s capital structure includes either two or more classes of common stock or common stock
and participating securities. Earnings per basic share under the two-class method is calculated based on dividends declared on
common shares and other participating securities (“distributed earnings”) and the rights of participating securities
in any undistributed earnings, which represents net income remaining after deduction of dividends accruing during the period. The
undistributed earnings are allocated to all outstanding common shares and participating securities based on the relative percentage
of each security to the total number of outstanding participating securities. Earnings per basic share represents the summation
of the distributed and undistributed earnings per share class divided by the total number of shares.
Through March 31, 2019, all of the Company’s
participating securities received dividends at an equal dividend rate per share. As a result, distributions to participating securities
for the three months ended March 31, 2019 and 2018 have been included in net income attributable to common stockholders to calculate
net income per basic and diluted share. As the Company has the intent and ability to settle the debt component of the Exchangeable
Senior Notes in cash and the excess conversion premium in shares, the Company only includes the effect of the excess conversion
premium in the calculation of diluted shares. For the three months ended March 31, 2019, the effect of the excess conversion premium
was anti-dilutive and therefore, excluded from the calculation of diluted shares. Computations of net income per basic and diluted
share (in thousands, except share data) were as follows:
|
|
For the Three Months Ended
March 31,
|
|
|
|
2019
|
|
|
2018
|
|
Net income
|
|
$
|
3,641
|
|
|
$
|
945
|
|
Preferred stock dividend
|
|
|
(338
|
)
|
|
|
(338
|
)
|
Distribution to participating securities
|
|
|
(64
|
)
|
|
|
(37
|
)
|
Net income available to common stockholders used to compute net income per share
|
|
$
|
3,239
|
|
|
$
|
570
|
|
|
|
|
|
|
|
|
|
|
Weighted average common share outstanding:
|
|
|
|
|
|
|
|
|
Basic
|
|
|
9,664,775
|
|
|
|
5,883,610
|
|
Diluted
|
|
|
9,797,676
|
|
|
|
6,025,067
|
|
|
|
|
|
|
|
|
|
|
Net income available to common stockholders per share:
|
|
|
|
|
|
|
|
|
Basic
|
|
$
|
0.34
|
|
|
$
|
0.10
|
|
Diluted
|
|
$
|
0.33
|
|
|
$
|
0.09
|
|
9. Fair Value of Financial Instruments
Fair value is defined as the price that
would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants on the
measurement date. Accounting guidance also establishes a fair value hierarchy that requires an entity to maximize the use of observable
inputs and minimize the use of unobservable inputs when measuring fair value. The standard describes three levels of inputs that
may be used to measure fair value:
Level 1—Observable inputs that reflect
quoted prices (unadjusted) for identical assets or liabilities in active markets.
Level 2—Includes other inputs that
are directly or indirectly observable in the marketplace.
Level 3—Unobservable inputs that
are supported by little or no market activities, therefore requiring an entity to develop its own assumptions.
The following table presents the carrying
value in the condensed consolidated financial statements and approximate fair value of financial instruments at March 31, 2019
and December 31, 2018:
|
|
March 31, 2019
|
|
|
December 31, 2018
|
|
|
|
Carrying Value
|
|
|
Fair Value
|
|
|
Carrying Value
|
|
|
Fair Value
|
|
Short-term investments
(1)
|
|
$
|
197,729
|
|
|
$
|
197,729
|
|
|
$
|
120,443
|
|
|
$
|
120,443
|
|
Exchangeable Senior Notes
(2)
|
|
$
|
133,196
|
|
|
$
|
181,125
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
(1)
|
Short-term investments consisting of obligations of the U.S. government with an original maturity at the time of purchase of
greater than three months are classified as held-to-maturity and valued using Level 1 inputs.
|
|
(2)
|
The fair value is determined based upon Level 2 inputs as the Exchangeable Senior Notes were trading in the private market
as of March 31, 2019.
|
At March 31, 2019, cash equivalent instruments
consisted of $22.7 million in short-term money market funds that were measured using the net asset value per share that have not
been classified using the fair value hierarchy. The fund invests primarily in short-term U.S. Treasury and government securities.
Short-term investments consisting of certificate of deposits and obligations of the U.S. government are stated at amortized cost,
which approximates their relative fair values due to the short-term maturities and market rates of interest of these instruments.
The carrying amounts of financial instruments
such as cash equivalents invested in certificates of deposit, receivables, accounts payable, accrued expenses and other liabilities
approximate their relative fair values due to the short-term maturities and market rates of interest of these instruments.
10. Common Stock Incentive Plan
Our board of directors adopted our 2016
Omnibus Incentive Plan (the “2016 Plan”) to enable us to motivate, attract and retain the services of directors, employees
and consultants considered essential to our long-term success. The 2016 Plan offers our directors, employees and consultants an
opportunity to own our stock or rights that will reflect our growth, development and financial success. Under the terms of the
2016 Plan, the aggregate number of shares of our common stock subject to options, restricted stock, stock appreciation rights,
restricted stock units and other awards, will be no more than 1,000,000 shares. The 2016 Plan has a term of ten years from the
date it was adopted by our board of directors.
