Earnings Call Transcript - IIPR Q4 2023

Operator, Operator

Good day. And welcome to the Innovative Industrial Properties Incorporated Fourth Quarter and Full Year 2023 Earnings Call. All participants will be in listen-only mode. After today’s remarks, there will be an opportunity to ask questions. Please note this event is being recorded. I would now like to turn the conference over to Brian Wolfe, General Counsel. Please go ahead.

Brian Wolfe, General Counsel

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

Alan Gold, Executive Chairman

Thank you, Brian, and welcome, everyone. We are pleased to discuss our results for the full year 2023 and recent activity as we enter into our eighth full year of operations. The company performed well in 2023 and has continued to execute year-to-date, demonstrated by annual AFFO per share growth of 7%, increasing our annual dividends declared each year since inception in 2016, committing capital totaling $119.5 million during 2023, executing new leases and LOIs to release five properties, representing over $140 million of invested capital, and further enhancing our liquidity position and strong balance sheet with the closing of a new $45 million revolving credit facility. For the year, IIP generated total revenues of $310 million and adjusted funds from operations of $256 million, increases of 12% and 10% over 2022, respectively. I would note that these growth results were achieved during a time when we strategically determined to reduce our investigate increase cost of capital. That financial performance allowed us to continue to grow our dividend. With $7.22 of common stock dividends declared over the course of 2023. Annual dividends increasing each year since inception. Our most recent dividend declared in Q4 of $1.82 per share was at the midpoint of our Board's target dividend payout range of 75% to 85% of AFFO. We have one of the strongest and most experienced teams of real estate professionals in the cannabis industry, a high-quality portfolio and a conservative and flexible balance sheet with a 12% debt to total gross assets. No variable rate debt, no debt maturities until May 2026. We further enhanced our balance sheet position during Q4 with the introduction of a revolving credit facility and then recently upsized that facility earlier this month. On the investments front, we are very pleased with our execution on releasing initiatives as well as the opportunities we are seeing to selectively close on new investments, which Ben will discuss in more detail. From a regulatory perspective, as we noted in our prior call, we continue to follow closely the potential rescheduling of cannabis from Schedule 1 to Schedule 3 under the Controlled Substance Act. Of course, there are significant benefits to this, the most important of which, from our perspective, is the potential lifting of the confiscatory federal taxes imposed on regulated cannabis operators, and Paul will discuss our thoughts in more detail. I will now turn the call over to Paul to discuss licensing, regulatory and industry dynamics.

