Cannabis Musings - April 2, 2025

What's going on with IIPR?

Friends, it seems like there’s little good news these days, and, well, the hits keep on coming. Enter Innovative Industrial Properties (IIPR), one of a handful of real estate investment trusts (REITs) providing capital to the cannabis industry. IIPR has been around for a while now, as one of the earliest and most prominent cannabis real estate financiers, and it made waves for securing a listing on the New York Stock Exchange (more about that later). It’s had some trouble as of late, and we should discuss.

Stepping back, let’s first talk about REITs. A traditional real estate lender (like a bank) would typically make a loan to a borrower, taking a mortgage (a lien) on the real estate to secure repayment. The borrower then pays back the loan over time, just like any other loan. A REIT, on the other hand, buys that property for cash and leases it back to the seller, with the seller then making lease payments back to the REIT – aptly referred to as a “sale-leaseback”. The seller then usually has the right to buy back the property at the end of the lease term.

In both scenarios, the borrower/seller ends up with a pile of cash (loan/purchase price) and the lender/REIT ends up with a payment stream (principal + interest/lease payments). The difference is in the details, mostly tax-related. Among other things, the buyer gets the benefit of depreciation (since it now owns the real estate), the seller recognizes gain on the sale (which could be of benefit if there’s eligible losses to offset), lease terms can typically be more flexible than loan terms because REITs aren’t trying to fit into as stringent parameters as lenders, and leases tend to have longer terms than loans. Depending on the circumstances, a sale-leaseback might make more sense for a company than a straight-up loan.

The key feature of REITs is that they have a particular tax advantage – they avoid paying corporate taxes so long as they distribute at least 90% of their taxable income to the owners, and those dividends are broken down into return of capital, ordinary income, and capital gains, adding further benefit relative to corporate taxation. They’re a product of the US Tax Code, and their unique tax treatment allows them to attract capital from investors seeking steady income backed by the stability of real estate – REIT investing is very much a yield play. (I learned about REITs through osmosis working for 15 years as personal deal counsel to the forefather of the modern REIT, Sam Zell – he built his fortune literally and figuratively through his office, residential, and mobile home REITs.)

Back in the salad days of 2016-2019, when unicorns and golems poured cheap capital into the coffers of cannabis operators, cash overflowing their golden goblets, rippling out of gleaming flagons of plenty, when everyone was a winner and the future shined as bright as Sirius during a new moon, cannabis REITs came into the fold to join the party as an alternative capital structure. MedMen laid off its real estate into Treehouse, which then became Aventine, which then spun out that old MedMen real estate. GreenAcreage owned a portfolio of Acreage Holdings’ real estate, later merging with NewLake Capital. Freehold Properties, Power REIT, Chicago Atlantic Real Estate Finance and AFC Gamma (which are actually mortgage REITs, a variation on the theme), and others rounded out the class.

Real estate financing – whether through straight-up loans or through sale-leasebacks – was something of a natural fit for cannabis operators. With landlords typically detesting leasing to plant-touching companies, operators found it easier to just buy properties outright, fueled by all of the equity being injected into the industry during the good times. Particularly when equity started to pull back in 2019, plant-touching companies turned to debt to fuel growth (and fund losses, because, as we know, positive net income is an elusive kreplach). Lenders love hard assets as security, so all of that owned real estate was a natural fit to lever up (borrow against). IIPR was uniquely positioned to take advantage of this shift because of its capital advantage – namely its US stock exchange listing.

The problem for the cannabis REITs is that, like plant-touching companies, they too directly violate the Controlled Substances Act. Section 856 of the CSA makes it a federal crime to “knowingly … lease, rent, use, or maintain any place … for the purpose of manufacturing, distributing, or using any controlled substance.” Endearingly referred to as the “Crack House Rule,” this means that knowingly leasing real property to a cannabis operator directly violates federal law. And who leases real property to cannabis operators? Cannabis REITs.

As you likely know, the US stock exchanges (the New York Stock Exchange and the Nasdaq) generally have avoided cannabis companies. The NYSE won’t list a cannabis company, plant-touching or ancillary. The Nasdaq listed a handful of ancillary companies, but continues to shy away from companies that are directly violating the CSA, including cannabis REITs because of Section 856.

