Innovative Industrial Properties Inc Q3 FY2025 Earnings Call

Good day, and welcome to the Innovative Industrial Properties, Inc. Q3 2025 Earnings Conference Call. Please note that this event is being recorded. I would now like to turn the conference over to Eli Kanter. Thank you, and over to you.

Thank you for joining the call. Presenting today are Alan Gold, Executive Chairman; Paul Smithers, President and Chief Executive Officer; David Smith, Chief Financial Officer; and Ben Regin, Chief Investment Officer. Before we begin, I'd like to remind everyone that statements made during today's conference call may be deemed forward-looking statements within the meaning of the safe harbor of the Private Securities Litigation Reform Act of 1995, and actual results may differ materially due to a variety of risks, uncertainties, and other factors. Please refer to the documents filed by the company with the SEC, specifically the most recent reports on Form 10-K and 10-Q, which identify important risk factors that could cause actual results to differ from those contained in the forward-looking statements. We are not obligated to publicly update or revise any forward-looking statements, whether as a result of new information, future events, or otherwise. In addition, on today's call, we will discuss certain non-GAAP financial information such as FFO, normalized FFO, and AFFO. You can find this information together with reconciliations to the most directly comparable GAAP financial measure in our earnings release issued yesterday as well as in our 8-K filed with the SEC. I'll now hand the call over to Alan.

Thanks, Eli. Good morning, and thank you for joining our call. In the third quarter, we completed our initial investment into IQHQ, a premier life science real estate platform that enhanced the diversification of the company and is expected to provide significant earnings accretion for the benefit of IIP shareholders. The total investment was $105 million, including $100 million into a revolving credit facility and $5 million in preferred stock. Our remaining commitment of $165 million in preferred stock is expected to be funded in multiple tranches through the second quarter of 2027. In conjunction with this investment, we successfully closed on a new $100 million secured revolving credit facility to support our investment into IQHQ and further strengthen our balance sheet. We were very pleased with the support of our largest lender in providing this facility, which we believe reflects continued confidence in our platform, balance sheet, and disciplined approach to growth and capital allocation. These transactions mark a significant step in our evolution and our return to growth as we diversify our portfolio beyond cannabis into the dynamic life science sector. We have strong conviction in the long-term fundamentals driving this industry, and we believe this strategic investment at this entry point positions us to deliver highly accretive returns to our shareholders. We believe in the value of our diversified portfolio across both cannabis and life science and the ability of our team to strengthen our platform and create long-term value for our shareholders. Now with that, I'll turn the call over to Paul.

Thanks, Alan, and welcome, everyone. Our investment in IQHQ, together with the new credit facility, marks a meaningful step forward in executing on our strategy to return to growth while further diversifying and strengthening our portfolio. Expanding into life sciences positions us to capture long-term secular growth while complementing our established leadership in the regulated cannabis real estate market. We continue to actively maximize the value of our assets to drive growth and optimize performance, while at the same time, our investment in IQHQ provides an additional avenue for future growth. We believe this dual-track strategy will significantly enhance shareholder value and position IIP for sustained success across both industries. I'd like to provide a few specific updates on our progress within our portfolio. Receivership proceedings for 4Front Ventures are ongoing. We are engaged with the U.S. receiver and bankruptcy trustee regarding the properties and related claims and are working closely with outside counsel to protect our legal interest and pursue our rights under the leases. Gold Flora remains in receivership. We remain in ongoing discussions with the receiver regarding the receivership and sale process. We will continue to monitor developments and provide updates as appropriate. With respect to PharmaCann, we are pleased to report that the judge in Illinois ruled in our favor in our dispute with PharmaCann, and we expect to regain possession of our Illinois property by year-end. Our efforts to also regain control of the properties located in New York, Ohio, and Pennsylvania remain a top priority. We continue to work closely with local counsel to pursue our rights and remedies under the leases and related guarantees, including monetary claims. Because timing varies by state and depends on local jurisdictions, we are unable to provide a specific timeline at the moment. We remain focused on advancing these processes as efficiently as possible, and we'll provide updates as developments occur. In September, we took back possession and control of the 4 California properties previously securing a loan totaling $16.1 million, which we declared in default and are evaluating options to maximize the value of these assets. Turning to federal developments impacting the cannabis industry. Recent commentary from President Trump has reaffirmed that cannabis reform remains a priority at the federal level. His endorsement of medical cannabinoids, particularly for senior citizens, alongside references to the potential $64 billion in healthcare savings, signals growing political momentum for rescheduling cannabis to Schedule III, eliminating the burdensome 280 tax for operators. We believe this shift will be a positive catalyst for the industry, unlocking broader access to capital and accelerating institutional participation, though we remain cautious on the likelihood and timing. We also see compelling demographic trends that reinforce the long-term opportunity in cannabis. Seniors, who are currently underrepresented among cannabis users, are the fastest-growing consumer segment, with usage growing at a 9% five-year compounded annual growth rate, triple the rate of the broader adult population. Importantly, this cohort is more likely to rely on physician recommendations and rescheduling could ease barriers for doctors to prescribe cannabis for conditions like pain, arthritis, and sleep disorders. Accounting for 35% of total drug spending, we believe increased adoption by seniors could drive meaningful incremental revenue for the industry and further validate cannabis as a mainstream therapeutic option. Finally, we are also pleased to share a significant legal update. Last month, the U.S. Court of Appeals for the Third Circuit unanimously affirmed the District Court's dismissal of the federal securities class action brought against IIP and certain of our officers and directors. While we disagreed with the arguments of this class action from the very beginning, it is great to see our views validated by the courts. This outcome allows us to continue focusing on executing our strategy and delivering long-term value to our shareholders. I'd like to now turn the call over to Ben to discuss our leasing, disposition, and investment activity.