Paul Smithers, President and Chief Executive Officer

Thanks, Alan. Licensing. Before discussing overall market developments, I'd like to provide an update on the properties leased or previously leased to Parallel, Green Peak and Kings Garden. As we have noted in the past, and I think it is worth repeating here, we are of course first and foremost focused on maximizing the value of each of our properties and having tenants with strong teams that can manage their businesses successfully through the inevitable ups and downs with the industry. As we discussed in detail previously, Green Peak was placed into receivership in March of last year, and we subsequently regained possession of the Summit Building, a cultivation and processing facility under redevelopment, and three small retail locations. The receiver also decided to turn back the Harvest Park cultivation and processing facility to us, but we expect the buyer of the remaining Green Peak receivership estate to assume the leases for the other three retail locations with no changes to terms. As you also know, we filed actions against Parallel for possession and damages at our Texas and Pennsylvania properties and regained possession of those two properties in March and October of last year, respectively. We are actively exploring all options for these properties. With respect to the Pennsylvania property, a consent order was issued in October awarding us damages of $15.5 million, of which we collected $1.7 million in Q4. And in late September, as we previously disclosed, we regained possession of the remaining four properties previously occupied by Kings Garden. As Alan noted, we are pleased with our releasing efforts to date for these properties, and Ben will provide further detail in his prepared remarks. Market Developments. Growth of the overall cannabis industry in the US continues to remain strong, with BDSA projecting cannabis sales to increase approximately 10% in 2024. BDSA estimates US cannabis sales were $29.5 billion in 2023, representing approximately a 12% growth from 2022. Although unit pricing for regulated cannabis products has been under pressure in certain states at the wholesale level for some time now, indoor cannabis cultivation continues to command significant, sustained premiums versus greenhouse and outdoor counterparts. Several factors affect unit pricing, including basic supply-demand dynamics, lack of meaningful enforcement in certain states on illicit non-licensed cannabis sales by state and local law enforcement authorities, taxation and general macroeconomic conditions. From a state market perspective, we continue to see divergence in performance and dynamics with new markets experiencing high growth, while some mature markets become increasingly competitive, especially after an extended period of price compression and the aforementioned challenges in competing with the illicit markets. For example, 2023 saw strong rollouts for adult-use sales in Missouri and Maryland and Ohio legalized adult-use in November, with sales expected to commence this year in Ohio expected to be one of the fastest-growing markets in the near future. On the flip side, while New York introduced its adult-use program more than a year ago, it remains constrained by limited retail availability and a thriving illicit market, though there are efforts in the state to ramp up enforcement efforts. For additional perspective, BDSA put out recent estimates that illicit competition drives more than three-quarters of total sales in the New York market, and that there were roughly 50 active adult-use retailers in the state earlier this month versus over 2,000 illicit retailers. Capital availability. Another continuing theme from our prior calls is the impact that the tightening of financial conditions has had on capital availability for the cannabis industry. As with other industries, the cost of capital and capital availability have fundamentally changed for cannabis operators over the course of the past few years. With Viridian Capital Advisors reporting that both U.S. operator capital raising and mergers and acquisitions activity in 2023 were at their lowest levels since before 2018, the funding environment continues to be challenged right now. That said, we've seen a significant balance in many publicly traded MSO stock prices since the announcement by the Department of Health & Human Services that recommended to the DEA a reclassification of cannabis from Schedule I to Schedule III. Federal legislation. On the Federal legislation front, we are closely watching for progress on the DEA's evaluation of the HHS recommendation to reschedule cannabis to Schedule III. Most importantly, such a reclassification is expected to end the 280E tax treatment, which has imposed an extreme unsustainable tax burden on regulated operators for years. We expect such a change to be a great win and potentially significant positive catalyst for the industry, immediately providing meaningful improvement in many operators' financials. To give you a sense of the magnitude for this potential adjustment, a recent Viridian analysis estimated that removal of 280E could reduce the 12 largest publicly traded operators’ collective tax burden by $700 million annually, providing for a rational tax structure for these operations, many of which faced effective tax rates of well over 100% under the 280E regime. I'd like to now turn the call over to Ben to discuss our portfolio and leasing activity in the fourth quarter and into 2024.

Ben Regin, Chief Investment Officer

Thanks, Paul. For my prepared remarks, I plan to highlight our leasing progress for our vacant and under-development assets. We took back possession of our Summit property in Michigan in March of 2023, while it was under redevelopment. We signed an LOI for the asset in Q3, less than six months after repossession, and executed a lease in Q4. We anticipate completing redevelopment of the 201,000 square foot project in Q4 of this year and are looking forward to our new tenant moving in and activating the building. In addition to the lease for the Summit building, we've also executed LOIs for both our McLane and 19th Avenue properties in Southern California. We are working diligently through lease negotiations on these assets and will provide updates as we progress. These two assets, along with Summit, represent over $120 million of invested capital, and we are very pleased with the demand we saw for the space and the speed in which we were able to get each asset under LOI or lease. Also, as Paul noted, Green Peak is expected to move out of our Harvest Park property on March 1. We saw significant interest in the asset since the announcement of Green Peak's departure and executed a letter of intent earlier this month ahead of Green Peak's move out date. Lastly, we signed a lease last month for one of our three vacant retail assets in Michigan. We are continuing to market to lease the remaining two retail assets, as well as our North Anza and Del Sol assets in Southern California, a total of which is less than 1% of our total invested capital. Regarding our San Bernardino property, as noted on previous calls, we are exploring a potential mixed-use development of the property, and we'll continue to provide updates on progress on future calls. For our land site in San Marcos, Texas, we continue to explore options for that site, where vertical construction has not yet commenced. And at our Pittsburgh, Pennsylvania asset, Parallel wound down its operations in late October, and we were awarded a consent judgment for possession and damages at that time, as Paul noted, and collected about $1.7 million on that judgment in December. As we now have control of the asset, we are actively exploring leasing options for the property. Regarding new investment activity, we have continued to selectively close on new opportunities, supporting our tenant partners and their growth initiatives in key markets. As we previously reported, we amended our lease with Goodness Growth in New York in Q4, providing additional funding to complete the development of the expanded cultivation and processing facility and increasing rent accordingly. As Goodness Growth previously disclosed, and we noted in our last call, the company is exploring the sale of its New York operations, including the operations at this facility. We also executed a lease amendment with PharmaCann to provide additional construction funding of $16 million for our New York asset as PharmaCann executes on its strategy to expand production capacity after being awarded an adult-use production license late last year. We are pleased with the demand we are seeing for our assets across markets and the significant leasing progress we have made in the last year, while also continuing to source attractive new investment opportunities, which we will continue to pursue on a very selective, disciplined basis. With that, I'll turn it over to Catherine.

