Properties
During 2018, we acquired six
additional properties in five new states, comprising approximately 391,000 additional rentable square feet. As of December 31,
2018, we owned eleven properties that were 100% leased to state-licensed medical-use cannabis operators and comprising an aggregate
of approximately 1,027,000 rentable square feet in Arizona, Colorado, Illinois, Maryland, Massachusetts, Michigan, Minnesota, New
York and Pennsylvania, with a weighted-average remaining lease term of approximately 14.7 years. As of December 31, 2018, we had
invested an aggregate of $147.9 million (consisting of purchase price and development and tenant reimbursement commitments funded,
if any, but excluding transaction costs) and had committed an additional $19.5 million to reimburse certain tenants and sellers
for completion of construction and tenant improvements at our properties.
Dividends
We commenced quarterly dividends
to our common stockholders in the second quarter 2017, which was our second full quarter after we completed our initial public
offering and commenced real estate operations with the acquisition of our first property in December 2016. During 2018, we declared
dividends to our common stockholders totaling $1.20 per share.
Capital Raising
In January 2018, we issued 3,220,000 shares
of our common stock in a follow-on public offering, including the exercise in full of the underwriters' option to purchase an additional
420,000 shares, resulting in net proceeds of approximately $79.3 million, after deducting the underwriters' discounts and commissions
and offering expenses.
In October 2018, we issued 2,990,000 shares
of common stock, including the exercise in full of the underwriters’ option to purchase an additional 390,000 shares, resulting
in in net proceeds of approximately $113.9 million, after deducting the underwriters' discounts and commissions and offering expenses.
Subsequent to December 31, 2018, in February
2019, our Operating Partnership issued $143.75 million aggregate principal amount of 3.75% exchangeable senior notes due 2024 (the
"Exchangeable Senior Notes"), including the exercise in full of the initial purchasers' option to purchase additional
Exchangeable Senior Notes.
Our Properties
Generally
We have acquired and intend to continue
to acquire specialized industrial real estate assets operated by state-licensed medical-use cannabis growers through sale-leaseback
transactions and third-party purchases. In sale-leaseback transactions, concurrently upon closing of the acquisition, we lease
the properties back to the sellers under long-term, triple-net lease agreements. We target properties owned by growers that have
been among the top candidates in the state licensing process and have been granted one or more licenses to operate multiple facilities.
Based on our properties and ongoing review of potential acquisitions, indoor cultivation facilities generally appear to have similar
shells as standard light industrial buildings or greenhouses. However, based on our diligence, the medical-use cannabis cultivation
process typically requires a finely tuned environment to achieve consistent high quality and specificity in cannabinoid levels
and to maximize yields, which translates into certain capital improvements in the building's infrastructure. These improvements
can include enhanced HVAC systems for climate and humidity control, high capacity electrical and plumbing systems, specialized
lighting systems, and sophisticated building management, cultivation monitoring and security systems. Through this sale-leaseback
strategy, we serve as a source of capital to these licensed medical-use cannabis growers, allowing them to redeploy their sale
proceeds back into their core operations to grow their business and achieve higher returns. In a third-party purchase of a property,
we may also fund the necessary tenant improvements through a long-term lease with an identified tenant, which also serves to free
up capital for the tenant to reinvest into their business.
As of December 31, 2018, the tenant at
each of our properties is responsible for paying all structural repairs, maintenance expenses, insurance and taxes related to the
property during the term of the applicable lease.
A summary of each of our properties
is provided below as of December 31, 2018, and organized by state:
Arizona
Pharm AZ Property
On December 15, 2017, we completed
the acquisition of a property in Arizona (the "Pharm AZ Property") comprising approximately 358,000 square feet of greenhouse
and industrial space, which we purchased from a subsidiary of The Pharm, LLC ("The Pharm") for $15.0 million (excluding
approximately $27,000 in transaction costs) in a sale-leaseback transaction. Concurrent with the closing of the acquisition, we
entered into a triple-net lease with another subsidiary of The Pharm, as tenant for continued use as a medical cannabis cultivation
and processing facility. The lease also provides that we would fund up to $3.0 million as reimbursement for future tenant
improvements at the Pharm AZ Property, which was fully funded as of December 31, 2018. As of December 31, 2018, the monthly base
rent under the lease was $216,825, and subject to annual increases of 3.25% during the lease term.
Colorado
The
Green Solution CO Property
On
October 30, 2018,
we completed the acquisition of a 58,000 square
foot industrial property located
in
Colorado
for approximately $11.3 million (excluding approximately $27,000 in transaction costs) and entered into a long-term, triple-net
lease with The Green Solution, LLC for continued operation of a cannabis cultivation facility.
Illinois
Ascend
IL Property
On
December 21, 2018,
we completed the acquisition of a 75,000 square foot industrial property located
in
Illinois for $19.0 million (excluding approximately $20,000 in transaction costs). Concurrent with the closing of the purchase,
we entered into a long-term, triple-net lease agreement with a wholly owned subsidiary of Ascend Wellness Holdings, LLC (“Ascend”),
which intends to operate the property as a medical-use cannabis cultivation and processing facility. Ascend is expected to complete additional tenant improvements for the building, for which we
have agreed to provide reimbursement of up to $6.0 million, none of which was incurred or funded as of December 31, 2018. Assuming
full reimbursement for the tenant improvements, our total investment in the property will be $25.0 million.
Maryland
Holistic MD Property
On May 26, 2017, we acquired a 72,000
square foot industrial property located in Maryland (the “Holistic MD Property”), which was under development at the
time of our acquisition. The initial purchase price was $8.0 million (excluding approximately $185,000 in transaction costs), with
an additional $3.0 million payable to the seller upon completion of certain development milestones. Concurrent with the closing
of the purchase of the Holistic MD Property, we entered into a triple-net lease agreement with Holistic Industries LLC (“Holistic
MD”) for use as a medical cannabis cultivation and processing facility. The initial term of the lease is 16 years, with three
options to extend the term of the lease for three additional five-year periods. Holistic MD has an option to purchase the property
upon a qualifying termination event or at the end of the initial lease term and subject to certain conditions, at the option purchase
price that is the greater of fair market value or a 7.5% capitalization rate derived from market rental rates for industrial properties
in the relevant competitive market.
On August 1, 2017, we paid the
additional $3.0 million to the seller upon the seller’s completion of the development milestones at the Holistic MD Property.
On September 25, 2017, we amended our lease with Holistic MD to, among other things, rescind the $1.9 million rent reserve
that we originally established for Holistic under the lease, and to reimburse up to $1.9 million of additional tenant improvements
for Holistic MD, such that a total of $5.9 million is reimbursable by us to Holistic for tenant improvements. On September
28, 2017, we approved and accrued for Holistic MD's draw request for reimbursement of the full $5.9 million of tenant improvements
and funded that amount on October 2, 2017. As a result, our total investment in the Holistic MD Property was approximately $16.9
million (excluding transaction costs). As of December 31, 2018 Holistic's monthly base rent was approximately $219,853, of which
$193,594 is subject to annual escalations of 3.25% during the initial lease term. We also receive a property management fee under
the lease equal to 1.5% of the then-current base rent throughout the initial term.
Massachusetts
PharmaCann MA Property
On May 31, 2018, we acquired a property
in Massachusetts and entered into a long-term lease and development agreement with a subsidiary of PharmaCann for an approximately
26,000 square foot industrial facility and an approximately 32,000 square foot greenhouse facility on the property. The purchase
price for the property was $3.0 million (excluding approximately $30,000 in transaction costs). The PharmaCann subsidiary is expected
to construct the two buildings at the property, for which we have agreed to provide reimbursement of up to $15.5 million (the “Construction
Funding”), of which approximately $9.7 million was incurred and approximately $9.5 million was funded as of December 31,
2018. Assuming full reimbursement for the Construction Funding, our total investment in the property will be $18.5 million. Concurrent
with the closing of the purchase of the property, we entered into a long-term, triple-net lease agreement with the PharmaCann subsidiary,
which intends to operate the property upon completion of development as a cannabis cultivation and processing facility.
Holistic MA Property
On
July 12, 2018,
we completed the acquisition of a 55,000 square
foot industrial property located
in
Massachusetts
for $12.75 million (excluding approximately $27,000 in transaction costs) in a sale-leaseback transaction. Upon the closing, we
entered into a long-term, triple-net lease for the entire property with Holistic Industries, Inc. to operate a cannabis cultivation
and processing facility.
Michigan
Green Peak MI Property
On
August 2, 2018,
we completed the acquisition of a 56,000 square
foot industrial property located
in
Michigan
for approximately $5.5 million (excluding approximately $29,000 in transaction costs). Upon the closing, we entered into a long-term,
triple-net lease for the entire property with Green Peak Industries, LLC ("Green Peak”) for use as a medical cannabis
cultivation and processing facility upon completion of development. We reimbursed the seller of the property approximately $5.3
million (the "Additional Purchase Price")
a
s
of December 31, 2018 for completing certain required development milestones for the building. Green Peak is also expected complete
certain tenant improvements, for which we have agreed to provide reimbursement of up to $2.2 million (the "TI Allowance"),
of which approximately $1.5 million was incurred and approximately $1.1 million was funded as of December 31, 2018.
Green
Peak also has a one-time right to request an additional tenant improvement allowance of up to $8.0 million (the "Additional
TI Allowance") for additional improvements to the property, subject to satisfaction of conditions set forth in the lease.
If we make available the Additional TI Allowance, the base rent shall be adjusted to reflect our total investment in the property.
In addition, the term of the lease shall be automatically extended to the date that is 15 years from the date that the Additional
TI Allowance is made available. If we fund the full amount of the Additional Purchase Price, the TI Allowance and the Additional
TI Allowance, our total investment in the property is expected to be $21.0 million. If we do not make the Additional TI Allowance
available to Green Peak, Green Peak shall have the right to purchase the property, subject to satisfaction of conditions set forth
in the lease, at a price equal to the greater of (a) the appraised value of the property and (b) the value determined by dividing
the then-current base rent by ten percent.
Minnesota
Vireo MN Property
On November 8, 2017, we completed the acquisition
of an industrial property located in Minnesota (the “Vireo MN Property”), which we purchased from a subsidiary of Vireo
Health, Inc. (“Vireo Minnesota”) for approximately $3.0 million (excluding approximately $58,000 in transaction costs)
in a sale-leaseback transaction. Concurrent with the closing of the acquisition, we entered into a long-term, triple-net lease
with Vireo Minnesota, as tenant for use as a medical cannabis cultivation and processing facility. In December 2018, we amended
our lease with Vireo Minnesota to increase our reimbursement for future tenant improvements at the Vireo MN Property from approximately
$1.0 million to a total of approximately $3.0 million, which also resulted in a corresponding increase to the base rent. As of
December 31, 2018, we had incurred approximately $1.6 million and funded approximately $788,000 as reimbursement for tenant improvements
at this property. In connection with these tenant improvements, we increased the footprint of the Vireo MN Property to approximately
39,000 square feet.
New York
PharmaCann NY Property
On December 19, 2016, we acquired
a 127,000 square foot industrial property located in New York (the “PharmaCann NY Property”), which we purchased from
PharmaCann LLC (“PharmaCann”) for approximately $30.0 million (excluding approximately $75,000 in transaction costs)
in a sale-leaseback transaction. Concurrent with the closing of the acquisition, we entered into a triple-net lease with PharmaCann,
as tenant for use as a medical cannabis cultivation and processing facility. The lease term is 15 years, with two options to extend
the term of the lease for two additional five-year periods. At December 31, 2018, the base rent of the PharmaCann lease was
approximately $345,658 per month, subject to annual increases at a rate based on the higher of (i) 4% or (ii) 75% of the
consumer price index. The lease also provides that we receive a property management fee equal to 1.5% of the then-current base
rent throughout the term, and supplemental base rent for the first five years of the term of the lease at a rate of $105,477
per month.
Vireo NY Property
On October 23, 2017, we completed the acquisition
of a 40,000 square foot industrial property located in New York (the “Vireo NY Property”), which we purchased from
a subsidiary of Vireo Health, Inc. (“Vireo New York”) for approximately $3.4 million (excluding approximately $60,000
in transaction costs) in a sale-leaseback transaction. Concurrent with the closing of the acquisition, we entered into a long-term,
triple-net lease with Vireo New York, as tenant for use as a medical cannabis cultivation and processing facility. In December
2018, we amended our lease with Vireo New York to increase our reimbursement for future tenant improvements at the Vireo NY Property
from $1.0 million to a total of $3.0 million, which also resulted in a corresponding increase to the base rent. As of December
31, 2018, we had incurred approximately $875,000 as reimbursement for tenant improvements at this property, of which no amount
was funded.
Pennsylvania
Vireo PA
Property
On April 6, 2018, we completed the acquisition
of an 89,000 square foot industrial property located in Pennsylvania (the "Vireo PA Property") for approximately $5.8
million (excluding approximately $115,000 in transaction costs) in a sale-leaseback transaction. Upon the closing, we entered into
a long-term, triple-net lease for the entire property with a subsidiary of Vireo Health, Inc. ("Vireo Pennsylvania"),
for use as a medical cannabis cultivation and processing facility. In December 2018, we amended our lease with Vireo Pennsylvania
to increase our reimbursement for future tenant improvements at the Vireo PA Property from approximately $2.8 million to a total
of approximately $3.8 million, which also resulted in a corresponding increase to the base rent. As of December 31, 2018, we had
incurred approximately $2.9 million and funded approximately $2.6 million as reimbursement for tenant improvements at this property.
Acquisitions of Properties Completed Subsequent to December
31, 2018:
Subsequent to December 31, 2018, we acquired
the following two properties:
On February 8, 2019, we completed
the acquisition of a 43,000 square foot industrial property located in California for approximately $6.7 million (excluding transaction costs). Concurrent with the closing of the purchase, we entered into a long-term, triple-net lease agreement
with an experienced operator, which intends to operate the property as a cannabis cultivation facility in accordance with California
cannabis regulations upon completion of redevelopment. The seller of the property is expected to complete redevelopment of the
building, for which we have agreed to provide reimbursement of up to approximately $4.8 million. Assuming full reimbursement for
the redevelopment, our total investment in the property will be approximately $11.5 million.
On March 13, 2019, we acquired
a property in Ohio and entered into a long-term lease and development agreement with a subsidiary of PharmaCann for an approximately
26,000 square foot industrial facility and an approximately 32,000 square foot greenhouse facility on the property. The purchase
price for the property was $700,000 (excluding transaction costs). The PharmaCann subsidiary is expected
to construct the two buildings at the property, for which we have agreed to provide reimbursement of up to $19.3 million. Assuming
full reimbursement for the construction, our total investment in the property will be $20.0 million.
Our Competitive Strengths
We believe that we have the following competitive
strengths:
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Experienced and Committed Management Team.
Alan
Gold, our executive chairman, and other members of our senior management team have substantial experience in all aspects of the
real estate industry, including acquisitions, dispositions, construction, development, management, finance and capital markets.
In particular, in August 2004, Mr. Gold and Gary Kreitzer, vice chairman of our board of directors, founded BioMed Realty Trust,
Inc. (formerly NYSE: BMR), or BioMed Realty, an internally-managed REIT focused on acquiring, developing, owning, leasing and managing
laboratory and office space for the life science industry, an industry they believed to be underserved by commercial property investors
and lenders and poised for significant growth. Mr. Gold served as chairman of the board of directors and chief executive officer
and Mr. Kreitzer served as executive vice president and a member of the board of directors from the founding of BioMed Realty in
2004 through the acquisition of BioMed Realty by an affiliate of The Blackstone Group, L.P. in 2016.
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Recurring Revenue with Contractual Escalations.
As
of December 31, 2018, we had acquired eleven properties that were 100% leased on long-term, triple-net leasing arrangements with
licensed medical-use cannabis cultivators, and which are subject to contractual rental rate increases. Along with our existing
portfolio, we expect to continue to enter into additional similar transactions structured to provide recurring revenue with contractual
escalations.
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Focus on Underserved Industry with Less Competition.
Our
focus on specialized industrial real estate assets leased to tenants in the regulated medical-use cannabis industry may result
in significantly less competition from existing REITs and institutional buyers due to the unique nature of the real estate and
its tenants. Moreover, we believe the banking industry's general reluctance to finance owners of state-licensed cannabis facilities,
coupled with the licensed operators' need for capital to fund the growth of their operations, will continue to provide significant
opportunities for us to acquire specialized industrial properties and execute long-term leases that are structured to generate
stable and increasing rental revenue, along with the potential for long-term appreciation in value.
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Demonstrated Investment Acumen.
We utilize rigorous
underwriting standards for evaluating acquisitions and potential tenants to ensure that they meet our strategic and financial criteria.
Our extensive experience and relationships in the real estate and medical-use cannabis industry enable us to identify, negotiate
and close on acquisitions and leases with growers who have been among the top candidates in the rigorous state licensing process.
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Positive Regulated Cannabis Industry Trends.
