New Lake Capital, IIPR And Cannabis REITs

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Concept image of Business Acronym REIT as Real Estate Investment Trust. 3d rendering

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Julian Lin and Bengal Capital’s Jerry Derevyanny discuss NewLake Capital and cannabis REITs (0:20). Valuations are up; yields are down – should that be telling investors something? (3:00) Redeployment risk in IIPR and other REITs (5:50). This is an excerpt from a recent episode of The Cannabis Investing Podcast.

Transcript

Rena Sherbill: Jerry Derevyanny and Julian Lin, always great to talk to you individually. Excited about this conjoining effort.

Jerry Derevyanny: I did have a question for Julian.

Julian Lin: Absolutely.

JD: We’ve debated some of the REITs and some of the debt providers, publicly traded debt providers in this space. Do you have like a current view on what their dividend yields look like and how you’re looking at those opportunities?

JL: Yeah, I think the main one we were talking about before was NewLake Capital (OTCQX:NLCP). Definitely now it’s trading at around an 8% dividend yield. I would say from a valuation perspective, it’s still interesting, right?

Especially when you have the traditional REITs trading more around the 5.5% range, but it’s definitely going to be way less compelling than what we were talking before.

I think we were talking before it was at a 12% yield. And one of the interesting points back then was like, it was so cheap that what is it like, they could have wrote down their assets, but was it like 50% and shareholders will still be good on the money.

Those kinds of dynamics are not quite the same now. So, the interesting thing with these REITs, these net lease REITS, especially NewLake Capital is, as their valuations expand, the risks facing them change, right? It’s not quite there yet, but when (NYSE:IIPR) was trading at like a 1%, 2% yield, a big risk was ironically just legalization and this idea that more capital could flow into the sector, just because that will stop their growth.

But when a stock, even if it’s trading at 8% yield, slowing growth probably is not really that much of an issue, just because that yield is already high enough, but what I could say about NewLake Capital is it’s definitely a team to look at.

Just look at how they executed the last many quarters. You don’t typically see, even outside the cannabis sector with REITs, you don’t typically see these management teams do what they did in that their stock was low, and what NewLake Capital did was instead of just buying more investments at the same valuation as their stock, they were buying back stock at a 12%, 10%, 11% yield. They initially were resistant, but at some point they started doing that and then they got more and more into it. And that’s just incredible.

So, you get to assume that they focus on being very lean. They’re generating this 80% actual cashflow margins that are not like adjusted by inventory or whatever. And then they were just deploying all excess capital into share repurchases instead of trying to grow the business.

And that’s exactly what you want to see a company do when their stock is really cheap. But yeah, I mean, just the short answer to your question would be, obviously the opinion is going to change as the valuation goes higher.

JD: That’s interesting. Yeah, it totally makes sense. I did notice that the valuations had ticked up, so the yields are down. I guess my question would be, not disagreeing at all, but isn’t that telling you something?

If NewLake Capital is going, hey, right now, if you look at their portfolio yields, I’m pretty sure they’re somewhere in the 13%, 14% right? In terms of what their leases that they’ve given out are yielding, just raw without expenses, right?

If they’re telling you that, hey, instead of making more leases, which are going to yield 13%, 14%, whatever percent it is raw, we’re just going to buy back our stock at that 12% implied yield, that’s telling you something on potentially how much – what they see the market and how the returns are looking.

I guess one of the ways that I also think about it, you’re talking about as legalization comes, most likely they will see – it’ll be interesting to see if they do take price hits and what will shift because the other thing that happens is they get leverage that gets available to them at most likely cheaper prices than they have it now.

And so, you would start to potentially see them become as levered as other REITs, comparable REITs are, because a lot of real estate investment trusts are, there’s a very big layer of debt and then a smaller layer of equity. And these – cannabis is unique in that they’re almost all, I think equity.

IIPR in particular has debt as a very small part of that capital that went into that company. And so, your return on equity might still be very, very good as they add leverage, but anyway, I just wanted your view on it because I think you’re very well educated. I was wondering what you thought.

JL: Yeah, I think you’re right. Of course, if there was going to be some repricing, as you mentioned, as legalization happens, it’s important to note that the leases still don’t expire until, I think there’s still another 10, 11 years left.

And typically in these net lease situations, these leases are ironclad unless the company goes bankrupt. And even then the new operator, they still have to assume the lease.

But yeah, as you’ve mentioned, even if they have to reprice, when these leases expire, that will be offset by leverage. And I think we might have even understated how much leverage these companies usually take.

For example, Realty Income (O) is considered to be one of the least levered companies in the sector, and they’re at like 5x or 5.5x debt-to-EBITDA, whereas NewLake has just no leverage at all. So, they have a lot of ways to go there, but I think they still look attractive, relative to just a traditional net-lease REIT, but yeah, my conviction is definitely a lot lower than when it was at a 12% yield.

JD: I think for me, the biggest, not the biggest, but one of the big risks with IIPR is that, or the REITs generally I should say, is that redeployment risk, right? As this money is coming back, eventually like all, your leases will come due and the market needs to take a view on, okay, well, what is the yield going to be on the leases that follow.

And all of that is going to be reflected in your net present value at some point. And so, I worry about if the market takes the view that your redeployment yields are going to be much lower, how does that reflect and then leverage. I don’t think – there’s a lot of moving pieces. I don’t know if you can go into it. Do you look at any of the other debt providers like a AFC Gamma (AFCG), Silver Spike (SSIC), do you take views on those?

JL: So I tend to not look at something like AFC Gamma just because they they’re externally managed and that tends to really change the game for the investor. But yeah, so you do bring a good point. And this is very important, like this redeployment.

In this case, it’s not really redeployment of assets, that’s more like when the lease expires and if everything’s legalized, just the asset all of a sudden, the rent might be cut by half or something, right? And that could be a big sticker shock for investors. So, as I mentioned before, when the stock is much cheaper, these risks are not so important.

For example, like when the NewLake was yielding 12%, and you’re thinking, oh, maybe in 12 years, if cannabis is legalized and they have to cut rent by half, that might be bad, but at the same time you’re like, okay, even if we assume they cut rent in half right now, they’re still going to be cheaper than a conventional net lease REIT like Realty Income, in which case you’re like, okay, that apocalyptic scenario is not so bad at all, right?

But when the yield all of a sudden has dropped to 8%, still attractive, but that same idea that, okay, if they cut it in half, it’s not quite the same, right? Suddenly they will actually be more expensive than one of those traditional REITs.

So, this kind of risk emerges just as the valuation gets higher and higher. So, it’s definitely something to keep in mind of in case someone was ignoring it before, it’s not something you can keep ignoring forever.

Related Articles:

My Top Pick: NewLake Capital Yields 12% With Net Cash Balance Sheet And Built-In Growth

Bengal Capital FY2023 Letter

Cannabis Investing Masterclass With Julian Lin + Jerry Derevyanny

Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.



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