Catherine Hastings, Chief Operating Officer

Thanks, Ben. For this call, I'll describe our property portfolio and tenant roster in addition to rent collection statistics and updates on our development projects. As of December 31, we owned 108 properties across 19 states, comprising 8.9 million rentable square feet, including 1.4 million square feet under development or redevelopment. Of these 108 net properties, 103 properties are included in our operating portfolio, which was 96% leased at year-end with a weighted average remaining lease term of approximately 14.6 years. Our portfolio continues to be well diversified with no one tenant representing more than 16% of our annualized base rent and no state representing more than 15% of our annualized base rent. We have relationships with some of the largest and most experienced operators in the industry, with our leased operating portfolio comprised of 90% multistate operators and 62% leased to public company tenants. The total amount of capital invested and committed across our operating portfolio equates to $275 per square foot, which we believe remains significantly below replacement cost. Moving on to rent collection. We collected 100% of contractually due base rent and property management fees from our operating portfolio in Q4. Rent collected for the quarter included approximately $800,000 of security deposits applied for the payment of rent in connection with an amendment with Forefront at one of our Illinois properties. As we indicated in the past, this property has been under development since August of 2021 and has experienced significant delays to get permanent power delivered to the building, which is needed to get it operational. We recognized this hardship, and in January this year, restructured 4Front's Illinois rental obligation to reduce the base rent due through September 2024 and increase their obligation thereafter, allowing for better alignment of 4Front’s future Illinois rental obligations with their ability to generate revenue from the property, while also extending the term of all four leases we have with 4Front. We're also pleased to report that the building did finally get permanent power in January, and we look forward to this project's completion in the near future. Q4 rent collection included approximately $700,000 of the $1.7 million collected in December 2023 from Parallel pursuant to a consent judgment awarded in our favor, and applied to rent due from Parallel for October 2023 at one of our Pennsylvania properties, which Parallel vacated on October 31st. As David will describe next, the full $1.7 million from Parallel increased our revenue for the fourth quarter, but only $700,000 impacted our Q4 rent collection statistics. Overall, for the full year 2023, we collected 98% of our contractual rent on our operating portfolio. As for the first two months of 2024, we collected 100% of contractually due base rent and property management fees from our operating portfolio. We also continued to fund draws for improvement allowances or construction development to our operators under our leases. As we previously noted on prior calls, these improvements are critical for the efficient production of quality cannabis products at scale. In Q4 of 2023, we funded $21 million for building improvements and construction activities at our properties. Recently, several projects received their operational status, including Battle Green in Ohio, with several other projects projected to complete this next quarter. And with that, I'll turn it over to David.