A summary of the activity under the 2016
Plan and related information is included in the table below.
|
|
Unvested
Restricted
Shares
|
|
|
Weighted-
Average Grant
Date Fair
Value
|
|
Balance at December 31, 2018
|
|
|
147,359
|
|
|
$
|
23.98
|
|
Granted
|
|
|
51,111
|
|
|
$
|
52.84
|
|
Vested
|
|
|
(36,334
|
)
|
|
$
|
25.72
|
|
Forfeited (1)
|
|
|
(20,717
|
)
|
|
$
|
18.98
|
|
Balance at March 31, 2019
|
|
|
141,419
|
|
|
$
|
34.70
|
|
|
(1)
|
Shares that were forfeited to cover the employees’ tax withholding obligation upon vesting.
|
The remaining unrecognized compensation
cost of $4.3 million will be recognized over a weighted-average amortization period of approximately 2.2 years as of March 31,
2019.
11. Commitments and Contingencies
Tenant Improvement Allowances
.
As of March 31, 2019, we had approximately $7.9 million of commitments related to tenant improvement allowances, which generally
may be requested by the tenants at any time up until a date that is near the expiration of the initial term of the applicable lease.
Construction Funding.
As
of March 31 2019, we had approximately $5.2 million and $17.8 million of commitments relating to construction funding for the development
of the properties in Massachusetts and Ohio, which the tenant has agreed to use commercially reasonable efforts to complete by
August 31, 2019 and June 13, 2020, respectively.
Additional Purchase Price.
As
of March 31, 2019, we had approximately $2.4 million of commitments relating to certain development milestones for the property
in California, which the seller is required to complete by September 30, 2019.
Office and Equipment Leases.
As
of March 31, 2019, we had approximately $143,000 outstanding in commitments related to our office and equipment leases, with approximately
$68,000 to be paid in the remainder of 2019 and approximately $75,000 to be paid in 2020.
Environmental Matters.
We
follow the policy of monitoring our properties, both targeted acquisition and existing properties, for the presence of hazardous
or toxic substances. While there can be no assurance that a material environmental liability does not exist, we are not currently
aware of any environmental liabilities that would have a material adverse effect on our financial condition, results of operations
and cash flow, or that we believe would require disclosure or the recording of a loss contingency.
Litigation
.
We
may, from time to time, be a party to legal proceedings, which arise in the ordinary course of our business. We are not aware of
any pending or threatened litigation that, if resolved against us, would have a material adverse effect on our consolidated financial
position, results of operations or cash flows.
12. Subsequent Events
On
April 16, 2019, we closed on the acquisition of a five-property portfolio in southern California, which comprises approximately
102,000 square feet of industrial space. The purchase price for the southern California portfolio was approximately $27.1 million
in the aggregate (excluding transaction costs). Concurrent with the closing of the purchase, we entered into a long-term, triple-net
lease at each property with a licensed operator, which intends to continue to operate the properties as licensed cannabis cultivation,
manufacturing, processing and distribution facilities.
On
April 24, 2019, we closed on the acquisition of a property in Pittsburgh, Pennsylvania, which comprises approximately 51,000 square
feet of industrial space. The purchase price for the property was approximately $6.3 million (excluding transaction costs). Concurrent
with the closing of the purchase, we entered into a long-term, triple-net lease at the property with Maitri Medicinals, LLC (“Maitri”),
which intends to operate the property as a licensed medical-use cannabis cultivation and processing facility upon completion of
redevelopment. Maitri is expected to complete tenant improvements for the building, for which we have agreed to provide reimbursement
of up to $10 million. Assuming full reimbursement for the tenant improvements, our total investment in the property will be approximately
$16.3 million (excluding transaction costs).
ITEM 2.
MANAGEMENT’S DISCUSSION
AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion should be read
in conjunction with the condensed consolidated financial statements and notes thereto appearing elsewhere in this report. We make
statements in this report that are “forward-looking statements” within the meaning of the Private Securities Litigation
Reform Act of 1995. In particular, statements pertaining to our capital resources, portfolio performance and results of operations
contain forward-looking statements. Likewise, our statements regarding anticipated growth in our funds from operations and anticipated
market and regulatory conditions, our strategic direction, demographics, results of operations, plans and objectives are forward-looking
statements. Forward-looking statements involve numerous risks and uncertainties, and you should not rely on them as predictions
of future events. Forward-looking statements depend on assumptions, data or methods which may be incorrect or imprecise, and we
may not be able to realize them. We do not guarantee that the transactions and events described will happen as described (or that
they will happen at all). You can identify forward-looking statements by the use of forward-looking terminology such as “believes,”
“expects,” “may,” “will,” “should,” “seeks,” “approximately,” “intends,”
“plans,” “estimates” or “anticipates” or the negative of these words and phrases or similar words
or phrases. You can also identify forward-looking statements by discussions of strategy, plans or intentions. The following factors,
among others, could cause actual results and future events to differ materially from those set forth or contemplated in the forward-looking
statements: our business and investment strategy; our projected operating results; actions and initiatives of the U.S. or state
governments and changes to government policies and the execution and impact of these actions, initiatives and policies, including
the fact that cannabis remains illegal under federal law; availability of suitable investment opportunities in the medical-use
cannabis industry; concentration of our portfolio of assets and limited number of tenants; our understanding of our competition
and our potential tenants’ alternative financing sources; the estimated growth in and evolving market dynamics of the medical-use
cannabis market; the demand for medical-use cannabis cultivation and processing facilities; the expected medical-use or adult-use
cannabis legalization in certain states; shifts in public opinion regarding medical-use cannabis; the additional risks that may
be associated with certain of our tenants cultivating and processing adult-use cannabis in our facilities; the state of the U.S.
