Innovative Industrial Properties, Inc.

Hello. Welcome to the Innovative Industrial Properties Inc. Q1 2022 Earnings Call. All participants will be in listen-only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star, then one on your touchtone phone. To withdraw your question, please press star, then two. Please note, today's event is being recorded. I now would like to turn the conference over to Brian Wolfe. Mr. Wolfe, please go ahead.

Thank you for joining the call. Presenting today are Alan Gold, Executive Chairman, Paul Smithers, President and Chief Executive Officer, Catherine Hastings, Chief Financial Officer, Ben Regan, Vice President of Investments, and Griffin Marquart, Director of Construction Management. Before we begin, I'd like to remind everyone that many of the 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 AK filed with the SEC. I'll now hand the call over to Alan. Alan?

Thank you, Brian, and welcome, everyone. As you know, our general approach has been to host an earnings call every other quarter, with our next regularly scheduled earnings call being to report the second quarter results in early August. That said, we wanted more time to discuss with you all as the owners of our company about how we evaluate our investment opportunities and walk through some of the analysis we employed on certain investments we've made to date. We felt this is the best venue to discuss with all of our stockholders and to answer any additional questions that you may have on these topics or any other topic that we can address. Since we began with our initial public offering and the first real estate transaction in 2016, we have always strived to be as transparent as we can about our business and the industry we serve, and we continually review our communications with our stockholders. including feedback on information that stockholders request. With that in mind, we are working on creating an investor supplement to our quarterly earnings, which we expect to introduce in connection with our second quarter earnings and conference call, and will provide more property-level detail describing the real estate we invested. For our call today, we plan to focus on two of our tenant partners, Parallel and King's Gardens. and do a deeper dive into our underwriting fundamentals as applied specifically to these two private company tenants. Paul will touch on the evolution of market dynamics of the states where these properties are located, Florida, Texas, Pennsylvania, and California. Ben will provide detail regarding tenant and project underwriting as applied to these two tenants. And Griffin, our Director of Construction Management will take a deeper dive into each property's improvements. Griffin, who worked with me at BioMid Realty Trust, is joining us for the first time on this call and is one of our team of construction management professionals who are charged with oversight of the evaluation of existing real estate we are evaluating for purchase and review of plans and progress for properties that we acquire with ongoing or future improvement plans. Now, finally, Kat will review our financial results for the quarter, which we are very proud to report consists of another quarter of successful execution, a strong capital position, and strong investment activity, especially in terms of both new property acquisitions and additional investments in key improvements at certain properties that are critical for our tenant partners as they ramp production to meet demand. Now, before I turn the call over to Paul, I want to reiterate our appreciation for you all as long-term owners of our company, and we are confident in our belief that through our thoughtful analysis and underwriting, we can continue to place your capital with prime real estate opportunities in this nascent high-growth industry. With that, I'd like to turn the call over to Paul. Paul?

Thanks, Alan. Before I discuss the state dynamics that Alan alluded to, just a brief update on the federal regulatory landscape. Nothing has fundamentally changed in our view since our last discussion in February, other than Senate Majority Leader Chuck Schumer delaying the release of his revised cannabis legalization bill until July. In our opinion, this may indicate a potential movement on a more limited SAFE Act on cannabis banking in the near term, but such legislation is still competing with numerous other congressional priorities and a midterm election cycle. I'd now like to turn to a state-level analysis for the properties where we have leases with Parallel and Kings Garden, namely Florida, Texas, Pennsylvania, and California. Florida. By way of background, Florida passed a constitutional amendment to legalize medical use cannabis in November 2016, garnering over 70% of the vote. Since the program was introduced, growth has been tremendous, with over 700,000 active qualified patients served by over 2,400 physicians qualified under the program, generating an estimated $1.3 billion in regulated medical use sales in 2021 alone. The medical use cannabis program is vertically integrated, with 22 total licenses issued as of now. As of late April, there are 16 licenses in operation, and 420 operating dispensaries. New Frontier data estimates that Florida will be the fourth largest legal cannabis market by 2025. The rules governing the medical cannabis program provide for the issuance of an additional four vertically integrated medical licenses for every 100,000 new medical marijuana cardholders, and so we expect a controlled issuance of additional licenses to be issued over time. Interestingly, The vertically integrated nature of the licensing structure requires that operators cultivate and process cannabis for their dispensaries, and so investments in cultivation and processing facilities that can deliver scalable production and quality products are a necessity for all license holders. Parallel holds one of the 22 licenses and has two cultivation properties, along with 44 dispensaries. Texas Texas, the second most populous state with 30 million residents, passed the Texas Compassionate Use Program in 2015, which is currently a limited CBD program with a low THC content threshold. Texas is estimated to account for more than one-third of the U.S. population currently without access to a full medical or adult use cannabis program. While Texas remains restrictive, it has slowly opened the program, expanding the list of qualifying medical conditions and modestly increasing the THC limit. Well, in the immediate term, the program remains highly restrictive. We believe that the medium and long-term prospects in the Texas market are very significant for these simple reasons. One, a recent survey by the University of Houston finding that two-thirds of Texans support the sale and use of adult-use cannabis. Two, neighboring states, New Mexico and Oklahoma, are expanding their regulated cannabis programs. And three, there already exists an illicit market in Texas, estimated by some to be a multi-billion dollar market, a significant part of which we believe could be effectively transitioned to regulated sales with sensible legislation. For now, there are only three license holders for vertical integration in the entire Texas market, one of them being parallel. Pennsylvania. With first sales in 2018, the Pennsylvania medical cannabis market has witnessed strong growth entering its fifth year. with over 700,000 registered medical cannabis patients and caregivers, and regulated sales expected to reach $2.2 billion to $2.7 billion by 2026. Many expect Pennsylvania to be in a position to legalize adult-use cannabis in the relatively near term, particularly now that both New Jersey and New York have done so. Adult use now includes the support of Pennsylvania legislators such as GOP Senator and former U.S. Marshal Mike Regan. Pennsylvania's program provides for up to 25 cultivation and processing licenses, all of which have been granted, and up to 150 cannabis dispensary licenses. Parallel is licensed for one cultivation and processing facility in up to six dispensary locations in Pennsylvania. California California is the largest regulated cannabis market in the United States, generating approximately $5.2 billion in regulated cannabis sales in 2021. a 17% increase from the $4.4 billion of sales in 2020. While California remains far and away the largest regulated cannabis market in the United States, the program has faced challenges since the formal adult use program was officially introduced in 2018. These challenges include the heavy taxation faced by operators at all stages, approaching 50% in some areas, and the relatively uninhibited illicit market that continues to thrive, which of course does not face the heavy tax and regulatory burdens of the state-regulated operators. In fact, the illicit cannabis market is estimated to be far larger than the regulated market, with some estimates at approximately $8 billion annually. The California cannabis market is one of the largest single markets in the world, but it needs sensible tax, regulation, and enforcement policies at all levels of government, in order to realize the potential of the regulated market. While all state markets have their nuances, I hope this provides a good overview of these four programs, and I will now hand it off to Ben to discuss our overall underwriting process as applied to these properties. Ben?