David Smith, Chief Financial Officer

Thank you, Catherine. For the fourth quarter, we generated total revenues of $79 million, a 12% increase from Q4 of last year. The increase was driven primarily by an increase in tenant reimbursements versus the prior period, as well as activity in prior periods for the acquisition and leasing of new properties, additional funding of building improvements provided to tenants at certain properties that resulted in base rent increases and contractual rental escalations. The $79 million of revenue for the fourth quarter included approximately $0.8 million of secured deposits applied for payment of rents or $0.03 per share and $1.7 million or $0.06 per share received as partial payment from the consent judgment against Parallel for its failure to pay rent at one of our Pennsylvania properties previously leased to Parallel. For the three months ended December 31, 2023, we recorded net income attributable to common stockholders of $41 million or $1.45 per share. Adjusted funds from operations for the fourth quarter was $64 million or $2.28 per share, an increase of 8% compared to the fourth quarter of 2022, driven by increased tenant reimbursements, revenue generated by properties acquired in prior periods, contractual rent escalations and revenue earned on additional CapEx investments at existing properties. AFFO for the fourth quarter was down $0.01 per share versus the third quarter AFFO of $2.29, with a decrease primarily due to our taking back the remaining four properties at Kings Garden occupied until late September. Regarding Kings Garden, as mentioned on last quarter's call, results in the third quarter included $1.7 million or $0.06 per share of rent from Kings Garden applicable to those four properties, which was partially offset by $0.4 million in payments made by Kings Garden in the fourth quarter, pursuant to a consent judgment issued in our favor. On January 12, we paid a quarterly dividend of $1.82 per share to common stockholders of record as of December 29, an increase of $0.02 per share versus the third quarter dividend of $1.80. As Alan noted, our dividend remained covered by our AFFO during the quarter with a payout ratio of 80%, which is in line with the Board's targeted payout ratio of 75% to 85% of AFFO. Turning to the balance sheet. At year-end, we had approximately $2.6 billion in total gross assets and roughly $304 million in fixed-rate debt. Our debt outstanding as of today consists solely of $300 million in unsecured bonds not maturing until May 2026 with the holders of the remaining $4 million of exchangeable senior notes having exchanged their notes in full, earlier this month for a mix of cash and common stock or receiving cash payment at maturity. We continue to maintain credit metrics that are among the best in the entire publicly traded REIT industry with a debt-to-gross assets ratio of less than 12% and a debt service coverage ratio in excess of 16x. On the liquidity front, we ended the fourth quarter with over $175 million of total liquidity and comprised of our cash, short-term investments and availability under our revolving credit facility. We closed on this credit facility last October, which, at that time, was a $30 million three-year facility. I'm pleased to report that just this month, we were able to increase our capacity by $15 million to provide us $45 million in total availability. We are well-positioned as we continue to maintain a conservative and low leverage balance sheet, generate positive free cash flow and have now added another liquidity option for the company with the closing of this credit facility in the fourth quarter. Finally, as a result of the investment activity that Ben mentioned, we opportunistically tapped our ATM program on a limited basis, issuing 101,000 shares of common stock for $9.6 million in net proceeds. With that, I will turn it back to Alan.

Alan Gold, Executive Chairman

Thanks, David. I'd like to note the following in closing. Now, into our eighth year of operations. I'm proud of what our team of dedicated professionals has accomplished over that time. With our property footprint, team expertise balance sheet position and strategic focus, I believe we are well positioned for the journey ahead, serving a dynamic industry with a continued long-term growth trajectory. With that, I'd like to open it up to questions. Operator, could you please open the call up for questions.

Operator, Operator

Thank you. We will now begin the question-and-answer session. Our first question comes from Tom Catherwood from BTIG. Please go ahead.

Tom Catherwood, Analyst

Thank you, and good morning, everyone. Paul, you had previously talked about and kind of mentioned that you expected weaker operators to exit mature markets over time. And there was an article out this week that spoke to a year-over-year decline in active US cannabis licenses in 2023, despite expansions of states like Maryland, New Jersey and Illinois. How has this tightening impacted your markets and are you expecting more consolidation in 2024?

Alan Gold, Executive Chairman

So, Tom, this is Alan. First, I'd like to say that we're really very proud of our current tenant base and our current portfolio and the geographic diversification of our properties. We think that we have some of the strongest tenants in the industry. And we believe that the growth that we exhibited in 2023 at 7% year-over-year growth is something that is replicable and we look forward to continued growth in 2024. But now I'm going to turn it over to Paul to answer the question.

Paul Smithers, President and Chief Executive Officer

Yeah, hey, Tom. So, yeah, I think we've always figured out that there would be some consolidation over the years and we have seen that. But I think it's important to note that our tenant base is, as you know, primarily indoor growers. So what we're seeing a lot of the consolidation is some of the states that have more outdoor grow and greenhouse grow. So we're very happy with the performance of our operators. And if we do see some consolidation in some of the bigger states with Michigan and California, as we've noted in the past, we think that's only a positive. 90% of our tenant base are MSOs. So we think we're really well-positioned going forward.

Tom Catherwood, Analyst

It's really helpful. Then we're trying to piece together a couple of items. Since 3Q, you've put more capital to work than you did over the prior two quarters. David, you mentioned tapping the equity markets opportunistically in Q4 and obviously, upsizing the credit facility to $45 million. How do these items relate to your interest and maybe comfort level in pursuing additional investments this year?

Alan Gold, Executive Chairman

So, again, this is Alan. I mean, I think that we are cautiously, as we were in 2023, keeping the same sort of view in 2024, being very cautious but opportunistic. We believe that we have been able to drive strong returns for our shareholders and are going to continue to do so. And that we believe that the strength of our existing tenants continues to be exceptional. And we look forward to a bright 2024. But now I'm going to let Ben talk about our portfolio and our pipeline.