economy generally or in specific geographic areas; economic trends and economic recoveries; our ability to access equity or debt
capital; financing rates for our assets; our expected leverage; changes in the values of our assets; our expected portfolio of
assets; our expected investments; interest rate mismatches between our assets and our borrowings used to fund such investments;
changes in interest rates and the market value of our assets; rates of default on leases for our assets; the degree to which any
interest rate or other hedging strategies may or may not protect us from interest rate volatility; impact of and changes in governmental
regulations, tax law and rates, accounting guidance and similar matters; our ability to maintain our qualification as a REIT for
U.S. federal income tax purposes; our ability to maintain our exemption from registration under the Investment Company Act of 1940;
availability of qualified personnel; and market trends in our industry, interest rates, real estate values, the securities markets
or the general economy.
The risks included here are not exhaustive,
and additional factors could adversely affect our business and financial performance, including factors and risks included in other
sections of this report. In addition, we discussed a number of material risks in our Annual Report on Form 10-K for the year ended
December 31, 2018 and in Part II, Item 1A below. Those risks continue to be relevant to our performance and financial condition.
Moreover, we operate in a very competitive and rapidly changing environment. New risk factors emerge from time to time and it is
not possible for management to predict all such risk factors, nor can it assess the impact of all such risk factors on our Company’s
business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those
contained in any forward-looking statements. Any forward-looking statement made by us speaks only of the date on which we make
it. The Company undertakes no obligation to publicly update or revise any forward-looking statements, whether as a result of new
information, future events or otherwise, except as may be required by law. Stockholders and investors are cautioned not to unduly
rely on such forward-looking statements when evaluating the information presented in the Company’s filings and reports.
The purpose of this Management’s Discussion
and Analysis (“MD&A”) is to provide an understanding of the Company’s consolidated financial condition, results of
operations and cash. MD&A is provided as a supplement to, and should be read in conjunction with, the Company’s condensed consolidated
financial statements and accompanying notes.
Overview
As used herein, the terms “we”,
“us”, “our” or the “Company” refer to Innovative Industrial Properties, Inc., a Maryland corporation,
and any of our subsidiaries, including IIP Operating Partnership, LP, a Delaware limited partnership (the “Operating Partnership”).
We are an internally-managed REIT focused
on the acquisition, ownership and management of specialized industrial properties leased to experienced, state-licensed operators
for their regulated medical-use cannabis facilities. We have leased and expect to continue to lease our properties on a triple-net
lease basis, where the tenant is responsible for all aspects of and costs related to the property and its operation during the
lease term, including structural repairs, maintenance, taxes and insurance.
We were incorporated in Maryland on June
15, 2016. We conduct our business through a traditional umbrella partnership real estate investment trust, or UPREIT structure,
in which our properties are owned by our Operating Partnership, directly or through subsidiaries. We are the sole general partner
of our Operating Partnership and own, directly or through a subsidiary, 100% of the limited partnership interests in our Operating
Partnership. As of March 31, 2019, we had seven full-time employees.
As of March 31, 2019, we owned 13 properties
that were 100% leased to state-licensed medical-use cannabis operators and comprising an aggregate of approximately 1,128,000 rentable
square feet in Arizona, California, Colorado, Illinois, Maryland, Massachusetts, Michigan, Minnesota, New York, Ohio and Pennsylvania,
with a weighted-average remaining lease term of approximately 14.3 years. As of March 31, 2019, we had invested an aggregate of
$162.3 million (consisting of purchase price and development and tenant reimbursement commitments funded, if any, but excluding
transaction costs) and had committed an additional $36.6 million to reimburse certain tenants and sellers for completion of construction
and tenant improvements at our properties.
Emerging Growth Company
We have elected to be an emerging growth
company, as defined in the Jumpstart Our Business Startups Act of 2012 (the “JOBS Act”). An emerging growth company may
take advantage of specified reduced reporting requirements and is relieved of certain other significant requirements that are otherwise
generally applicable to public companies. As an emerging growth company, among other things:
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·
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we are exempt from the requirement to obtain an attestation and report
from our auditors on the assessment of our internal control over financial reporting pursuant to the Sarbanes-Oxley Act;
|
|
·
|
we are permitted to provide less extensive disclosure about our executive
compensation arrangements;
|
|
·
|
we are not required to give our stockholders non-binding advisory
votes on executive compensation or golden parachute arrangements; and
|
|
·
|
we have elected to use an extended transition period for complying
with new or revised accounting standards.
|
We may take advantage of the other provisions
until the last day of the fiscal year following the fifth anniversary of the completion of our initial public offering, or December
31, 2020; or such earlier time that we are no longer an emerging growth company. We will cease to be an emerging growth company
upon the earliest to occur of: (i) the last day of the first fiscal year in which our annual gross revenues exceed $1.07 billion,
(ii) the date that we become a “large accelerated filer” as defined in Rule 12b-2 under the Securities Exchange Act of
1934, as amended (the “Exchange Act”), which would occur if the market value of our common stock that is held by non-affiliates
exceeds $700 million as of the last business day of our most recently completed second fiscal quarter, or (iii) the date on which
we have issued more than $1 billion in non-convertible debt during the preceding three-year period.
