Raising capital is a constant challenge for U.S. cannabis companies. Because marijuana remains illegal under federal law, financial institutions are loath to make loans to businesses in the industry, even where state laws permit cannabis use.
To get around this constraint, many cannabis businesses opt for creative solutions — among them, entering into sale-leaseback deals with Innovative Industrial Properties (IIPR -1.49%), a real estate investment trust (REIT).
Innovative Industrial Properties’ business model involves buying cannabis cultivation and processing properties, thereby providing the sellers with the capital they need to grown and operate their businesses. IIP then immediately leases back those new purchases to the prior owners, gaining a long-term income stream from their rent payments. That model works well in the current legal situation, where traditional financing is hard for cannabis companies to come by. But everything might be about to change, and that could be a problem for IIP.
Opening the bank door to cannabis
There’s a real possibility that the federal impediments preventing banks from dealing with cannabis companies will be removed soon. Legislators in the House of Representatives recently introduced the Capital Lending and Investment for Marijuana Businesses (CLIMB) Act. If it passes, the CLIMB Act would mean that private financial institutions and government agencies like the Small Business Administration would no longer face the threat of federal sanction for doing business with legal cannabis companies.
Still, similar attempts at federal marijuana finance reform have stumbled, including most recently on June 23, when the SAFE Banking Act was stripped from the omnibus spending bill working its way through Congress. The House of Representatives has passed versions of the SAFE Banking Act on numerous occasions, but progress on those has always come to a halt in the Senate.
And more broadly, the outlook for federal marijuana legalization remains uncertain.
Aside from the CLIMB Act, smaller-scale attempts at reform are in progress. A bill in Pennsylvania has passed the state legislature and is awaiting the governor’s signature. If it gets signed into law, it would protect financial institutions and insurance companies from state-level prosecution if they choose to work with cannabis businesses. But federal regulations would still pose a threat, so it’s unclear if the Pennsylvania bill would change the status quo.
Giving IIP some competition
The bill in Pennsylvania is unlikely to be a major threat to Innovative Industrial, but it could be a minor one. Pennsylvania is home to around 13.8% of IIP’s properties, a greater percentage than any other state. Nonetheless, given that lenders would still be exposed to federal legal liability, removing their state-level risk would probably not lead to much of a change in the banking environment. And even if local banks and credit unions weren’t intimidated any longer, IIP could still play a role in the financing process. After all, most public companies can issue stock, take out debt, and use a range of other capital-raising tools to get cash. Making one avenue easier doesn’t completely destroy demand for the others.
In contrast, the CLIMB Act would change the game in every state where IIP operates, and its consequences might be more serious. Though the previous point about businesses utilizing multiple types of financing would still apply, selling a company’s core properties to raise operating capital probably isn’t the first tool that most management teams will reach for if they can legally take out loans at a decent interest rate.
On the other hand, even if the CLIMB Act passes, the REIT would still be the owner of more than 8.1 million square feet of space that it could rent out. For smaller marijuana businesses that are just getting started, perhaps with the help of the easier access to financing enabled by the new regulations, it might be cheaper to lease facilities from IIP than to build them. And if demand for such facilities surges amid a new cannabis gold rush, it could pivot into building out new locations rather than doing leasebacks. So Innovative Industrial shareholders probably shouldn’t be panicking. A regulatory environment that is financially friendlier to the cannabis industry could turn out to be another opportunity for IIP in the long run.
Alex Carchidi has positions in Innovative Industrial Properties. The Motley Fool has positions in and recommends Innovative Industrial Properties. The Motley Fool has a disclosure policy.