The Contagion Continues: Could The Cannabis Goliaths Start Falling?

Considering what happens when expensive grow facilities become regular old properties again

Are you interested in a two-year job with an interesting pay structure? 

This one requires the ability to make snap decisions. The pay starts at one dollar per month but doubles every month after that—for two years. The backer is one of the wealthiest names in the US, so the payment is assured. Your skillset is perfect. You have 20 seconds to decide.


That sort of math is referred to as geometric progression, which basically means something is picking up speed quickly and getting faster at each step, “a sequence of non-zero numbers where each term after the first is found by multiplying the previous one by a fixed, non-zero number called the common ratio.”

On Jan. 19, the Green Market Report wrote that all is not well in cannabis landlord land. GMR Executive Editor Debra Borchardt revealed, “Industry heavyweight landlord Innovative Industrial Properties, Inc. (NYSE: IIPR) announced that its rent collections have dropped from 100% at this time last year to just 92% for the month ending January 31, 2023. The company said it had collected 97% of its rent at the end of December. The company’s stock was plunging by over 14% on the news to lately sell at $94. This is a huge drop from the 52-week high of $211.”

Like the geometric trajectory of crashing cannabis flower prices, IIPR rent collections dropped 3% in all of 2022, and then 5% further in January 2023. April will be telling. Geometric progression. Collections would have dropped further but IIPR was able to restructure some of its tenant leases. This isn’t the first time IIPR has had to restructure leases.

Stability and pivot points

The first 20-plus years of my career was spent in the equipment leasing industry. I held various roles including portfolio management. When a client fell behind on a lease, we would try to restructure. If the customer was four months in arrears and we restructured the lease, when they made their first payment under the restructure—typically commensurate with executing the lease amendment—the account moved from delinquent to current. There was a large well-known public equipment lessor that was known for restructuring deals at the end of each quarter to reduce delinquency reporting. I realized way back then that to evaluate a portfolio, one should look at rewrites (as they were known) and determine what percent of the portfolio had been rewritten.

In the equipment leasing industry, at the time (I left in 2004, in my mid-40s, to pursue an MBA and enter the consulting field, which eventually led me to cannabis via a consulting engagement), if a client made it successfully through the first 16 to 22 months of a 60-month lease, the likelihood of default was small. Problems happened early. My experience tells me it won’t be the same in cannabis. The industry is not as stable as most other industries and will likely experience several pivot points due to the loss of market homogenization—the fact that low-price products in Massachusetts cannot legally migrate across the adjoining border into New York, Connecticut, or Rhode Island (see “Seismic Shifts” article 1 and article 2).

As an aside, if Mass is in a product glut and experiencing a price crash, and cultivators here have a couple of years of paydown on their debt and return of capital to their investors (generally at pre-inflation prices), when cross-border commerce opens up, how will all the sparkly new cultivation facilities now being built in New York compete locally (meaning with adjoining states) on price? The contagion will spread like COVID prior to the vaccine.

Therefore, the shadow figure of IIPR rewrites could be a meaningful metric to track and understand. Just as we have discussed provisional versus final licenses in past articles, think of the rewrites as candidates for default in waiting.

Also bear in mind that in the cannabis industry, the largest and most expensive real estate is cultivation facilities and IIPR has plenty—90% of its portfolio is cultivation and related processing, while 3% is retail only, and 7% is retail and “industrial,” which we take to mean cultivation and related processing (like manufacturing). As the market price of flower erodes, there will be more stress on the portfolio and the first to fall could be the rewrites.

And it’s worth noting that as of Dec. 3, 2022, IIPR owned 110 properties located in 19 states, representing a total of approximately 8.7 million rentable square ft. (including approximately 1.9 million rentable square ft. under development / redevelopment). That means IIPR has 6.8 million square ft. in its active portfolio and another 28% (1.9 million) under development. If market conditions are becoming stressed, that additional 28% portfolio increase could amp up their stress level.

Assets and leverage

Dane Bowler covered some of the IIPR issues nicely in an article on Seeking Alpha. He jumped into the rent rate, an issue we touched upon in our early 2020 article on the Canopy Economy. Bowler’s research indicates that, “In premier locations, industrial warehouses cost about $100 per foot.” While, “In [many IIPR tenant locations, one] can buy warehouses for $50-$70 per square foot.” 

