Innovative Industrial Properties - Q1 2024

Transcript

Operator (participant)

Good day, and welcome to the Innovative Industrial Properties Q1 2024 earnings call. All participants will be in listen-only mode. Should you need assistance, please signal a conference specialist by pressing the star key, followed by zero. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star, then one on a touch-tone phone. To withdraw your question, please press star, then two. Please note, this event is being recorded. I would now like to turn the conference over to Brian Wolfe, General Counsel. Please go ahead.

Brian Wolfe (General Counsel)

Thank you for joining the call. Presenting today are Alan Gold, Executive Chairman, Paul Smithers, President and Chief Executive Officer, David Smith, Chief Financial Officer, Catherine Hastings, Chief Operating Officer, and Ben Regin, Chief Investment Officer. Before we begin, I'd like to remind everyone that statements made during today's conference call may be deemed forward-looking statements within the meaning of the Safe Harbor of the Private Securities Litigation Reform Act of 1995, and actual results may differ materially due to a variety of risks, uncertainties, and other factors. Please refer to the documents filed by the company with the SEC, specifically the most recent reports on Forms 10-K and 10-Q, which identify important risk factors that could cause actual results to differ from those contained in the forward-looking statements.

We are not obligated to publicly update or revise any forward-looking statements, whether as a result of new information, future events, or otherwise. In addition, on today's call, we will discuss certain non-GAAP financial information, such as FFO, normalized FFO, and adjusted FFO. You can find this information, together with reconciliations to the most directly comparable GAAP financial measure in our earnings release issued yesterday, as well as in our 8-K filed with the SEC. I'll now hand the call over to Alan. Alan?

Alan Gold (Executive Chairman)

Thank you, Brian, and welcome everyone. We are pleased to discuss our results here today as we enter into our eighth full year of operations. The first four months of 2024 have been very productive for our team, with our focus on driving leasing activity and monitoring the completion of significant development projects at our properties, along with continued support of our tenants in funding critical infrastructure improvements to both further enhance production capacity and efficiency and activate significant projects under development. In the first four months of 2024, the company executed new leases at four properties, representing $69 million of invested capital, and completed construction on three fully leased properties, totaling 732,000 sq ft. We also strategically divested our Los Angeles, California, property, which was leased until the closing, with a combined consideration exceeding our carrying value of the property.

As you may recall, that property was never fully built out for cannabis operations. Ben and Catherine will discuss this progress in more detail. The company notched another solid quarter in Q1, generating $2.21 in AFFO per share, and further enhancing the company's liquidity position in the first four months of the year, with the upsizing of its revolving credit facility from $30 million-$50 million. While AFFO per share was down modestly quarter-over-quarter, we note that rents for the new leases we executed in late 2023 and year to date are not expected to commence for some months to come, as new tenants need the time to obtain the requisite approvals to operate and transition into these properties, in addition to certain pre-lease properties under development where construction needs to be completed.

As we have reiterated in the past, we are really pleased with our capital position, especially in light of the macroeconomic environment impacting real estate companies and the cannabis industry as a general matter. Our total available liquidity exceeded $200 million as of the quarter end and fully funds any remaining development commitments we have, along with providing ample dry powder for additional strategic investments. As Ben will share in more detail, we are evaluating a number of promising new investments in several state markets. Additionally, we have one of the lowest levered balance sheets in the REIT industry at 11% debt to total gross assets. No variable rate debt, no debt maturities until May 2026. David will provide more detail, as well as our financial results for the quarter and capital position.

From a regulatory perspective, all eyes continue to be focused on potential rescheduling of cannabis from Schedule I to Schedule III under the Controlled Substances Act. With the recent media reports indicating that the DEA is expected to agree with the HHS recommendation on this matter. Paul will discuss our thoughts in more detail on this rescheduling process, pending federal legislation and state-level dynamics that we are seeing. I will now turn the call over to Paul to discuss market dynamics and regulatory developments. Paul?