Thanks, Paul. Within our cannabis portfolio, we've executed leases totaling 281,000 square feet year-to-date across properties located in California and Michigan and taking advantage of capital recycling opportunities by selling two assets. We are also closely monitoring the situations with our tenants that Paul described and are encouraged by the strong demand for our real estate and look forward to sharing additional updates in the future. Turning to IQHQ, we're very excited about our return to growth. We closed on our initial $105 million investment with additional commitments of $165 million expected to be funded over time. We expect this investment to be highly accretive and positions us to capitalize on secular tailwinds. Just last month, Lila Sciences, an AI biotech company, leased 244,000 square feet across two buildings at IQHQ's Alewife Park asset in Cambridge, Massachusetts. The transaction represents one of the largest leases in the region since the beginning of the year and underscores the improving leasing momentum for IQHQ and continued demand for premier real estate assets. Overall, global spending on AI and pharma and biotech is projected to reach $3 billion in 2025 and $16.5 billion by 2034, reflecting a 27% CAGR. The use of AI can accelerate drug discovery and innovation, resulting in an associated increase in real estate needs according to Cushman & Wakefield. We believe the IQHQ portfolio located in key AI and life science hubs in San Diego, San Francisco, and Boston is well positioned to capitalize on these trends. And within our investment pipeline, we will continue to selectively pursue assets in the cannabis and life science industries, focusing on the highest quality investments with the most attractive risk-adjusted returns for our shareholders. I'll now turn the call over to David.

Thank you, Ben. For the third quarter, we generated total revenues of $64.7 million, a 3% increase compared to the prior quarter. This increase was primarily due to a payment of $0.8 million we received from the Gold Flora receivership, along with annual rent escalations in our portfolio. Adjusted funds from operations for the quarter totaled $48.3 million or $1.71 per share, representing no change from the second quarter results. Our balance sheet remains strong, supported by $2.7 billion in primarily unencumbered gross assets and a low leverage capital structure. We ended the quarter with nearly $80 million in liquidity, including cash on hand and availability under our credit facility. As Paul and Alan noted earlier, subsequent to quarter end, we secured a second revolver with a federally regulated bank for $100 million, reflecting our view that as we diversify into a new sector, it should increase IIP's access to attractively priced bank financing. The new revolving credit facility secured by our IQHQ investment was structured at favorable terms of SOFR plus 200 basis points or 6.1% on the closing date of the facility and includes an accordion feature that could expand capacity to $135 million, subject to additional bank commitments. This facility, combined with our low leverage capital structure and strong liquidity ensures we have ample flexibility to fund future growth. Our investment in IQHQ is expected to be highly accretive with a blended interest rate exceeding 14% or roughly 800 basis points higher than the current pricing on the new credit facility and aligns with our commitment to delivering strong risk-adjusted returns for our shareholders. As always, we remain focused on maintaining a conservative financial profile while pursuing strategic opportunities that drive long-term value, highlighted by a low debt to gross assets ratio of 13% and a robust debt service coverage ratio exceeding 11x. On the capital markets front, during the quarter, we opportunistically issued 246,000 shares of our preferred stock for total net proceeds of $5.9 million. Looking ahead, we are actively evaluating our capital structure and having ongoing discussions regarding our bonds maturing next year to proactively address this maturity in the near term. We will continue to explore a range of strategic financing alternatives that align with our long-term growth objectives and conservative financial philosophy. With that, we thank you for joining the call and would like to open up the call for questions. Operator, could you please open up the call for questions?