Thanks, Paul. As Alan noted, our plan today is to provide a glimpse into some of the factors we evaluate when we underwrite proposed transactions. While we are only able to provide a short overview of our process given the time constraints on this call, our underwriting process for the transactions across our portfolio involves numerous elements of evaluation, including, but of course not limited to, our underwriting of the tenant, including in-depth reviews of the tenant's management team, capital position, financial results, operational footprint, and financial projections, including assessments of their results versus prior projections. With respect to the state, A review of the state's market dynamics and evolution, in addition to the existing regulatory framework and expectations for adjustments to that framework, including the forecasted timing for potential adoption of adult use programs and medically use only states and with respect to the property. in addition to detailed third-party reports for property condition assessments, zoning, title, and environmental review, in-depth review of the costs and quality of the improvements made to date, in addition to information regarding production and processing capacity and potential for additional improvements to enhance those capabilities. Paul started his discussion with the Industry Dynamics of Florida, and that's where I'd like to begin with our initial acquisition and lease back of a property in Waimama with Parallel. prizing approximately 373,000 square feet of industrial and greenhouse space for $35.3 million, or about $95 per square foot. We closed on that acquisition in March of 2020, shortly before the full onset of the global COVID-19 pandemic. In total, we have invested $51.5 million with two additional lease amendments. Parallel's management team at that time included CEO and Chairman Beau Wrigley Jr., who was former chairman and CEO of the William Wrigley Jr. Company, which was acquired by Mars in 2008 for $23 billion. CFO for Reedcon, whose prior tenure included CFO positions with Kellogg Company and U.S. Foods. Executive Director Ed Brown, who spent 20 years as CEO of Patron Spirits International and the Patron Spirits Company. Chief Marketing Officer Lee Applebaum. who previously served as Global Chief Marketing Officer of Patron Tequila and Grey Goose Vodka at Bacardi, Stephen St. Rose, former Chief Human Resources Officer of U.S. Walgreens and Senior VP of HR at Coca-Cola, and Kevin Fisher, an industry pioneer in the regulated cannabis industry and the co-founder and former CEO of New England Treatment Access. Parallel had raised over $300 million in private capital prior to our first acquisition, and as noted, had assembled a team with deep management experience and success in a number of consumer packaged goods industries. We also evaluated their footprint with licenses in Florida, Massachusetts, Pennsylvania, and Texas, and their position as the second largest operator in Florida at the time in terms of operational dispensaries, which we believe provided them with a strong foothold on which to focus on growth, and obtaining the appropriate market share commensurate with their dispensary count in one of the largest high-growth cannabis markets in the U.S. At that time, they had 39 operating dispensaries and were second in terms of production of smokable flower in the state, though well behind the leading company. I'll turn it over to Griffin, who can provide some color on the YMAMA project.

Thanks, Ben. By way of background on the property, Parallel originally purchased the property for $9.2 million in September 2017, which required a substantial build-out of the necessary infrastructure and additional improvements to convert the site and make it an operational cannabis facility. Parallel invested an additional $29 million into the facility improvements after its acquisition, which we generally ascribe to the following areas. One, site work improvements including security systems, electrical and gas utility enhancements, water wells for potable water, and irrigation. Two, cultivation improvements including upgrades for HVAC, fertigation control systems, electrical distribution and lighting, in addition to a new dry house and curing warehouse. Three, production facility improvements including new Venlo processing building, plant tissue culture operations, and lab upgrades. While Parallel has invested almost $38 million in the property in total with these investments and its initial purchase price, with certain projects still underway, our purchase price for the property was negotiated to a little over $35 million. In connection with the closing, we agreed to make up to $8 million available for reimbursement for future costs incurred with the connection with the completion of the build-out of the property, which included reimbursement for Parallel's improvements made in accordance the three areas noted previously but no reimbursement for costs incurred prior to our acquisition we amended our lease with parallel a bit later to increase the amount available for reimbursement by another eight million dollars based on changes to the real estate scope and resulting additional costs all major real estate construction work has been completed though parallel is completing a few minor upgrades to the fire suppression system and mechanical electrical, and plumbing upgrades for their ethanol extraction lab. To sum up, the project comprises approximately 373,000 square feet on 20 acres, including 15 greenhouse ranges, a dry house building, a trim and cure house, and a new 36,000 square foot Venlo processing building. Needless to say, we also believe the replacement cost for this property to be significantly higher than our current basis. pass the call back to Ben, who will now cover our acquisition of Parallel's other cultivation and processing assets in Florida in September 2020. Ben?

Thanks, Griffin. In September 2020, we closed on our second transaction with Parallel for its cultivation and processing facility in Lakeland, Florida. At the time, Parallel was continuing to ramp up in Florida as the Florida Department of Health moved to allow the production and sale of edible medical cannabis products. At the time, Parallel's company had over 1,600 employees and had raised more than $400 million in capital to date. Industry estimates were that the introduction of edible cannabis products would drive an additional $250 million in sales in 2021 alone. With Florida's authorization of edibles, as well as its prior authorization of flour in 2019, Parallel's development plans were to construct an additional 150,000 square feet of cultivation and production space to address the strong demand for flour, expecting to result in approximately 215,000 square feet of production area. The original acquisition was a little under $20 million for the existing 65,000 square feet of industrial and greenhouse space and 35 acres of land, and we agreed to provide reimbursement for development of the additional 155,000 square feet of up to $37 million or $242 per square foot. I'll pass along to Griffin now for a short description of our Lakeland facility. Griffin.

