ITEM 1. BUSINESS
General
As used herein, the terms “we”,
“us”, “our” or the “Company” refer to Innovative Industrial Properties, Inc., a Maryland corporation,
and any of our subsidiaries, including IIP Operating Partnership, LP, a Delaware limited partnership, or our Operating Partnership.
We are an internally-managed
real estate investment trust (“REIT”) focused on the acquisition, ownership and management of specialized industrial
properties leased to experienced, state-licensed operators for their regulated state-licensed cannabis facilities. We have acquired
and intend to continue to acquire our properties through sale-leaseback transactions and third-party purchases. We have leased
and expect to continue to lease our properties on a triple-net lease basis, where the tenant is responsible for all aspects of
and costs related to the property and its operation during the lease term, including structural repairs, maintenance, taxes and
insurance.
We
were incorporated in Maryland on June 15, 2016.We conduct our business through a traditional umbrella partnership real estate investment
trust, or UPREIT structure, in which our properties are owned by our Operating Partnership, directly or through subsidiaries. We
are the sole general partner of our Operating Partnership and own, directly or through subsidiaries, 100% of the limited partnership
interests in our Operating Partnership. As of December 31,
2019, we had 13 full-time employees.
Our corporate office is located
at 1389 Center Drive, Suite 200, Park City, Utah 84098. Our telephone number is (858) 997-3332.
2019 Highlights
Investments
During
2019, we acquired 35 properties, comprising approximately 1.9 million additional rentable square feet. As of December 31,
2019, we owned 46 properties that were 100% leased to state-licensed medical-use cannabis operators and comprising an
aggregate of approximately 3.1 million rentable square feet (including approximately 913,000 rentable square feet under
development/redevelopment) in Arizona, California, Colorado, Florida, Illinois, Maryland, Massachusetts, Michigan, Minnesota,
Nevada, New York, North Dakota, Ohio and Pennsylvania, with a weighted-average remaining lease term of approximately 15.3
years. As of December 31, 2019, we had invested an aggregate of approximately $491.6 million (consisting of purchase price
and development and tenant reimbursement commitments funded, if any, but excluding transaction costs) and had committed an
additional approximately $142.6 million to reimburse certain tenants and sellers for completion of construction and tenant
improvements at our properties. These statistics do not include up to approximately $57.8 million, in the aggregate, that
certain tenants may elect to be reimbursed in the future and pay the corresponding base rent pursuant to certain of our
leases as follows: approximately $16.4 million pursuant to our lease with GR Companies, Inc. (“Grassroots”) at
one of our Illinois properties, approximately $37.4 million pursuant to our lease with Trulieve Cannabis Corp.
(“Trulieve”) at one of our Massachusetts properties and $4.0 million pursuant to our lease with PharmaCann LLC
(“PharmaCann”) at one of our Pennsylvania properties. Subsequent to December 31, 2019, in February 2020, the $4.0
million construction funding commitment related to our lease with PharmaCann at one of our Pennsylvania properties was
canceled. For more information regarding our properties and tenants, see the sections entitled “— Tenant
Concentration” and “— Geographic Concentration” below.
Financial Results
|
|
Years Ended December 31,
|
|
|
|
|
|
|
2019
|
|
|
2018
|
|
|
Percentage
Increase
|
|
|
|
(dollars in thousands, except per share data)
|
|
Rental revenues (excluding tenant reimbursements)
|
|
$
|
43,352
|
|
|
$
|
14,342
|
|
|
|
202
|
%
|
Net income available to common stockholders
|
|
$
|
22,123
|
|
|
$
|
5,633
|
|
|
|
293
|
%
|
Net income available to common stockholders per share – diluted
|
|
$
|
2.03
|
|
|
$
|
0.75
|
|
|
|
171
|
%
|
AFFO(1)
|
|
$
|
34,895
|
|
|
$
|
9,727
|
|
|
|
259
|
%
|
AFFO per share – diluted(1)
|
|
$
|
3.27
|
|
|
$
|
1.34
|
|
|
|
144
|
%
|
Dividends per share of common stock declared
|
|
$
|
2.83
|
|
|
$
|
1.20
|
|
|
|
136
|
%
|
|
(1)
|
For a definition and discussion of adjusted funds from operations, or AFFO, and a reconciliation
of AFFO to net income attributable to common stockholders, see Item 7, “Management’s Discussion
and Analysis of Financial Condition and Results of Operations.”
|
Capital Raising
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, resulting in net proceeds of approximately $138.5 million, after deducting the initial purchasers’ discounts
and offering expenses.