We have the first question from Tom Catherwood from BTIG.

I wanted to start with the dividend question, but from a different perspective. So the way we see it, there are two near-term catalysts that can help bridge the gap from the $1.71 per share of AFFO that you did in Q3 to the $1.90 of quarterly dividend. The first is, as you guys have spoken about, the IQHQ investment, which we think conservatively can contribute, let's call it, $0.11 per share on a cash basis when it's fully deployed. And the second is your signed but not commenced backfill leases. And we think those can contribute something in the range of $0.11 to $0.15 a share per quarter. So regarding that second bucket, what are your expectations for the timing of rent commencements at your re-leased assets? And how does that timing factor into the company's dividend policy?

I'm not sure I completely understand your calculations. I think we might have slightly different views on the IQHQ investment, but we can discuss that later. Regarding the timing of rent commencements for unleased assets or those we will be getting back, it's important to note that the Gold Flora assets are currently in receivership. The receiver has awarded an opportunity to an entity that will close the transaction and start paying rent for the facilities they plan to use. Any remaining assets, if available for us to lease again, should generate income fairly quickly due to the interest we've seen in that portfolio. Similarly, for Gold or 4Front, they are also in receivership, seeking a buyer to continue operations. We expect that once that process is completed, revenue will start almost immediately after the receivership is finalized. Paul, what do you estimate that timeframe to be?

On 4Front, it could be another three to nine months.

Regarding PharmaCann, we see a positive outlook for the industry overall, with continued and growing interest in those specific assets across individual states. While we are pleased to be progressing through the legal aspects of the Illinois transaction, we believe there is interest from potential parties to take over that facility. Unfortunately, we have been delayed due to court proceedings that have prevented us from engaging with those interested parties. With the favorable response from the court to our pleadings, we expect significant interest and anticipate generating revenue within the next six to nine months. I apologize; I will let Paul finish with that.

Yes, Tom. I wanted to share some additional thoughts regarding the litigation. We're currently in the fourth quarter and approaching resolutions. Securing trial dates in various jurisdictions can be a lengthy process. As we noted, we achieved a favorable outcome in Illinois. Pennsylvania and Ohio should follow, either through a trial or summary judgment, with New York coming afterward. We're getting much closer to resolving these issues. Additionally, concerning the bankruptcy cases involving 4Front and Gold Flora, the back rent owed to us is classified as an administrative claim within the receivership process. Once the receivership concludes, we expect to receive significant funds through this claim. Gold Flora will likely be settled before 4Front, but we will continue to provide updates on the timing.

That's great. That was really helpful. And just kind of to add to that, there's a couple of other leases that you signed since the end of 2023. So these are like the re-leasing you did with Mitten Extracts or Lume Cannabis, Tri-Mountain Pure, and Berry Green, all the backfills that were already done. For that run rate that you had this quarter, that $1.71 million, how many of those leases have commenced in that run rate this quarter? And how many are still left to commence kind of near term?

Tom, this is Ben. Yes, I think it's pretty minimal for the third quarter. I think just as a general statement, when we sign a lease, there's sometimes a licensing process, ramp-up of operations, and various things that impact when that revenue starts. However, I want to echo what Alan and Paul said, I think we've been very pleased with the leasing success. We're very optimistic about the demand we're seeing across all assets that are going through the various legal processes. Timing is a little more difficult to pinpoint, but again, we're very encouraged by the demand that we're seeing.

Okay, just to clarify, Ben, the ones I mentioned that you backfilled over the past two years contributed minimally to the third quarter. So there's still more of that to come in, correct?

Yes. I mean, Tom, on that side, there was a slight benefit, but I would say it was de minimis this quarter as those leases come online and ramp up.

And to wrap up in the fourth quarter and beyond.

Perfect. Perfect. Alright. And then the last one for me in terms of the balance sheet, as we think through sources and uses over the next six months, you obviously mentioned in the prepared remarks the new $100 million revolver, which can continue to support your ongoing investment in IQHQ. For the unsecured bonds that mature in May, what are the specific options or avenues that you're currently pursuing? And what is your expectation in terms of timing and getting to a resolution on those?