Ben Regin, Chief Investment Officer

Hey, Tom, appreciate the question. The pipeline, we're seeing a lot of attractive new opportunities. And we really think about driving revenue growth going forward. There's the pipeline where we're seeing opportunistic transactions out there that we can take advantage of and also want to highlight the 460,000 square feet of leasing and LOI activity we had out of our development portfolio, as well as another 128,000 square feet within our operating portfolio that we have under lease or LOI in the last year. So not only the new transactions that we can pursue, but nearly 600,000 square feet of leasing activity between our new leases and LOI last year, I think we'll continue to set us up well for continued revenue growth going forward.

Tom Catherwood, Analyst

Appreciate that color. And then last one for me. Ben, and Paul, I know you both touched on New York and the challenges that it has had but sentiment from MSOs seems to be improving in the market. I think PharmaCann announced plans to increase headcount by nearly 3x in the state and obviously, you've made incremental investments over the last few months in New York. What are you seeing on the ground in the state? And how do you expect the market to evolve going forward?

Ben Regin, Chief Investment Officer

Thank you, Tom. We're pleased to see more retail licenses being issued. While there have been historical challenges, we are optimistic about the position our tenant partners hold in the state. Regarding PharmaCann, we believe there is significant value in that asset, especially since much of the cultivation in the state is done in outdoor greenhouses. As Paul mentioned, it is one of the few high-quality indoor facilities available, which positions PharmaCann well to capitalize on upcoming wholesale opportunities. The market is projected to be among the top in the country; while its growth may not be as rapid as previously anticipated, we are witnessing improvements and more favorable sentiment from the multi-state operators. Many are enthusiastic about entering the market as they recognize its potential, and we are committed to supporting our tenant partners in their growth efforts in the state.

Tom Catherwood, Analyst

Appreciate all your thoughts. That's it for me. Thanks, everyone.

Paul Smithers, President and Chief Executive Officer

Thanks, Tom.

Operator, Operator

The next question comes from Scott Fortune from ROTH MKM. Please go ahead.

Scott Fortune, Analyst

Thank you for the questions. I would like to delve a bit deeper into the discussions with your tenant partners. Many are concentrating on cost efficiencies and enhancing yields in their facilities to boost profitability as pricing pressures emerge in certain markets. First, it's crucial to enhance your tenants' cash flow generation, which is vital for their overall health. Secondly, how is IPA involved in improving facility efficiencies and yields? Do you anticipate a greater need for facility enhancements moving forward to thrive in a normalized lower pricing environment? Additionally, while demand for cannabis remains strong, where are you observing pricing stabilize in key states to support this trend? Apologies for the long question, but I wanted to explore this topic more thoroughly.

Alan Gold, Executive Chairman

So Scott, this is Alan. From the outset, our business model and plan was to provide funding to some of the most talented growers in the country, and we have succeeded in that. We maintain a strong portfolio, with over 90% made up of MSOs. Notably, over 62% of our tenants are public entities, and most, if not almost all, are now cash flow neutral or generating positive EBITDA. Our model is designed to offer them capital so they can create efficient operational spaces, allowing them to focus on efficiency in their operations. They've been actively working on this and are effectively adopting technology and operational efficiencies to address pricing pressures and the macroeconomic challenges facing the broader economy. That’s how we view the situation. As for pricing pressures in the wholesale market, if Paul or Ben would like to add their insights on that, it's important to note, as mentioned by both, that we primarily engage with indoor grow facilities and products, rather than outdoor grow products, which are facing the most significant pricing challenges.

Ben Regin, Chief Investment Officer

Hey Scott, this is Ben. To follow up on Alan's comments on pricing, I think we've been very pleased to see the stabilization in particular, some of the markets people have been focusing on historically being California and Michigan. And the sentiment there has certainly gotten better, and I think that's evidenced by the leasing success we've had in those two markets. I mean a good chunk of the nearly 600,000 square feet of leasing activity we mentioned with both in Michigan and California. And most recently, the Harvest Park facility that Green Peak intends to move out of after they announced that, we received a tremendous amount of interest, multiple offers, and we're able to successfully put that under LOI before Green Peak even moved out of the building. So I think that really speaks to the way operators on the ground of those markets, their confidence going forward and the pricing stability in the markets overall.