Based
on the tremendous historical and projected growth for the regulated cannabis industry, we expect to see significant spending by
state-licensed cannabis cultivators on their existing and new state-licensed cannabis facilities, presenting an opportunity for
us to be a key capital provider in their expansion initiatives.
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Our Business Objectives and Growth Strategies
Our principal business objective is to
maximize stockholder returns through a combination of (1) distributions to our stockholders, (2) sustainable long-term growth in
cash flows from increased rents, which we hope to pass on to stockholders in the form of increased distributions, and (3) potential
long-term appreciation in the value of our properties from capital gains upon future sale. Our primary strategy to achieve our
business objective is to acquire and own a portfolio of specialized industrial properties, including medical-use cannabis facilities
leased to tenants holding the requisite state licenses to operate in the regulated medical-use cannabis industry. This strategy
includes the following components:
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Owning Specialized Industrial Properties and Related Real Estate
Assets for Income.
We primarily acquire medical-use cannabis facilities from licensed growers who will continue
their cultivation operations after our acquisition of the property. We expect to hold acquired properties for investment and to
generate stable and increasing rental income from leasing these properties to licensed growers.
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Owning Specialized Industrial Properties and Related Real Estate
Assets for Appreciation.
We primarily lease our acquired properties under long-term, triple-net leases. However,
from time to time, we may elect to sell one or more properties if we believe it to be in the best interests of our stockholders.
Accordingly, we will seek to acquire properties that we believe also have potential for long-term appreciation in value.
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Expanding as Additional States Permit Medical-Use Cannabis Cultivation
and Production.
We acquire properties in the United States, with a focus on states that permit cannabis cultivation
for medical use. As of December 31, 2018, we owned properties in nine states, and we expect that our acquisition opportunities
will continue to expand as additional states legalize medical-use cannabis and license new cultivators.
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Preserving Financial Flexibility on our Balance Sheet.
We are focused on maintaining a conservative capital structure, in order to provide us flexibility in financing our growth initiatives.
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Our Target Markets
Our target markets include states that
permit cannabis cultivation for medical use. As of December 31, 2018, we owned eleven properties located in Arizona, Colorado,
Illinois, Maryland, Massachusetts, Michigan, Minnesota, New York and Pennsylvania. According to the National Conference of State
Legislatures, as of December 31, 2018, 33 states and the District of Columbia have legalized cannabis for medical use.
Although these states have approved the
medical use of cannabis, the applicable state and local laws and regulations vary widely. For example, most states' laws allow
commercial production and sales through dispensaries and set forth rigorous licensing requirements; in other states the licensing
rules are unclear. In some states, dispensaries are mandated to operate on a not-for-profit basis. Some states permit home cultivation
activities. The states also differ on the form in which cannabis can be sold. For example, some states do not permit cannabis-infused
products such as concentrates, edibles and topicals, while other states ban smoking cannabis.
In addition, we expect other factors will
be important in the development and growth of the medical-use cannabis industry in the United States, including the timeframes
for developing regulations and issuing licenses in states that recently passed laws allowing for medical-use cannabis, and continued
legislative authorization of medical-use cannabis at the state level. Progress in the regulated medical-use cannabis industry,
while encouraging, is not assured and any number of factors could slow or halt progress in this area.
Market Opportunity
The Industrial Real Estate Sub-Market
The industrial real estate sub-market
continues to perform well in this real estate cycle. According to CBRE Group, Inc., the U.S. industrial property vacancy rate declined
to 4.3% in the fourth quarter of 2018, reflecting the 35
th
consecutive quarter of positive net absorption. Nearly 30.0
million square feet of industrial real estate were absorbed in 2018, which resulted in the highest net asking rents since CBRE
Group, Inc. began tracking this metric in 1989.
We believe this supply/demand dynamic creates
significant opportunity for owners of industrial facilities, particularly those focused on niche categories, as options are limited
for tenants requiring specialized buildings. We intend to capitalize on this opportunity by purchasing specialized industrial real
estate assets that are critical to the medical-use cannabis industry.
The Regulated Medical-Use Cannabis Industry
Overview
We believe that a convergence of changing
public attitudes and increased legalization momentum in various states toward regulated medical-use cannabis creates an attractive
opportunity to invest in the industrial real estate sector with a focus on regulated medical-use cannabis facilities. We also believe
that the increased sophistication of the regulated medical-use cannabis industry and the development of strong business, operational
and compliance practices have made the sector more attractive for investment. Increasingly, state-licensed, medical-use cannabis
cultivation and processing facilities are becoming sophisticated business enterprises that use state-of-the-art technologies and
well-honed business and operational processes to maximize product yield and revenues. Additionally, medical-use cannabis growers
and dispensers have developed a growing portfolio of products into which they are able to incorporate legal medical-use cannabis
in a safe and appealing manner.
In the United States, the development and
growth of the regulated medical-use cannabis industry has generally been driven by state law and regulation, and accordingly, the
market varies on a state-by-state basis. State laws that legalize and regulate medical-use cannabis allow patients to consume cannabis
for medicinal reasons with a doctor's recommendation, subject to various requirements and limitations. States have authorized numerous
medical conditions as qualifying conditions for treatment with medical-use cannabis, which vary significantly from state to state
and may include, among others, treatment for cancer, glaucoma, HIV/AIDs, wasting syndrome, pain, nausea, seizures, muscle spasms,
multiple sclerosis, post-traumatic stress disorder (PTSD), migraines, arthritis, Parkinson's disease, Alzheimer's, lupus, residual
limb pain, spinal cord injuries, inflammatory bowel disease and terminal illness. As of December 31, 2018, 33 states, plus the
District of Columbia, have passed laws allowing their citizens to use medical cannabis.
We believe that the following conditions,
which are described in more detail below, create an attractive opportunity to invest in industrial real estate assets that support
the regulated medical-use cannabis industry:
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significant industry growth in recent years and expected continued
growth;
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a shift in public opinion and increasing momentum toward the legalization
of medical-use cannabis under state law; and
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limited access to capital by industry participants in light of risk
perceived by financial institutions of violating federal laws and regulatory guidelines for offering banking services to cannabis-related
businesses.
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Industry Growth and Trends
According to Arcview Market Research, sales
of state-legal cannabis in the United States grew to $8.6 billion in 2017, including $5.9 billion of medical-use cannabis sales,
and are expected to reach $22.2 billion by 2022.
According to ProCon.org, a non-profit organization,
as of May 2018, over 2.1 million people used or were registered to use state-legalized medical cannabis in the United States, taking
data available from the 26 states and Washington, D.C. that had implemented their medical cannabis programs as of that date. As
the industry continues to evolve, new ways to consume medical-use cannabis are being developed in order for patients to have the
treatment needed for their condition in a safe and appealing manner. In addition to smoking and vaporizing of dried leaves, cannabis
can be incorporated into a variety of edibles, pills, spray products, transdermal patches and topicals, including salves, ointments,
lotions and sprays with low or high levels of delta-9-tetrahydrocannabinol (“THC”), the principal psychoactive constituent
of the cannabis plant.
As with any nascent but growing industry,
operational and business practices evolve and become more sophisticated over time. We believe that the quality and experience of
industry participants and the development of sound business, operational and compliance practices have strengthened significantly
over time, increasing the attractiveness for investment in the regulated medical-use cannabis industry.
Shifting Public Attitudes and State
Law and Legislative Activity
We believe that the growth of the regulated
medical-use cannabis industry has been fueled, in part, by the rapidly changing public attitudes in the United States. A 2018 poll
by Quinnipiac University found that 93% of Americans support patient access to medical-use cannabis, if recommended by a doctor.
As of December 31, 2018, 33 states, plus
the District of Columbia, have passed laws allowing their citizens to use medical cannabis. The first state to permit the use of
cannabis for medicinal purposes was California in 1996, upon adoption of the Compassionate Care Act. The law allowed doctors to
recommend cannabis for serious medical conditions and patients were permitted to use, possess and grow cannabis themselves. Several
other states adopted medical-use cannabis laws in 1998 and 1999, and the remaining medical-use cannabis states adopted their laws
on various dates through 2018.
Following the approval of medical-use cannabis,
state programs must be developed and businesses must be licensed before commencing cannabis sales. Some states have developed the
necessary procedures and licensing requirements quickly, while other states have taken years to develop their programs for production
and sales of cannabis. Even where regulatory frameworks for medical-use cannabis production and sales are in place, states tend
to revise these rules over time. These revisions often impact sales, making it difficult to predict the potential of new markets.
States may restrict the number of medical-use cannabis businesses permitted, restrict the method by which medical cannabis can
be consumed, limit the medical conditions that are eligible for cannabis treatment or require registration of doctors and/or patients,
each of which can limit growth of the medical-use cannabis industry in those states. Alternatively, states may relax their initial
regulations relating to medical-use cannabis production and sales, which would likely accelerate growth of the medical-use cannabis
industry in such states.
Access to Capital
To date, the status of state-licensed cannabis
under federal law has significantly limited the ability of state-licensed industry participants to fully access the U.S. banking
system and traditional financing sources. These limitations, when combined with the high costs of maintaining licensed and stringently
regulated medical-use cannabis facilities (including meeting extensive zoning requirements), substantially increase the cost of
production. While future changes in federal and state laws may ultimately open up financing options that have not been available
to date in this industry, we believe that such changes, if they do occur, will take time, thereby creating an opportunity over
the next few years to provide our sale-leaseback and other real estate solutions to state-licensed industry participants that have
limited access to traditional financing sources.
Market Opportunity and Associated Risks
We focus on purchasing specialized industrial
real estate assets for the regulated medical-use cannabis industry, with emphasis on properties that we believe also have potential
for long-term appreciation in value. We believe that our sale-leaseback and other real estate solutions offer an attractive alternative
to state-licensed medical-cannabis cultivators who have limited access to traditional financing alternatives. We have acquired
and intend to continue to acquire medical-use cannabis facilities in states that permit medical-use cannabis cultivation.
Notwithstanding the foregoing market opportunity
and trends, and despite legalization at the state level, we continue to believe that the current state of federal law creates significant
uncertainty and potential risks associated with investing in medical-use cannabis facilities, including but not limited to potentially
heightened risks related to the use of such facilities for adult-use cannabis operations, if a state passes such laws. For a more
complete description of these risks, see the sections "Risks Related to Regulation" and "Business — Governmental
Regulation" under Item 1A, "Risk Factors."
Tenant Concentration
As of December 31, 2018, all of our revenues
were derived from eleven properties. PharmaCann leases two properties from us in New York and Massachusetts, which comprised approximately
39% and 82% of rental revenues for the years ended December 31, 2018 and 2017, respectively. In addition, our tenant Holistic MD
comprised approximately 18% and 14% of rental revenues for the years ended December 31, 2018 and 2017, respectively. Furthermore,
our tenant The Pharm comprised approximately 16% of rental revenues for the year ended December 31, 2018. Our tenants are generally
start-up businesses with limited histories of operations, and have not yet been profitable, or have been profitable only for a
short period of time. For some or all of 2019, we expect that many of our tenants will continue to incur losses as their expenses
increase in connection with the expansion of their operations, and that they have made and will continue to make rent payments
to us from proceeds from the sale of the applicable property or cash on hand, and not funds from operations. Furthermore, each
of our leases does not prohibit the tenant from conducting adult-use cannabis operations at the applicable property, provided such
operations are in compliance with applicable state and local laws. As such, our tenant may conduct adult-use cannabis operations
at the property it leases from us, which in turn could expose that tenant, us and our property to different and greater risks,
including heightened risks of enforcement of federal laws. For example, the voters of the Commonwealth of Massachusetts passed
an initiative to legalize cannabis for adult-use in 2016, having previously voted to legalize medical-use cannabis in 2012. Massachusetts
began issuing licenses to operators for the sale of adult-use cannabis in July 2018. Our existing leases at our Massachusetts properties
do not prohibit our tenants from conducting adult-use cannabis cultivation, processing or dispensing that is permissible under
state and local laws. Similarly, the states of California and Colorado permits licensed adult-use cannabis cultivation, processing
and dispensing, and our leases with tenants in those states allow for adult-use cannabis operations to be conducted at the properties
in compliance with state and local laws. In addition, Michigan voters passed an initiative in November 2018 to legalize cannabis
for adult-use.
See each of the discussions under
Item 1A, "Risk Factors," under the captions "Many of our existing tenants are, and we expect that most of our future
tenants will be, start-up businesses and may be unable to pay rent with funds from operations or at all, which could adversely
affect our cash available to make distributions to our stockholders or otherwise impair the value of our common stock," and
"Our current real estate portfolio consists of only 13 properties and will likely continue to be concentrated in a limited
number of properties in the future, which subjects us to an increased risk of significant loss if any property declines in value
or if we are unable to lease a property."
Geographic Concentration
As of December 31, 2018, all of our revenues
were derived from our eleven properties located in Arizona, Colorado, Illinois, Maryland, Massachusetts, Michigan, Minnesota, New
York and Pennsylvania. See each of the discussions under Item 1A, "Risk Factors," under the caption "Our properties
are, and are expected to continue to be, geographically concentrated in states that permit medical-use cannabis cultivation, and
we will be subject to social, political and economic risks of doing business in these states and any other state in which we may
own property." The medical-use cannabis market is in its early stages, and is subject to strict regulations providing for,
among other things, limited medical conditions for treatment with medical-use cannabis, limitations on the form in which medical
cannabis can be consumed and enhanced registration requirements for patients and physicians, which may result in the market not
growing and developing in the way that we or our tenants projected.
Our Financing Strategy
We intend to meet our long-term liquidity
needs through cash flow from operations and the issuance of equity and debt securities, including common stock, preferred stock
and long-term notes. Where possible, we also may issue limited partnership interests in our Operating Partnership to acquire properties
from existing owners seeking a tax-deferred transaction. We expect to issue equity and debt securities at times when we believe
that our stock price is at a level that allows for the reinvestment of offering proceeds in accretive property acquisitions. We
may also issue common stock to permanently finance properties that were previously financed by debt securities. However, we cannot
assure you that we will have access to the capital markets at times and on terms that are acceptable to us. Our ability to access
the capital markets and to obtain other financing arrangements is also significantly limited by our focus on serving the medical-use
cannabis industry. Our investment guidelines initially provide that our aggregate borrowings (secured and unsecured) will not exceed
50% of the cost of our tangible assets at the time of any new borrowing, subject to our board of directors' discretion.
We have filed a shelf registration statement,
which was subsequently declared effective by the SEC, which may permit us, from time to time, to offer and sell common stock, preferred
stock, warrants and other securities to the extent necessary or advisable to meet our liquidity needs.
Risk Management
As of December 31, 2018, we owned eleven
properties located in Arizona, Colorado, Illinois, Maryland, Massachusetts, Michigan, Minnesota, New York and Pennsylvania. We
will continue to attempt to diversify the investment size and location of our portfolio of properties in order to manage our portfolio-level
risk. Over the long term, we intend that no single property will exceed 25% of our total assets and that no single tenant will
exceed 30% of our total assets.
We expect that single tenants will continue
to occupy our properties pursuant to triple-net lease arrangements in general and, therefore, the success of our investments will
be materially dependent on the financial stability of these tenants. Our existing tenants generally are, and we expect that most
of our tenants will be in the future, start-up businesses that have little or no revenue and, at least initially, will make rent
payments to us from the sale proceeds of a sale-leaseback transaction with us or cash on hand. We also expect the success of our
tenants, and their ability to make rent payments to us, to significantly depend on the projected growth and development of the
applicable state market; as many of these state markets have a very limited history, and other state markets are still forming
their regulations, issuing licenses and otherwise establishing the market framework, significant uncertainty exists as to whether
these markets will develop in the way that we or our tenants project.
We evaluate the credit quality of our tenants
and any guarantors on an ongoing basis by reviewing, where available, the publicly filed financial reports, press releases and
other publicly available industry information regarding our tenants and any guarantors. In addition, we monitor the payment history
data for all of our tenants and, in some instances, we monitor our tenants by periodically conducting site visits and meeting with
the tenants to discuss their operations. In many instances, we will generally not be entitled to financial results or other credit-related
data from our tenants. See the section "Risks Related to Our Business" under Item 1A, "Risk Factors."
Competition
The current market for properties that
meet our investment objectives is limited. In addition, we believe finding properties that are appropriate for the specific use
of allowing medical-use cannabis growers may be limited as more competitors enter the market, and as medical-use cannabis growers
obtain greater access to alternative financing sources, including but not limited to equity and debt financing sources. We face
significant competition from a diverse mix of market participants, including but not limited to, other companies with similar business
models, independent investors, hedge funds and other real estate investors, hard money lenders, and cannabis operators themselves,
all of whom may compete with us in our efforts to acquire real estate zoned for medical-use cannabis facilities. In some instances,
we will be competing to acquire real estate with persons who have no interest in the cannabis industry, but have identified value
in a piece of real estate that we may be interested in acquiring.