Paul Smithers (President and CEO)

Thanks, Alan. I would like to start with some general macroeconomic observations from our perspective that are impacting the regulated cannabis industry. 2023 was another year of strong growth in terms of overall unit volume for regulated cannabis sales across the United States. However, overall regulated cannabis sales growth from a dollars perspective was more subdued, given the price compression that continued through the year in many states. Although some of that price compression was driven by oversupply of regulated products in a particular market, we see much of the compression continuing to come from the illicit market. In particular, illicit grows in California that both compete within the state and have products that are transported across the country.

All that said, the outlook for overall growth of the regulated cannabis industry remains robust, with MJ Business's most recent fact book, published in late April, projecting overall U.S. regulated sales to grow from $32 billion in 2024-$58 billion by 2030. At the same time, we are seeing some relief on those pricing pressures, which gives us more optimism for 2024 and beyond, as operators focus on the strength of their brands, driven in large part by the quality and consistency of their products. We also believe that the push by many of the multi-state operators to become more efficient and cost-conscious in this environment should bode well for their future financial results.

From a state market perspective, we continue to see divergence in performance and dynamics, with new markets experiencing high growth, while some mature markets become increasingly competitive, especially after the aforementioned extended period of price compression and the challenges in competing with the illicit markets. For example, as we noted on our last call, 2023 saw strong rollouts for adult use sales in Missouri and Maryland, both of which also benefited from cross-border purchasing by residents in neighboring states with either a medical use-only program or no program at all. Ohio, which legalized adult use in November, is expected to commence sales this year and earlier than originally anticipated, perhaps in June.

While Ohio is expected to be one of the fastest-growing markets in the near future and follows on the heels of very successful adult use introductions in Missouri and Maryland, New York's adult use program, which was introduced more than a year ago in December of 2022, has struggled. With total illicit and legal demand estimated in excess of $5 billion, New York's regulated sales in 2023 came in at well below $1 billion for the year. However, there have been certain recent developments that make us significantly more optimistic on the prospects for New York market, including the ramping up of licensing for retail stores, stronger enforcement against illicit operations, and regulatory authorities allowing incumbent medical use operators to begin wholesaling.

I would also like to touch on two other states that are in the running for adoption of adult use programs in the near term: Florida and Pennsylvania. In Florida, earlier this month, the Florida Supreme Court cleared the way for a legalization initiative on the November ballot. The threshold for approval of the measure is 60%, a relatively high bar, although I would note that Florida's medical use program passed with 72% support. While polling has been both above and below that threshold, we will be closely following the progress there, noting that if passed, Florida legalization is projected to provide the largest incremental revenue and profit opportunity for MSOs compared to any prior state conversion.

In Pennsylvania, adult-use cannabis legislation has bipartisan support and is also supported by the Pennsylvania governor, having been noted as a priority in the governor's February 2024 budget address. We are hopeful that action will be taken in the coming months, also given the fact that Pennsylvania is largely surrounded by adult-use states at this point, with West Virginia as the exception. Federal legislation. From the federal perspective, we are, of course, pleased to hear from the recent media reports that the DEA is expected to take up the prior recommendation from HHS to reschedule cannabis from Schedule I to Schedule III. As we noted previously, the most important impact of that reclassification is expected to be the elimination of the 280E tax treatment, with an immediate significant boost to operator financials across the board.

President Biden has made this an important issue for his administration heading into the election, and he was the first president in the United States to address cannabis reform in his State of the Union Address, so we believe there is significant momentum on this issue. That said, the DEA's proposed rule, when issued, will be followed by a public comment period before it issues a final rule. In that timeline, election timing and any corresponding potential administration change may also come into play. Legislatively, we also continue to track the proposed SAFER banking legislation, which could allow, among other things, expanded lending opportunities for operators.