Factors Impacting Our Operating Results
Our results of operations are affected
by a number of factors and depend on the rental revenue we receive from the properties that we acquire, the timing of lease expirations,
general market conditions, the regulatory environment in the medical-use cannabis industry, and the competitive environment for
real estate assets that support the regulated medical-use cannabis industry.
Rental Revenues
We receive income primarily from rental
revenue generated by the properties that we acquire. The amount of rental revenue depends upon a number of factors, including:
|
·
|
our ability to enter into leases with increasing or market value rents
for the properties that we acquire; and
|
|
·
|
rent collection, which primarily relates to each of our tenant’s financial
condition and ability to make rent payments to us on time.
|
The properties that we acquire consist
of real estate assets that support the regulated medical-use cannabis industry. Changes in federal law and current favorable state
or local laws in the cannabis industry may impair our ability to renew or re-lease properties and the ability of our tenants to
fulfill their lease obligations and could materially and adversely affect our ability to maintain or increase rental rates for
our properties.
Conditions in Our Markets
Positive or negative changes in regulatory,
economic or other conditions, drought, and natural disasters in the markets where we acquire properties may affect our overall
financial performance.
Competitive Environment
We face competition from a diverse mix
of market participants, including but not limited to, other companies with similar business models, independent investors, hedge
funds, hard money lenders and other real estate investors, as well as potential tenants (cannabis operators themselves), all of
whom may compete with us in our efforts to acquire real estate zoned for cannabis cultivation and production operations. Competition
from others may diminish our opportunities to acquire a desired property on favorable terms or at all. In addition, this competition
may put pressure on us to reduce the rental rates below those that we expect to charge for the properties that we acquire, which
would adversely affect our financial results.
Operating Expenses
Our operating expenses include general
and administrative expenses, including personnel costs, stock-based compensation, and legal, accounting, and other expenses related
to corporate governance, public reporting and compliance with the various provisions of U.S. securities laws. We generally structure
our leases so that the tenant is responsible for taxes, maintenance, insurance, and structural repairs with respect to the premises
throughout the lease term. Increases or decreases in such operating expenses will impact our overall financial performance.
Our Qualification as a REIT
We have
been organized and operate our business so as to qualify to be taxed as a REIT for U.S. federal income tax purposes. Shares of
our common stock and Series A Preferred Stock are subject to restrictions on ownership and transfer that are intended, among other
purposes, to assist us in qualifying and maintaining our qualification as a REIT. In order for us to qualify as a REIT under the
Code, the relevant sections of our charter provide that, subject to certain exceptions, no person or entity may own, or be deemed
to own, by virtue of the applicable constructive ownership provisions of the Code, more than 9.8% (in value or number of shares,
whichever is more restrictive) of the aggregate of our outstanding shares of stock or Series A Preferred Stock or more than 9.8%
(in value or number of shares, whichever is more restrictive) of our outstanding common stock or any class or series of our outstanding
preferred stock.
Results of Operations
We acquired the following properties during
the three months ended March 31, 2019 (dollars in thousands):
Property
|
|
Market
|
|
Closing Date
|
|
Rentable
Square
Feet (1)
|
|
|
Purchase
Price
|
|
|
Transaction
Costs
|
|
|
Total
|
|
Sacramento CA
|
|
California
|
|
February 8, 2019
|
|
|
43,000
|
|
|
$
|
6,664
|
|
|
$
|
35
|
|
|
$
|
6,699
|
(2)
|
PharmaCann OH
|
|
Ohio
|
|
March 13, 2019
|
|
|
58,000
|
|
|
|
700
|
|
|
|
11
|
|
|
|
711
|
(3)
|
Total
|
|
|
|
|
|
|
101,000
|
|
|
$
|
7,364
|
|
|
$
|
46
|
|
|
$
|
7,410
|
|
|
(1)
|
Includes expected rentable square feet at completion of construction.
|
|
(2)
|
The seller of the property is expected to complete redevelopment of the building, for which we have agreed to provide reimbursement
of up to approximately $4.8 million as additional purchase price. As of March 31, 2019, we incurred approximately $2.4 million
of the additional purchase price, of which we funded approximately $2.3 million.
|
|
(3)
|
Concurrent with the closing, we entered into a long-term lease and development agreement with a subsidiary of
PharmaCann, LLC, which is expected to construct two
buildings at the property, for which we have agreed to provide reimbursement of up to
$19.3 million. As of March 31, 2019, we incurred approximately $1.5 million of the development costs, of which no amounts had
been funded.