The options are quite clear. We will either refinance them or refinance them. That's our current situation. We believe we have a strong and affirmed rating from Egan-Jones and maintain that our balance sheet is among the strongest in the REIT sector. We expect investors to recognize this strength and appreciate that we have consistently honored our bond repayments for the last four and a half years. We are confident that we have ample time to manage the refinancing as it approaches next year, with the earliest repayment likely in the first quarter.

Correct. Yes.

So timing-wise, we should expect to complete that process in the first quarter of 2026, correct?

That is the plan that we have on the table today.

We have the next question from the line of Aaron Grey from Alliance Global Partners.

So first one for me, just on the potential impact of rescheduling. I know it's been talked about in the past. I just wanted to revisit it again because, in terms of direct impact, it would seem better cash and stabilizing your existing base of tenants, so maybe less worry of incremental defaults. But how do you think about potential opportunities for growth and more uses for acquisitions and new tenants? Is it less so dependent on rescheduling and more so dependent on additional states coming online? Just want to give your broader outlook on cannabis, given the supply/demand that we've seen in a lot of the existing states, the appetite that you're seeing for potential additional cultivation or if that's more so dependent on new states versus rescheduling there.

No, I think as we alluded to earlier in our comments that we're really seeing some really positive interest in our facilities that we have in the states when we do have facilities. So we're seeing continued interest by the existing growers in those states who have maybe survived or as you want to say, we think the consolidation phase of this market, of the cannabis, industry seems to have worked. It's worked through the majority of that consolidation and that the most efficient and the efficient growers and companies in that industry have survived and are continuing to look to consolidate but grow their focus in the individual states that they're in. So we're seeing that positive green shoot there without the rescheduling occurring. We believe that, that will continue to build over time. And as it builds over time, we are absolutely best positioned to take advantage of any new demand for the sale-leaseback program that we continue to offer to the market and to use our capital for the benefit of IIP and our shareholders. Now Paul, do you want to add anything with regards to the rescheduling and what you think how the impact might be for our tenants?

Sure. So I think we've, Aaron, in the past, discussed what rescheduling would look like and how that helps. I think you identified it that I think the first real impact is really improving the credit of the operators. They have just much more free cash to use. So that improves the credit as far as our tenant base, but also gives them the opportunity to use that cash to expand. So much of our development is our operators expanding the existing facilities coming to us for additional investments. We think that's certainly a possibility or likelihood, I think, with rescheduling. And as we noted in our remarks that there is this kind of up-and-down enthusiasm about rescheduling. Now we're in a place where some really positive comments have come out of the White House, both by the President and the President's staff that said we expect a resolution on the rescheduling by the end of this year, which means what, two months now. So we are anxiously awaiting that. We do believe that it makes sense for the President to get ahead of this issue politically, and he is motivated that way. His comments about CBD usage for the elderly really give a lot of momentum to having some resolution. We think it would be a positive resolution on rescheduling, hopefully by the end of the year.

I appreciate the information you provided. It was very helpful. Looking at the near term, before we see any rescheduling, you mentioned potential opportunities in both life sciences and cannabis. How should we prioritize these in the short run, considering your current liquidity position? Does the life sciences segment present more immediate opportunities, especially in light of what we observed with IQHQ and the favorable rate on the revolver? This rate is significantly better than the one associated with the cannabis revolver. If rescheduling does not occur, do you foresee more opportunities in the life sciences in the near term, or do you view both sectors as having equal potential?

Yes. No, I think we are highly focused on the cannabis industry and making sure that we are supporting our tenant partners as best we can. We believe that that's our primary focus. Secondarily, do I think that there are more double-digit plus yield opportunities in the life science industry? We are constantly looking at that. But I think that was a very unique opportunity that we were able to capitalize based on our expertise and knowledge. We will continue to look at that, but I think our primary focus will remain in the cannabis industry.

We have the next question from the line of Bill Kirk from ROTH Capital Partners.

So the press release mentioned, I think, a few new names where you're collecting security deposits. One was named, the other is unnamed in Sacramento. Can you give us a sense for size on those? What do you expect the outcome to be? And were those two identified when you went through that tenant health work that you did earlier in the year?

Yes, we're less than 1% of our revenue. And we're monitoring all of our tenants, and we spent time with those tenants and understood what was going on with them. Ben, do you have any color associated with those two tenants or anything you want to add to that?