Thanks, Ben. Similar to the Waimama property, Parallel purchased the property from a third party for $2.4 million and proceeded to spend approximately $18.3 million on improvements to the buildings, with the bulk of that spending going towards development of an industrial indoor cultivation facility. We purchased the property for an amount modestly below Parallel's historical investment. As Ben mentioned, our improvement allowance is for the construction of approximately 155,000 square feet of brand new industrial space. At completion, the property is expected to include 130,000 square feet of cultivation and processing space, 25,000 square feet of office and warehouse, 25,000 square feet of kitchen space for production of edibles, and 60,000 square feet of mechanical rooms and supporting space. Similar to our other Florida real estate assets, we believe the replacement costs for this property to be significantly higher than our current basis.

Ben? Thanks, Griffin. We next executed our Texas transaction in March of 2021, with our purchase price for the 12-acre property being $3.4 million, where we expected parallel to construct three buildings, one retail and two industrial, comprising an aggregate of 63,000 square feet on the property. for which we agreed to provide reimbursement of up to $24 million. Parallel is one of the three license holders for the entire state. In the month prior to our acquisition, Parallel announced the execution of a definitive business combination agreement with Series Acquisition Corp., a SPAC, pursuant to which a group of investors had committed to participate in the transaction through an oversubscribed investment of $225 million, with closing expected in the summer of 2021. In the SPAC securities filings, the transaction valued parallel at approximately $1.9 billion, with the SPAC reporting that additional $225 million in funds were intended to be used to fund Parallel's continued growth and market expansion. Parallel, through the SPAC securities filings, was also projecting at the time net revenues of approximately $447 million in adjusted EBITDA of over $100 million in 2021 across its platform. Ultimately, in September of 2021, Parallel and the SPAC mutually terminated their merger agreement. The Texas property is in its early stages of development, consisting of planning, site preparation, and the steal for two pre-engineered metal buildings on site, for which we have reimbursed less than $5 million. On to Pennsylvania, where we purchased the 239,000 square foot industrial facility in May of 2021. Parallel had been a tenant of the prior owner of the property since October of 2020 and executed a purchase agreement with the prior owner to acquire the property for $22 million, or about $92 per square foot. In addition, during Parallel's eight-month tenancy with the prior owner, Parallel invested approximately $20 million of its own funds and improvements to the building, for which we agreed to provide reimbursement. As a result, we acquired the property for approximately $41.8 million, consisting of the original purchase price for the standard industrial building to the prior owner, and the costs reimbursed to Parallel for build-out of the facility for regulated cannabis cultivation and processing, while Parallel was a tenant under the prior ownership. We also agreed to provide additional funding for improvements of up to $26 million for the build-out of the facility. In the month prior to our acquisition, Parallel announced it had entered into a definitive agreement to acquire certain operations of Windy City Cannabis, an adult use cannabis operator in Illinois, in a part cash, part stock transaction, and that Windy City was expected to generate over $75 billion in annualized net revenue in 2021, with closing in the second half of 2021. At the time, Parallel was pre-operational in Pennsylvania and opened its first dispensary location in July 2021 in that state. I'll pass along to Griffin to discuss more about the building. Griffin?

Thanks, Ben. This Pennsylvania property is located on about eight acres and is a one-story industrial building. As Ben noted, we purchased the base building for approximately $22 million, which was Parallel's purchase price from the owner, or about $92 per square foot. In addition to reimbursing Parallel for qualifying base building improvements, designing, and permitting, Electrical and other improvements totaling approximately $20 million that Parallel had invested in the eight months prior to our acquisition, while Parallel was a tenant of the prior owner. The improvement allowance was utilized for further build-out of the infrastructure for this cultivation, processing and lab space, in addition to office and mechanical support areas after acquisition. As of today, 124,000 square feet is operational for cannabis cultivation and processing. with 79,000 square feet of space subleased to other tenants and approximately 30,000 square feet under development. I will pass the call now to Alan for final thoughts on parallel and these properties. Alan?

Thank you, Griffin. While we do not have the hours it would take to fully discuss every nuance of our underwriting, individual property characteristics and state-level market dynamics We wanted to provide this brief overview to give you a sense of some of the considerations made over the course of the relationship with Parallel and the strong opportunity we continue to see in these markets and these properties over the long term. As we indicated on our prior call in February, Parallel formed a strategic alternatives committee late last year to evaluate potential new capital and M&A options for the company. We continue to be in close contact with Parallel representatives and we will endeavor to share with you any update we can on the process as soon as we are able. I'd like to now ask Ben to provide a brief overview of Kings Garden, a top operator in California that has been a tenant partner of ours since early 2019. Ben? Thanks, Alan.