|
Comparison of the Three Months Ended March 31, 2019 and
2018
The following table sets forth the results
of our operations (in thousands):
|
|
For the Three Months Ended
March 31,
|
|
|
|
2019
|
|
|
2018
|
|
Revenues:
|
|
|
|
|
|
|
|
|
Rental
|
|
$
|
6,576
|
|
|
$
|
2,677
|
|
Tenant reimbursements
|
|
|
247
|
|
|
|
87
|
|
Total revenues
|
|
|
6,823
|
|
|
|
2,764
|
|
Expenses:
|
|
|
|
|
|
|
|
|
Property expenses
|
|
|
247
|
|
|
|
87
|
|
General and administrative expense
|
|
|
1,918
|
|
|
|
1,477
|
|
Depreciation expense
|
|
|
1,218
|
|
|
|
476
|
|
Total expenses
|
|
|
3,383
|
|
|
|
2,040
|
|
Income from operations
|
|
|
3,440
|
|
|
|
724
|
|
Interest income
|
|
|
993
|
|
|
|
221
|
|
Interest expense
|
|
|
(792
|
)
|
|
|
—
|
|
Net income
|
|
|
3,641
|
|
|
|
945
|
|
Preferred stock dividend
|
|
|
(338
|
)
|
|
|
(338
|
)
|
Net income available to common stockholders
|
|
$
|
3,303
|
|
|
$
|
607
|
|
Revenues
.
Rental.
Rental revenues for the three months ended March
31, 2019 increased by approximately $3.9 million, or 146%, to approximately $6.6 million, compared to approximately $2.7 million
for the three months ended March 31, 2018. The increase in rental revenues was related to rent and property management fees generated
from leases for properties we acquired in 2018 and 2019, as well as annual escalations of base rent on certain leases and amendments
to certain leases to increase tenant improvement allowances at the properties, which resulted in corresponding increases to base
rent.
Tenant Reimbursements.
Tenant reimbursements related
to reimbursements by tenants for property insurance premiums paid at certain properties. The increase in tenant reimbursements
primarily related to properties that we acquired in 2018.
Expenses
.
Property Expense.
Property expense related to property
insurance premiums at certain of our properties, which were reimbursed by the tenants. The increase in property expense primarily
related to properties that we acquired in 2018.
General and Administrative Expense
. General and administrative
expense for the three months ended March 31, 2019 increased by approximately $441,000, or 30%, to approximately $1.9 million, compared
to $1.5 million for the three months ended March 31, 2018. The increase in general and administrative expense was primarily due
to higher cash compensation to employees and higher public company costs, travel and occupancy costs. Compensation expense for
the three months ended March 31, 2019 and 2018 included approximately $563,000 and $330,000, respectively, of non-cash stock-based
compensation.
Depreciation Expense.
The increase in depreciation expense
was related to depreciation on properties that we acquired in 2018 and the placement into service of construction and tenant improvements
at certain of our properties.
Interest Income.
The increase in interest income was
due to higher interest bearing investments resulting from proceeds from our common stock offerings and issuance of our Exchangeable
Senior Notes.
Interest Expense.
Interest expense related
to our Exchangeable Senior Notes issued in February 2019, including $208,000 related to the amortization of debt discount and
issuance costs.
Cash Flows
Comparison of the Three Months Ended
March 31, 2019 and 2018
|
|
Three Months Ended
|
|
|
|
|
|
|
March 31,
|
|
|
|
|
|
|
2019
|
|
|
2018
|
|
|
Change
|
|
Net cash provided by operating activities
|
|
$
|
6,158
|
|
|
$
|
1,355
|
|
|
$
|
4,803
|
|
Net cash used in investing activities
|
|
|
(93,843
|
)
|
|
|
(48,763
|
)
|
|
|
(45,080
|
)
|
Net cash provided by financing activities
|
|
|
133,859
|
|
|
|
77,726
|
|
|
|
56,133
|
|
Ending cash and cash equivalents balance
|
|
|
59,224
|
|
|
|
42,076
|
|
|
|
17,148
|
|
Operating Activities
Cash flows provided by operating
activities for the three months ended March 31, 2019 and 2018 were approximately $6.2 million and $1.4 million, respectively.
Cash flows provided by operating activities were generally from contractual rent and security deposits from our properties, partially
offset by our general and administrative expense.
Investing Activities
Cash flows used in investing
activities for the three months ended March 31, 2019 were approximately $93.8 million, of which approximately $14.2 million related
to the purchases of investments in real estate and funding of a portion of the tenant improvement allowances and construction
funding, approximately $1.6 million related to deposits to escrow for acquisitions, and approximately $78.0 million related to
net purchases and maturities of short-term investments. Cash flows used in investing activities for the three months ended March
31, 2018 was approximately $48.8 million relating to the purchases of short-term investments. We did not acquire any properties
during the three months ended March 31, 2018.
Financing Activities
Net cash provided by financing activities
of approximately $133.9 million during the three months ended March 31, 2019 was the result of approximately $138.6 million in
net proceeds from the issuance of our Exchangeable Senior Notes, partially offset by dividend payments of approximately $3.8 million
to common and preferred stockholders and approximately $939,000 related to net share settlement of equity awards to pay the required
withholding taxes upon vesting of restricted stock for certain employees.
Net cash provided by financing activities
of approximately $77.7 million during the three months ended March 31, 2018 was the result of approximately $79.3 million in net
proceeds from the sale of 3,220,000 shares of common stock, partially offset by dividend payments of approximately $1.2 million
to common and preferred stockholders and approximately $390,000 related to net share settlement of equity awards to pay the required
withholding taxes upon vesting of restricted stock for certain employees.