Yes, I would just add that those were two tenants in California. I think this is a theme we've seen in many markets where the growth and expansion of the efficient operators and the demand that we're seeing for these facilities, along with some of the other vacancies that we've taken back, really reflects the consolidation that we're seeing play out in the industry and the less efficient operators moving out, while the more efficient operators continue to grow their platforms within these individual markets. I feel very good about the quality of those assets, along with the rest of our portfolio, which I think is reflected again in the amount of interest that we're seeing across the board.

With the additional square footage leased at IQHQ with biosciences, what does that take occupancy to at IQHQ? And ultimately, kind of where do you expect occupancy to go? Maybe how long does it take to get there? And what capital do you think is required to get that occupancy rate up further?

IQHQ is a private organization, so it's really up to them. From our viewpoint, we see that the occupancy level is around 24% to 25%, and we certainly hope they can increase it to over 90% in the next 18 to 24 months.

We have the next question from the line of Alexander Goldfarb from Piper Sandler.

So big picture, at the end of last year, around 27% of ABR was in default. It seems you have signed some new backfills and are working on resolutions and receivership. However, there were new tenants, including a $16 million loan that went bad. Can you tell me the current percentage of ABR that is still not rent paying? I'm not asking about occupancy, but specifically how much of the ABR is not generating rent. What is the current status?

Alex, since we announced that last December, some things have moved around too. We've taken some properties back from PharmaCann, but from kind of an overall ABR collection, there's roughly 20%.

Okay. So David, we're currently at 20%, down from 27%, and that includes the impact of the latest tenants from the third quarter along with the $16 million loan.

That's correct. Keep in mind, as Alan mentioned before, those two tenants during the quarter were very small, 1%, so kind of immaterial to the overall portfolio. But you're roughly correct.

Okay, that's great. We recognize your background in life science, Alan. You co-founded and stayed at IQHQ until December, and there's significant experience there. However, in both industries, especially cannabis, there are still issues with tenants facing challenges. Alexandria, the only dedicated REIT in this sector, along with BXP, has mentioned difficulties in life science as well. While we acknowledge the current strength of the balance sheet, it seems there may be potential capital needs for both cannabis and any developments related to your position at IQHQ. The risks associated with being involved in IQHQ remain unclear, given that life science has not fully recovered. If the sector was thriving and active, it would make sense, but it appears to be struggling. How do we address the capital demands of both industries when there are ongoing tenant challenges in cannabis?

Yes. First of all, we made the investments with the intention of being in a strong credit position, not to defend the investment itself. It’s the common shareholders at IQHQ and other investors who need to focus on that aspect. That’s not our responsibility. Secondly, we maintain a strong and conservative balance sheet, which enables us, as we've demonstrated, to secure additional credit from our bank group at favorable rates. We believe we continue to have excellent access to various capital sources. Lastly, I understand your desire for companies to invest only when opportunities are clearly advantageous. However, our role is to seek out unique investment opportunities that present attractive returns for our shareholders. We have successfully done this. If in three or four years you ask about the performance of our investment in IQHQ, I will be glad to share the results with you.

Okay. And just the final question is, Paul, over the years, there have been many hopeful developments in cannabis, such as state legalization or rescheduling, that seemed like they would really boost the sector. I appreciate your update on the rescheduling efforts and the interest from seniors in adopting cannabis. However, in the past, despite hearing positive news, it hasn't sparked growth in the industry. Do you believe these positive developments could truly jumpstart the industry, or do you think there are still significant challenges, such as the gray market and black market? I'm just trying to get clarity on whether we should be excited about these positive steps or if we need to remain cautious due to ongoing issues in the industry, particularly with the gray market and the black market.

Yes, Alex, obviously, rescheduling doesn't make the black market go away. Those are two separate things that need to be separately addressed. With rescheduling, I think that will be a huge shot in the arm to the industry for the reasons we've discussed in great detail. At the same time, I think we've seen some real positive movement on state-by-state combating the black market. It's not fixed by any means, but it's getting much more attention, I think, in the larger states. You've seen in California, Massachusetts, Michigan, especially some significant movement in curtailing the black market grows, but also the gray market retail. I know you and I have discussed this in New York, the actual physical blackouts of the retail. So we're moving in the right direction on that.

This concludes our question-and-answer session. I would now like to turn the conference back to Alan Gold for any closing remarks.

Thank you. And I thank you all for joining today. Again, I'd like to thank our team for the hard work that they've done. And with that, we conclude the call.

Thank you. The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.