In July 2019, we issued 1,495,000
shares of common stock, including the exercise in full of the underwriters’ option to purchase an additional 195,000 shares,
resulting in net proceeds of approximately $180.1 million.
In September 2019, we
entered into equity distribution agreements with three sales agents, pursuant to which we may offer and sell from time to
time through an “at-the-market” offering program (the “ATM Program”) up to $250.0 million in shares
of our common stock. Through February 28, 2020 we sold 2,328,782 shares of our common stock for net proceeds of approximately
$184.8 million under the ATM Program, and had approximately $61.4 million in shares of common stock available for future
issuance under the ATM Program.
Subsequent to the end of the
year, in January 2020, we issued 3,412,969 shares of common stock, including the exercise in full of the underwriters’ option
to purchase an additional 445,170 shares, resulting in gross proceeds of approximately $250.0 million.
Board of Directors
In December 2019, we
announced the appointment of Mary Allis Curran to our board of directors, expanding our board size to six, with four
independent directors. In January 2020, Ms. Curran was also appointed as a member of our board of director’s audit
committee and nominating and corporate governance committee. Ms. Curran spent 25 years at MUFG Union Bank, N.A. and held
several executive level positions during her tenure, including as Executive Vice President, Corporate Banking Chief Risk
Officer and Executive Vice President, Head of The Private Bank at Union Bank. Ms. Curran currently serves on the Board of
Directors, Audit Committee and Enterprise Risk Committee of Banc of California, Inc. (NYSE: BANC), a financial institution.
She also serves on the Board of Directors, Nominating/Governance Committee and Compensation Committee for Hunter Industries,
a privately held global irrigation, landscape lighting and custom manufacturing company.
Our Properties
Generally
We have acquired and intend to
continue to acquire specialized industrial real estate assets operated by state-licensed cannabis operators, primarily for medical
use, 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 licensed operators 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 our sale-leaseback strategy, we serve as a source of capital to these licensed medical-use cannabis growers,
allowing them to redeploy their sale proceeds into their core operations to grow their business and achieve higher returns. We
may also purchase properties from third parties and fund the necessary tenant improvements through a long-term lease with an identified
tenant, which provides those tenants with increased cash flow to deploy in their operating businesses.
As of December 31, 2019, 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. For additional information on our properties as of December 31, 2019,
see Item 2, “Properties.”
Our Competitive Strengths
We believe that we have the following
competitive strengths:
|
·
|
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.
|
|
·
|
Recurring Revenue with Contractual
Escalations. As of December 31, 2019, we had acquired 46 properties that were 100% leased on long-term, triple-net
leasing arrangements with licensed medical-use cannabis operators, 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.
|
|
·
|
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.
|
|
·
|
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 operators who have been among the top candidates in the rigorous
state licensing process.
|
|
·
|
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 operators on their existing and new state-licensed
cannabis facilities, presenting an opportunity for us to be a key capital provider in their expansion initiatives.
|
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:
|
·
|
Owning Specialized Industrial Properties
and Related Real Estate Assets for Income. We primarily acquire medical-use cannabis facilities from licensed
operators who will continue their cultivation, processing and/or dispensing 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 operators.
|
|
·
|
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.
|
|
·
|
Expanding as Additional States
Enact Medical-Use Cannabis Programs. We acquire properties in the United States, with a focus on states that
have established medical-use cannabis programs. As of December 31, 2019, we owned properties in 14 states, and we expect that our
acquisition opportunities will continue to expand as additional states legalize cannabis and license new operators.
|
|
·
|
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.
|
Our Target Markets
Our target markets include states
that have established medical-use cannabis programs. As of December 31, 2019, we owned 46 properties located in Arizona, California,
Colorado, Florida, Illinois, Maryland, Massachusetts, Michigan, Minnesota, Nevada, New York, North Dakota, Ohio and Pennsylvania.