We made our initial investment with Kings Garden in April 2019, acquiring a five-property portfolio in Southern California. consisting of approximately 102,000 square feet of industrial space, all of which was operational at the time of our acquisition, for approximately $27 million, or roughly $266 per square foot. At that time, we evaluated King's Garden as a leading indoor cannabis operator in California, with profitable operations and a distribution agreement with one of the largest distributors in the state, delivering King's Garden products to over 60% of the state's regulated dispensaries. In May of 2020, we followed with the acquisition of a fully operational property comprised of approximately 70,000 square feet of industrial space for $17.5 million, or $250 per square foot. Shortly after that closing, Kings Garden announced the initiation of a quarterly dividend to its stockholders, something that was and is considered highly unusual among any prominent brand in the industry, and which demonstrates their belief in the long-term prospects in the business. In November of 2020, we made another investment with Kings garden agreeing to purchase 192,000 square foot building from a third party in San Bernardino for approximately $25 million or approximately $130 per square foot. And to provide reimbursement to Kings garden for improvements at that facility of another $25 million for key infrastructure requirements for the regulated cannabis cultivation. or another $130 per square foot, such that our total investment in the facility was expected to be $260 per square foot. In February 2021, We acquired 3.5 acres adjacent to one of our first acquisitions with Kingsgarden for approximately $1.4 million, amending the lease for that property and providing for reimbursement to Kingsgarden of up to $51.4 million for the construction of two brand new facilities totaling 180,000 square feet of space, or about $285 per square foot. At that time, Kings Garden was projected to have approximately 665,000 square feet of indoor operations and over $300 million in revenue starting in 2024, with the expectation that upon completion of all facilities under development or redevelopment, that Kings Garden would be producing approximately 140,000 pounds of finished cannabis product annually in California. Finally, earlier this year, we acquired a 23,000 square foot facility in Cathedral City for $8.2 million, equating to about $353 per square foot. The single story building is being renovated from office space to a fully operational cultivation facility with a hold back in the purchase price to the seller until the seller completes the final improvements. Kings Garden continues to be one of the largest indoor cultivation operators in California. with 3,400 flowering lights producing in excess of 36,000 pounds of indoor flower annually, which does not include at all the approximately 395,000 square feet of projects slated to come online in the coming months, as Griffin will discuss. I'll pass along to Griffin to discuss our King's Garden property portfolio. Griffin?

Thanks, Ben. As Ben mentioned, we have a number of properties leased to King's Gardens. Of that portfolio, six properties comprising of approximately 172,000 square feet are operational with no additional improvements in process. Of the properties under development or redevelopment, I will touch on those individually. In San Bernardino, the 192,000 square foot project is located on approximately seven acres. As Ben mentioned, our base cost for the industrial building was roughly $130 per square foot, and we have provided an improvement allowance of an additional $130 per square foot for conversion of the facility to cannabis cultivation. Of that $25 million allowance, approximately $5 million relates to base building improvements, $8.7 million to electrical upgrades, $8.2 million to mechanical systems, and a little over $3 million to plumbing and sprinklers. The interior of the building has been demolished and a new second floor has been installed consisting of steel columns and decking and concrete deck topping. At completion, the facility is expected to have 14 flower rooms, four dry rooms, a mother room, clone room, trim room, packaging room, veg room, and small head house space for employees and security. We have funded approximately $18 million of the $25 million and expect the remaining to be drawn over the coming months. Improvement disbursements have been made for design, permitting, interior demolition, material procurement due to long lead times, and the construction of the new steel structure and metal decking of the second floor. For the 19th Street project, as Ben mentioned, we acquired the land adjacent to our existing property and amended the existing lease with Kings Garden to incorporate that property and provide funding of up to $51.4 million for two brand-new industrial cultivation buildings expected to comprise 180,000 square feet. Together with the existing facility on the property, the completed site is expected to be 236,000 square feet, and project costs are expected to be about $67.7 million, equating to about $287 per square foot. Site is currently being graded with anticipated pad certification for all buildings in a few months. Kings Garden again is procuring the long lead time items given the supply chain challenges of the current environment, including many of the same items requested for San Bernardino that I mentioned previously. At this point, we have funded approximately $27 million of the $51.4 million allowance for improvements. At completion, each building is expected to have 11 flower rooms, four dry rooms, a mother room, clone room, trim room, packaging room, bedroom, and small head house space for employees and security. With that, I will turn it back over to Alan. Alan?

Thank you, Griffin. Again, very challenging to condense thoughts on underwriting the properties and market dynamics in the span of a few minutes and appreciate Ben's and Griffin's detail and effort to do so. We have been Kings Gardens' partners for three years now and believe Michael King and his team have one of the best reputations for product quality and consistency in perhaps the single largest cannabis market in the world. While we are disappointed in how the California state and local governments have performed in the rollout and administration of the regulated adult use cannabis program with continued heavy and even increasing tax burdens in certain jurisdictions and lack of enforcement for illicit activities by non-licensed operators, we believe King's Garden has navigated this environment well. And our firm believers that high-quality producers like King's Garden will continue to effectively adapt to the changing landscape in California. While we touched on just two of our tenants today, we apply a similar multifaceted approach to underwriting our tenants, the properties, and the markets across our portfolios. I would also like to point out that it is our belief that our portfolio has a replacement cost that is well above our current basis, driven by the significant and continuing increases across the board in building costs that we are all experiencing. As one example among many, structural steel costs have increased by over 40% in just the last 15 months. With that, I will turn it over to Catherine. Catherine?