Liquidity and Capital Resources
Liquidity is a measure of our ability to
meet potential cash requirements. We expect to use significant cash to acquire our target properties, pay dividends to our stockholders,
make interest payments on our Exchangeable Senior Notes, fund our operations, and meet other general business needs.
Sources and Uses of Cash
We derive all of our revenues from the
leasing of our properties, collecting rental income and operating expense reimbursements based on contractual arrangements with
our tenants. This source of revenue represents our primary source of liquidity to fund our dividends, general and administrative
expenses, property operating expenses and other expenses incurred related to managing our existing portfolio, service our Exchangeable
Senior Notes and invest in additional properties. To the extent additional resources are needed, we expect to fund our investment
activity generally through equity or debt issuances either in the public or private markets. Where possible, we also may issue
limited partnership interests in our Operating Partnership to acquire properties from existing owners seeking a tax-deferred transaction.
In February 2019, our Operating Partnership
issued $143.75 million aggregate principal amount of Exchangeable Senior Notes, including the exercise in full of the initial purchasers’
option to purchase additional Exchangeable Senior Notes, resulting in net proceeds of approximately $138.6 million, after deducting
the initial purchasers’ discounts and offering expenses.
We have filed a shelf registration statement
which may permit us, from time to time, to offer and sell common stock, preferred stock, warrants and other securities to the extent
necessary or advisable to meet our liquidity needs.
We expect to meet our liquidity needs through
cash on hand, cash flows from operations and cash flows from sources discussed above. We believe that our liquidity and sources
of capital are adequate to satisfy our cash requirements. We cannot, however, be certain that these sources of funds will be available
at a time and upon terms acceptable to the Company in sufficient amounts to meet its liquidity needs. Our investment guidelines
also provide that our aggregate borrowings (secured and unsecured) will not exceed 50% of the cost of our tangible assets at the
time of any new borrowing, subject to our board of directors’ discretion.
Dividends
The Company is required to pay dividends
to its stockholders at least equal to 90% of its taxable income in order to qualify and maintain its qualification as a REIT. As
a result of this distribution requirement, our Operating Partnership cannot rely on retained earnings to fund its ongoing operations
to the same extent that other companies whose parent companies are not REITs can. Our ability to continue to pay dividends is dependent
upon our ability to continue to generate cash flows, service any debt obligations we have, including our Exchangeable Senior Notes,
and make accretive new investments.
Contractual Obligations
As of March 31, 2019, we had approximately $7.9 million outstanding
in commitments related to tenant improvement allowances, which generally may be requested by the tenants at any time up until a
date that is near the expiration of the initial term of the applicable lease, approximately $5.2 million and $17.8 million of commitments
relating to construction funding for the development of the properties in Massachusetts and Ohio, which the tenant has agreed to
use commercially reasonable efforts to complete by August 31, 2019 and June 13, 2020, respectively, and approximately $2.4 million
of commitments relating to certain development milestones for the property in California, which the seller is required to complete
by September 30, 2019. Additionally, we had approximately $143,000 outstanding in commitments related to our office and equipment
leases, with approximately $68,000 to be paid in the remainder of 2019 and approximately $75,000 to be paid in 2020.
Our Exchangeable Senior Notes require interest payment semiannually
at a rate of 3.75% per annum and will mature on February 21, 2024.
Non-GAAP Financial Information and Other Metrics
In addition to the required GAAP presentations,
we use certain non-GAAP performance measures as we believe these measures improve the understanding of our operational results.
We continually evaluate the usefulness, relevance, limitations, and calculation of our reported non-GAAP performance measures to
determine how best to provide relevant information to the public and thus such reported measures could change.
Funds from Operations and Adjusted Funds from Operations
Funds from operations (“FFO”)
and FFO per share are operating performance measures adopted by the National Association of Real Estate Investment Trusts, Inc.
(“NAREIT”). NAREIT defines FFO as the most commonly accepted and reported measure of a REIT’s operating performance
equal to “net income, computed in accordance with accounting principles generally accepted in the United States (“GAAP”),
excluding gains (or losses) from sales of property, plus depreciation and amortization related to real estate properties, and after
adjustments for unconsolidated partnerships and joint ventures.”
Management believes that net income, as
defined by GAAP, is the most appropriate earnings measurement. However, management believes FFO and FFO per share to be supplemental
measures of a REIT’s performance because they provide an understanding of the operating performance of our properties without
giving effect to certain significant non-cash items, primarily depreciation expense. Historical cost accounting for real estate
assets in accordance with GAAP assumes that the value of real estate assets diminishes predictably over time. However, real estate
values instead have historically risen or fallen with market conditions. We believe that by excluding the effect of depreciation,
FFO and FFO per share can facilitate comparisons of operating performance between periods. We report FFO and FFO per share because
these measures are observed by management to also be the predominant measures used by the REIT industry and by industry analysts
to evaluate REITs and because FFO per share is consistently reported, discussed, and compared by research analysts in their notes
and publications about REITs. For these reasons, management has deemed it appropriate to disclose and discuss FFO and FFO per share.
