Could New Marijuana Funding Regulations Threaten Innovative Industrial Property Stock?
Raising capital is a constant challenge for American cannabis companies. Because marijuana remains illegal under federal law, financial institutions are loath to lend to businesses in the industry, even when state laws permit cannabis use.
To circumvent this constraint, many cannabis companies are opting for creative solutions – including entering into sale-leaseback agreements with Innovative industrial properties (IIPR 3.91%)a real estate investment trust (REIT).
Innovative Industrial Properties’ business model is to purchase cannabis cultivation and processing properties, providing sellers with the capital they need to grow and operate their businesses. IIP then immediately rents out these new purchases to previous landlords, earning a long-term revenue stream through their rent payments. This model works well in the current legal situation, where traditional funding is hard to come by for cannabis companies. But everything could be about to change, and that could be a problem for the IPI.
Opening the door to cannabis banking
It is quite possible that the federal barriers preventing banks from doing business with cannabis companies will soon be removed. Lawmakers in the House of Representatives recently introduced the CLIMB Act (Capital Lending and Investment for Marijuana Businesses). If passed, the CLIMB Act would mean that private financial institutions and government agencies like the Small Business Administration would no longer be threatened with federal penalties for doing business with legal cannabis companies.
Yet similar attempts at federal marijuana funding reform have failed, including most recently on June 23, when the SAFE Banking Act was removed from the omnibus spending bill pending in Congress. The House of Representatives has passed versions of the SAFE Banking Act numerous times, but progress on them has always stalled in the Senate.
And more broadly, the prospects for federal marijuana legalization remain uncertain.
In addition to the CLIMB Act, smaller-scale reform attempts are underway. A bill in Pennsylvania has passed the state legislature and is awaiting the governor’s signature. If enacted, it will protect financial institutions and insurance companies from state-level lawsuits if they choose to work with cannabis companies. But federal regulations would still pose a threat, so it’s unclear whether Pennsylvania’s bill would change the status quo.
Give IIP some competition
The bill in Pennsylvania is unlikely to be a major threat to Innovative Industrial, but it could be a minor threat. Pennsylvania is home to approximately 13.8% of IIP properties, a higher percentage than any other state. Nonetheless, since lenders would still be exposed to federal legal liability, removing their risk at the state level would likely not result in much change in the banking environment. And even if local banks and credit unions were no longer intimidated, IIP could still play a role in the financing process. After all, most public companies can issue stock, incur debt, and use a range of other capital-raising tools to raise cash. Facilitating one avenue does not completely destroy demand for others.
In contrast, the CLIMB Act would be a game-changer in all states where IPI operates, and its consequences could be more severe. While the previous point about companies using multiple types of financing still applies, selling a company’s core properties to raise working capital is probably not the first tool most management teams will use. if they can legally take out loans at a decent interest rate. .
On the other hand, even if the CLIMB Act is passed, the REIT would still own over 8.1 million square feet of space that it could lease. For small marijuana businesses that are just getting started, perhaps with the help of easier access to financing afforded by the new regulations, it might be cheaper to lease facilities from IIP than to build them. And if demand for such facilities increases amid a new cannabis gold rush, it could pivot to building new locations rather than doing sale-leasebacks. So Innovative Industrial shareholders probably shouldn’t panic. A financially more favorable regulatory environment for the cannabis industry could prove to be another opportunity for IPI in the long run.
Alex Carchidi holds positions in Innovative Industrial Properties. The Motley Fool fills positions and recommends innovative industrial properties. The Motley Fool has a disclosure policy.