Thanks, Alan. To start off, we're focused, as always, on being as transparent as we can and providing the most valuable information that we can about our business and this industry to our stockholders. In that light, and in the context of recent discussions with our stockholders over the past few weeks, we'll be working on a supplemental property level disclosure that we plan to issue in connection with our second quarter financial results. As always, we welcome the opportunity to discuss with you all, our long-term owners, our business, and appreciate your feedback. Including property level disclosures, we will look to provide additional detail regarding our tenant roster, recognizing that a number of our tenants, of course, are private companies. For this call, we wanted to touch on the top 10 tenants. In the past, we provided updated information about each of these tenants, and here we'd like to provide some consolidated metrics that provide a different perspective. To frame the discussion, our top 10 tenants represent 74% of our total committed capital and our total stabilized rents. A number of our top 10 tenants became our top 10 tenants through M&A activity in the past few years, acquiring other tenants in the portfolio. Of those top 10 tenants, six are public. Ascend Wellness, ColumbiaCare, Trulieve, GreenThumb, Cresco, and Curaleaf. For the full year 2021, those six public companies on a consolidated basis reported revenues of $4.7 billion and adjusted EBITDA ranging from a low of $58 million to a high of $385 million and raised capital totaling approximately $3 billion. These six public tenants accounted for 39% of our total invested capital and 37% of our stabilized rents. The remaining four of our top 10 tenants are private companies accounting for approximately 36% of our invested capital and 37% of our stabilized rents. Our top 10 tenants on a consolidated basis conduct operations in 31 states with approximately 190 production facilities and over 650 dispensaries and represent approximately 74% of both our invested capital and our stabilized rents. I hope that gives a small glimpse into the scale of these tenants and the breadth of their operations. Before I touch on our financial results, I wanted to touch briefly on our process for evaluating and approving reimbursements for improvements at our properties, which is a uniform process across our portfolio. All of our existing leases with any building infrastructure allowances require that the allowance is reimbursable only for qualifying improvements to the building. As required by our leases, we as landlord work closely with our tenant partners throughout the process, including our reviewing timelines, engagement of architects, engineers, and general contractors, schematics, construction plans and budgets, and approvals of any substantive changes to the previously approved plans or budgets. For draws, our leases dictate the draw packages that our tenants need to submit in connection with any draw request. including detailed summaries of completed improvements attested to by the GC and architect, and supporting invoices, in addition to the standard administrative items such as lien releases. Griffin is a member of our internal construction team, and they, together with our third-party construction management consultants, regularly attend construction meetings, conduct on-site visits to monitor progress, and review and confirm improvements and cost information, regardless of project size. I would also like to note, with all of the property improvements, development projects, and ground-up construction that we have funded at our properties since our inception, we do not provide funding to tenants for use to purchase FF&E, any other personal property, or to fund any general corporate expenses, which is made clear in the company's audited financial statements by the fact that none of the company's leases have recorded lease incentives since inception. Turning now to our results for the quarter, we generated total revenues of approximately $64.5 million for the quarter, a 50% increase from Q1 of last year. The increase was driven primarily by the acquisition and leasing of new properties, additional building infrastructure allowances provided to tenants at certain properties that resulted in base rent adjustments, and contractual rent escalations at certain properties. And as we've indicated in the past, our Q1 revenue reflects only partial quarters of revenues from the acquisitions and investments executed during the quarter, and no revenues, of course, for the leases or lease amendments executed after the end of the quarter. And our revenues for the quarter were also impacted by scheduled rent phase-ins under certain leases as we continue to account for all of our leases on a cash basis. For the three months ended March 31, 2022, we recorded net income of $34.7 million or $1.32 per diluted share. During the first quarter, we also exchanged approximately $24 million in principal amount of our exchangeable senior notes for shares of our common stock pursuant to the holder's request to exchange the notes at the then current exchange rate under the indenture. We did not pay any inducement related to these exchange requests. Starting in Q4, in order to provide a meaningful comparison of our funds from operations between time periods, so investors can better compare operational performance on an apples-to-apples basis, we've included normalized funds from operations. which adds back to funds from operations transaction-specific expenses, which we exclude from funds from operations to provide investors a better understanding of ongoing operational performance. As a result of adding back acquisition-related expenses and the non-cash loss on exchange of our exchangeable senior notes, normalized funds from operations was $49.1 million, or $1.87 per diluted share for the first quarter. Adjusted funds from operations for the first quarter, which adds back non-cash stock-based compensation and non-cash interest expense related to our unsecured senior notes to normalized FFO, was approximately $53.8 million, or $2.04 per diluted share. On April 14th, we paid our quarterly dividend of $1.75 per share to common stockholders of record as of March 31st. equivalent to an annualized dividend of $7 per common share and a 33% increase from the prior year's first quarter. As we noted in our prior press releases, our Board of Directors generally evaluates adjustments to the level of our quarterly common stock dividend every six months, with any adjustments expected to be declared in Q1 and Q3 of each year. The Board continues to target a dividend payout ratio of 75 to 85% of AFFO on a stabilized portfolio basis. On a stabilized basis, which assumes the full quarter of rents for investments we made during Q1 and the expiration of any scheduled rent phase-ins under existing leases relating to future improvements that we fund after those improvements have been constructed, our payout ratio was 79% of AFFO. We also continue to fund real estate improvements into many of our properties as offered in improvement allowances or construction development to our operators under our leases. As we've previously noted and discussed extensively on this call, these improvements are critical to either redeveloping an existing facility to a cannabis facility or funding expansion to address growing market demands. In Q1 of 2022, We capitalized costs of approximately $127 million and funded approximately $129 million relating to improvements and construction activity at our properties. At quarter end, we had $2.2 billion in total gross assets and a total of about $310 million in debt, consisting solely of unsecured debt, with no maturities this year or next year, and $300 million of that debt not maturing until 2026. Our debt to total gross assets ratio stood at 14% at quarter end. Also, in order to reconcile our current cash position with our existing commitments to fund improvements pro forma for our most recent stock offering and fundings to date, we have approximately $175 million of uncommitted capital as of today, i.e. capital available for future acquisitions or expansions to existing properties. In our pipeline, we have under PSA or LOI approximately $138 million. Assuming we close on all of those transactions, which may or may not occur, of course, we have a balance of approximately $37 million left for further investment, absent any additional capital raising activity. With that, I'll turn it back to Alan. Alan?

Thank you, Catherine. We sought to provide you all, our long-term owners, with as much meaningful detail that could be consolidated on this call as it relates to how we evaluate our investments and industry dynamics through the lens of the history of two of our tenant partner relationships. I want to reiterate as well that we are very appreciative of your feedback on ways we can continue to enhance our communications with you about our business and look forward to sharing with you the company's developments going forward. Thank you sincerely for your long-term commitment to our company, and we will always do our very best to be long-term, responsible stewards of your capital. With that, I'd like to open it up to questions. Operator, could you please open the call up for questions?

Yes, certainly. Thank you. And as mentioned, we will begin the question and answer session now. To ask a question, you may press star, then one on your touchtone phone. If you're using a speakerphone, please pick up your handset before pressing the keys. To try your question, please press star then two. At this time, we will pause momentarily to assemble the roster. And the first question comes from Tom Catherwood with PTIG.

Thanks, and good afternoon, everybody. So really appreciate the deep dive on the underwriting and the real estate is really helpful. One of the things that struck me, though, is things obviously change from initial underwriting. And Ben, that was the kind of thing that jumped out as I was thinking of you giving some of those examples. And over the past five years, you've had tenants that have restructured, that have sold individual state licenses, that have sold themselves entirely. When a tenant's business changes from that initial underwriting, what has IIPR's role been in in the process that follows? Do tenants come to you saying, I can't pay these rents? Or do they look to restrike their leases? Or do you have another kind of role in that process?