These competitors may prevent us from acquiring
desirable properties or may cause an increase in the price we must pay for properties. Our competitors may have greater financial
and operational resources than we do and may be willing to pay more for certain assets or may be willing to accept more risk than
we believe can be prudently managed. In particular, larger companies may enjoy significant competitive advantages that result from,
among other things, a lower cost of capital and enhanced operating efficiencies. Our competitors may also adopt transaction structures
similar to ours, which would decrease our competitive advantage in offering flexible transaction terms. In addition, due to a number
of factors, including but not limited to potential greater clarity of the laws and regulations governing medical-use cannabis by
state and federal governments, the number of entities and the amount of funds competing for suitable investment properties may
increase substantially, resulting in increased demand and increased prices paid for these properties. If we pay higher prices for
properties, our profitability may decrease, and you may experience a lower return on our common stock. Increased competition for
properties may also preclude us from acquiring those properties that would generate attractive returns to us.
Governmental Regulation
Federal Laws Applicable to the Medical-Use Cannabis Industry
Cannabis is classified as a Schedule I
controlled substance by the Drug Enforcement Agency ("DEA") and the U.S. Department of Justice ("DOJ") with
no medical use, and therefore it is illegal to grow, possess and consume cannabis under federal law. The Controlled Substances
Act of 1910 ("CSA") bans cannabis-related businesses; the possession, cultivation and production of cannabis-infused
products; and the distribution of cannabis and products derived from it. Moreover, on two separate occasions the U.S. Supreme Court
ruled that the CSA trumps state law. That means that the federal government has the option of enforcing U.S. drug laws, creating
a climate of legal uncertainty regarding the production and sale of medical-use cannabis.
Under the Obama administration, the DOJ
previously issued memoranda, including the so-called “Cole Memo” on August 29, 2013, providing internal guidance to
federal prosecutors concerning enforcement of federal cannabis prohibitions under the CSA. This guidance essentially characterized
use of federal law enforcement resources to prosecute those complying with state laws allowing the use, manufacture and distribution
of cannabis as an inefficient use of such federal resources when state laws and enforcement efforts are effective with respect
to specific federal enforcement priorities under the CSA.
On January 4, 2018, U.S. Attorney General
Jeff Sessions issued a written memorandum rescinding the Cole Memo and related internal guidance issued by the DOJ regarding federal
law enforcement priorities involving cannabis (the “Sessions Memo”). The Sessions Memo instructs federal prosecutors
that when determining which cannabis-related activities to prosecute under federal law with the DOJ’s finite resources, prosecutors
should follow the well-established principles set forth in the U.S. Attorneys’ Manual governing all federal prosecutions.
The Sessions Memo states that “these principles require federal prosecutors deciding which cases to prosecute to weigh all
relevant considerations, including federal law enforcement priorities set by the Attorney General, the seriousness of the crime,
the deterrent effect of criminal prosecution, and the cumulative impact of particular crimes on the community.” The Sessions
Memo went on to state that given the DOJ’s well-established general principles, “previous nationwide guidance specific
to marijuana is unnecessary and is rescinded, effective immediately.” It is unclear what impact the Sessions Memo will have
on the medical-use cannabis industry, if any.
In addition, pursuant to the current omnibus
spending bill previously approved by Congress, the DOJ is prohibited from using funds appropriated by Congress to prevent states
from implementing their medical-use cannabis laws. A similar provision was also included in each prior Congressional omnibus spending
bill since 2014. This provision, however, is currently set to expire on September 30, 2019, and there is no assurance that Congress
will approve inclusion of a similar prohibition on DOJ spending in the appropriations bills for future years. In
USA vs.
McIntosh
, the United States Circuit Court of Appeals for the Ninth Circuit held that this provision prohibits the DOJ from
spending funds from relevant appropriations acts to prosecute individuals who engage in conduct permitted by state medical-use
cannabis laws and who strictly comply with such laws. However, the Ninth Circuit's opinion, which only applies in the states of
Alaska, Arizona, California, Hawaii and Idaho, also held that persons who do not strictly comply with all state laws and regulations
regarding the distribution, possession and cultivation of medical-use cannabis have engaged in conduct that is unauthorized, and
in such instances the DOJ may prosecute those individuals.
Furthermore, while we target the acquisition
of medical-use cannabis facilities, our leases do not prohibit cannabis cultivation for adult-use that is permissible under the
state and local laws where our facilities are located. Consequently, certain of our tenants cultivate adult-use cannabis now (or
may in the future) in our medical-use cannabis facilities that are permitted by such state and local laws, which may in turn subject
the tenant, us and our properties to greater and/or different federal legal and other risks than exclusively medical-use cannabis
facilities, including not providing protection under the above Congressional spending provision.
Federal prosecutors have significant discretion
and no assurance can be given that the federal prosecutor in each judicial district where we purchase a property will not choose
to strictly enforce the federal laws governing cannabis production or distribution. Any change in the federal government's enforcement
posture with respect to state-licensed cultivation of medical-use cannabis, including the enforcement postures of individual federal
prosecutors in judicial districts where we purchase properties, would result in our inability to execute our business plan, and
we would likely suffer significant losses with respect to our investment in medical-use cannabis facilities in the United States,
which would adversely affect the trading price of our securities. Furthermore, following any such change in the federal government's
enforcement position, we could be subject to criminal prosecution, which could lead to imprisonment and/or the imposition of penalties,
fines, or forfeiture. See “Risk Factors – Risks Relating to Regulation.”
State Laws Applicable to the Medical-Use Cannabis Industry
In most states that have legalized medical-use
cannabis in some form, the growing and/or dispensing of cannabis generally requires that the operator obtain one or more licenses
in accordance with applicable state requirements. In addition, many states regulate various aspects of the growing and/or dispensing
of medical-use cannabis. For example, New York limits the types of treatable medical conditions, requires registration of both
patients and recommending physicians, limits the types of strains that can be grown, sets prices through the State Program Commissioner,
requires that a registered pharmacist be on the premises of all dispensaries during hours of operation, and prohibits cannabis
in flower form. Local governments in some cases also impose rules and regulations on the manner of operating cannabis businesses.
As a result, applicable state and local laws and regulations vary widely. As a result of licensing requirements, if our tenants
default under their leases, we may not be able to find new tenants that have the requisite license to engage in the cultivation
of medical cannabis on the properties.
Laws Applicable to Banking for Cannabis Industry
All banks are subject to federal law, whether
the bank is a national bank or state-chartered bank. At a minimum, all banks maintain federal deposit insurance which requires
adherence to federal law. Violation of federal law could subject a bank to loss of its charter. Financial transactions involving
proceeds generated by cannabis-related conduct can form the basis for prosecution under the federal money laundering statutes,
unlicensed money transmitter statutes and the Bank Secrecy Act. For example, under the Bank Secrecy Act, banks must report to the
federal government any suspected illegal activity, which would include any transaction associated with a cannabis-related business.
These reports must be filed even though the business is operating in compliance with applicable state and local laws. Therefore,
financial institutions that conduct transactions with money generated by cannabis-related conduct could face criminal liability
under the Bank Secrecy Act for, among other things, failing to identify or report financial transactions that involve the proceeds
of cannabis-related violations of the CSA.
The Financial Crimes Enforcement Network
("FinCen") issued guidance in February 2014 which clarifies how financial institutions can provide services to cannabis-related
businesses consistent with their obligations under the Bank Secrecy Act. Concurrently with the FinCen guidance, the DOJ issued
supplemental guidance directing federal prosecutors to consider the federal enforcement priorities enumerated in the Cole Memo
with respect to federal money laundering, unlicensed money transmitter and Bank Secrecy Act offenses based on cannabis-related
violations of the CSA. The FinCen guidance sets forth extensive requirements for financial institutions to meet if they want to
offer bank accounts to cannabis-related businesses, including close monitoring of businesses to determine that they meet all of
the requirements established by the DOJ, including those enumerated in the Cole Memo. This is a level of scrutiny that is far beyond
what is expected of any normal banking relationship.
As a result, many banks are hesitant to
offer any banking services to cannabis-related businesses, including opening bank accounts. While we currently have a bank account,
our inability to maintain that account or the lack of access to bank accounts or other banking services in the future, would make
it difficult for us to operate our business, increase our operating costs, and pose additional operational, logistical and security
challenges. Similarly, if our proposed tenants are unable to access banking services, they will not be able to enter into triple-net
leasing arrangements with us, as our leases will require rent payments to be made by check or wire transfer.
Furthermore, it is unclear what impact
the rescission of the Cole Memo will have, but federal prosecutors may increase enforcement activities against institutions or
individuals that are conducting financial transactions related to cannabis activities. The increased uncertainty surrounding financial
transactions related to cannabis activities may also result in financial institutions discontinuing services to the cannabis industry.
See “Risk Factors – Risks Relating to Regulation.”
Agricultural Regulation
The medical-use cannabis properties that
we acquire are used primarily for cultivation and production of medical-use cannabis and are subject to the laws, ordinances and
regulations of state, local and federal governments, including laws, ordinances and regulations involving land use and usage, water
rights, treatment methods, disturbance, the environment, and eminent domain.
Each governmental jurisdiction has its
own distinct laws, ordinances and regulations governing the use of agricultural lands. Many such laws, ordinances and regulations
seek to regulate water usage and water runoff because water can be in limited supply, as is the case in certain locations where
our properties are located. In addition, runoff from rain or from irrigation is governed by laws, ordinances and regulations from
state, local and federal governments. Additionally, if any of the water used on or running off from our properties flows to any
rivers, streams, ponds, the ocean or other waters, there may be specific laws, ordinances and regulations governing the amount
of pollutants, including sediments, nutrients and pesticides, that such water may contain.
We believe that our existing properties
have, and other properties that we acquire in the future will have, sources of water, including wells and/or surface water that
provide sufficient amounts of water necessary for the current operations at each location. However, should the need arise for additional
water from wells and/or surface water sources, we may be required to obtain additional permits or approvals or to make other required
notices prior to developing or using such water sources. Permits for drilling water wells or withdrawing surface water may be required
by federal, state and local governmental entities pursuant to laws, ordinances, regulations or other requirements, and such permits
may be difficult to obtain due to drought, the limited supply of available water within the districts of the states in which our
properties are located or other reasons.
In addition to the regulation of water
usage and water runoff, state, local and federal governments also seek to regulate the type, quantity and method of use of chemicals
and materials for growing crops, including fertilizers, pesticides and nutrient rich materials. Such regulations could include
restricting or preventing the use of such chemicals and materials near residential housing or near water sources. Further, some
regulations have strictly forbidden or significantly limited the use of certain chemicals and materials. Licenses, permits and
approvals must be obtained from governmental authorities requiring such licenses, permits and approvals before chemicals and materials
can be used at grow facilities. Reports on the usage of such chemicals and materials must be submitted pursuant to applicable laws,
ordinances, and regulations and the terms of the specific licenses, permits and approvals. Failure to comply with laws, ordinances
and regulations, to obtain required licenses, permits and approvals or to comply with the terms of such licenses, permits and approvals
could result in fines, penalties and/or imprisonment.
The use of land for agricultural purposes
in certain jurisdictions is also subject to regulations governing the protection of endangered species. When agricultural lands
border, or are in close proximity to, national parks, protected natural habitats or wetlands, the agricultural operations on such
properties must comply with laws, ordinances and regulations related to the use of chemicals and materials and avoid disturbance
of habitats, wetlands or other protected areas.
Because properties we own may be used for
growing medical-use cannabis, there may be other additional land use and zoning regulations at the state or local level that affect
our properties that may not apply to other types of agricultural uses. For example, certain states in which our properties are
located require stringent security systems in place at grow facilities, and require stringent procedures for disposal of waste
materials.
As an owner of agricultural lands, we may
be liable or responsible for the actions or inactions of our tenants with respect to these laws, regulations and ordinances.
Environmental Matters
Our properties and the operations thereon
are subject to federal, state and local environmental laws, ordinances and regulations, including laws relating to water, air,
solid wastes and hazardous substances. Our properties and the operations thereon are also subject to federal, state and local laws,
ordinances, regulations and requirements related to the federal Occupational Safety and Health Act, as well as comparable state
statutes relating to the health and safety of our employees and others working on our properties. Although we believe that we and
our tenants are in material compliance with these requirements, there can be no assurance that we will not incur significant costs,
civil and criminal penalties and liabilities, including those relating to claims for damages to persons, property or the environment
resulting from operations at our properties.
Real Estate Industry Regulation
Generally, the ownership and operation
of real properties are subject to various laws, ordinances and regulations, including regulations relating to zoning, land use,
water rights, wastewater, storm water runoff and lien sale rights and procedures. These laws, ordinances or regulations, such as
the Comprehensive Environmental Response and Compensation Liability Act and its state analogs, or any changes to any such laws,
ordinances or regulations, could result in or increase the potential liability for environmental conditions or circumstances existing,
or created by tenants or others, on our properties. Laws related to upkeep, safety and taxation requirements may result in significant
unanticipated expenditures, loss of our properties or other impairments to operations, any of which would adversely affect our
cash flows from operating activities.
Our property management activities, to
the extent we are required to engage in them due to lease defaults by tenants or vacancies on certain properties, will likely be
subject to state real estate brokerage laws and regulations as determined by the particular real estate commission for each state.
Seasonality
Our business has not been, and we do not
expect it to become subject to, material seasonal fluctuations.
Available Information
We make available to the public
free of charge through our internet website our Definitive Proxy Statement, Annual Report on Form 10-K, Quarterly Reports on Form
10-Q, Current Reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of
the Exchange as soon as reasonably practicable after we electronically file such reports with, or furnish such reports to, the
SEC. Our internet website address is www.innovativeindustrialproperties.com. The SEC also maintains electronic versions of the
Company’s reports on its website at www.sec.gov. You can also access on our website our Code of Business Conduct and Ethics,
Corporate Governance Guidelines, Audit Committee Charter, Compensation Committee Charter, and Nominating and Corporate Governance
Committee Charter. The content of our website is not incorporated by reference into this Annual Report on Form 10-K or in any other
report or document we file with the SEC, and any references to our website are intended to be inactive textual references only.
ITEM IA.
RISK FACTORS
Certain factors may have a material adverse
effect on our business, financial condition, and results of operations. You should consider carefully the risks and uncertainties
described below, in addition to other information contained in this Annual Report on Form 10-K, including our consolidated financial
statements and related notes. The risks and uncertainties described below are not the only ones we face. Additional risks and
uncertainties that we are unaware of, or that we currently believe are not material, may also become important factors that adversely
affect our business. If any of the following risks actually occurs, our business, financial condition, results of operations,
and future prospects could be materially and adversely affected. In that event, the trading price of our common stock could decline,
and you could lose part or all of your investment.
Risks Related to Our Business
We have a limited operating history, and may not be
able to operate our business successfully or generate sufficient cash flow to sustain distributions to our stockholders.
We completed our initial public
offering and commenced real estate operations with the acquisition of our first property in December 2016, and have a limited operating
history. We currently own only 13 properties. We are subject to many of the business risks and uncertainties associated with any
new business enterprise. We cannot assure you that we will be able to operate our business successfully or profitably or find additional
suitable investments. Our ability to provide attractive risk-adjusted returns to our stockholders over the long term is dependent
on our ability both to generate sufficient cash flow to pay an attractive dividend and to achieve capital appreciation, and we
cannot assure you we will do either. There can be no assurance that we will be able to continue to generate sufficient revenue
from operations to pay our operating expenses and make distributions to stockholders. The results of our operations and the execution
on our business plan depend on several factors, including the availability of additional opportunities for investment, the performance
of our existing properties and tenants, the availability of adequate equity and debt financing, the federal and state regulatory
environment relating to the medical-use cannabis industry, conditions in the financial markets and economic conditions.
Our current real estate portfolio consists of only 13
properties and will likely continue to be concentrated in a limited number of properties in the future, which subjects us to an
increased risk of significant loss if any property declines in value or if we are unable to lease a property.
We currently own only 13 properties.
Three of our tenants, PharmaCann (at two of our properties located in New York and Massachusetts), Holistic MD (at our Maryland
property) and The Pharm (at our Arizona property), represented approximately 39%, 18% and 16%, respectively, of our rental revenues
for the year ended December 31, 2018. Lease payment defaults by any of our tenants or a significant decline in the value of any
single property would materially adversely affect our business, financial position and results of operations, including our ability
to make distributions to our stockholders. Our lack of diversification also increases the potential that a single underperforming
investment could have a material adverse effect on our cash flows and the price we could realize from the sale of our properties.
Any adverse change in the financial condition of any of our tenants, including but not limited to the state medical-use cannabis
markets not developing and growing in ways that we or our tenants projected, or any adverse change in the political climate regarding
medical-use cannabis where our properties are located, would subject us to a significant risk of loss.
In addition, failure by any our tenants
to comply with the terms of its lease agreement with us could require us to find another lessee for the applicable property. We
may experience delays in enforcing our rights as landlord and may incur substantial costs in protecting our investment and re-leasing
that property. Furthermore, we cannot assure you that we will be able to re-lease that property for the rent we currently receive,
or at all, or that a lease termination would not result in our having to sell the property at a loss. The result of any of the
foregoing risks could materially and adversely affect our business, financial condition and results of operations and our ability
to make distributions to our stockholders.