According to the National Conference of State Legislatures, as of December 31, 2019, 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 they permit cannabis to
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,
continued legislative authorization of medical-use cannabis at the state level, support from local municipalities within a state,
and federal, state and local taxation of medical cannabis products. 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 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 produce at scale high-quality, high-consistency medical cannabis
products that drive in part their financial performance.
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 designated healthcare provider’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, 2019, 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:
|
·
|
significant industry growth in recent years and expected continued
growth;
|
|
|
|
|
·
|
a continuing shift in public opinion and increasing momentum toward
the legalization of medical-use cannabis under state law; and
|
|
|
|
|
·
|
limited access to capital by industry participants in light of
risk perceived by financial institutions of violating federal laws and onerous regulatory guidelines for offering banking
services to cannabis-related businesses.
|
Industry Growth and Trends
According to Arcview Market Research
and BDS Analytics, state-legal cannabis sales in the United States grew to an estimated $12.2 billion in 2019, an increase of 34%
over 2018’s total of $9.1 billion, and are expected to grow to over $31 billion by 2024.
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 2019 poll by Quinnipiac University found that 93% of Americans support patient access to medical-use cannabis, if recommended
by a doctor, which was the same level of support from a similar poll conducted by Quinnipiac University in 2018.
As of December 31, 2019, 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 2019.
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; impose significant taxes on regulated
cannabis products, in addition to taxes imposed by local municipalities; take limited enforcement actions against non-licensed
cannabis operators; restrict the method by which medical cannabis can be consumed; restrict the ability of alternative health care
providers to recommend medical cannabis for treatment; 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 and take other
actions to support the growth of the regulated cannabis program, 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. We believe that our sale-leaseback and other real
estate solutions offer an attractive alternative to state-licensed medical-cannabis operators 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 operations.
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 “— Governmental Regulation”
below and “Risks Related to Regulation” under Item 1A, “Risk Factors.”
Tenant Concentration
As of December 31, 2019, all
of our revenues were derived from 46 properties. The following table sets forth the four tenants in our property portfolio that
represented the largest percentage of our total rental revenue for the year ended December 31, 2019:
Tenant
|
|
Number of
Leases
|
|
|
Percentage
of
Rental Revenue (2)
|
|
PharmaCann(1)
|
|
|
5
|
|
|
|
26.2
|
%
|
Ascend Wellness Holdings, LLC(1)
|
|
|
2
|
|
|
|
11.7
|
%
|
Vireo Health, Inc. (1)
|
|
|
4
|
|
|
|
8.9
|
%
|
Green Peak Industries, LLC
|
|
|
7
|
|
|
|
7.3
|
%
|
Totals
|
|
|
18
|
|
|
|
54.1
|
%
|
|
(1)
|
Includes leases with affiliates of the entity, for which the entity has provided a corporate guaranty.
|
|
(2)
|
Excludes tenant reimbursements.
|
Many of our tenants are 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 2020, 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, California, Colorado, Illinois, Massachusetts and Michigan permit licensed adult-use cannabis operations,
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.
See each of the discussions under
Item 1A, “Risk Factors,” under the captions “Many of our existing tenants are, and we expect that many 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
“Because we lease our properties to a limited number of tenants, and to the extent we depend on a limited number of tenants
in the future, the inability of any single tenant to make its lease payments could adversely affect our business and our ability
to make distributions to our stockholders.”