Yet, Dane reports, IIPR has a committed capital cost of $274 per square foot. And rightly asked, if a “warehouse … is worth about $70 per foot, what is the other $200 per foot that IIPR paid for the sale leaseback?” Concluding that this excess cost to IIPR is likely “more accurately described as a loan” from IIPR to the tenants to cover their unique fit-up cost (I added “unique,” but assume Dane was thinking it too). In the event of a default, IIPR can certainly redeploy these warehouses. Just as certain is that much of that specific fit-up will be a loss.

Think about that. Cost of $274 and a potential recovery of $70. That’s not how conventional landlords operate.

If a troubled operator hires a sharp restructuring advisor (like me), the tables could quickly turn with IIPR coming to grips that the tenant may actually have the leverage. There is an adage in lending that goes something like, If I owe you $200,000, I have a problem, but if I owe you $2 million, you have a problem. The translation is that if I can pay the bill, I must worry. But if I cannot pay the bill and there are not enough assets for you as the lender to collect, you have a material likelihood of loss and therefore you have a problem. With assets that are not easily redeployed (without a major loss), IIPR might not hold the leverage.

Sweat equity

In Tom Wolfe’s 1998 novel, A Man In Full, the author described an Atlanta real estate mogul who is in financial trouble and is called in for a visit to his lender. The workout guys bring him into a conference room, one a bit less glamorous than the room they entertained him in when they were wooing him for his business.

The workout guys know how debtors in trouble get nervous and sweat and they developed a secret game to see how long it takes to get the deadbeat to sweat so profusely that the perspiration stains (they referred to as the saddlebags) would meet in the middle of his shirt. I suspect in a major workout, even though IIPR is the creditor, they might be the ones wearing the saddlebags. Buildings can be redeployed, but fancy grow operations, with HVAC that exceeds typical warehouse needs, and all the nice lighting (which would have to be removed by an expensive and licensed electrician) likely cannot. 

In his Seeking Alpha piece, Bowler reports that IIPR’s weighted-average lease term is 15.3 years. Does anyone believe we won’t have interstate commerce in cannabis within 10 years? IIPR appears to be skiing down a black diamond trail that ends at a long, tall cliff.

Debra Borchardt of GMR summed it up nicely: “Remember when IIPR said it could always find a new tenant if a cannabis one left?” IIPR has a vacant San Bernardino property (approximately 192,000 rentable square ft.), which the company said it is actively evaluating alternative non-cannabis uses for due to market conditions in California and changes in the zoning of the property. IIPR stated there can be no assurance it will lease the property on the terms anticipated, or at all.

As Bowler observed, “IIPR gives somewhere in the ballpark of $200 per square foot of TI or equivalent (tenant improvement allowances) on a $70 per square foot building. In exchange, IIPR gets rent that is many times higher than what is typically paid on an industrial property.” It is a great model until market realities set in.

Without the cannabis premium, IIPR could be looking at market-level rents based on a non-cannabis cost structure. If they replace tenants who were willing to pay a $274 per square foot cost with conventional tenants willing to pay a $70 per square foot cost, the rent roll will drop faster than the snow in a nor’easter.

Cold times could be coming.

I hope they have a good shovel.

P.S. If you’re not an investor, then why should you care? Because IIPR finances the big guys who raised the most money. If the big players are having problems, as a smaller operator you need to determine (a) will it spread to my business, (b) how might a troubled big player in my market impact me if they drop prices to raise cash if they close, (c) if the big players have higher fixed costs than I do, how does this impact my competitive position, (d) if the big players have lower fixed costs than I do, how do I compete, and last for today, (e) if a large player has 30,000 square ft. of cultivation at a certain rent rate and they drop their canopy in half, the rent doesn’t necessarily drop, which means if the canopy cuts in half, the effective rent per square foot doubles. That could impact your competitiveness. These players are often the whales, and when they hit the water, their waves will often rock your boat. Know that and you can be prepared.