So Tom, I think that is a good question because we spend a lot of time dealing with our tenants and understanding what they're trying to accomplish with either a sale of a license or an M&A transaction. Keep in mind that all of our leases come with a corporate guarantee, and that corporate guarantee gives us certain rights, and we use those rights to be able to review, get advanced notice, review, and approve any transfers, that occur at that time. So we spend a great deal of time, that's why we consider our tenants partners, because we are intimately involved in things that they're trying to accomplish with their businesses.

Appreciate that, Alan. Maybe if we step back a bit and kind of look at the last probably four to five years in the cannabis industry, there's been three to four downdrafts in sentiment. At first it was the RTO phase and the vape crisis and then the start of COVID. And we're in one right now. But in each of those other phases, the industry came out and proved more resilient. Is there something different this time? Are your tenants facing pressures that could really upend their business models this go-around?

We don't see anything that is different than any of the other previous downturns, other than the fact that the gross revenues have achieved, I think, a reported loss of $25 billion, and they're expected to get to $46 billion by 2025. So I think the reason that every time you come out of those industries is because the broader industry continues its rapid growth, and a new state gets approved, and new programs get approved, programs morph from in addition to just having medical cannabis to adult-use cannabis. So all of those are rapid. things that occur and have occurred over the last four to five years. And I think what you're seeing, and it's the only thing you really have a sense to see, is that the stock prices of these tenants have come under significant pressure. And there's a variety of reasons, you know, generalists moving out of the different sectors, generalists moving into the sectors. The fact that the majority of those public companies that you're reviewing are all on a very small exchange up in Canada. But what we're focused on is the overall health of the industry and our tenants. And from everything that we're seeing, sales are continuing to grow year over year. Sales are projected to grow significantly year over year, and that I think this current downturn provides greater opportunity reduction because of the reduction in values for mergers and acquisitions, and therefore greater opportunities for the very strong tenants.

That's helpful, and that's actually kind of the next thing I want to talk about, which the flip side to those prior downturns was that it seemed to create opportunities, whether it was higher deal volumes or transactions with larger operators. In effect, it seemed like operators that had been resistant to sale leasebacks in the past then began to accept it more as part of their capital stack, and your volumes obviously increased, as did the strength of your tenant roster. Are you seeing a similar trend, this go-around, as kind of pressure remains on your tenants?

Well, I think because of the industry continuing to have very positive outlooks, we are seeing increased demand for for the sale-leaseback type transaction. It is just one tool that our healthy tenants have. And they have not only access to raising capital from the private sector, but raising capital in the form of debt, which they've been very prolific at doing, raising debt. And there is a variety of other sources of capital for them, including our specialized single-purpose program of a sale-leaseback where we acquire real estate that they already own and then lease it back to them on a long-term basis.

Got it. And then last for me, kind of specifically, Going back to tenant underwriting and the outlook for your tenants, kind of two-part questions. First is, you've talked in the past about how, as you do additional tranches of investments in buildings, you get a chance to re-underwrite. You obviously get regular financials from the tenants. The two-part question is, do you make any changes in any of the collateral that's required, whether it's security deposits or letters of credit or anything of those nature if the underwriting does change in those later phases or yields. And then along that, with your thinking of underwriting as well, as you're, we're now through April, so you have a read on April rents, are all of your tenants current through this most recent month?

So, if you think about, if you think about the question, the question is when there's a a request for additional capital. Well, that's usually because the tenant is growing. There's a good thing occurring. So we are adding, enhancing, and developing, creating new real estate or new improvements to the facility. And so the answer is yes. We typically get some sort of modifications of the terms, like an extension of the lease term. We make sure that the financial statements are updated, even from the last quarter, which we've reviewed them. We get a deep dive into what the tenant is doing and why they need growth capital. We get a much better understanding of what's going on with their demand for the product that they're selling. So all that comes into play. So I think that's the first answer. And the second is we collected all the rents that we have got scheduled to collect, keeping in mind that we worked with three tenants during the pandemic that did struggle and asked for support, and we provided support, which has all been paid back. One of those tenants does, which represents less than 1% of our portfolio, is continuing to have some struggles. And while we've collected partial rent, we haven't collected full rent from them.

Gotcha. And is that first quarter or is that April?

or just both both got it i appreciate the time everyone thank you so much thanks tom thank you thank you and the next question comes from alexander goldfar with piper sandler uh good morning good morning and apologies uh there's some background noise uh so one you know appreciate the uh the ad hoc conference call uh definitely definitely a good good good thing and certainly the depth of information provided If we can boil it down just a few, I probably have maybe three or four questions, so apologies. But if we can just boil it down in the most simple terms, when, if you have to replace a tenant, be it a grower or retail, how much of the existing investment, you know, building improvements that you guys have funded, how much of that can be reused? So such that, you know, and we'll do simple terms. If you buy, you know, if the building is half the value and let's say the other half of the improvements, you basically get dollar for dollar back when you re-tenant it, or is some of that stuff that you have to junk and throw away the way we see office guys who rip out floors when they re-tenant a building?

These are mission-critical facilities. They're complex, expensive facilities that have dedicated HVAC, electrical, security, plumbing, lab, dry rooms, cure rooms, packaging. inventory, storage, shipping and receiving and storage, and a little tiny bit of space, office space, a little tiny bit of office space. Uh, keeping also in mind that we don't buy vacant buildings and, and fix them up and then release them. And that in our last, uh, six years of experience, we've only had to, uh, re tenant one property. So that's our, that's our experience. Keep in mind that during this last six years, there have been a countless number of license sales, tenant mergers and acquisitions where new owners have come in, and we have not had to scrap, lose anything. Our belief is that these facilities have long-term, generic, reusable value, especially are the improvements that we pay for. And then lastly, keeping in mind, we believe, and I think it's a fact if you speak to anybody out there who is developing anything, that replacement costs today are significantly higher than our current basis and than any historical basis that any of these builders or developers who are creating any type of product is experiencing today.