Geographic Concentration
The following table sets forth
certain state-by-state information regarding our property portfolio for the year ended and as of December 31, 2019 (dollars
in thousands):
State
|
|
Number of
Properties
|
|
|
Percent
Leased
|
|
|
Rentable
Sq. Ft.(1)
|
|
|
Rental
Revenue
for
the Year Ended
December 31, 2019(3)
|
|
|
Percentage
of
Rental
Revenue
|
|
Arizona
|
|
|
2
|
|
|
|
100%
|
|
|
|
360,000
|
|
|
$
|
2,726
|
|
|
|
6.3%
|
|
California
|
|
|
10
|
|
|
|
100(2)
|
|
|
|
259,000
|
|
|
|
5,542
|
|
|
|
12.8
|
|
Colorado
|
|
|
1
|
|
|
|
100
|
|
|
|
58,000
|
|
|
|
1,357
|
|
|
|
3.1
|
|
Florida
|
|
|
1
|
|
|
|
100
|
|
|
|
120,000
|
|
|
|
357
|
|
|
|
0.8
|
|
Illinois
|
|
|
5
|
|
|
|
100
|
|
|
|
351,000
|
|
|
|
5,609
|
|
|
|
12.9
|
|
Maryland
|
|
|
1
|
|
|
|
100
|
|
|
|
72,000
|
|
|
|
2,711
|
|
|
|
6.3
|
|
Massachusetts
|
|
|
3
|
|
|
|
100
|
|
|
|
263,000
|
|
|
|
5,241
|
|
|
|
12.1
|
|
Michigan
|
|
|
10
|
|
|
|
100
|
|
|
|
488,000
|
|
|
|
5,506
|
|
|
|
12.7
|
|
Minnesota
|
|
|
1
|
|
|
|
100
|
|
|
|
89,000
|
|
|
|
1,062
|
|
|
|
2.4
|
|
Nevada
|
|
|
1
|
|
|
|
100
|
|
|
|
43,000
|
|
|
|
642
|
|
|
|
1.5
|
|
New York
|
|
|
2
|
|
|
|
100
|
|
|
|
167,000
|
|
|
|
6,497
|
|
|
|
15.0
|
|
North Dakota
|
|
|
1
|
|
|
|
100
|
|
|
|
33,000
|
|
|
|
40
|
|
|
|
0.1
|
|
Ohio
|
|
|
2
|
|
|
|
100
|
|
|
|
69,000
|
|
|
|
1,974
|
|
|
|
4.6
|
|
Pennsylvania
|
|
|
6
|
|
|
|
100
|
|
|
|
680,000
|
|
|
|
4,088
|
|
|
|
9.4
|
|
Total / Average
|
|
|
46
|
|
|
|
100%
|
|
|
|
3,052,000
|
|
|
$
|
43,352
|
|
|
|
100.0%
|
|
|
(1)
|
Includes approximately 913,000 square feet under development/redevelopment.
|
|
(2)
|
The tenant at our Los Angeles, California property is in receivership and defaulted on its obligations
to pay rent for January and February 2020. This property represented approximately 35,000 square feet and approximately $776,000
in rental revenue for the year ended December 31, 2019.
|
|
(3)
|
Excludes tenant reimbursements of approximately $1.3 million.
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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 regulated medical-use cannabis market
is in its early stages; is generally 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; is subject in many instances to significant taxation burdens at the federal, state and
local levels; competes in many instances with non-licensed cannabis operators due in part to limited enforcement by state and local
authorities; and may face opposition from local municipalities within a state, any of which may contribute to a particular 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 exchangeable 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 an automatic shelf
registration statement, 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, 2019, we
owned 46 properties located in 14 states. Many of our tenants are tenants at multiple properties. 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 20% of our total assets and that properties leased
to a single tenant (individually or together with its affiliates) will not exceed 20% 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. Many of our existing tenants are, and we
expect that many 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. We compete
for the acquisition of properties primarily based on purchase price and the rental rates that we charge in our sale leaseback transactions.
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 may enforce U.S. drug laws against companies
operating in accordance with state cannabis 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, then-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 remains 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, 2020, 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, process and/or
dispense adult-use cannabis now (and 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, processing 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 Item 1A, “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, processing 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, processing and/or dispensing of medical-use cannabis. 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, including,
but not limited to, regulations governing the medical cannabis program (such as the type of cannabis products permitted under
the program, qualifications and registration of health professionals that may recommend treatment with medical cannabis, and the
types of medical conditions that qualify for medical cannabis), the level of enforcement by state and local authorities on non-licensed
cannabis operators, state and local taxation of regulated cannabis products, local municipality bans on operations and operator
licensing processes and renewals. As a result of these and other factors, if our tenants default under their leases, we may not
be able to find new tenants that can successfully engage in the cultivation, processing or dispensing of medical cannabis on the
properties.