Competition for the acquisition of properties suitable
for the cultivation and production of medical-use cannabis may impede our ability to make acquisitions or increase the cost of
these acquisitions, which could adversely affect our operating results and financial condition.
We compete for the acquisition of properties
suitable for the cultivation and production of medical-use cannabis with other entities engaged in agricultural and real estate
investment activities, including corporate agriculture companies, cultivators and producers of medical-use cannabis, private equity
investors, and other real estate investors (including public and private REITs). We also compete as a provider of capital to medical-use
cannabis operators with alternative financing sources to these companies, including both equity and debt financing alternatives.
These competitors may prevent us from acquiring desirable properties, may cause an increase in the price we must pay for properties
or may result in us having to lease our properties on less favorable terms than we expect. Our competitors may have greater financial
and operational resources than we do and may be willing to pay more for certain assets or may be willing to accept more risk than
we believe can be prudently managed. In particular, larger companies may enjoy significant competitive advantages that result from,
among other things, a lower cost of capital and enhanced operating efficiencies. Our competitors may also adopt transaction structures
similar to ours, which would decrease our competitive advantage in offering flexible transaction terms. In addition, due to a number
of factors, including but not limited to potential greater clarity of the laws and regulations governing medical-use cannabis by
state and federal governments, the number of entities and the amount of funds competing for suitable investment properties may
increase, resulting in increased demand and increased prices paid for these properties. If we pay higher prices for properties
or enter into leases for such properties on less favorable terms than we expect, our profitability and ability to generate cash
flow and make distributions to our stockholders may decrease. Increased competition for properties may also preclude us from acquiring
those properties that would generate attractive returns to us.
Our growth will depend upon future acquisitions of medical-use
cannabis facilities, and we may be unable to consummate acquisitions on advantageous terms.
Our growth strategy is focused on the acquisition
of specialized industrial real estate assets on favorable terms as opportunities arise. Our ability to acquire these real estate
assets on favorable terms is subject to the following risks:
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competition from other potential acquirers or increased availability
of alternative debt and equity financing sources for tenants may significantly increase the purchase price of a desired property;
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we may not successfully purchase and lease our properties to meet
our expectations;
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we may be unable to obtain the necessary equity or debt financing
to consummate an acquisition on satisfactory terms or at all;
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agreements for the acquisition of properties are typically subject
to closing conditions, including satisfactory completion of due diligence investigations, and we may spend significant time and
money and divert management attention on potential acquisitions that we do not consummate; and
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we may acquire properties without any recourse, or with only limited
recourse, for liabilities, whether known or unknown, against the former owners of the properties.
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Our failure to consummate acquisition on
advantageous terms without substantial expense or delay would impede our growth and negatively affect our results of operations
and our ability to generate cash flow and make distributions to our stockholders.
There may only be a limited number of medical-use cannabis
facilities operated by suitable tenants available for us to acquire, which could adversely affect the return on our common stock.
We target medical-use cannabis facilities
for acquisition and leasing to licensed growers under triple-net lease agreements. We also target properties owned by growers that
have been among the top candidates in the rigorous state licensing process and have been granted one or more licenses to operate
multiple facilities. In light of the current regulatory landscape regarding medical-use cannabis, including but not limited to,
the rigorous state licensing processes, limits on the number of licenses granted in certain states and in counties within such
states, zoning regulations related to medical-use cannabis facilities, the inability of potential tenants to open bank accounts
necessary to pay rent and other expenses and the ever-changing federal and state regulatory landscape, we may have only a limited
number of medical-use cannabis facilities available to purchase that are operated by licensees that we believe would be suitable
tenants. These tenants may also have increased access to alternative equity and debt financing sources over time, which may limit
our ability to negotiate leasing arrangements that meet our investment criteria. Our inability to locate suitable investment properties
and tenants would have a material adverse effect on our ability to generate cash flow and make distributions to our stockholders.
Many of our existing tenants are, and we expect that
most of our future tenants will be, start-up businesses and may be unable to pay rent with funds from operations or at all, which
could adversely affect our cash available to make distributions to our stockholders or otherwise impair the value of our common
stock.
Single tenants currently occupy our properties,
and we expect that single tenants will occupy our properties that we acquire in the future. Therefore, the success of our investments
will be materially dependent on the financial stability of these tenants. We rely on our management team to perform due diligence
investigations of our potential tenants, related guarantors and their properties, operations and prospects, of which there is generally
little or no publicly available operating and financial information. We may not learn all of the material information we need to
know regarding these businesses through our investigations. As a result it is possible that we could enter into a sale-leaseback
arrangement with tenants or otherwise lease properties to tenants that ultimately are unable to pay rent to us, which could adversely
impact our cash available for distributions.
Many of our existing tenants are, and we
expect that most of our future tenants will be, start-up businesses that have little or no revenue when they enter triple-net leasing
arrangements with us and therefore, may be unable to pay rent with funds from operations. Many of our current tenants are not profitable
and have experienced losses since inception, or have been profitable for only a short period of time. As a result, many of our
current tenants have made, and we expect that most our future tenants will make, initial rent payments to us from proceeds from
the sale of the property, in the case of sale-leaseback transactions, or other cash on hand.
In addition, in general, as start-up businesses,
our tenants are more vulnerable to adverse conditions resulting from federal and state regulations affecting their businesses or
industries and have limited access to traditional forms of financing. The success of our tenants will heavily depend on the growth
and development of the state markets in which the tenants operate, many of which have a very limited history or are still in the
stages of establishing the regulatory framework. For example, New York’s medical-use cannabis market is in its early stages,
and is subject to strict regulations providing for, among other things, limited medical conditions for treatment with medical-use
cannabis, limitations on the form in which medical cannabis can be consumed and enhanced registration requirements for patients
and physicians, which may result in the New York market not growing and developing in the way that we or our tenants projected.
In Maryland, the medical-use cannabis market is also in its very early stages, with commercial operations commencing upon the issuance
of the first round of final licenses in late 2017, after significant delays in the development of the state's regulatory framework
and litigation surrounding the application process.
In our evaluation of our existing
leases with tenants at our properties, we determined to record associated revenue on a cash basis due to the uncertainty of collectability
of lease payments from tenants due to their limited operating history and the U.S. federal regulatory uncertainty surrounding the
medical-use cannabis industry (see the section entitled "Critical Accounting Policies — Revenue Recognition and Accounts
Receivable" in Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations" for
more information).
Some of our tenants may also be subject
to significant debt obligations. Tenants that are subject to significant debt obligations may be unable to make their rent payments
if there are adverse changes in their business plans or prospects, the regulatory environment in which they operate or in general
economic conditions. In addition, the payment of rent and debt service may reduce the working capital available to tenants for
the start-up phase of their business. Furthermore, we may be unable to monitor and evaluate tenant credit quality on an on-going
basis.
In addition, many states issue licenses
for medical-use cannabis operations for a limited time period, which must be renewed periodically. If one or more of our tenants
is unable to renew or otherwise maintain its license, or if it is unable to renew or otherwise maintain other requisite authorizations
on state and local levels for business operations, that tenant will not be able to operate its business, and may default on its
lease payments to us.
Any lease payment defaults by a tenant
could adversely affect our cash flows and cause us to reduce the amount of distributions to stockholders. In the event of a default
by a tenant, we may also experience delays in enforcing our rights as landlord and may incur substantial costs in protecting our
investment and re-leasing our property as operators of medical-use cannabis cultivation and production facilities are generally
subject to extensive state licensing requirements. Furthermore, we will not operate any of the facilities that we purchase.
We acquired our properties, and may acquire other properties,
"as-is," which increases the risk of an investment that requires us to remedy defects or costs without recourse to the
prior owner.
We acquired our properties, and may acquire
other real estate properties, "as is" with only limited representations and warranties from the property seller regarding
matters affecting the condition, use and ownership of the property. There may also be environmental conditions associated with
properties we acquire of which we are unaware despite our diligence efforts. In particular, medical-use cannabis facilities may
present environmental concerns of which we are not currently aware. If environmental contamination exists on properties we acquire
or develops after acquisition, we could become subject to liability for the contamination. As a result, if defects in the property
(including any building on the property) or other matters adversely affecting the property are discovered, including but not limited
to environmental matters, we may not be able to pursue a claim for any or all damages against the property seller. Such a situation
could harm our business, financial condition, liquidity and results of operations.
Our properties are, and are expected to continue to
be, geographically concentrated in states that permit medical-use cannabis cultivation, and we will be subject to social, political
and economic risks of doing business in these states and any other state in which we may own property.
Our current properties are located in Arizona,
California, Colorado, Illinois, Maryland, Massachusetts, Michigan, Minnesota, New York and Pennsylvania, and we expect that the
properties that we acquire will be geographically concentrated in these states and other states that permit medical-use cannabis
cultivation. Circumstances and developments related to operations in these markets that could negatively affect our business, financial
condition, liquidity and results of operations include, but are not limited to, the following factors:
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the responsibility of complying with multiple and, in some respects,
conflicting state and federal laws in the United States, including with respect to cultivation and distribution of medical-use
cannabis, licensing, banking and insurance;
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difficulties and costs of staffing and managing operations;
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unexpected changes in regulatory requirements and other laws;
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potentially adverse tax consequences;
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the state medical-use cannabis market fails to develop and grow in
ways that we or our tenants projected;
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the impact of national, regional or state specific business cycles
and economic instability; and
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access to capital may be more restricted, or unavailable on favorable
terms or at all in certain locations.
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Because our real estate investments consist of primarily
industrial and greenhouse properties suitable for cultivation and production of medical-use cannabis, our rental revenues are significantly
influenced by demand for these facilities generally, and a decrease in such demand would likely have a greater adverse effect on
our rental revenues than if we owned a more diversified real estate portfolio.
Because our portfolio of properties consists
of industrial and greenhouse properties used in the regulated medical-use cannabis industry, we are subject to risks inherent in
investments in a single industry. A decrease in the demand for medical-use cannabis cultivation facilities would have a greater
adverse effect on our rental revenues than if we owned a more diversified real estate portfolio. Demand for medical-use cannabis
cultivation facilities has been and could be adversely affected by changes in current favorable state or local laws relating to
cultivation and production of medical-use cannabis or any change in the federal government's current enforcement posture with respect
to state-licensed cultivation of medical-use cannabis, among others. To the extent that any of these conditions occur, they are
likely to affect demand and market rents for medical-use cannabis cultivation facilities, which could cause a decrease in our rental
revenue. Any such decrease could impair our ability to make distributions to you. We do not currently and do not expect in the
future to invest in other real estate or businesses to hedge against the risk that industry trends might decrease the profitability
of our medical-use cannabis cultivation facilities.
We face significant risks associated with the development
and redevelopment of properties that we acquire.
We may, from time to time, engage in development
or redevelopment of properties that we acquire. Development and redevelopment activities entail risks that could adversely impact
our financial condition and results of operations, including:
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construction costs, which may exceed our original estimates due to
increases in materials, labor or other costs, which could make the project less profitable;
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permitting or construction delays, which may result in increased project
costs, as well as deferred revenue;
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unavailability of raw materials when needed, which may result in project
delays, stoppages or interruptions, which could make the project less profitable;
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claims for warranty, product liability and construction defects after
a property has been built;
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health and safety incidents and site accidents;
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poor performance or nonperformance by, or disputes with, any of our
contractors, subcontractors or other third parties on whom we rely;
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unforeseen engineering, environmental or geological problems, which
may result in delays or increased costs;
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labor stoppages, slowdowns or interruptions;
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liabilities, expenses or project delays, stoppages or interruptions
as a result of challenges by third parties in legal proceedings; and
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weather-related and geological interference, including landslides,
earthquakes, floods, drought, wildfires and other events, which may result in delays or increased costs.
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On May 31, 2018, we executed a development
agreement with a subsidiary of PharmaCann for the ground-up construction of a medical-use cannabis cultivation facility at one
of our Massachusetts properties, for which we have agreed to provide funding for construction of up to $15.5 million, of which
approximately $9.7 million was incurred and approximately $9.5 million was funded as of December 31, 2018.
On August 2, 2018, we acquired a property
in Michigan in mid-construction, for which we have agreed to provide reimbursement to the seller for completion of certain development
milestones for the building and a tenant improvement allowance to the tenant totaling approximately $7.5 million, of which approximately
$6.8 million was incurred and approximately $6.4 million was funded as of December 31, 2018.
In addition, as of December 31, 2018, we
had remaining commitments of approximately $12.4 million to reimburse certain tenants for future tenant improvements at our properties.
Subsequent to the end of the year, on March
13, 2019, we executed a development agreement with a subsidiary of PharmaCann for the ground-up construction of a medical-use
cannabis cultivation facility at our Ohio property, for which we have agreed to provide funding for construction of up to $19.3
million.
Failure to complete development or redevelopment
activities on budget or on schedule may adversely affect our financial condition and results of operations and the ability of our
tenants at such properties to make payments under their leases with us.
If our properties' access to adequate water and power
supplies is interrupted, it could harm our ability to lease the properties for medical-use cannabis cultivation and production,
thereby adversely affecting our ability to generate returns on our properties.
In order to lease the properties that we
acquire, these properties require access to sufficient water and power to make them suitable for the cultivation and production
of medical-use cannabis. Although we expect to acquire properties with sufficient access to water, should the need arise for additional
wells from which to obtain water, we would be required to obtain permits prior to drilling such wells. Permits for drilling water
wells are required by state and county regulations, and such permits may be difficult to obtain due to the limited supply of water
in areas where we acquire properties. Similarly, our properties may be subject to governmental regulations relating to the quality
and disposition of rainwater runoff or other water to be used for irrigation. In such case, we could incur costs necessary in order
to retain this water. If we are unable to obtain or maintain sufficient water supply for our properties, our ability to lease them
for the cultivation and production of medical-use cannabis would be seriously impaired, which would have a material adverse impact
on the value of our assets and our results of operations.
Historically, states that have legalized
medical-use cannabis cultivation have typically required that such cultivation take place indoors. Indoor cultivation of medical-use
cannabis requires significant power for growing lights and ventilation and air conditioning to remove the hot air generated by
the growing lights. While outdoor cultivation is gaining acceptance in many states with favorable climates for such growth, we
expect that a significant number of our properties will continue to utilize indoor cultivation methods. Any extended interruption
of the power supply to our properties, particularly those using indoor cultivation methods, would likely harm our tenants' crops,
which could result in their inability to make lease payments to us for our properties. Any lease payment defaults by a tenant could
adversely affect our cash flows and cause us to reduce the amount of distributions to stockholders.
Some of our tenants could be susceptible to bankruptcy,
which would affect our ability to generate rents from them and therefore negatively affect our results of operations.
In addition to the risk of tenants being
unable to make regular rent payments, certain of our tenants may depend on debt, which could make them especially susceptible to
bankruptcy in the event that their cash flows are insufficient to satisfy their debt. Any bankruptcy, if allowed, of one of our
tenants would result in a loss of lease payments to us, as well as an increase in our costs to carry the property.
Additionally, under bankruptcy law generally,
a tenant who is the subject of bankruptcy proceedings generally has the option of continuing ("assuming") or giving up
("rejecting") any unexpired lease of non-residential real property. If a bankrupt tenant decides to give up (reject)
a lease with us, any claim we might have for breach of the lease, excluding a claim against (1) collateral securing the lease,
or (2) a guarantor guaranteeing lease obligations, would be treated as a general unsecured claim in the tenant's bankruptcy case.
The laws governing bankruptcy cases would impact the treatment of our general unsecured claim. Our claim would likely be capped
at the amount the tenant owed us for unpaid rent prior to the bankruptcy unrelated to the termination, plus the greater of one
year of lease payments or 15% of the lease payments payable under the remaining term of the lease, but in no case more than three
years of lease payments. In addition to the cap on our damages for breach of the lease, even if our claim is timely submitted to
the bankruptcy court, there is no guaranty that the tenant's bankruptcy estate would have sufficient funds to satisfy the claims
of general unsecured creditors. Finally, a bankruptcy court could re-characterize a net lease transaction as a disguised secured
lending transaction. If that were to occur, we would not be treated as the owner of the property, but might have additional rights
as a secured creditor. This would mean our claim in bankruptcy court could be limited to the amount we paid for the property, which
could adversely impact our financial condition.
Furthermore, U.S. bankruptcy courts have
generally refused to grant bankruptcy protections to cannabis businesses. The inability of our tenants to seek bankruptcy protection
may impact their ability to secure financing for their operations and prevents our tenants from utilizing the benefits of reorganization
of their businesses under bankruptcy protection to operate in a financially sustainable way, thereby reducing the probability that
such a tenant would be able to honor its lease obligations with us.
Our real estate investments consist of primarily industrial
and greenhouse properties suitable for cultivation and production of medical-use cannabis, which may be difficult to sell or re-lease
upon tenant defaults or early lease terminations, either of which would adversely affect returns to stockholders.