Right. So simply put, if a tenant had, you know, whatever, for whatever reason, closed down, moved out, you know, any replacement tenant would use basically the entire fit out as is because of all the capital that's been invested. That's a fair statement.

They absolutely could.

Okay. Second question is on the licenses, how many of these licenses are tradable? Meaning if a tenant closes, is that the end of the license or is the license sort of this separate vehicle that remains in effect. And, you know, I don't know if the whole portfolio, if that's true of the whole portfolio or it's different by states, but just sort of curious how many of the licenses are sort of independent of the operator in a sense.

I'm going to turn that over to Paul and let Paul handle that one.

Yeah, so thanks, Alex, for the question. So, yeah, I think you're right when you notice it. It varies from state to state. But as a general statement, the licenses, I think, for the most part, are tradable. But that being said, the state commission, cannabis commission, also has to approve the transferal to the new operator. So there are transferable, but generally need to be approved by the state.

Okay. Okay. And then in that, you know, I know obviously we're familiar with healthcare where a facility closes down and there's downtime when licenses are transferred, but also there are states that allow, you know, operations to continue with a sort of you know, piece of paper in the window that says, you know, under review, the process for re-tenanting and transferring the license, is that, it doesn't sound like you've really done that a lot, but is that an arduous process or, you know, it's maybe, you know, a short time trying to figure out if it's government bureaucracy or it's pretty efficient to complete that process?

So I think the only anecdotal way for us to respond to that is that These mergers and acquisitions, which occur regularly, where licenses are transferred from one ownership to another ownership, do take a tremendous amount of time. And you're talking 12 to 24 months.

Okay. And then final question is for Kat. Kat, on the GNA, obviously you guys have payroll pressure that every other REIT has. There's also, you know, there's annual comp and such. What should we expect for the balance of the year? And then as we think about 2023, should we think about sort of a big 1Q? Is that sort of how we should think about it? That 1Q is always the big G&A quarter and then it stabilizes from there. I just want to obviously better get our G&A in line with how you guys look at it.

Yeah, no, I appreciate that. And generally we do have, I think like most companies, increases for our entire employee base at the beginning of the year to reset salaries for that year. And we typically disclose that, especially for the executive officers in the 8K disclosures. We do have some corporate level activity that tends to hit hard in the first quarter related to you know, the audit, the proxy reporting. So those tend to be more heavily weighted toward the first and second quarters. But, you know, we continue to grow our team. We've added some additional positions and some expanded our space here. So we do tend to see a little bit of an increase but have been a very scalable and lean team that continues to execute really well.

And I do think you can use the first quarter runway as a good proxy for going forward. Yeah.

So 1Q, we should use that for the balance of the year. 1Q will be the same as for the next three quarters?

Yeah. There's nothing in there that is a one-time item.

Okay. Thank you very much. Thank you.

Thank you, Alex. Thank you. And next question comes from Eric Desaliers from Craig Allen Capital.

All right, great. Thanks for taking my questions, and I appreciate all that underwriting color on your prepared remarks. I guess along those same lines, can you kind of give us some more color on, you know, not the underwriting process, but just sort of, you know, your continuous kind of checking in on your tenants' financial health you know, just kind of give us a sense of, you know, how often, what do you look for, and then as a follow-up, can you help us understand what it takes for you guys to defer rent or adjust terms, you know, just kind of what kind of financial distress, you know, that would take, basically, just kind of some more color on that, you know, follow-up process, basically. Thank you.

Yeah, well, I appreciate the question. So, we do do, as Ben and Kat have described in the prepared remarks a great deal of analysis of the tenant's financial conditions, and we do get annual and quarterly financial information from our tenants, and we can check in with them. We do check in with them quarterly with our review processes, and certainly when when we're being asked to fund any portion of the improvement dollars that have been allocated for improvements in the real estate that we've agreed to. So that's number one. And the second question, I can't remember what the second question was.

Yeah, basically just kind of what it takes for you guys to actually defer rent. I mean, pretty much all these MSOs are facing some pricing pressures, and then, of course, inflationary pressures. So, you know, we're seeing, you know, margins get impacted here and just wondering, you know, sort of where the line is to, you know, getting some relief on the rent side of things.

Yeah, I think we typically defer rent every time there's a global pandemic. That's, you know, been the only time that we've actually even thought about it. And it was a reaction to something that obviously was unprecedented. And we were trying to be proactive at the time that it was done. But as I mentioned in, I think, one of the last answers, we've received all that deferral has been repaid. We, in our transactions themselves, we do phase in rent based on the stage of the development of the project to a certain period of time. Or on some projects, but that isn't our, I mean, we have a unique ability to demand full rent payments for every dollar that we've invested, and we use that in our business today.

Okay, great. So I guess maybe another way to think of it is it's pretty much bankruptcy is what it's going to take for you to not collect your rent.

I guess it's sort of a fair assessment or some other... Keep in mind that our tenants are not able to access federal bankruptcy because they are... There is no federal law allowing the sale of cannabis at this point. They're all subject to state laws. And so because these facilities are mission critical, because these facilities are complex and expensive, because they can't operate their business, they can't produce product without the business. It's not like they can move it out in one day and keep building. the complexity of growing a high-quality plant that delivers a high-quality product in the end is enormous, and which is why it costs so much to develop these facilities. So if any tenant decided to not pay rent, what we have before us is, you know, no different than all landlords, but with the fact that they can't use – bankruptcy to delay it, we can require them to issue a three-day notice to pay rent or vacate. And I can assure you that there's nothing that a tenant would hate most is to lose access to all the plant and product that they have if they didn't pay rent.

And just remembering, too, that we report our revenue on a cash basis. So 100% of the revenue that we've reported, we've received in cash. We do not record straight line rents or have other receivables to write down.

Okay, great. Yeah, I appreciate that color as well. And then just last question from me here. As you guys think about your tenant concentration and you look at your pipeline, how do you sort of What's your feeling on kind of going deeper, expanding your relationships with your current tenants versus looking for some diversification and getting some new tenants in there? Any thoughts on that would be great. Thanks.