Laws Applicable to Financial Services 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 remains 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.
In addition, for our tenants
that are publicly traded companies, securities clearing firms may refuse to accept deposits of securities of those tenants, which
may negatively impact the trading and valuations of such tenants and have a material adverse impact on our tenants’ ability
to finance their operations and growth through the capital markets.
The increased uncertainty surrounding
financial transactions related to cannabis activities may also result in financial institutions discontinuing services to the cannabis
industry. See Item 1A, “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 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 regulated cannabis industry, conditions in the financial markets and economic conditions.
Because we lease our properties to a limited number of
tenants, and to the extent we depend on a limited number of tenants in the future, the inability of any single tenant to make its
lease payments could adversely affect our business and our ability to make distributions to our stockholders.
As of December 31, 2019,
we owned 46 total properties. Four of our tenants, PharmaCann (at five of our properties), Ascend Wellness Holdings, LLC (at
two of our properties), Vireo Health, Inc. (at four of our properties) and Green Peak Industries, LLC (at seven of our
properties), represented approximately 26%, 12%, 9% and 7%, respectively, of our rental revenues (excluding tenant
reimbursements) for the year ended December 31, 2019. 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 or tenant 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 cannabis markets not developing and growing in ways that we or our tenants projected,
or any adverse change in the political climate regarding cannabis where our properties are located, would subject us to a
significant risk of loss.
In addition, failure by any of 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. For example, the tenant at our property located in Los Angeles, California is in receivership and defaulted on its
obligation to pay rent to us for January and February 2020. 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 retail sale, cultivation or production of medical-use cannabis and alternative financing
sources for licensed operators 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 retail sale, cultivation or production of medical-use cannabis with
other entities engaged in retail, 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.
By
way of example, Congress has introduced several proposed bills focused on the regulated cannabis industry, including the Marijuana
Opportunity Reinvestment and Expungement Act (the “MORE Act”) and the Secure and Fair Enforcement (SAFE) Banking Act
of 2019 (the “SAFE Banking Act”). If it became law, the MORE Act, introduced by U.S. Senator Kamala Harris and U.S.
Representative Jerrold Nadler in July 2019, would, among other things, remove cannabis as a Schedule I controlled substance under
the CSA and make available U.S. Small Business Administration funding for regulated cannabis operators.
If it became law, the SAFE Banking Act would, among other things, provide protection from federal prosecution to banks and other
financial institutions that provide financial services to state-licensed, compliant cannabis operators, which may include the provision
of loans by financial institutions to such operators. If any of the proposed bills in Congress became law, there would be further
increased competition for the acquisition of properties that can be leased to licensed medical-use cannabis operators, and such
operators would have greater access to alternative financing sources with lower costs of capital. These factors may reduce the
number of operators that wish to enter into lease transactions with us or renew leases with us, or may result in us having to enter
into leases on less favorable terms with tenants, each of which may significantly adversely impact our profitability and ability
to generate cash flow and make distributions to our stockholders.
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 operators under triple-net lease agreements. We also target properties owned by operators
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 many
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, and these businesses are subject to numerous risks and uncertainties,
including but not limited to regulatory risks and the rapidly evolving market dynamics of each state’s regulated cannabis
program. 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 many of 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, including cash received from debt
financings.
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 or other changes in the marketplace for their products, 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, in California,
the illicit market for cannabis in California remains a much larger portion of overall sales in the state, and state and local
authorities have assessed significant taxes on regulated cannabis products, both of which have had the impact of significantly
limiting the growth of the regulated cannabis market.
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 (for more information, 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 be subject to
significant debt obligations and may rely on debt financing to make rent payments to us. 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 October 2019, a court
appointed a receiver over all property and assets of the tenant at our Los Angeles, California property. That tenant
subsequently defaulted on its obligations to pay rent in January and February 2020.