Scott Fortune, Analyst

Got it. I appreciate that color. And maybe a follow-up on this discussion. On '23, we saw a year of retrenching by your tenants. Obviously, CapEx for most of the major MSOs that you work with came off anywhere from 30% to 50% and kind of similar expectations, although earnings are coming up here shortly kind of for '24 as far as the CapEx. But what are you hearing from your tenants kind of moving forward, if we get the federal relief? Obviously, you highlighted that the cash flow from the tax savings will be generated by the MSOs, that could be passed through the pricing, but also they're looking to grow, right? And just kind of give a sense that your tenants and what you're hearing from them, as far as regarding sales leaseback opportunities going into later in '24 into '25 compared to the last two, three quarters versus kind of their CapEx expectations. Just kind of the temperature around your tenants from that standpoint improving.

Alan Gold, Executive Chairman

This is Alan again. I believe that 2024 will be quite similar to 2023. We see strong demand for the capital we provide and significant opportunities that we've been able to take advantage of recently, which has helped us achieve above-average growth year-over-year. We remain optimistic that these opportunities are still present, although we are taking a cautious approach. I think Ben would agree that tenants are also exercising caution.

Ben Regin, Chief Investment Officer

Yes, I think that's fair. I think we will be very strategic and disciplined in investing additional capital. I think, as Alan mentioned, 2024 looking like 2023, where we were able to source very accretive, attractive opportunities, support our tenants, grow our portfolio, and we intend to continue to do that in the future.

Alan Gold, Executive Chairman

And then...

Scott Fortune, Analyst

And one, go ahead.

Alan Gold, Executive Chairman

I'm sorry, Paul, you mentioned the overall industry growth rate and

Paul Smithers, President and Chief Executive Officer

Yes. When discussing the relatively slower years in 2023 and perhaps 2024, we must remember that we experienced a 12% increase in the overall market in 2023, and we're anticipating a 10% increase in 2024. These are not insignificant figures. We're also excited about potential new states coming on board, particularly Florida and Pennsylvania, which may introduce adult-use programs this year. This is generating a lot of enthusiasm among our operators, especially in those states. Even if we set aside the conversation about rescheduling, we see significant growth with or without it. Our operators are enthusiastic about this. Additionally, last year, we saw progress in states like Oklahoma, Minnesota, Delaware, and Ohio with their faster programs, and we're looking forward to further developments in those areas in 2024. The prospect of new adult-use states is quite thrilling for the industry.

Scott Fortune, Analyst

I agree completely Ohio, Minnesota and Virginia, are all expected to really come on board too. And last question real quick, just from a housekeeping side of things. Congrats on kind of the pre-leases and LOIs in place. But just a follow-up on the amended leases you had from 2023, are those now being fully paid back as the increase toward the pro-rata payback, we're supposed to start January 2024. Is that starting going forward here?

Alan Gold, Executive Chairman

I'll have Cath address that. It highlights the strength of our tenants and, although we needed to provide some additional relief, things seem to be proceeding very well.

Catherine Hastings, Chief Operating Officer

Yes. We were pleased to receive the limited deferrals that we had issued to some of our tenants last quarter, and they've all started paying rents, again, cash rent, holistic forefront were the three tenants that we'd offer that program to, and we're happy to see them start paying cash out again.

Scott Fortune, Analyst

Great. Thank you for all the detail.

Alan Gold, Executive Chairman

Thanks Jeff.

Operator, Operator

The next question comes from Alexander Goldfarb from Piper Sandler. Please go ahead.

Alexander Goldfarb, Analyst

Morning out there. A few questions for me. First, just thinking about the spaces that you guys have recaptured and then re-letting, how much NOI is coming back online this year from the spaces that you recaptured last year or previous and that you've now backfilled and have tenants that are opening up this year. Just want to get a sense for how much NOI that is on an annualized basis and then when that NOI will come online this year from an earnings perspective?

Ben Regin, Chief Investment Officer

Hey, Alex, this is Ben. I would just say that each situation is going to be different. Some of the deals that we mentioned are under LOI. We are diligently working through lease negotiations. But the real estate company that takes some time. So I can't give you an exact number as to when that revenue will commence given the status of negotiations. But again, I think we, as a company are very happy with not only the amount of leasing activity, the pace of leasing activity, the quality of the tenants that we've been able to source to backfill these properties in hand. I think it's been a tremendous amount of progress that we've made. But as to specific timing, we will continue to report and provide updates as we can throughout the year.