While our business objectives
consist of principally acquiring and deriving rental income from industrial and greenhouse properties used in the regulated medical-use
cannabis industry, we expect that at times we will deem it appropriate or desirable to sell or otherwise dispose of certain properties
we own. These types of properties are relatively illiquid compared to other types of real estate and financial assets. This illiquidity
could limit our ability to quickly dispose of properties in response to changes in regulatory, economic or other conditions. Therefore,
our ability at any time to sell assets may be restricted and this lack of liquidity may limit our ability to make changes to our
portfolio promptly, which could materially and adversely affect our financial performance. We cannot predict the various market
conditions affecting the properties that we expect to acquire that will exist in the future. Due to the uncertainty of regulatory
and market conditions which may affect the future disposition of the real estate assets we expect to acquire, we cannot assure
you that we will be able to sell these assets at a profit in the future. Accordingly, the extent to which we will realize potential
appreciation on the real estate investments we expect to acquire will depend upon regulatory and other market conditions. In addition,
in order to maintain our REIT status, we may not be able to sell properties when we would otherwise choose to do so, due to market
conditions or changes in our strategic plan.
Furthermore, we may be required to make
expenditures to correct defects or to make improvements before a property can be sold and we cannot assure you that we will have
funds available to correct such defects or to make such improvements. With these kinds of properties, if the current lease is terminated
or not renewed, we may be required to make expenditures and rent concessions in order to lease the property to another tenant.
In addition, in the event we are forced to sell or re-lease the property, we may have difficulty finding qualified purchasers who
are willing to buy the property or tenants who are willing to lease the property on terms that we expect, or at all. These and
other limitations may affect our ability to sell or re-lease properties, which may adversely affect returns to our stockholders.
Liability for uninsured losses could adversely affect
our financial condition.
While the terms of our leases with our
tenants generally require property and casualty insurance, losses from disaster-type occurrences, such as earthquakes, floods and
weather-related disasters, and other types of insurance, such as landlord's rental loss insurance, may be either uninsurable or
not insurable on economically viable terms. Should an uninsured loss occur, we could lose our capital investment or anticipated
profits and cash flows from one or more properties.
Contingent or unknown liabilities could materially and
adversely affect our business, financial condition, liquidity and results of operations.
We acquired our properties and may in the
future acquire properties, subject to liabilities and without any recourse, or with only limited recourse, with respect to unknown
liabilities. As a result, if a claim were asserted against us based on ownership of any of these properties, we may have to pay
substantial amounts to defend or settle the claim. If the magnitude of such unknown liabilities is high, individually or in the
aggregate, our business, financial condition, liquidity and results of operations would be materially and adversely affected.
The assets we acquire may be subject to impairment charges.
We periodically evaluate the real estate
investments we acquire and other assets for impairment indicators. The judgment regarding the existence of impairment indicators
is based upon factors such as market conditions, tenant performance and legal structure. For example, the termination of a lease
by a tenant may lead to an impairment charge. If we determine that an impairment has occurred, we would be required to make an
adjustment to the net carrying value of the asset which could have an adverse effect on our results of operations in the period
in which the impairment charge is recorded.
Due to our involvement in the regulated medical-use
cannabis industry, we may have a difficult time obtaining the various insurance policies that are desired to operate our business,
which may expose us to additional risks and financial liabilities.
Insurance that is otherwise readily available,
such as workers' compensation, general liability, and directors' and officers' insurance, is more difficult for us to find and
more expensive, because we lease our properties to companies in the regulated medical-use cannabis industry. There are no guarantees
that we will be able to find such insurance in the future, or that the cost will be affordable to us. If we are forced to go without
such insurance, it may prevent us from entering into certain business sectors, may inhibit our growth, and may expose us to additional
risk and financial liabilities.
We may purchase properties subject to ground leases
that expose us to the loss of such properties upon breach or termination of the ground leases.
A ground lease agreement permits a tenant
to develop and/or operate a land parcel (property) during the lease period, after which the land parcel and all improvements revert
back to the property owner. Under a ground lease, property improvements are owned by the property owner unless an exception is
created and all relevant taxes incurred during the lease period are paid for by the tenant. Ground leases typically have a long
duration generally ranging from 50 to 99 years with additional extension options. As a lessee under a ground lease, we would be
exposed to the possibility of losing the property upon termination, or an earlier breach by us, of the ground lease, which could
have a material adverse effect on our business, financial condition and results of operations, our ability to make distributions
to our stockholders and the trading price of our common stock.
The occurrence of cyber incidents or cyber attacks could
disrupt our operations, result in the loss of confidential information and/or damage our business relationships and reputation.
We rely on technology to run our business,
and as such we are subject to risk from cyber incidents, including cyber attacks attempting to gain unauthorized access to our
systems to disrupt operations, corrupt data or steal confidential information, and other electronic security breaches. While
we have implemented measures to help mitigate these threats, such measures cannot guarantee that we will be successful in preventing
a cyber incident. The occurrence of a cyber incident or cyber attack could disrupt our operations, compromise the confidential
information of our employees or tenants, and/or damage our business relationships and reputation.
We cannot predict every event and circumstance that
may affect our business, and therefore, the risks and uncertainties discussed herein may not be the only ones you should consider.
We are not aware of any other
publicly-traded REIT that focuses on the acquisition, ownership and management of medical-use cannabis facilities. Therefore, we
may encounter risks of which we are not aware at this time, which could have a material adverse impact on our business.
Risks Related to Regulation
Cannabis remains illegal under
federal law, and therefore, strict enforcement of federal laws regarding cannabis would likely result in our inability and the
inability of our tenants to execute our respective business plans.
Cannabis is a Schedule I controlled substance
under the CSA. Even in those jurisdictions in which the manufacture and use of cannabis has been legalized at the state level,
the possession, use and cultivation all remain violations of federal law that are punishable by imprisonment, substantial fines
and forfeiture. Moreover, individuals and entities may violate federal law if they intentionally aid and abet another in violating
these federal controlled substance laws, or conspire with another to violate them. The U.S. Supreme Court has ruled in
United
States v. Oakland Cannabis Buyers' Coop.
and
Gonzales v. Raich
that it is the federal government that
has the right to regulate and criminalize the sale, possession and use of cannabis, even for medical purposes. We would likely
be unable to execute our business plan if the federal government were to strictly enforce federal law regarding cannabis.
In January 2018, the DOJ rescinded certain
memoranda, including the so-called “Cole Memo” issued on August 29, 2013 under the Obama Administration, which had
characterized enforcement of federal cannabis prohibitions under the CSA to prosecute those complying with state regulatory systems
allowing the use, manufacture and distribution of medical cannabis as an inefficient use of federal investigative and prosecutorial
resources when state regulatory and enforcement efforts are effective with respect to enumerated federal enforcement priorities
under the CSA. The impact of the DOJ's recent rescission of the Cole Memo and related memoranda is unclear, but may result in the
DOJ increasing its enforcement actions against the regulated cannabis industry generally, including our tenants and us.
Congress previously enacted an omnibus
spending bill that includes a provision prohibiting the DOJ (which includes the DEA) from using funds appropriated by that bill
to prevent states from implementing their medical-use cannabis laws. This provision, however, expires on September 30, 2019, and
must be renewed by Congress. In
USA vs. McIntosh
, the U.S. Court of Appeals for the Ninth Circuit held that this provision
prohibits the DOJ from spending funds from relevant appropriations acts to prosecute individuals who engage in conduct permitted
by state medical-use cannabis laws and who strictly comply with such laws. However, the Ninth Circuit's opinion, which only applies
to the states of Alaska, Arizona, California, Hawaii, and Idaho, also held that persons who do not strictly comply with all state
laws and regulations regarding the distribution, possession and cultivation of medical-use cannabis have engaged in conduct that
is unauthorized, and in such instances the DOJ may prosecute those individuals. Furthermore, while we target the acquisition of
medical-use cannabis facilities, our leases do not prohibit cannabis cultivation for adult-use that is permissible under the state
and local laws where our facilities are located, such as in California, Colorado, Massachusetts and Michigan. Consequently, certain
of our tenants currently (and additional tenants may in the future) cultivate adult-use cannabis in our medical-use cannabis facilities,
as permitted by such state and local laws now or in the future, which may in turn subject the tenant, us and our properties to
greater and/or different federal legal and other risks as compared to facilities where cannabis is cultivated exclusively for medical
use, including not providing protection under the Congressional spending bill provision described above.
Additionally, financial transactions involving
proceeds generated by cannabis-related conduct can form the basis for prosecution under the federal money laundering statutes,
unlicensed money transmitter statutes and the Bank Secrecy Act. The penalties for violation of these laws include imprisonment,
substantial fines and forfeiture. Prior to the DOJ's rescission of the Cole Memo, supplemental guidance from the DOJ issued under
the Obama administration directed federal prosecutors to consider the federal enforcement priorities enumerated in the Cole Memo
when determining whether to charge institutions or individuals with any of the financial crimes described above based upon cannabis-related
activity. With the rescission of the Cole Memo, there is increased uncertainty and added risk that federal law enforcement authorities
could seek to pursue money laundering charges against entities or individuals engaged in supporting the cannabis industry.
Federal prosecutors have significant discretion
and no assurance can be given that the federal prosecutor in each judicial district where we purchase a property will not choose
to strictly enforce the federal laws governing cannabis production or distribution. Any change in the federal government's enforcement
posture with respect to state-licensed cultivation of cannabis, including the enforcement postures of individual federal prosecutors
in judicial districts where we purchase properties, would result in our inability to execute our business plan, and we would likely
suffer significant losses with respect to our investment in cannabis facilities in the United States, which would adversely affect
the trading price of our securities. Furthermore, following any such change in the federal government's enforcement position, we
could be subject to criminal prosecution, which could lead to imprisonment and/or the imposition of penalties, fines, or forfeiture.
Certain of our tenants engage in operations for
the adult-use cannabis industry in addition to or in lieu of operations for the medical-use cannabis industry, and such
tenants, we and our properties may be subject to additional risks associated with such adult-use cannabis operations.
Our existing leases at our properties do
not, and we expect that leases that we enter into with future tenants at other properties we acquire will not, prohibit cannabis
cultivation for adult-use that is permissible under state and local laws where our facilities are located and certain of our tenants
are currently engaged in operations for the adult-use cannabis industry, which may subject our tenants, us and our properties to
different and greater risks, including greater prosecution risk for aiding and abetting violation of the CSA and federal laws governing
money laundering. For example, the prohibition in the current omnibus spending bill that prohibits the DOJ from using funds appropriated
by Congress to prevent states from implementing their medical-use cannabis laws does not extend to adult-use cannabis laws. In
addition, while we may purchase properties in states that only permit medical-use cannabis at the time of acquisition, such states
may in the future authorize by state legislation or popular vote the legalization of adult-use cannabis, thus permitting our tenants
to engage in adult-use cannabis operations at our properties. For example, the voters of the Commonwealth of Massachusetts passed
an initiative to legalize cannabis for adult-use in 2016, having previously voted to legalize medical-use cannabis in 2012. Massachusetts
began issuing licenses to operators for the sale of adult-use cannabis in July 2018. Our existing leases at our Massachusetts properties
do not prohibit our tenants from conducting adult-use cannabis cultivation, processing or dispensing that is permissible under
state and local laws. Similarly, the states of California and Colorado permit licensed adult-use cannabis cultivation, processing
and dispensing, and our leases with tenants in California and Colorado allow for adult-use cannabis operations to be conducted
at the properties in compliance with state and local laws. In addition, Michigan voters passed an initiative in November 2018 to
legalize cannabis for adult-use.
New laws that are adverse to the business of our tenants
may be enacted, and current favorable national, state or local laws or enforcement guidelines relating to cultivation and production
of cannabis may be modified or eliminated in the future.
We have acquired and are targeting for
acquisition properties that are owned by state-licensed cultivators and producers of cannabis. Relevant state or local laws may
be amended or repealed, or new laws may be enacted in the future to eliminate existing laws permitting cultivation and production
of cannabis. If our tenants were forced to close their operations, we would need to replace those tenants with tenants who are
not engaged in the cannabis industry, who may pay significantly lower rents. Moreover, any changes in state or local laws that
reduce or eliminate the ability to cultivate and produce cannabis would likely result in a high vacancy rate for the kinds of properties
that we seek to acquire, which would depress our lease rates and property values. In addition, we would realize an economic loss
on any and all improvements made to properties that were specific to the cannabis industry.
Our ability to grow our business depends on state laws
pertaining to the cannabis industry.
Continued development of the medical-use
cannabis industry depends upon continued legislative authorization of cannabis at the state level. The status quo of, or progress
in, the regulated medical-use cannabis industry is not assured and any number of factors could slow or halt further progress in
this area. While there may be ample public support for legislative action permitting the manufacture and use of cannabis, numerous
factors impact the legislative process. For example, many states that voted to legalize medical and/or adult-use cannabis have
seen significant delays in the drafting and implementation of industry regulations and issuance of licenses. In addition, burdensome
regulation at the state level could slow or stop further development of the medical-use cannabis industry, such as limiting the
medical conditions for which medical cannabis can be recommended by physicians for treatment, restricting the form in which medical
cannabis can be consumed, imposing significant registration requirements on physicians and patients or imposing significant taxes
on the growth, processing and/or retail sales of cannabis, which could have the impact of dampening growth of the cannabis industry
and making it difficult for cannabis businesses, including our tenants, to operate profitably in those states. Any one of these
factors could slow or halt additional legislative authorization of medical-use cannabis, which could harm our business prospects.
FDA regulation of medical-use cannabis and the possible
registration of facilities where medical-use cannabis is grown could negatively affect the medical-use cannabis industry, which
would directly affect our financial condition.
Should the federal government legalize
cannabis for medical-use, it is possible that the U.S. Food and Drug Administration ("FDA") would seek to regulate it
under the Food, Drug and Cosmetics Act of 1938. Additionally, the FDA may issue rules and regulations including certified good
manufacturing practices, or cGMPs, related to the growth, cultivation, harvesting and processing of medical cannabis. Clinical
trials may be needed to verify efficacy and safety. It is also possible that the FDA would require that facilities where medical-use
cannabis is grown register with the FDA and comply with certain federally prescribed regulations. In the event that some or all
of these regulations are imposed, we do not know what the impact would be on the medical-use cannabis industry, including what
costs, requirements and possible prohibitions may be enforced. If we or our tenants are unable to comply with the regulations or
registration as prescribed by the FDA, we and or our tenants may be unable to continue to operate their and our business in its
current form or at all.
We and our tenants may have difficulty accessing the
service of banks, which may make it difficult to contract for real estate needs.
Financial transactions involving proceeds
generated by cannabis-related conduct can form the basis for prosecution under the federal money laundering statutes, unlicensed
money transmitter statute and the Bank Secrecy Act. Previous guidance issued by the FinCen, a division of the U.S. Department of
the Treasury, clarifies how financial institutions can provide services to cannabis-related businesses consistent with their obligations
under the Bank Secrecy Act. Prior to the DOJ’s announcement in January 2018 of the rescission of the Cole Memo and related
memoranda, supplemental guidance from the DOJ directed federal prosecutors to consider the federal enforcement priorities enumerated
in the Cole Memo when determining whether to charge institutions or individuals with any of the financial crimes described above
based upon cannabis-related activity. It is unclear what impact the rescission of the Cole Memo will have, but federal prosecutors
may increase enforcement activities against institutions or individuals that are conducting financial transactions related to cannabis
activities. The increased uncertainty surrounding financial transactions related to cannabis activities may also result in financial
institutions discontinuing services to the cannabis industry.
Consequently, those businesses involved
in the regulated medical-use cannabis industry continue to encounter difficulty establishing banking relationships, which may increase
over time. Our inability to maintain our current bank accounts would make it difficult for us to operate our business, increase
our operating costs, and pose additional operational, logistical and security challenges and could result in our inability to implement
our business plan.
The terms of our leases require that our
tenants make rental payments via check or wire transfer. The inability of our current and potential tenants to open accounts and
continue using the services of banks will limit their ability to enter into triple-net lease arrangements with us or may result
in their default under our lease agreements, either of which could materially harm our business and the trading price of our securities.
Owners of properties located in close proximity to our
properties may assert claims against us regarding the use of the property as a medical cannabis cultivation and processing facility,
which if successful, could materially and adversely affect our business.
Owners of properties located in close
proximity to our properties may assert claims against us regarding the use of our properties for medical cannabis cultivation and
processing, including assertions that the use of the property constitutes a nuisance that diminishes the market value of such owner's
nearby property. Such property owners may also attempt to assert such a claim in federal court as a civil matter under the Racketeer
Influenced and Corrupt Organizations Act. If a property owner were to assert such a claim against us, we may be required to devote
significant resources and costs to defending ourselves against such a claim, and if a property owner were to be successful on such
a claim, our tenants may be unable to continue to operate their business in its current form at the property, which could materially
adversely impact the tenant's business and the value of our property, our business and financial results and the trading price
of our securities.