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.
Our tenants may be unable
to renew or otherwise maintain their licenses or other requisite authorizations for their cannabis operations, which may result
in such tenants not being able to operate their businesses and defaulting on their lease payments to us.
Most states where we own properties issue
licenses for medical-use cannabis operations for a limited period. We rely on our tenants to renew or otherwise maintain the requisite
state and local cannabis licenses and other authorizations on a continuous basis. If one or more of our tenants are unable to
renew or otherwise maintain its licenses or other state and local authorizations necessary to continue its cannabis operations,
such tenants may default on their lease payments to us.
Any such noncompliance by our tenants of
state and local laws, rules and regulations may also subject us, as the owner of such properties, to potential penalties, fines
or other liabilities.
Any lease payment defaults by a
tenant or additional liability on us 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.
We acquired our properties, and expect to 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 expect
to 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.
As of February 28, 2020, we owned properties
in 15 states, and we expect that the properties that we acquire will be geographically concentrated in these states and other states
that have established medical-use cannabis programs. See “Geographic Concentration” under Item 1, “Business”
for a table of properties owned by us and organized by state as of December 31, 2019. 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 state medical-use cannabis market fails to develop and grow in
ways that we or our tenants projected;
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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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access to capital may be more restricted, or unavailable on favorable
terms or at all in certain locations;
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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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the impact of national, regional or state specific business cycles
and economic instability; and
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potentially adverse tax consequences.
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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 primarily
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 and processing 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 and processing 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 medical-use cannabis operations, 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 and processing
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 facilities leased for medical-use cannabis operations.
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 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 (or depreciation) on the real estate investments we have acquired and 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.
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.
We face significant risks associated with the development
and redevelopment of properties that we acquire.
In many instances, we 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 or our tenant’s
original estimates due to increases in materials, labor or other costs, which could make the project less profitable for our
tenant, require us or our tenant to commit additional funds to complete the project and adversely impact our tenant’s
business and prospects as a result;
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permitting or construction delays, which may result in increased project
costs, as well as deferred revenue and delayed commencement of operations by our tenant;
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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 hurricanes,
landslides, earthquakes, floods, drought, wildfires and other events, which may result in delays or increased costs.
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The realization of any of the risks
above or other delays in development and redevelopment activities at a property may also materially adversely impact our
tenant’s ability to commence, continue or expand its operations, which may result in that tenant defaulting on its rent
obligations to us. As of February 28, 2020, we had properties consisting of an aggregate of approximately 871,000 square feet
under development or redevelopment. As of February 28, 2020, we had committed to provide construction funding and fund tenant
improvements at our properties in the future totaling up to approximately $169 million.
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. Because cannabis remains illegal under federal law, there is no assurance
that federal bankruptcy courts will provide relief for parties who engage in cannabis-related businesses. Recent bankruptcy court
rulings have denied bankruptcy relief for certain cannabis businesses on the basis that businesses cannot violate federal law and
then claim the benefits of federal bankruptcy for such activity and on the basis that courts cannot ask a bankruptcy trustee to
take possession of, and distribute cannabis assets, as such action would violate the CSA. Any inability of our tenants to seek
bankruptcy protection may impact their ability to secure financing for their operations and prevent 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.
Generally, under bankruptcy law, a tenant
who is the subject of bankruptcy proceedings may continue (“assume”) or give up (“reject”) any unexpired
lease of non-residential real property. If a bankrupt tenant decides to give up (reject) a lease, any claim for breach of the
lease is treated as a general unsecured claim in the tenant’s bankruptcy case, subject to certain exceptions for collateral
and guarantees. In the event one of our tenants is permitted to seek bankruptcy protection in the U.S., our general unsecured
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. 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.
In October 2019, a court appointed a receiver over all property and assets of the tenant at our Los Angeles,
California property. That tenant subsequently defaulted on its lease payments to us in January and February 2020.
Our tenants may be subject to Section 280E of the Code
because of the nature of their business activities, which could have an adverse impact on their financial condition due to a disallowance
of certain tax deductions.