Sure. So, no, I think as we've described over the past, our business model is focused on supporting our existing tenant relationships and helping those tenant relationships grow. That is the business thesis, and it is what we intend to do or have done. And we, you know, having only, I think, 29 different tenant relationships today, it isn't a lot, and we do look to carefully expand those tenant relationships so that we have a continued source and demand for new capital. but being very cautious in doing so because we only have access to so much capital. So that's the matrix that we look at.

Thank you for taking my questions.

Thank you.

Thank you. And the next question comes from Scott Fortune with Roth Capital.

Scott? Thank you for fitting me in. Very thoughtful discussion here. And just are most cannabis companies showing a pandemic currently? So their shares are off, obviously. But real quick, can you provide color on the challenges and the pressures facing some of your smaller tenants and the difficulties raising capital there, the cost of capital going up? And how is that affecting your underwriting now for some of the smaller tenants? And how do you view kind of the social equity licenses that's being pushed or trying to go down that avenue, which you're underwriting, and a limited amount of capital, you said, for the different states to expand into that area potentially.

Believe it or not, I think new tenant licensees are able to raise equity capital. There is still a a lot of capital that exists in the market today, especially on the private side, and that I would certainly concur with your question, or the way you presented the question, that costs for those startup tenants because of the cost of equity capital have increased. But that's their business, and if they wish to give a greater piece of the ownership of the company to equity investors, that's what is going to be required in order for them to raise the money necessary to move forward with a new license and a new business. I think that the costs... to create a new business in this industry have increased significantly. And they've increased significantly because of inflation and the inflationary pressures to build out a new facility. So the amount of capital that a new entity would have to raise today as compared to somebody who had raised capital or started businesses in the past is greater. I think that's what we're seeing. In terms of social equity, I think that we believe we have a very strong ESG report that we have posted and continue to review and evaluate. We focus in on our tenant underwriting and we look to support the communities in which we're involved with. And we'll certainly evaluate any opportunity from any part of the world and look to do that, keeping in mind that our job is to protect our shareholders and provide returns for our shareholders.

Great. And one last question, real quick, just kind of big picture, longer term, as you see additional consolidation with the potential divetures and eventually potential shuttering of higher cost facilities in kind of oversupplied markets. You know, let's say federal legalization comes on board, interstate commerce comes on board, globalization and such, and you're able to supply from lower cost facilities. How does that affect potentially your portfolio if, let's say, a tenant wants to consolidate or shut down some of their facilities from a cost standpoint?

Well, I mean, you've packed a lot of issues in that question. One, we've got corporate guarantees. A tenant can't just, you know, say, hey, you know, The power over here cost me twice as much as the power over there, so I'm going to move my facility. So that means, look, let me think. I'm going to build a new building, which takes 12 to 18 months. I'm going to put in new HVAC, which now costs 30% to 40% more. I'm going to put in new plumbing, and I'll just save a few pennies on electrical costs. And I still have an obligation to pay the rent on the other side. It's not going to happen. And the concept that facilities are shutting down or closing down, we're not seeing that. We don't see that. We haven't seen that. So I don't know where you're getting that from, but we haven't seen that.

I'm not thinking short-term, but as long-term as this gets built out, commoditization happens for lower-cost outdoor or greenhouse facilities or indoor fishing and that structure.

Yeah, Scott, I mean, I think, again, our business is very unique, and we have focused specifically on indoor grow facilities. so that we are protecting our shareholders and and their investment because these facilities in order to produce the highest quality product it has to be produced indoors we are not our growers who are doing indoor grow are not competing with outdoor grow product that's not that's not who's what they're trying that's not the the product that they're competing against they're competing against other indoor growth facilities that are producing high-quality products.

I agree. I appreciate the cover. Thanks for all the detail today. It's helpful.

Thanks, John. Thank you. And the next question, John Masako with Leidenberg Thalmann.

Good morning.

Hey, how are we doing?

So you provided some good color on the economic reasons your facilities are sticky, but from a purely hypothetical perspective, if you saw a tenant default, is there anything legally binding rather than economic that ties the license from the operations at one of your properties to the property itself?

So legally binding, well, the license itself, it requires a location in order for it to be issued so the license has a location associated with it so legally that's where they can grow does that answer the question so let's say it's in a hypothetical world you have a default someone purchases the defaulting company's assets and they decide maybe just whatever reason they want to they want to grow

They want to build a new facility somewhere else nearby and grow there instead. I mean, is that a potential option at all for that company? Or do they have to go back into your property?

They could do whatever they want. They've got a corporate guarantee. We're going to go after them, and they're going to pay the rent. As long as they pay the rent, we're good. We're happy.

But if it's a defaulted company, right? I'm just thinking to your point earlier, right? State court, you can go, if they don't want to pay the rent, you can call the county sheriff, throw locks on the doors and evict them. But if their assets get distributed, however they may get distributed in default, would that person who purchased the license have to come back into your property?

No. No. No, but let's think about it in reality. So the person has a license. The license, in order for them to utilize the license that they've just paid for, that they have, they would have to buy a piece of land, build a building, or buy a piece of land with a building on it, improve it with $300 to $500 a square foot in property, improvements and get state approval for this new location and be in the right zoning and have local approval for all this stuff. Or they could just pay the rent on the facility that the license is already licensed for.

That makes sense. That's very helpful. I just kind of wanted to go through this very granular level of how things are kind of tied or not. And then you mentioned earlier that one tenant was paying, a very small tenant in California was paying partial rent. I mean, is that the only tenant in the portfolio currently not paying full rent? Yes. Okay. And then do you have color or kind of insight into if parallel paid, it's may rent and have you had any conversations or requests from parallel about rent relief?

They paid me from May rent, and there's been no discussions about rent relief.

Okay. That's it for me. I appreciate the caller and the call. Thank you very much.

Thanks, John. Thank you. And this concludes the question and answer session. I would like to turn the floor to Alan Gold for any closing comments.

Well, thank you. And thank you all for joining us on the call today. Really appreciate all the hard work by our employees and and staff and all the support from investors. Thank you.

Thank you. The conference is now concluded. Thank you for attending today's presentation.