Alexander Goldfarb, Analyst

Okay. But Ben, is there a sense of how much total NOI there is? It seems that the leasing you have done will really impact 2025. I'm trying to understand when we should expect it to affect the bottom line. It seems like it's more connected to 2025.

Ben Regin, Chief Investment Officer

We prefer not to provide specific guidance or deal terms at this time. However, we are very pleased with the returns on our investments in these assets. It's important to note that these processes take time. We will continue to work through letters of intent, finalize leases, and onboard tenants as quickly as possible to generate revenue, drive growth, and add value for our shareholders.

Alexander Goldfarb, Analyst

Okay. Next question is for Paul, who mentioned the pricing differences, noting that your indoor product is commanding a premium while the outdoor and hot house products face pricing pressure. Additionally, regarding the illicit market, I want to revisit a topic we've discussed before, particularly in relation to fentanyl. Are you noticing a shift in the market's understanding of the regulatory advantages of the products grown in your facilities? Is that accurate? Do you believe that gives you an advantage over the illicit market, or is the cannabis market still primarily driven by price, meaning consumers do not value the quality you offer compared to what's available from the illicit market or other sources?

Alan Gold, Executive Chairman

So Alex, this is Alan. Before I turn it over to Paul, I just want to just remind you and all the listeners that we don't touch the plant. We don't sell a single…

Paul Smithers, President and Chief Executive Officer

Yeah. So yeah, we've talked about this, Alex. And you're right that a product growing in a controlled environment, is vastly superior to a product that's grown outdoors and is subject to everything outdoors, including pests and variances in the weather. So can you just start with the idea that when you can control the growth, you get a better product? And that's certainly true for the medical product, which can be manipulated in centralizing the growth to address very certain medical conditions. So medical product really needs to be drawn indoors. When you talk about the quality of the adult use product, it is also similar because you can really maintain potency consistencies in the indoor environment. And that's very important, I think, for consumers. And when you talk about the illicit market, certainly a risk that people do take, consumers take, buying it off the street corner is you don't have consistency of product. And that's very important. And you don't have the quality controls with the testing. So, yes, I do believe that informed consumers certainly are going to the regulated cannabis environment for their product. But, people are people, and there is a price-driving quotient, too. And I think, some of the states that really did create an artificial pricing structure based on taxing are coming around, and California is one of them, and figuring out that when they overtax a product, it makes it really hard for the consumer to buy it. So we're very optimistic that the states will come around and pricing will be more in line where it should be. And yes, the indoor product will remain the choice of informed consumers.

Alexander Goldfarb, Analyst

Okay. And just…

Alan Gold, Executive Chairman

This is Alan, and before I pass it over to Paul, I want to emphasize that we are not politicians or part of the government. The political process can be slow, but we are managing our business with a strong and stable balance sheet that will enable us to navigate any potential challenges or opportunities arising from economic or market changes.

Paul Smithers, President and Chief Executive Officer

Yeah, obviously, we're kind of reading what you're reading, and there's a lot of guesswork going on as to when there will be an announcement, what the announcement will be, but it's guesswork. What we do know is the DEA did confirm that it is conducting its review. So that's a fact we know. So that's a very positive thing, I think. So we're going to stay tuned. And if history is any indicator, you know, the DEA does typically follow HHS regulations, but that certainly doesn't mean they have to. So we'll see, but we are optimistic like the rest of the world, but anything can happen.

Alexander Goldfarb, Analyst

Okay. Thank you very much.

Paul Smithers, President and Chief Executive Officer

Thank you.

Operator, Operator

The next question comes from Eric Des Lauriers from Craig-Hallum Capital Group. Please go ahead.

Eric Des Lauriers, Analyst

Great. Thank you for taking my questions. First one, a bit of a high-level question from me, just kind of understanding the mechanics behind the rent collection statistics. So I'm just kind of wondering if you can help me understand what happens sort of mechanically to those statistics when a tenant stops paying. We have some defaulted properties, some development properties, some operational properties not fully leased, some security deposits being applied towards rent. But then rent collection statistics remain at 100%. So could you maybe just walk us through the mechanics of what happens to your rent collection statistics when a tenant stops paying? And then maybe to help with modeling, is there a simple way to quantify the difference between the rent you're collecting from tenants in a given quarter versus what you would be collecting if your portfolio was 100% operational, 100% leased, 100% rent collection? Yeah, there's a way to quantify sort of the rent that you're actually collecting versus the total potential rent to be collected. I think that'd be helpful. Thank you.