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. Our tenants are engaged in the cultivation, processing and sale
of cannabis and cannabis-related products, and therefore may be subject to Section 280E. Application of the provisions of Section
280E to our tenants would result in the disallowance of certain tax deductions, including for depreciation or interest expense,
which could have an adverse impact on their respective financial condition and ability to make lease payments to us. Any lease
payment defaults by a tenant could adversely affect our results of operations and cash flows, and cause us to reduce the amount
of distributions to our stockholders.
We have
acquired and may continue to acquire cannabis retail stores and dispensaries and enter into leases with licensed operators for
those properties, which present additional risks and challenges in comparison to properties for the cultivation and production
of medical-use cannabis.
We
have acquired and may continue to acquire cannabis retail stores and dispensaries and enter into leases with licensed operators
for those locations. Cannabis retail stores and dispensaries entail risks that could adversely impact our financial condition and
results of operations, and that are in addition to risks associated with regulated cannabis cultivation and processing facilities,
including but not limited to:
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the impact of the continued evolution of
the retail distribution model for cannabis and customer preferences, including the impact of e-commerce and home delivery
on demand for cannabis retail space;
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negative perceptions by customers of the
safety, convenience and attractiveness of cannabis dispensaries;
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the handling of significant cash transactions
and cannabis inventory at the property, which may increase security risks associated with dispensary operations;
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local real estate conditions (such as an
oversupply of, or a reduction in demand for, cannabis retail space);
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our and our tenants’ ability to procure
and maintain appropriate levels of property and casualty insurance; and
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risks associated with data breaches through
cyberattacks, cyber intrusions or otherwise that expose customer personal information at dispensaries, which may result in liability
and reputational damage to our tenants and our company.
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realization of any of the risks above, among others, with respect to one or more of our properties or tenants could have a material
adverse impact on our business.
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, hurricanes,
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.
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.
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.
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 cyberattacks 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 cyberattacks 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 cyberattack 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, 2020, 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, Illinois, 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 operations. Any change in the federal government’s enforcement posture
with respect to state-licensed cannabis operations, 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
operations 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, California, Colorado, Illinois, Massachusetts and Michigan
permit licensed adult-use cannabis operations, 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.
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 cannabis operations may
be modified or eliminated in the future.
We have acquired and are targeting for
acquisition properties that are owned by state-licensed cannabis operators. Relevant state or local laws may be amended or repealed,
or new laws may be enacted in the future to eliminate existing laws permitting cannabis operations. 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 conduct
cannabis operations 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.
For example, in connection with the Centers
for Disease Control and Prevention identifying cases of vaping-related lung injuries, certain state and local governments have
instituted temporary bans. In addition to litigation and reputational risks surrounding vaping-related lung injuries, bans or heightened
regulations, especially if they become permanent, could have a material adverse impact on our tenants’ operations in those
states and localities where such a ban or other restrictive regulation has been implemented.
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 cannabis operations, 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, not strictly enforcing regulations for non-licensed
cannabis operators, 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 and other financial institutions, 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 remains 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. Only a small percentage of financial institutions in the United States
currently provide banking services to licensed cannabis operators. 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.
In addition, for our tenants that are publicly
traded companies, securities clearing firms may refuse to accept deposits of securities of those tenants, which may negatively
impact the trading and valuations of such tenants and have a material adverse impact on our tenants’ ability to finance their
operations and growth through the capital markets.
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, processing or dispensing
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,
processing or dispensing, 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 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 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.
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
DOJ 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, 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, processing or dispensing 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, changes in market conditions for the
regulated 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, production or dispensing 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.
In addition, securities clearing firms may refuse to accept
deposits of our securities, which may negatively impact the trading of our securities and have a material adverse impact on our
ability to obtain capital.
Our Exchangeable Senior Notes and any future indebtedness
reduces our cash available for distribution and may expose us to the risk of default.
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 subsidiaries, 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; in addition,
due to losing emerging growth company status on December 31, 2019, we have incurred and continue to incur substantial costs, and
significant demands are being placed upon management in connection with continued compliance with non-emerging growth company requirements
earlier than we had planned.
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.