Laws and regulations affecting the regulated cannabis
industry are constantly changing, which could materially adversely affect our proposed operations, and we cannot predict the impact
that future regulations may have on us.
Local, state and federal cannabis laws
and regulations are broad in scope and subject to evolving interpretations, which could require us to incur substantial costs associated
with compliance or alter our business plan. In addition, violations of these laws, or allegations of such violations, could disrupt
our business and result in a material adverse effect on our operations. It is also possible that regulations may be enacted in
the future that will be directly applicable to our proposed business. We cannot predict the nature of any future laws, regulations,
interpretations or applications, nor can we determine what effect additional governmental regulations or administrative policies
and procedures, when and if promulgated, could have on our business.
Applicable state laws may prevent us from maximizing
our potential income.
Depending on the laws of each particular
state, we may not be able to fully realize our potential to generate profit. For example, some states have residency requirements
for those directly involved in the medical-use cannabis industry, which may impede our ability to contract with cannabis businesses
in those states. Furthermore, cities and counties are being given broad discretion to ban certain cannabis activities. Even if
these activities are legal under state law, specific cities and counties may ban them.
Assets leased to cannabis businesses may be forfeited
to the federal government.
Any assets used in conjunction with the
violation of federal law are potentially subject to federal forfeiture, even in states where cannabis is legal. In July 2017, the
U.S. Department of Justice issued a new policy directive regarding asset forfeiture, referred to as the "equitable sharing
program." Under this new policy directive, federal authorities may adopt state and local forfeiture cases and prosecute them
at the federal level, allowing for state and local agencies to keep up to 80% of any forfeiture revenue. This policy directive
represents a reversal of the DOJ's policy under the Obama administration, and allows for forfeitures to proceed that are not in
accord with the limitations imposed by state-specific forfeiture laws. This new policy directive may lead to increased use of asset
forfeitures by local, state and federal enforcement agencies. If the federal government decides to initiate forfeiture proceedings
against cannabis businesses, such as the medical-use cannabis facilities that we have acquired and intend to acquire, our investment
in those properties may be lost.
We may have difficulty accessing bankruptcy courts.
As discussed above, the cannabis is illegal
under federal law. Therefore, there is a compelling argument that the federal bankruptcy courts cannot provide relief for parties
who engage in the cannabis or cannabis related businesses. Recent bankruptcy rulings have denied bankruptcies for dispensaries
upon the justification that businesses cannot violate federal law and then claim the benefits of federal bankruptcy for the same
activity and upon the justification that courts cannot ask a bankruptcy trustee to take possession of, and distribute cannabis
assets as such action would violate the CSA. Therefore, we may not be able to seek the protection of the bankruptcy courts and
this could materially affect our business or our ability to obtain credit.
The properties that we acquire are subject to extensive
regulations, which may result in significant costs and materially and adversely affect our business, financial condition, liquidity
and results of operations.
Our properties are and other properties
that we expect to acquire will be subject to various local laws and regulatory requirements. Local property regulations, including
restrictive covenants of record, may restrict the use of properties we acquire and may require us to obtain approval from local
authorities with respect to the properties that we expect to acquire, including prior to acquiring a property or when developing
or undertaking renovations. Among other things, these restrictions may relate to cultivation of medical-use cannabis, the use of
water and the discharge of waste water, fire and safety, seismic conditions, asbestos-cleanup or hazardous material abatement requirements.
We cannot assure you that existing regulatory policies will not materially and adversely affect us or the timing or cost of any
future acquisitions, developments or renovations, or that additional regulations will not be adopted that would increase such delays
or result in additional costs. Our failure to obtain such regulatory approvals could have a material adverse effect on our business,
financial condition, liquidity and results of operations.
Compliance with environmental laws could materially
increase our operating expenses.
There may be environmental conditions associated
with properties we acquire of which we are unaware. If environmental contamination exists on properties we acquire, we could become
subject to liability for the contamination. The presence of hazardous substances on a property may materially and adversely affect
our ability to sell the property and we may incur substantial remediation costs. In addition, although we may require in our leases
that tenants operate in compliance with all applicable laws and indemnify us against any environmental liabilities arising from
a tenant's activities on the property, we could nonetheless be subject to liability by virtue of our ownership interest and we
cannot be sure that our tenants would satisfy their indemnification obligations to us. Such environmental liability exposure associated
with properties we acquire could harm our business, financial condition, liquidity and results of operations.
Risks Related to Financing Our Business
Our growth depends on external sources of capital, which
may not be available on favorable terms or at all. In addition, banks and other financial institutions may be reluctant to enter
into lending transactions with us, including secured lending, because we acquire properties used in the cultivation and production
of medical-use cannabis. If this source of funding is unavailable to us, our growth may be limited and our levered return on the
properties we purchase may be lower.
We expect to acquire additional real estate
assets, which we intend to finance primarily through newly issued equity or debt. We may not be in a position to take advantage
of attractive investment opportunities for growth if we are unable, due to global or regional economic uncertainty, changes in
the state or federal regulatory environment relating to the medical-use cannabis industry, our own operating or financial performance
or otherwise, to access capital markets on a timely basis and on favorable terms or at all. In addition, U.S. federal income tax
law generally requires that a REIT distribute annually at least 90% of its REIT taxable income, without regard to the deduction
for dividends paid and excluding net capital gain and that it pay U.S. federal income tax at regular corporate rates to the extent
that it annually distributes less than 100% of its taxable income. Because we intend to grow our business, this limitation may
require us to raise additional equity or incur debt at a time when it may be disadvantageous to do so.
Our access to capital will depend upon
a number of factors over which we have little or no control, including general market conditions and the market's perception of
our current and potential future earnings. If general economic instability or downturn leads to an inability to borrow at attractive
rates or at all, our ability to obtain capital to finance the purchase of real estate assets could be negatively impacted. In addition,
banks and other financial institutions may be reluctant to enter into lending transactions with us, particularly secured lending,
because we intend to acquire properties used in the cultivation and production of medical-use cannabis. If this source of funding
is unavailable to us, our growth may be limited and our levered return on the properties we purchase may be lower.
If we are unable to obtain capital on terms
and conditions that we find acceptable, we likely will have to reduce the number of properties we can purchase. In addition, our
ability to refinance all or any debt we may incur in the future, on acceptable terms or at all, is subject to all of the above
factors, and will also be affected by our future financial position, results of operations and cash flows, which additional factors
are also subject to significant uncertainties, and therefore we may be unable to refinance any debt we may incur in the future,
as it matures, on acceptable terms or at all. All of these events would have a material adverse effect on our business, financial
condition, liquidity and results of operations.
Our Exchangeable Senior Notes and any future indebtedness
reduces our cash available for distribution and may expose us to the risk of default.
Subsequent to December 31, 2018, in February
2019, we issued $143.75 million aggregate principal amount of Exchangeable Senior Notes. Payments of principal and interest on
our Exchangeable Senior Notes and borrowings that we may incur in the future may leave us with insufficient cash resources to operate
the properties that we expect to acquire or to pay the distributions currently contemplated or necessary to satisfy the requirements
for REIT qualification. Our level of debt and the limitations imposed on us by these debt agreements could have significant material
and adverse consequences, including the following:
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our cash flow may be insufficient to meet our required principal and
interest payments;
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we may be unable to borrow additional funds as needed or on favorable
terms, or at all;
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we may be unable to refinance our indebtedness at maturity or the
refinancing terms may be less favorable than the terms of our original indebtedness;
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to the extent we borrow debt that bears interest at variable rates,
increases in interest rates could materially increase our interest expense;
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we may be forced to dispose of one or more of the properties that
we expect to acquire, possibly on disadvantageous terms;
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we may default on our obligations or violate restrictive covenants,
in which case the lenders may accelerate these debt obligations; and
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our default under any loan with cross default provisions could result
in a default on other indebtedness.
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If any one of these events were to occur,
our financial condition, results of operations, cash flow, and our ability to make distributions to our stockholders could be materially
and adversely affected.
Risks Related to Our Organization and Structure
We are dependent on our key personnel for our success.
We depend upon the efforts, experience,
diligence, skill and network of business contacts of our senior management team, and our success will depend on their continued
service. The departure of any of our executive officers or key personnel could have a material adverse effect on our business.
If any of our key personnel were to cease their employment, our operating results could suffer. Further, we do not intend to maintain
key person life insurance that would provide us with proceeds in the event of death or disability of any of our key personnel.
We believe our future success depends upon
our senior management team's ability to hire and retain highly skilled managerial, operational and marketing personnel. Competition
for such personnel is intense, and we cannot assure you that we will be successful in attracting and retaining such skilled personnel.
If we lose or are unable to obtain the services of key personnel, our ability to implement our investment strategies could be delayed
or hindered, and the value of our common stock may decline.
Furthermore, we may retain independent
contractors to provide various services for us, including administrative services, transfer agent services and professional services.
Such contractors have no fiduciary duty to us and may not perform as expected or desired.
Our senior management team manages our portfolio subject
to very broad investment guidelines.
Our senior management team has broad discretion
over our investments, and our stockholders will have no opportunity to evaluate the terms of transactions or other economic or
financial data concerning our investments that are not described in periodic filings with the SEC. We rely on the senior management
team's ability to execute acquisitions and dispositions of medical-use cannabis facilities, subject to the oversight and approval
of our board of directors. Our senior management team is authorized to pursue acquisitions and dispositions of real estate investments
in accordance with very broad investment guidelines, subject to approval of our board of directors.
Our board of directors may change our investment objectives
and strategies without stockholder consent.
Our board of directors determines our major
policies, including with regard to financing, growth, debt capitalization, REIT qualification and distributions. Our board of directors
may amend or revise these and other policies without a vote of the stockholders. Under our charter and Maryland General Corporation
Law (the "MGCL"), our stockholders generally have a right to vote only on the following matters:
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the election or removal of directors;
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the amendment of our charter, except that our board of directors may
amend our charter without stockholder approval to:
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change the name or other designation or the par value of any class
or series of stock and the aggregate par value of our stock;
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increase or decrease the aggregate number of shares of stock that
we have the authority to issue;
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increase or decrease the number of our shares of any class or series
of stock that we have the authority to issue; and
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effect certain reverse stock splits;
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our liquidation and dissolution; and
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our being a party to a merger, consolidation, sale or other disposition
of all or substantially all of our assets or statutory share exchange.
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All other matters are subject to the discretion
of our board of directors.
Certain provisions of Maryland law could inhibit changes
in control.
Under the MGCL, "business combinations"
(including a merger, consolidation, statutory share exchange or, in certain circumstances, an asset transfer or issuance or reclassification
of equity securities) between a Maryland corporation and an "interested stockholder" or an affiliate of an interested
stockholder are prohibited for five years after the most recent date on which the interested stockholder becomes an interested
stockholder. An interested stockholder is defined as: (a) any person who beneficially owns 10% or more of the voting power of the
then-outstanding voting stock of the corporation; or (b) an affiliate or associate of the corporation who, at any time within the
two-year period prior to the date in question, was the beneficial owner of 10% or more of the voting power of the then-outstanding
stock of the corporation.
A person is not an interested stockholder
under the statute if the board of directors approved in advance the transaction by which the person otherwise would have become
an interested stockholder. A Maryland corporation's board of directors may provide that its approval is subject to compliance with
any terms and conditions determined by the board of directors prior to the time that the interested stockholder becomes an interested
stockholder.
Thereafter, any such business combination
must generally be recommended by the board of directors of such corporation and approved by the affirmative vote of at least:
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80% of the votes entitled to be cast by holders of outstanding voting
stock of the corporation; and
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two-thirds of the votes entitled to be cast by holders of voting stock
of the corporation, other than shares held by the interested stockholder with whom (or with whose affiliate) the business combination
is to be effected, or held by an affiliate or associate of the interested stockholder unless, among other conditions, the corporation's
common stockholders receive a minimum price (as defined in the MGCL) for their shares and the consideration is received in cash
or in the same form as previously paid by the interested stockholder for its shares.
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A Maryland corporation's board of directors
may provide that its approval is subject to compliance with any terms and conditions determined by it. These provisions of the
MGCL do not apply, however, to business combinations that are approved or exempted by a Maryland corporation's board of directors
prior to the time that the interested stockholder becomes an interested stockholder.
The "control share" provisions
of the MGCL provide that, subject to certain exceptions, a holder of "control shares" of a Maryland corporation (defined
as shares which, if aggregated with all other shares of stock owned by the acquirer or in respect of which the acquirer is able
to exercise or direct the exercise of voting power (except solely by virtue of a revocable proxy), entitle the stockholder to exercise
one of three increasing ranges of voting power in electing directors) acquired in a "control share acquisition" (defined
as the direct or indirect acquisition of ownership or control of issued and outstanding "control shares") has no voting
rights with respect to such shares except to the extent approved by our stockholders by the affirmative vote of at least two-thirds
of all the votes entitled to be cast on the matter, excluding votes entitled to be cast by the acquirer of control shares, our
officers and our personnel who are also our directors. Our bylaws contain a provision exempting from the control share acquisition
statute any and all acquisitions by any person of shares of our stock. Our bylaws contain a provision exempting from the control
share acquisition statute any and all acquisitions by any person of shares of our stock. There can be no assurance that such provision
will not be amended or eliminated at any time in the future by our board of directors.
The "unsolicited takeover" provisions
of Title 3, Subtitle 8 of the MGCL, or Subtitle 8, permit our board of directors, without stockholder approval and regardless of
what is currently provided in our charter or bylaws, to implement certain takeover defenses, some of which (for example, a classified
board) we do not yet have. Our charter provides that vacancies on our board may be filled only by the remaining directors and for
the remainder of the full term of the directorship in which the vacancy occurred. Through provisions in our charter and bylaws
unrelated to Subtitle 8, we already (i) require the affirmative vote of stockholders entitled to cast not less than two-thirds
of all of the votes entitled to be cast generally in the election of directors for the removal of any director from the board,
only with cause, (ii) vest in the board of directors the exclusive power to fix the number of directorships and (iii) require,
unless called by our chairman of the board, our chief executive officer or our board of directors, the written request of stockholders
entitled to cast not less than a majority of all votes entitled to be cast at such a meeting to call a special meeting of our stockholders.
These provisions may have the effect of
inhibiting a third party from making an acquisition proposal for us or of delaying, deferring or preventing a change in control
of us under the circumstances that otherwise could provide the holders of shares of common stock with the opportunity to realize
a premium over the then current market price.
Our authorized but unissued shares of common and preferred
stock may prevent a change in our control.
Our charter permits our board of directors
to authorize us to issue additional shares of our authorized but unissued common or preferred stock. In addition, our board of
directors may, without stockholder approval, amend our charter to increase the aggregate number of our shares of stock or the number
of shares of stock of any class or series that we have the authority to issue and classify or reclassify any unissued shares of
common or preferred stock and set the terms of the classified or reclassified shares. As a result, our board of directors may establish
a class or series of shares of common or preferred stock that could delay or prevent a transaction or a change in control that
might involve a premium price for shares of our common stock or otherwise be in the best interest of our stockholders.
Severance agreements with our executive officers could
be costly and prevent a change in our control.
The severance agreements that we entered
into with our executive officers provide that, if their employment with us terminates under certain circumstances (including upon
a change in our control), we may be required to pay them significant amounts of severance compensation, including accelerated vesting
of equity awards, thereby making it costly to terminate their employment. Furthermore, these provisions could delay or prevent
a transaction or a change in our control that might involve a premium paid for our common stock or otherwise be in the best interests
of our stockholders.
Because of our holding company structure, we depend
on our Operating Partnership and its subsidiaries for cash flow and we will be structurally subordinated in right of payment to
the obligations of such operating subsidiary and its subsidiaries.
We are a holding company with no business
operations of our own. Our only significant asset is and will be the general and limited partnership interests in our Operating
Partnership. We conduct, and intend to conduct, all of our business operations through our Operating Partnership. Accordingly,
our only source of cash to pay our obligations is distributions from our Operating Partnership and its subsidiaries of their net
earnings and cash flows. We cannot assure our stockholders that our Operating Partnership or its subsidiaries will be able to,
or be permitted to, make distributions to us that will enable us to make distributions to our stockholders from cash flows from
operations. Each of our Operating Partnership's subsidiaries is or will be a distinct legal entity and, under certain circumstances,
legal and contractual restrictions may limit our ability to obtain cash from such entities. In addition, because we are a holding
company, your claims as stockholders will be structurally subordinated to all existing and future liabilities and obligations of
our Operating Partnership and its subsidiaries. Therefore, in the event of our bankruptcy, liquidation or reorganization, our assets
and those of our Operating Partnership and its subsidiaries will be able to satisfy your claims as stockholders only after all
of our and our Operating Partnership's and its subsidiaries' liabilities and obligations have been paid in full. Furthermore, U.S.
bankruptcy courts have generally refused to grant bankruptcy protections to cannabis businesses.