Paul Smithers, President and Chief Executive Officer

In general, we believe we have a very strong portfolio. We operate similarly to other real estate companies. If a property we give back is in a development state, we categorize it as part of our development portfolio because there is work that needs to be done. Leasing a property that is incomplete or requires additional work is very challenging. However, if a property is fully completed, it remains in our operating portfolio and impacts our leasing statistics. An example of an asset that moved to our development portfolio is the San Marcos, Texas property, which was essentially just land. Additionally, I think we should note what we collected on that.

Ben Regin, Chief Investment Officer

Yeah. So our basis in that asset is about $8 million, and we collected over $6 million in rents from the tenant during their occupancy.

Paul Smithers, President and Chief Executive Officer

But it's still just land, and in order for us to release it, we'd have to either build it out or find a tenant who wanted to actually complete the fully designed project that was designed by Parallel at the time. So that's why that's in our development portfolio and not part of our operating statistics.

Eric Des Lauriers, Analyst

Okay. And is there a way to sort of help us calculate or quantify the difference between sort of total rent potential and then what you're collecting, especially with some of these development properties and other lease properties potentially start collecting revenue or, I guess, collecting rents in 2024, just kind of trying to help quantify the potential impact here, given rent collection statistics remain at 100%?

Paul Smithers, President and Chief Executive Officer

We'll need to follow up with you offline about that, if that's alright. That would be the ideal approach.

Eric Des Lauriers, Analyst

No problem. My last question is about the property expenses and tenant reimbursement. Are these property expenses still being fully reimbursed? If there's a difference between the property expense and the amount reimbursed, is it just a timing issue? That's my first question. The second question is how should we approach this in the future? It has increased each quarter for the past two years. Is this increase tied to a specific tenant or property? Will it start to decrease at any point? Any insights on how to model these property expenses would be appreciated. Thank you.

David Smith, Chief Financial Officer

Yes. Sure, Eric. This is David. So one item I'll just clarify on your comment for the net expense that we've had throughout this year from Q1 to Q3 has actually gone down, not gone up versus what you said. But separately, I think you're alluding to going from Q3 to Q4, we did see an increase in the overall net expense and so in other words, a reimbursement we received from tenants less say taxes insurance that we paid. That was driven by the properties we took back from Kings Garden in September and Parallel, Pennsylvania in October. So we did have elevated property expenses in Q4 just because we are on the hook for those expenses. That being said, given what Paul and Ben mentioned on the re-leasing activity that we've had, those will go down over time, just given in the substantial releasing efforts that we've announced today with our results.

Eric Des Lauriers, Analyst

Sorry, I just want to clarify. I'm talking about the first line item in the expenses, the property expenses, which have increased every quarter. My understanding is that these are also reflected in revenue and are essentially reimbursements where you recognize the expenses and then receive a reimbursement. I hope that helps clarify my question, as I was focusing on that first line item.

David Smith, Chief Financial Officer

Yes. Yes, if you're looking at just that line item, that's correct. But those can also go up. You're going to see inflationary increases in insurance and property taxes. But to your point, Eric, the actual reimbursement from the tenants, that's coming through the revenue line as well. So you really need to net those two together. But they can – they can be episodic, to your point, depending on when those come through for the taxes of insurance. So there can be a timing difference as well.

Eric Des Lauriers, Analyst

Okay. And then I guess just one last thing on this, overall, these have been increasing each quarter. Should we expect this trend to continue moving forward, assuming a steady inflationary environment? I'm trying to understand the first expense line item and how it will develop going forward.

David Smith, Chief Financial Officer

Sure. I would just go back to my prior comment on that, Eric, where you did see the expenses increase from Q3 to Q4. And again, that was driven by taking back properties between Kings Garden and Parallel. So as those properties get released, with the re-leasing activities that Ben had mentioned, you'll see some of those come down over time.

Paul Smithers, President and Chief Executive Officer

Thanks, Eric.

Operator, Operator

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

Alan Gold, Executive Chairman

Thank you. And I'd like to thank you all the stakeholders for your continued support. I thank all the team here at Innovative Industrial Properties for their continued hard work. Thank you all. With that, we'll sign off. Thank you all.

Operator, Operator

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