Though a version of this bill has passed the House seven times and has been around for the better part of a decade, recent commentary makes us think there is some potential for movement here, including commentary from Senate Majority Leader Chuck Schumer, that the Senate is working very hard to enact this bill later this year. Treasury Secretary Janet Yellen also recently commented in a House committee hearing on the importance of passing reform legislation to address the banking issues presented by the current regulatory structure, which we think also may hold some sway in stressing the importance of resolving these issues. I'd like to now turn the call over to Ben to discuss our portfolio and leasing activity to start the year. Ben?

Ben Regin (CIO)

Thanks, Paul. For my prepared remarks, I plan to highlight our continued leasing progress for our vacant and under development assets. Year to date, we've made substantial progress on this front, executing four new leases covering $69 million of invested capital in California and Michigan. In California, we've executed new leases for our Nineteenth Avenue and McLane Street properties in Palm Springs with Gold Flora, an existing tenant of ours, and a leading vertically integrated operator in California. And in Michigan, as we noted last quarter, we executed an LOI for our Harvest Park facility prior to the move-out of the former tenant, and earlier this quarter, executed a lease with Lume Cannabis Company, one of the largest operators in the Michigan market. We also signed a lease in January for one of our three small retail vacancies in the state.

We were very pleased with the demand we saw for these assets, the speed at which we executed new leases, and the relatively minimal amount of incremental capital required for re-tenanting. We believe our ongoing execution on our leasing initiative supports our underlying thesis regarding the high-quality, purpose-built, mission-critical nature of our real estate portfolio. Moving on to our development portfolio, as noted on previous calls, we continue to explore potential development options for our San Bernardino property, focusing on self-storage, and will continue to provide updates on progress on future calls. For our land site in San Marcos, Texas, we executed an LOI for a short-term lease with one of our existing tenant partners in anticipation of potential new licenses being issued. As you may know, Texas currently has a limited medical use program, with only 3 licenses issued to date.

While we remain optimistic that Texas will eventually adopt a more open approach to regulated cannabis activities and issue new licenses in that process, it remains uncertain. At our Pittsburgh, Pennsylvania asset, we continue to explore leasing options for the property and are closely watching developments as it relates to potential adult-use legislation, as Paul alluded to previously. Regarding new investment activity, in the first four months of 2024, we executed three lease amendments to fund additional improvements at properties totaling $22.1 million, including $16 million of PharmaCann in New York, where PharmaCann is focused on expanding production capacity after being awarded an adult-use production license late last year.

In Ohio, we provided an additional $4.5 million improvement allowance to Battle Green to complete construction and expand their production capacity as Ohio gets set to roll out its adult use program later this year. We also provided an additional $1.6 million to 4Front Ventures to round out development of 4Front's 250,000 sq ft production facility in Illinois. Battle Green in Ohio and 4Front in Illinois both recently received their temporary certificates of occupancy, as Kat will touch on, with operations expected to commence in the near term. Finally, earlier this week, we closed on the disposition of our property in Los Angeles, which was leased up until the sale.

We sold the property for $9.1 million and received a lease termination fee from the tenant of $3.9 million, in addition to reimbursement of our closing costs in connection with the sale, with the total consideration exceeding the net carrying value of the property on our books. This property was never fully built out for cannabis use, and we expect the sale to free up additional capital to recycle into other opportunities that we believe will provide superior risk-adjusted returns. In addition to our leasing activity, which has been off to a strong start in 2024, we continue to track a strong, active pipeline, where we are seeing a notable uptick in activity on the heels of some of the market and industry developments that Paul described.

We are seeing demand for our capital across markets from those with near-term adult use potential, such as Florida and Pennsylvania, to more established markets such as Maryland and Arizona. We are actively evaluating opportunities in these and other markets and look forward to executing on new investment opportunities on a very selective, disciplined basis. For that, I'll turn it over to Catherine. Catherine?