Management believes that adjusted
funds from operations (“AFFO”) and AFFO per share are also appropriate supplemental measures of a REIT’s operating
performance. We calculate AFFO by adding to FFO certain non-cash or infrequent or unpredictable expenses which may impact comparability,
consisting of non-cash stock-based compensation expense and non-cash interest expense.
Our computation of FFO and AFFO
may differ from the methodology for calculating FFO and AFFO utilized by other equity REITs and, accordingly, may not be comparable
to such REITs. Further, FFO and AFFO do not represent cash flow available for management's discretionary use. FFO and AFFO should
not be considered as an alternative to net income (computed in accordance with GAAP) as an indicator of our financial performance
or to cash flow from operating activities (computed in accordance with GAAP) as an indicator of our liquidity, nor is it indicative
of funds available to fund our cash needs, including our ability to pay dividends or make distributions. FFO and AFFO should be
considered only as supplements to net income computed in accordance with GAAP as measures of operations.
The table below is a reconciliation of
net income to FFO and AFFO for the three months ended March 31, 2019 and 2018 (in thousands, except share and per share amounts):
|
|
For the Three Months Ended
March 31,
|
|
|
|
2019
|
|
|
2018
|
|
Net income available to common stockholders
|
|
$
|
3,303
|
|
|
$
|
607
|
|
Real estate depreciation
|
|
|
1,218
|
|
|
|
476
|
|
|
|
|
|
|
|
|
|
|
FFO available to common stockholders
|
|
|
4,521
|
|
|
|
1,083
|
|
Stock-based compensation
|
|
|
563
|
|
|
|
330
|
|
Non-cash interest expense
|
|
|
208
|
|
|
|
—
|
|
|
|
|
|
|
|
|
|
|
AFFO available to common stockholders
|
|
$
|
5,292
|
|
|
$
|
1,413
|
|
FFO per share — basic
|
|
$
|
0.47
|
|
|
$
|
0.18
|
|
FFO per share — diluted
|
|
$
|
0.46
|
|
|
$
|
0.18
|
|
AFFO per share — basic
|
|
$
|
0.55
|
|
|
$
|
0.24
|
|
AFFO per share — diluted
|
|
$
|
0.54
|
|
|
$
|
0.23
|
|
|
|
|
|
|
|
|
|
|
Weighted average shares outstanding — basic
|
|
|
9,664,775
|
|
|
|
5,883,610
|
|
|
|
|
|
|
|
|
|
|
Weighted average shares outstanding — diluted
|
|
|
9,797,676
|
|
|
|
6,025,067
|
|
As the Company has the intent and ability
to settle the debt component of the Exchangeable Senior Notes in cash and the excess conversion premium in shares, the Company
only includes the effect of the excess conversion premium in the calculation of diluted shares. For the three months ended March
31, 2019, the effect of the excess conversion premium was anti-dilutive and therefore, excluded from the calculation of diluted
shares.
Average Current Yield on Invested Capital
In addition, we have provided our calculation
of our average current yield on invested capital, which is a measure of financial performance used by management to evaluate its
current investment returns on capital invested or committed to invest in our properties. Average current yield on invested capital
is not a substitute for financial results as reported in accordance with GAAP, and should not be utilized in place of such GAAP
results. We believe that average current yield on invested capital is a meaningful measure because it quantifies our effectiveness
in generating returns relative to the capital we have invested or have committed to invest in our properties. Our computation of
average current yield on invested capital may also differ from the methodology for calculating average current yield on invested
capital by other real estate companies, and, accordingly, may not be comparable to such real estate companies.
As of March 31, 2019, our average current
yield on invested capital was approximately 15.1% for the 13 properties that we owned, calculated as the sum of the initial base
rents, supplemental rent (with respect to the lease with PharmaCann, LLC at one of our New York properties) and property management
fees (after the expiration of applicable base rent abatement periods) of approximately $30.0 million, divided by our aggregate
investment in these properties of approximately $198.9 million (excluding transaction costs and including the aggregate potential
tenant reimbursements of $36.6 million).
Critical Accounting Policies
Our condensed consolidated financial statements
have been prepared in accordance with GAAP, which require us to make estimates and assumptions that affect the reported amounts
of assets and liabilities and disclosure of contingent assets and liabilities at the date of the condensed consolidated financial
statements and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ materially
from those estimates and assumptions. Set forth below is a summary of our accounting policies that we believe are critical to the
preparation of our condensed consolidated financial statements.
Acquisition of Rental Property, Depreciation and Impairment
We depreciate each of our buildings and
improvements over its estimated remaining useful life, not to exceed 35 years. We depreciate tenant improvements at our buildings
over the shorter of the estimated useful lives or the terms of the related leases.
Upon acquisition of property, we allocate
the purchase price based upon the relative fair values of all assets acquired and liabilities assumed. For transactions that are
an asset acquisition, acquisition costs are capitalized as incurred. All of our acquisitions to date have been recorded as asset
acquisitions.
On a quarterly basis, we review current
activities and changes in the business conditions of all of our properties prior to and subsequent to the end of each quarter to
determine the existence of any triggering events or impairment indicators requiring an impairment analysis. If triggering events
or impairment indicators are identified, we review an estimate of the future undiscounted cash flows for the properties, including,
if necessary, a probability-weighted approach if multiple outcomes are under consideration.