Our Operating Partnership may issue additional limited
partnership interests to third parties without the consent of our stockholders, which would reduce our ownership percentage in
our Operating Partnership and would have a dilutive effect on the amount of distributions made to us by our Operating Partnership
and, therefore, the amount of distributions we can make to our stockholders.
We are the sole general partner of our
Operating Partnership and own, directly or through a subsidiary, 100% of the outstanding partnership interests in our Operating
Partnership. We may, in connection with our acquisition of properties or otherwise, cause our Operating Partnership to issue additional
limited partnership interests to third parties. Such issuances would reduce our ownership percentage in our Operating Partnership
and affect the amount of distributions made to us by our Operating Partnership and, therefore, the amount of distributions we can
make to our stockholders. Because our stockholders will not directly own any interest in our Operating Partnership, our stockholders
will not have any voting rights with respect to any such issuances or other partnership level activities of our Operating Partnership.
If we issue limited partnership interests in our Operating
Partnership in exchange for property, the value placed on such partnership interests may not accurately reflect their market value,
which may dilute your interest in us.
If we issue limited partnership interests
in our Operating Partnership in exchange for property, the per unit value attributable to such interests will be determined based
on negotiations with the property seller and, therefore, may not reflect the fair market value of such limited partnership interests
if a public market for such limited partnership interests existed. If the value of such limited partnership interests is greater
than the value of the related property, your interest in us may be diluted.
Our rights and the rights of our stockholders to take
action against our directors and officers are limited, which could limit your recourse in the event of actions not in your best
interests.
We have entered into indemnification agreements
with each of our executive directors and officers that provide for indemnification to the maximum extent permitted by Maryland
law. Maryland law permits us to include in our charter a provision eliminating the liability of our directors and officers and
our stockholders for money damages except for liability resulting from:
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actual receipt of an improper benefit or profit in money, property
or services; or
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active and deliberate dishonesty that was established by a final judgment
and was material to the cause of action.
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Our charter authorizes us to obligate ourselves
and our bylaws obligate us, to the fullest extent permitted by Maryland law in effect from time to time, to indemnify and, without
requiring a preliminary determination of the ultimate entitlement to indemnification, pay or reimburse reasonable expenses in advance
of final disposition of a proceeding to:
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any present or former director or officer who is made or threatened
to be made a party to or witness in the proceeding by reason of his or her service in that capacity; or
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any individual who, while a director or officer of our company and
at our request, serves or has served as a director, officer, partner, manager, member or trustee of another corporation, REIT,
partnership, limited liability company, joint venture, trust, employee benefit plan or any other enterprise and who is made or
threatened to be made a party to or witness in the proceeding by reason of his or her service in that capacity.
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Our charter contains provisions that make removal of
our directors difficult, which could make it difficult for our stockholders to effect changes to our management.
Our charter provides that, subject to the
rights of holders of any series of preferred stock, a director may be removed only with cause upon the affirmative vote of stockholders
entitled to cast at least two-thirds of the votes entitled to be cast generally in the election of directors. Vacancies may be
filled only by a vote of the majority of the remaining directors in office, even if less than a quorum. These requirements make
it more difficult to change our management by removing and replacing directors and may prevent a change in control of our company
that is in the best interests of our stockholders.
Ownership limitations may restrict change in control
or business combination opportunities in which our stockholders might receive a premium for their shares.
In order for us to qualify as a REIT under
the Internal Revenue Code of 1986, as amended (the "Code"), shares of our stock must be owned by 100 or more persons
during at least 335 days of a taxable year of 12 months (other than the first year for which an election to be a REIT has been
made) or during a proportionate part of a shorter taxable year. Also, not more than 50% of the value of the outstanding shares
of our stock may be owned, directly or indirectly, by five or fewer individuals (as defined in the Code to include certain entities)
during the last half of a taxable year (other than the first year for which an election to be a REIT has been made). In order for
us to qualify as a REIT under the Code, the relevant sections of our charter provide that, subject to certain exceptions, no person
or entity may own, or be deemed to own, by virtue of the applicable constructive ownership provisions of the Code, more than 9.8%
(in value or number of shares, whichever is more restrictive) of the aggregate of our outstanding shares of stock or more than
9.8% (in value or number of shares, whichever is more restrictive) of our outstanding common stock or any class or series of our
outstanding preferred stock, including our 9.00% Series A Cumulative Redeemable Preferred Stock (the “Series A Preferred
Stock”). These ownership limits and other restrictions could have the effect of discouraging a takeover or other transaction
in which holders of our common stock might receive a premium for their shares over the then prevailing market price or which holders
might believe to be otherwise in their best interests.
The requirements of being a public company impose costs
and demands upon our management, which could make it difficult to manage our business, particularly after we are no longer an “emerging
growth company.”
Complying with the reporting and other
regulatory requirements of the Exchange Act and the requirements of the Sarbanes-Oxley Act of 2002 (the "Sarbanes-Oxley Act")
is time-consuming and costly. The Exchange Act requires that we file annual, quarterly and current reports with respect to our
business and financial condition. The Sarbanes-Oxley Act requires that we maintain effective disclosure controls and procedures
and internal controls over financial reporting. To maintain and improve the effectiveness of our disclosure controls and procedures
and internal control over financial reporting, we have committed additional resources and provided additional management oversight.
We expect these resources and management oversight requirements to continue. These activities may divert management’s attention
from other business concerns, which could have a material adverse effect on our business, financial condition and results of operations.
As an “emerging growth company”
as defined in the Jumpstart Our Business Startups Act of 2012 (the "JOBS Act"), we benefit from certain temporary exemptions
from various reporting requirements, including, but not limited to, not being required to comply with the auditor attestation requirements
of Section 404 of the Sarbanes-Oxley Act and reduced disclosure obligations regarding executive compensation in our periodic reports
and proxy statements. In addition, we have elected under the JOBS Act to delay adoption of new or revised accounting pronouncements
applicable to public companies until such pronouncements are made applicable to private companies. When these exemptions cease
to apply, we expect to incur additional expenses and devote increased management effort toward ensuring compliance with them. We
cannot predict or estimate the amount of additional costs we may incur as these exemptions cease to apply.
We plan to continue to operate our business so that
we are not required to register as an investment company under the Investment Company Act.
We engage primarily in the business of
investing in real estate and we have not and do not intend to register as an investment company under the Investment Company Act.
If our primary business were to change in a manner that would require us register as an investment company under the Investment
Company Act, we would have to comply with substantial regulation under the Investment Company Act which could restrict the manner
in which we operate and finance our business and could materially and adversely affect our business operations and results.
Risks Related to Our Securities
The market prices and trading volumes of our common
stock and Series A Preferred Stock have been and may continue to be volatile.
The market prices for our common stock
and Series A Preferred Stock have been, and may continue to be, volatile. In addition, the trading volume in our common stock and
Series A Preferred Stock has fluctuated and may continue to fluctuate, resulting in significant price variations.
Some of the factors that could negatively
affect the share price or result in fluctuations in the price or trading volume of our common stock and preferred stock include:
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our actual or projected operating results, financial condition, cash
flows and liquidity or changes in business strategy or prospects;
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changes in government policies, regulations or laws;
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our ability to make acquisitions on preferable terms or at all;
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the performance of our current properties and additional properties
that we acquire;
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equity issuances by us, or share resales by our stockholders, or the
perception that such issuances or resales may occur;
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actual or anticipated accounting problems;
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publication of research reports about us, the real estate industry
or the cannabis industry;
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changes in market valuations of similar companies;
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adverse market reaction to any increased indebtedness we may incur
in the future;
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additions to or departures of our senior management team;
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speculation in the press or investment community or negative press
in general;
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our failure to meet, or the lowering of, our earnings estimates or
those of any securities analysts;
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failure to maintain our qualification as a REIT;
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refusal of securities clearing firms to accept deposits of our securities;
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a delisting of our common stock or preferred stock from the New York
Stock Exchange ("NYSE");
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the realization of any of the other risk factors presented in this
report;
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actions by institutional stockholders;
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price and volume fluctuations in the stock market generally; and
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market and economic conditions generally, including the current state
of the credit and capital markets and the market and economic conditions.
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Market factors unrelated to our performance
could also negatively impact the market price of our common stock and preferred stock. One of the factors that investors may consider
in deciding whether to buy or sell our common stock or Series A Preferred Stock is our distribution rate as a percentage of our
stock price relative to market interest rates. If market interest rates increase, prospective investors may demand a higher distribution
rate or seek alternative investments paying higher dividends or interest. As a result, interest rate fluctuations and conditions
in capital markets can affect the market value of our common stock or Series A Preferred Stock.
Common stock and preferred stock eligible for future
sale may have material and adverse effects on our share price.
Subject to applicable law, our board of
directors, without stockholder approval, may authorize us to issue additional shares of our common stock or to raise capital through
the issuance of preferred stock (including equity or debt securities convertible into preferred stock), options, warrants and other
rights, on terms and for consideration as our board of directors in its sole discretion may determine. Any such issuance could
result in dilution of the equity of our stockholders. Sales of substantial amounts of shares of our common stock in the public
market, or the perception that such sales might occur, could adversely affect the market price of our common stock.
Our charter also authorizes our board of
directors, without stockholder approval, to designate and issue one or more classes or series of preferred stock (including equity
or debt securities convertible into preferred stock) and to set or change the voting, conversion or other rights, preferences,
restrictions, limitations as to dividends or other distributions and qualifications or terms or conditions of redemption of each
class of shares so issued. If any preferred stock is publicly offered, the terms and conditions of such preferred stock (including
any equity or debt securities convertible into preferred stock) will be set forth in a registration statement registering the issuance
of such preferred stock or equity or debt securities convertible into preferred stock. Because our board of directors has the power
to establish the preferences and rights of each class or series of preferred stock, it may afford the holders of any series or
class of preferred stock preferences, powers, and rights senior to the rights of holders of common stock or other preferred stock.
If we ever create and issue additional preferred stock or equity or debt securities convertible into preferred stock with a distribution
preference over common stock or preferred stock, payment of any distribution preferences of new outstanding preferred stock would
reduce the amount of funds available for the payment of distributions on the common stock and junior preferred stock. Further,
holders of preferred stock are normally entitled to receive a preference payment if we liquidate, dissolve, or wind up before any
payment is made to the common stockholders, likely reducing the amount common stockholders would otherwise receive upon such an
occurrence. In addition, under certain circumstances, the issuance of additional preferred stock may delay, prevent, render more
difficult or tend to discourage a merger, tender offer, or proxy contest, the assumption of control by a holder of a large block
of our securities, or the removal of incumbent management.
Furthermore, we filed a shelf registration
statement, which was subsequently declared effective by the SEC, which may permit us, from time to time, to offer and sell common
stock, preferred stock, warrants and other securities to the extent necessary or advisable to meet our liquidity needs.
Additionally, from time to time we also
may issue shares of our common stock or operating partnership units of our Operating Partnership in connection with property acquisitions.
We may grant additional demand or piggyback registration rights in connection with these issuances. Sales of substantial amounts
of our common stock or operating partnership units of our Operating Partnership, or the perception that these sales could occur,
may adversely affect the prevailing market price of our common stock or may adversely affect the terms upon which we may be able
to obtain additional capital through the sale of equity securities.
As of March 13, 2019, 9,806,194 shares
of our common stock were issued and outstanding, and we had reserved an additional 753,806 shares of common stock for future issuance
under our 2016 Omnibus Incentive Plan and 2,066,116 shares potentially issuable upon exchange of our Exchangeable Senior Notes
(based on the exchange rate as of March 13, 2019). The existence of operating partnership units Exchangeable Senior Notes, shares
of Series A Preferred Stock and shares of our common stock reserved for issuance under our 2016 Omnibus Incentive Plan may adversely
affect the terms upon which we may be able to obtain additional capital through the sale of equity securities.
We cannot assure you of our ability to make distributions
in the future. We may be unable to pay or maintain cash dividends, and may borrow money, sell assets or use offering proceeds to
make distributions to our stockholders, if we are unable to make distributions from cash flows from operations.
U.S. federal income tax law generally requires
that a REIT distribute annually at least 90% of its REIT taxable income, determined without regard to the deduction for dividends
paid and excluding net capital gain (which does not equal net income as calculated in accordance with U.S. generally accepted accounting
principles ("GAAP")), and that it pay U.S. federal income tax at regular corporate rates to the extent that it annually
distributes less than 100% of its taxable income. We may not continue our current level of distributions to stockholders. Our board
of directors will determine future distributions based on a number of factors, including cash available for distribution, economic
conditions, operating results, our financial condition, especially in relation to our anticipated future capital needs, then current
expansion plans, the distribution requirements for REITs, and other factors our board deems relevant. In addition, we may borrow
money, sell assets or use offering proceeds to make distributions to our stockholders, if we are unable to make distributions from
cash flows from operations.
Our charter permits us to pay distributions from any
source and, as a result, the amount of distributions paid at any time may not reflect the performance of our properties or as cash
flow from operations.
Our organizational documents permit us
to make distributions from any source. To the extent that our cash available for distribution is insufficient to cover our distributions,
we expect to use our cash on hand, the proceeds from the issuance of securities in the future, the proceeds from borrowings or
other sources to pay distributions. It is possible that any distributions declared will be paid from our cash on hand or future
issuances of shares of our common stock or preferred stock, which would constitute a return of capital to our stockholders. If
we fund distributions from borrowings, sales of properties, future issuances of securities or cash on hand, we will have fewer
funds available for the acquisition of additional properties resulting in potentially fewer investments, less diversification of
our portfolio and a reduced overall return to our stockholders. In addition, the value of our shares of common stock and preferred
stock may be diluted because funds that would otherwise be available to make investments would be diverted to fund distributions.
The market price of our common stock and Series A Preferred
Stock could be materially and adversely affected by our level of cash distributions.
The market value of our common stock and
Series A Preferred Stock is based primarily upon the market's perception of our growth potential and our current and potential
future cash distributions, whether from operations, sales or re-financings, and is secondarily based upon the real estate market
value of our underlying assets. For that reason, our stock may trade at prices that are higher or lower than our net asset value
per share. To the extent we retain operating cash flow for investment purposes, working capital reserves or other purposes, these
retained funds, while increasing the value of our underlying assets, may not correspondingly increase the market price of our
stock. Our failure to meet the market's expectations with regard to future earnings and cash distributions likely would materially
and adversely affect the market price of our common stock and Series A Preferred Stock.
Our Exchangeable Senior Notes and future offerings
of debt or preferred equity securities, which may rank senior to our common stock and existing preferred stock, may materially
and adversely affect the market price of our common stock.
Our Exchangeable Senior
Notes rank senior to our common stock and existing preferred stock. If we decide to issue additional debt securities in
the future, which would rank senior to our common stock and
existing preferred stock, it is likely that they will be governed by an indenture or other instrument containing covenants
restricting our operating flexibility. Additionally, any preferred equity securities or convertible or exchangeable
securities that we issue in the future may have rights, preferences and privileges more favorable than those of our common
stock and/or existing preferred stock and may result in dilution to owners of our common stock and existing preferred stock.
We and, indirectly, our stockholders will bear the cost of issuing and servicing such securities. Because our decision to
issue debt or preferred equity securities in any future offering will depend on market conditions and other factors beyond
our control, we cannot predict or estimate the amount, timing or nature of our future offerings. Thus, holders of our common
stock and existing preferred stock will bear the risk of our future offerings reducing the market price of our common
stock and existing preferred stock and diluting the value of their stock holdings in us.
We are an “emerging growth company” and
we cannot be certain if the reduced disclosure requirements applicable to emerging growth companies will make our common stock
less attractive to investors.
We are an “emerging growth company,”
and we benefit from certain exemptions from various reporting requirements that are applicable to other public companies that are
not “emerging growth companies” including, but not limited to, not being required to comply with the auditor attestation
requirements of Section 404 of the Sarbanes-Oxley Act, which may increase the risk that weaknesses or deficiencies in our internal
control over financial reporting go undetected, and reduced disclosure obligations regarding executive compensation in our periodic
reports and proxy statements, which may make it more difficult for investors and securities analysts to evaluate our company. In
addition, we have elected under the JOBS Act to delay adoption of new or revised accounting pronouncements applicable to public
companies until such pronouncements are made applicable to private companies. As a result of this election, our financial statements
may not be comparable to companies that comply with public company effective dates. If some investors find our common stock and
existing preferred stock less attractive as a result, there may be a less active trading market for our common stock and existing
preferred stock, and corresponding stock prices may be more volatile. We may take advantage of these reporting exemptions until
we are no longer an “emerging growth company,” which in certain circumstances could be up to five years.
Risks Related to Our Taxation as a REIT
Our failure to qualify or remain qualified as a REIT
would subject us to U.S. federal income tax and applicable state and local taxes, which would reduce the amount of cash available
for distribution to our stockholders and have significant adverse consequences on the market price of our common stock and existing
preferred stock.