Interestingly, AFC Gamma listed in 2021 on the Nasdaq because, as a mortgage REIT, all it holds are real estate loans to cannabis operators – it doesn’t hold the properties itself. And since Section 856 doesn’t talk about lending, that makes AFC Gamma (and Chicago Atlantic’s similar mortgage REIT) an ancillary business, which has its own risks and implications (money laundering, aiding-and-abetting, RICO, the Wire Act (not legal advice)), but directly violating the CSA isn’t one of them. The Nasdaq is cool with that, apparently.

And yet, IIPR’s stock is listed on the NYSE. The company raised $67 million in its IPO in December 2016 (interestingly, it originally filed to raise up to $175 million) and its shares were granted vaunted NYSE status for trading. Why? Great question. It’s one of the true unsolved mysteries of the cannabis capital world. I’ve spent too much time digging into the question and have come up empty. The best theory I can come up with is that, because the listing took place in the early days of the state-licensed cannabis boom, no one at the NYSE asked the question about CSA Section 856, and then, when the exchange finally got smart on the issue (which it eventually did because it refused to list any others), it was loathe to rescind the listing. To be clear, that’s sheer speculation for wont of a better explanation.

That NYSE listing gives IIPR a distinctive edge over its other cannabis REIT competitors, which didn’t (and still don’t) have access to US stock markets to raise capital (putting aside the mortgage REITs AFC Gamma and Chicago Atlantic). It’s simply easier to sell highly-liquid stock in an underwritten offering for trading on a major stock exchange than to get individual investors to tie up their money in a private investment vehicle. And its stock price held up relative to other cannabis stock, probably because it’s a landlord, not an operator.

That’s a bit of history of how we got here. So, what happened to IIPR and why does it matter? The saga has been fairly widely reported, but, in short, IIPR has suffered defaults in the past few months by a slew of its tenants. They came to a short-term resolution with PharmaCann back in January, but that fell through within weeks. IIPR then just reported lease defaults by three other large cannabis operators – 4Front, TILT, and Gold Flora (the last of which just filed for receivership after a tumultuous couple of years following its 2023 merger with The Parent Co. (full disclosure: when I was practicing law, I worked on the The Parent Co.’s 2021 de-SPAC transactions).

Oy gevalt. This isn’t good. We’ve talked before about the upcoming debt maturity wall, the “cataclysm of capital recoupment” that’s staring at us from the distance. Four more storied, well-regarded US cannabis operators all basically handing back the keys on their properties. Now, there’s a difference between defaulting on debt and defaulting on a lease – typically, the lender has a lien on all assets, with rights to foreclose on them, while the landlord (REIT) typically only has a lien on anything relating to the property itself (like what’s inside), so it’s probably going to be less impactful to default on your landlord than stop paying your senior lender. The tenant company probably guaranteed payment on the lease, so that obligation remains outstanding, and that lease can’t be discharged (wiped out) through bankruptcy, because, well, US law. The typical distressed negotiating leverage expectations are turned on their head. So, the landlord either has to negotiate some sort of deal with the tenant (which IIPR tried to do with PharmaCann), or hope for the best, sue the tenant for unpaid rent, and try to re-lease a property that is likely best suited to cannabis use (e.g., weird zoning).

I fear this is indicative of what we’re going to see more of in the short- and mid-term. There’s little good news on the horizon for licensed cannabis, what with rescheduling in limbo and who knows what with the current White House. Sales nationally remain feh. The product is overtaxed, and continues to have to compete both with an unlicensed market and unregulated/underregulated “intoxicating hemp”. It looks like it may get worse before it gets better.

“Tsores vi holtz, un mit vos eintsuhaitsen dem oiven iz nito.” (“Troubles (as plenty) as firewood, but you can’t heat the oven with them.”)

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© 2025 Marc Hauser. None of the foregoing is legal, investment, or any other sort of advice, and it may not be relied upon in any manner, shape, or form. The foregoing represents my own views and not those of Jardín.