Long-lived
assets to be held and used are individually evaluated for impairment when conditions exist that may indicate that the carrying
amount of a long-lived asset may not be recoverable. The carrying amount of a long-lived asset to be held and used is not recoverable
if it exceeds the sum of the undiscounted cash flows expected to result from the use and eventual disposition of the asset. Impairment
indicators or triggering events for long-lived assets to be held and used are assessed by project and include significant fluctuations
in estimated net operating income, occupancy changes, significant near-term lease expirations, current and historical operating
and/or cash flow losses, construction costs, estimated completion dates, rental rates, and other market factors. We assess the
expected undiscounted cash flows based upon numerous factors, including, but not limited to, construction costs, available market
information, current and historical operating results, known trends, current market/economic conditions that may affect the property,
and our assumptions about the use of the asset, including, if necessary, a probability-weighted approach if multiple outcomes are
under consideration. Upon determination that an impairment has occurred, a write-down is recognized to reduce the carrying amount
to its estimated fair value. We may adjust depreciation of properties that are expected to be disposed
of or redeveloped prior to the end of their useful lives.
Revenue Recognition and Accounts Receivable
Our
existing tenant leases are and future tenant leases are generally expected to be triple-net leases, an arrangement under
which the tenant maintains the property while paying us rent and property management fees. We account for our leases as
operating leases. Under this method, leases that have fixed and determinable rent increases are recognized on a straight-line
basis over the lease term, unless the collectability of minimum lease payments is not reasonably predictable. Rental
increases based upon changes in the CPI are recognized only after the changes in the indexes have occurred and are then
applied according to the lease agreements. Contractually obligated reimbursements from tenants for recoverable real estate
taxes and operating expenses will be included in tenant reimbursements in the period when such costs are incurred.
Contractually obligated real estate taxes that are paid directly by the tenant to the tax authorities are not reflected in
our consolidated financial statements.
We record revenue for each of our properties
on a cash basis due to the uncertainty of collectability of lease payments from each tenant due to its limited operating history
and the uncertain regulatory environment in the United States relating to the medical-use cannabis industry.
Stock-Based Compensation
Stock-based compensation for equity awards
is based on the grant date fair value of the equity instrument and is recognized over the requisite service period. If awards are
forfeited prior to vesting, we reverse any previously recognized expense related to such awards in the period during which the
forfeiture occurs and reclassify any non-forfeitable dividends previously paid on these awards from retained earnings to compensation
expense.
Income Taxes
We have been organized to operate our business
so as to qualify to be taxed as a REIT, for U.S. federal income tax purposes. Under the REIT operating structure, we are permitted
to deduct dividends paid to our stockholders in determining our taxable income for U.S. federal income tax purposes. As long as
our dividends equal or exceed our taxable net income, we generally will not be required to pay U.S. federal income tax on such
income.
The Tax Cuts and Jobs Act was enacted in
December 2017 and is generally effective for tax years beginning in 2018. This new legislation is not expected to have a material
adverse effect on the Company’s business and contains several potentially favorable provisions.
Adoption of New or Revised Accounting Standards
As an “emerging growth company”
under the JOBS Act, we can take advantage of the extended transition period provided in Section 7(a)(2)(B) of the Securities Act
of 1933, as amended, for complying with new or revised accounting standards. In other words, an “emerging growth company”
can delay the adoption of certain accounting standards until those standards would otherwise apply to private companies. An “emerging
growth company” may opt out of the extended transition period for complying with new or revised accounting standards. A decision
to opt out, however, is irrevocable. We have elected not to opt out of such extended transition period, which means that when a
standard is issued or revised and it has different application dates for public or private companies, we can adopt the standard
for the private company. This may make comparison of our financial statements with a public company that either is not an “emerging
growth company” or is an “emerging growth company” that has opted out of using the extended transition period difficult
or impossible as different or revised accounting standards may be used.
Impact of Real Estate and Credit Markets
In the commercial real estate market, property
prices generally continue to fluctuate. Likewise, during certain periods, the U.S. credit markets have experienced significant
price volatility, dislocations, and liquidity disruptions, which may impact our access to and cost of capital. We continually monitor
the commercial real estate and U.S. credit markets carefully and, if required, will make decisions to adjust our business strategy
accordingly.
Off-Balance Sheet Arrangements
We have no unconsolidated investments or
any other off-balance sheet arrangements.
Interest Rate Risk
As of
March 31, 2019, we had approximately $143.75 million of Exchangeable Senior Notes outstanding at a fixed interest rate, and therefore,
if interest rates decline, our required payments may exceed those based on current market rates. It is possible that a property
we acquire in the future would be subject to a mortgage, which we may assume.
Impact of Inflation
We enter into leases that generally provide
for limited increases in rent as a result of increases in the U.S. Consumer Price Index (typically subject to ceilings) or fixed
increases. We expect these lease provisions to result in rent increases over time. During times when inflation is greater than
increases in rent, as provided for in the leases, rent increases may not keep up with the rate of inflation.
Seasonality
Our business has not been, and we do not
expect our business in the future to be, subject to material seasonal fluctuations.