In addition, as an emerging growth
company, we previously benefited from certain temporary exemptions from various reporting requirements. On December 31, 2019, we
lost emerging growth company status due to our becoming a large accelerated filer, which required us to significantly accelerate
our compliance efforts to, for example, engage our independent registered public accounting firm to attest to the effectiveness
of our internal controls as required by Section 404(b) of the Sarbanes-Oxley Act in this Annual Report on Form 10-K.
Furthermore, as an emerging
growth company, we had elected under the Jumpstart Our Business Startups Act of 2012 (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. Due to our ceasing to be an emerging growth company on December 31, 2019, we are no longer
eligible to delay adoption of such new or revised accounting pronouncements applicable to public companies.
As a result, we have incurred
and expect to continue to incur significant additional costs beyond what we had planned as an emerging growth company. Also, due
to the complexity and logistical difficulty of implementing the standards, rules and regulations that apply to non-emerging growth
companies, such as Section 404(b) of the Sarbanes-Oxley Act, on an accelerated timeframe, the risk of our non-compliance with such
standards, rules and regulations or of significant deficiencies or material weaknesses in our internal controls over financial
reporting is increased.
In addition, these public company
requirements, including the enhanced requirements as a result of our losing emerging growth company status, 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.
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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the performance of our current properties and additional properties
that we acquire;
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our ability to make acquisitions on preferable terms or at all;
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equity issuances by us, including issuances by us of shares of common
stock in connection with exchanges of our Exchangeable Senior Notes or under our ATM Program, 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 an automatic shelf
registration statement, 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 February 28, 2020, 17,035,660 shares
of our common stock were issued and outstanding, and we had reserved an additional 761,091 shares of common stock for future issuance
under our 2016 Omnibus Incentive Plan (the “2016 Plan”) and 2,100,307 shares potentially issuable upon exchange of
our Exchangeable Senior Notes (based on the exchange rate as of February 28, 2020). In addition, as of February 28, 2020, we had
approximately $61.4 million in shares of common stock available for future issuance under the ATM Program. The existence of operating
partnership units, Exchangeable Senior Notes, shares of Series A Preferred Stock, shares of our common stock reserved for issuance
under our 2016 Plan and shares available for future issuance under the ATM Program 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.
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 made an election to be taxed as
a REIT under Sections 856 through 860 of the Code commencing with our taxable year ended December 31, 2017. We believe that we
have been organized and operated in such a manner as to qualify for taxation as a REIT under the Code for such taxable year and
all subsequent taxable years to date, and intend to continue to operate in such a manner in the future. 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 (for taxable years beginning before December 31, 2017), on our taxable income
at regular corporate rates (and possibly increased state and local taxes. 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 taxable REIT subsidiaries (“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 20% 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.
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.
Non-corporate stockholders, including individuals,
generally may deduct 20% of dividends from a REIT, other than capital gain dividends and dividends treated as qualified dividend
income, for taxable years beginning after December 31, 2017 and before January 1, 2026. If we fail to qualify as a REIT, such stockholders
may not claim this deduction with respect to dividends paid by us.
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, provided, however,
losses in a TRS arising in taxable years beginning after December 31, 2017 may only be deducted against 80% of future taxable
income in the TRS.
Re-characterization
of sale-leaseback transactions may cause us to lose our REIT status.
We
purchase many properties and lease them back to the sellers of such properties. While we will use our best efforts to structure
any such sale-leaseback transaction so that the lease will be characterized as a “true lease,” thereby allowing us
to be treated as the owner of the property for federal income tax purposes, the Service could challenge such characterization.
In the event that any sale-leaseback transaction is challenged and re-characterized as a financing transaction or loan for federal
income tax purposes, deductions for depreciation and cost recovery relating to such property would be disallowed. If a sale-leaseback
transaction were so re-characterized, we might fail to satisfy the REIT qualification “asset tests” or the “income
tests” and, consequently, lose our REIT status effective with the year of re-characterization. Alternatively, the amount
of our REIT taxable income could be recalculated which might also cause us to fail to meet the distribution requirement for a
taxable year.
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 remains unclear 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.