We have been organized and we intend to
operate in a manner that will enable us to qualify as a REIT for U.S. federal income tax purposes commencing with our taxable year
ended December 31, 2017. We have not requested and do not intend to request a ruling from the Internal Revenue Service (the "Service")
that we qualify as a REIT, and the statements in this report are not binding on the Service or any court. Qualification as a REIT
involves the application of highly technical and complex Code provisions and regulations promulgated by the U.S. Treasury Department
thereunder ("Treasury Regulations") for which there are limited judicial and administrative interpretations. Accordingly,
we cannot provide assurance that we will qualify or remain qualified as a REIT.
To qualify as a REIT, we must meet, on
an ongoing basis, various tests regarding the nature and diversification of our assets and our income, the ownership of our outstanding
stock, and the amount of our distributions to stockholders. Our ability to satisfy these asset tests depends upon the characterization
and fair market values of our assets, some of which are not susceptible to a precise determination, and for which we will not obtain
independent appraisals. Our compliance with the REIT income and quarterly asset requirements also depends upon our ability to manage
successfully the composition of our income and assets on an ongoing basis. Moreover, new legislation, court decisions or administrative
guidance, in each case possibly with retroactive effect, may make it more difficult or impossible for us to qualify as a REIT.
Thus, while we intend to operate in a manner to qualify as a REIT, in view of the highly complex nature of the rules governing
REITs, the ongoing importance of factual determinations, and the possibility of future changes in our circumstances, we cannot
provide assurance that we will so qualify for any particular year. These considerations also might restrict the types of income
we can realize, or assets that we can acquire in the future.
If we fail to qualify as a REIT in any
taxable year, and we do not qualify for certain statutory relief provisions, we would be required to pay U.S. federal income tax,
including any applicable alternative minimum tax, on our taxable income at regular corporate rates. We will not be able to deduct
distributions to our stockholders in any year in which we fail to qualify, nor will we be required to make distributions to our
stockholders. In such a case, we might need to borrow money, sell assets, or reduce or even cease making distributions in order
to pay our taxes. Our payment of income tax would reduce significantly the amount of cash available for distribution to our stockholders.
If we fail to qualify as a REIT, all distributions to stockholders, to the extent of current and accumulated earnings and profits,
will be taxable to the stockholders as dividend income (which may be subject to tax at preferential rates) and corporate distributions
may be eligible for the dividends received deduction if they satisfy the relevant provisions of the Code. Furthermore, if we fail
to qualify as a REIT, we no longer would be required to distribute substantially all of our net taxable income to our stockholders.
In addition, unless we were eligible for certain statutory relief provisions, we could not re-elect to qualify as a REIT until
the fifth calendar year following the year in which we failed to qualify. We might not be entitled to the statutory relief described
in this paragraph in all circumstances.
The REIT distribution requirements could adversely affect
our ability to execute our business plan, require us to borrow funds during unfavorable market conditions or subject us to tax,
which would reduce the cash available for distribution to our stockholders.
To qualify as a REIT, we must distribute
to our stockholders, on an annual basis, at least 90% of our REIT taxable income, determined without regard to the deduction for
dividends paid and excluding net capital gain. In addition, we will be subject to U.S. federal income tax at regular corporate
rates to the extent that we distribute less than 100% of our net taxable income (including net capital gain) and will be subject
to a 4% nondeductible excise tax on the amount by which our distributions in any calendar year are less than a minimum amount specified
under U.S. federal income tax laws. We intend to distribute our net income to our stockholders in a manner intended to satisfy
the REIT 90% distribution requirement and to avoid U.S. federal income tax and the 4% nondeductible excise tax. However, we can
provide no assurances that we will have sufficient cash or other liquid assets to meet these requirements. Difficulties in meeting
the distribution requirements might arise due to competing demands for available funds or timing differences between tax reporting
and cash receipts. In addition, if the Service were to disallow certain of our deductions, such as employee salaries, depreciation
or interest expense, by alleging that we, through our rental agreements with our state-licensed medical cannabis tenants, are primarily
or vicariously liable for "trafficking" a Schedule 1 substance (cannabis) under Section 280E of the Code or otherwise,
we would be unable to meet the distribution requirements and would fail to qualify as a REIT. Likewise, if any governmental entity
were to impose fines on us for our business involvement in state-licensed medical-use cannabis, such fines would not be deductible
and the inability to deduct such fines could also cause us to be unable to satisfy the distribution requirement.
We may also generate less cash flow than
taxable income in a particular year. In such event, we may be required to use cash reserves, incur debt or liquidate assets at
rates or times that we regard as unfavorable or, to the extent possible, make a taxable distribution of our stock in order to satisfy
the REIT 90% distribution requirement and to avoid U.S. federal income tax and the 4% nondeductible excise tax in that year. Under
certain circumstances, we may be able to rectify a failure to meet the distribution requirement for a year by paying "deficiency
dividends" to stockholders in a later year, which may be included in our deduction for dividends paid for the earlier year.
Thus, we may be able to avoid being taxed on amounts distributed as deficiency dividends; however, we will be required to pay penalties
and interest based upon the amount of any deduction taken for deficiency dividends. If we do not have sufficient cash to distribute,
we may incur U.S. federal income tax, U.S. federal excise tax and/or our REIT status may be jeopardized.
If we are deemed to be subject to Section 280E of the
Code because of the business activities of our tenants, the resulting disallowance of tax deductions could cause us to incur U.S.
federal income tax and jeopardize our REIT status.
Section 280E of the Code provides that,
with respect to any taxpayer, no deduction or credit is allowed for expenses incurred during a taxable year "in carrying on
any trade or business if such trade or business (or the activities which comprise such trade or business) consists of trafficking
in controlled substances (within the meaning of Schedule I and II of the CSA) which is prohibited by federal law or the law of
any State in which such trade or business is conducted." Because cannabis is a Schedule I controlled substance under the CSA,
Section 280E by its terms applies to the purchase and sale of medical-use cannabis products. Although we will not be engaged in
the purchase, sale, growth, cultivation, harvesting, or processing of medical-use cannabis products, we will lease our properties
to tenants who will engage in such activities, and therefore our tenants will likely be subject to Section 280E. If the Service
were to take the position that, through our rental agreements with our state-licensed medical-use cannabis tenants, we are primarily
or vicariously liable under federal law for "trafficking" a Schedule 1 substance (cannabis) under section 280E of the
Code or for any other violations of the CSA, the Service may seek to apply the provisions of Section 280E to our company and disallow
certain tax deductions, including for employee salaries, depreciation or interest expense. If such tax deductions are disallowed,
we would be unable to meet the distribution requirements applicable to REITs under the Code, which could cause us to incur U.S.
federal income tax and fail to qualify as a REIT. Because we are not engaged in the purchase and/or sale of a controlled substance,
we do not believe that we will be subject to the disallowance provisions of Section 280E, and neither we nor our tax advisors are
aware of any tax court cases or guidance from the Service in which a taxpayer not engaged in the purchase or sale of a controlled
substance was disallowed deductions under Section 280E. However, there is no assurance that the Service will not take such a position
either currently or in the future.
Complying with REIT requirements may cause us to forego
otherwise attractive business opportunities or liquidate otherwise attractive investments.
To qualify as a REIT, we must ensure that
we meet the REIT gross income tests annually. In addition, we must ensure that, at the end of each calendar quarter, at least 75%
of the value of our total assets consists of cash, cash items, government securities and qualified REIT real estate assets, including
certain mortgage loans, certain kinds of mortgage-backed securities and certain securities issued by other REITs. The remainder
of our investment in securities (other than government securities, securities of corporations that are treated as TRSs, and qualified
REIT real estate assets) generally cannot include more than 10% of the outstanding voting securities of any one issuer or more
than 10% of the total value of the outstanding securities of any one issuer. In addition, in general, no more than 5% of the value
of our assets (other than government securities and qualified real estate assets) can consist of the securities of any one issuer,
no more than 25% (20% for taxable years beginning after December 31, 2017) of the value of our total securities can be represented
by securities of one or more TRSs, and, the aggregate value of debt instruments issued by public REITs held by us that are not
otherwise secured by real property may not exceed 25% of the value of our total assets. If we fail to comply with these asset requirements
at the end of any calendar quarter, we generally must correct the failure within 30 days after the end of the calendar quarter
or qualify for certain statutory relief provisions to avoid losing our REIT qualification and suffering adverse tax consequences.
To meet these tests, we may be required
to take or forgo taking actions that we would otherwise consider advantageous. For instance, in order to satisfy the gross income
or asset tests applicable to REITs under the Code, we may be required to forego investments that we otherwise would make. Furthermore,
we may be required to liquidate from our portfolio otherwise attractive investments. In addition, we may be required to make distributions
to stockholders at disadvantageous times or when we do not have funds readily available for distribution. These actions could have
the effect of reducing our income and amounts available for distribution to our stockholders. Thus, compliance with the REIT requirements
may hinder our investment performance.
The tax on prohibited transactions could limit our ability
to engage in certain transactions or subject us to a 100% penalty tax.
We are subject to a 100% tax on any income
from a prohibited transaction. "Prohibited transactions" generally include sales or other dispositions of property (other
than property treated as foreclosure property under the Code) that is held as inventory or primarily for sale to customers in the
ordinary course of a trade or business by a REIT, either directly or indirectly through certain pass-through subsidiaries. Although
we do not intend to hold a significant amount of assets as inventory or primarily for sale to customers in the ordinary course
of our business, the characterization of an asset sale as a prohibited transaction depends on the particular facts and circumstances.
The Code provides a safe harbor that, if met, allows a REIT to avoid being treated as engaged in a prohibited transaction. It is
likely that we may sell certain properties that have not met all of the requirements of such safe harbor if we believe the transaction
would not be a prohibited transaction based on a facts and circumstances analysis. If the Service were to successfully argue that
such a sale was in fact a prohibited transaction, we would be subject to a 100% penalty tax with respect to such sale.
If we were considered to actually or constructively
pay a "preferential dividend" to certain of our stockholders, our status as a REIT could be adversely affected.
In order to qualify as a REIT, we must
annually distribute to our stockholders at least 90% of our REIT taxable income (which does not equal net income, as calculated
in accordance with GAAP), determined without regard to the deduction for dividends paid and excluding net capital gain. In order
for distributions to be counted as satisfying the annual distribution requirements for REITs, and to provide us with a REIT-level
tax deduction, the distributions must not be "preferential dividends." A dividend is not a preferential dividend if the
distribution is pro rata among all outstanding shares of stock within a particular class, and in accordance with the preferences
among different classes of stock as set forth in our organizational documents. Currently, there is uncertainty as to the Service's
position regarding whether certain arrangements that REITs have with their stockholders could give rise to the inadvertent payment
of a preferential dividend (e.g., the pricing methodology for stock purchased under a distribution reinvestment program inadvertently
causing a greater than 5% discount on the price of such stock purchased). There is no de minimis exception with respect to preferential
dividends; therefore, if the Service were to take the position that we inadvertently paid a preferential dividend, we may be deemed
to have failed the 90% distribution test, and our status as a REIT could be terminated for the year in which such determination
is made if we were unable to cure such failure. While we believe that our operations will be structured in such a manner that we
will not be treated as inadvertently paying preferential dividends, we can provide no assurance to this effect.
The "preferential dividend" prohibition
described above does not apply to a "publicly offered REIT," which generally is a REIT that is required to make regular
filings with the SEC under the Exchange Act. While we intend to qualify as a "publicly offered REIT" and therefore expect
that the preferential dividend prohibition will not apply to us, we cannot provide you with assurance that we will so qualify and,
accordingly, we may be subject to the prohibition.
The ability of our board of directors to revoke our
REIT election without stockholder approval may cause adverse consequences to our stockholders.
Our charter provides that the board of
directors may revoke or otherwise terminate our REIT election, without the approval of our stockholders, if the board of directors
determines that it is no longer in our best interest to attempt to, or continue to, qualify as a REIT. If we cease to qualify as
a REIT, we would become subject to U.S. federal income tax on our net taxable income and we generally would no longer be required
to distribute any of our net taxable income to our stockholders, which may have adverse consequences on our total return to our
stockholders.
Dividends payable by REITs do not qualify for the reduced
tax rates on dividend income from regular corporations, which could adversely affect the value of our common stock.
The maximum U.S. federal income tax rate
for certain qualified dividends payable to U.S. stockholders that are individuals, trusts and estates is 20%. Dividends (other
than capital gain dividends) payable by REITs, however, generally are not eligible for the reduced rates. Although the reduced
U.S. federal income tax rate applicable to dividend income from regular corporate dividends does not adversely affect the taxation
of REITs or dividends paid by REITs, the more favorable rates applicable to regular corporate dividends could cause investors
who are individuals, trusts and estates to perceive investments in REITs to be relatively less attractive than investments in
the stocks of non-REIT corporations that pay dividends, which could adversely affect the value of the shares of our common stock.
Complying with REIT requirements may limit our ability
to hedge our liabilities effectively and may cause us to incur tax liabilities.
The REIT provisions of the Code may limit
our ability to hedge our liabilities. Any income from a hedging transaction we enter into to manage risk of interest rate changes,
price changes or currency fluctuations with respect to borrowings made or to be made to acquire or carry real estate assets, if
properly identified under applicable Treasury Regulations, does not constitute "gross income" for purposes of the 75%
or 95% gross income tests. To the extent that we enter into other types of hedging transactions, the income from those transactions
will likely be treated as non-qualifying income for purposes of both of the gross income tests. As a result of these rules, we
may need to limit our use of advantageous hedging techniques or implement those hedges through a TRS. This could increase the cost
of our hedging activities because our TRSs would be subject to tax on gains or expose us to greater risks associated with changes
in interest rates than we would otherwise want to bear. In addition, losses in a TRS generally will not provide any tax benefit,
except for being carried forward against future taxable income of such TRS.
Non-U.S. stockholders will generally be subject to withholding
tax with respect to our ordinary dividends.
Non-U.S. stockholders generally will be
subject to U.S. federal withholding tax on ordinary dividends received from us at a 30% rate, subject to reduction under an applicable
treaty or a statutory exemption under the Code.
Legislative, regulatory or administrative
changes could adversely affect us or our stockholders.
At any time, the U.S. federal income tax
laws or Treasury Regulations governing REITs or the administrative interpretations of those laws or regulations may be changed,
possibly with retroactive effect, and may adversely affect us and our stockholders. We cannot predict if or when any new U.S. federal
income tax law, regulation or administrative interpretation, or any amendment to any existing U.S. federal income tax law, regulation
or administrative interpretation, will be adopted, promulgated or become effective or whether any such law, regulation or interpretation
may take effect retroactively.
It is unclear at this time what impact
the rescission of the Cole Memo may have on our ability to qualify as a REIT. If rescission of the Cole Memo is followed by strict
enforcement of federal prohibitions regarding cannabis, the Service could seek to apply the provisions of Section 280E of the Code
to our company. Section 280E of the Code provides that, with respect to any taxpayer, no deduction or credit is allowed for expenses
incurred during a taxable year “in carrying on any trade or business if such trade or business (or the activities which comprise
such trade or business) consists of trafficking in controlled substances (within the meaning of Schedule I and II of the CSA) which
is prohibited by federal law or the law of any State in which such trade or business is conducted.” Because cannabis is a
Schedule I controlled substance under the CSA, Section 280E of the Code by its terms applies to the purchase and sale of medical-use
cannabis products. If the Service were to take the position that, through our rental agreements with our state-licensed medical-use
cannabis tenants, we are primarily or vicariously liable under federal law for “trafficking” a Schedule 1 substance
(cannabis) under Section 280E of the Code or for any other violations of the CSA, the Service may apply the provisions of Section
280E of the Code to our company and disallow certain tax deductions, including for employee salaries, depreciation or interest
expense. If such tax deductions are disallowed, we would be unable to meet the distribution requirements applicable to REITs under
the Code, which could cause us to incur U.S. federal income tax and fail to qualify as a REIT.
In addition, tax legislation originally
introduced as the Tax Cuts and Jobs Act and signed into law in December 2017 (the “TCJA”) makes numerous changes to
the tax rules that do not affect the REIT qualification rules directly, but may otherwise affect us or our stockholders. Among
the changes made by the TCJA are permanently reducing the generally applicable corporate tax rate, generally reducing the tax rate
applicable to individuals and other non-corporate taxpayers for tax years beginning after December 31, 2017 and before January
1, 2026, eliminating or modifying certain previously allowed deductions (including substantially limiting interest deductibility
and, for individuals, the deduction for non-business state and local taxes), and, for taxable years beginning after December 31,
2017 and before January 1, 2026, providing for preferential rates of taxation through a deduction of up to 20% (subject to certain
limitations) on most ordinary REIT dividends and certain trade or business income of non-corporate taxpayers. The TCJA also imposes
new limitations on the deduction of net operating losses, which may result in us having to make additional taxable distributions
to our stockholders in order to comply with REIT distribution requirements or avoid taxes on retained income and gains. The effect
of the significant changes made by the TCJA is highly uncertain, and administrative guidance will be required in order to fully
evaluate the effect of many provisions. The effect of any technical corrections with respect to the TCJA could have an adverse
effect on us or our stockholders.