Catherine Hastings (CFO)

Thanks, Ben. As Ben noted, we've made a lot of progress over the last few months on closing out or nearing completion on several of our tenants' major development projects. So far in 2024, we completed construction on three leased projects totaling $200 million of invested and committed capital. PharmaCann's 325,000 sq ft expansion in New York, 4Front's 250,000 sq ft ground-up development in Illinois, and Battle Green's 157,000 sq ft ground-up development in Ohio. We further expect to substantially complete the 23,000 sq ft Perez Road development project in California shortly, which is pre-leased, and the 104,000 sq ft cultivation component of our Summit building in Michigan in the summer.

As you may recall, the 97,000 sq ft processing section of that building is approved for operations now, and the entire project is leased. In light of the challenges presented over the past few years with real estate development projects nationwide, we are very pleased to get these projects to the finish line and allow our operators to start generating revenues from these state-of-the-art facilities. Remember that under our lease structure, these tenants began paying rent during construction, which we've recorded in our revenues, but this is an important milestone for our tenants to ramp operations and generate cash flows in the facilities.

Regarding our portfolio as of March 31st and pro forma for development properties placed in service subsequent to quarter end, we owned 108 properties across 19 states, comprising 8.9 million rentable sq ft, including 647,000 sq ft of development or redevelopment. Of these 108 properties, 103 properties are included in our operating portfolio, which was 95.2% leased at quarter end, with a weighted average remaining lease term of approximately 14.8 years. Of the five properties under development, redevelopment, three were pre-leased at quarter end. Our portfolio continues to be well-diversified, with no one tenant representing more than 17% of our annualized base rent, and no state representing more than 15% of our annualized base rent.

We have relationships with some of the largest and most experienced operators in the industry, with our leased operating portfolio comprised of 90% multi-state operators and 60% leased to public company tenants. The total amount of capital invested and committed across our operating portfolio equates to $277 per sq ft, which we believe remains significantly below replacement cost. With that, I'll turn it over to David. David?

David Smith (COO)

Thank you, Catherine. For the first quarter, we generated total revenues of $75.5 million, a 1% decrease from Q1 of last year. Decrease was primarily driven by properties which were leased for all or part of the three months ended March 31st, 2023, and properties which were not leased or were re-leased, but rent had not yet commenced during the three months ended March 31st, 2024. As we noted in our earnings release issued yesterday, total revenues for Q1 also do not include $1.5 million in rent received during the quarter, but not recognized in total revenues due to a reclassification of two leases as sales type leases starting January 1st, 2024, as a result of lease term extensions that were executed for both leases.

The modest decline in rental revenues was partially offset by activity in prior periods for the acquisition and leasing of new properties, additional funding and building improvements provided to tenants at certain properties that resulted in base rent increases, and contractual rental escalations. It is also noteworthy that no security deposits were applied for payment of rent during the three months ended March 31st, 2024, while a total of $4.2 million of security deposits were applied for payment of rent for Q1 of 2023. Revenues for the quarter were also down sequentially versus Q4 of last year, primarily related to a Q4 payment of $1.7 million received from a former tenant at one of our properties in Pennsylvania as part of a judgment in our favor for unpaid rent.

A previously disclosed temporary reduction in base rent for 4Front at the Illinois property starting in January 2024, which was under development and had experienced significant delays in construction, primarily relating to bringing power to the property. For the three months ended March 31st, 2024, we recorded net income attributable to common stockholders of $39.1 million or $1.36 per share. Adjusted funds from operations for the first quarter was $63 million or $2.21 per share, a decrease of 2% compared to the first quarter of 2023, driven primarily by the same factors that drove the 1% decrease in revenues period to period. AFFO was also down sequentially from Q4, again, primarily driven by the $0.06 attributable to the $1.7 million judgment paid to IIP in Q4.

Looking ahead, I would note that while we expect the leasing activity that has been discussed to contribute meaningfully to our long-term rental revenues, the timeline to rent stabilization may differ between the properties as there are state and local approvals needed for these transitions, additional regulatory requirements to be completed at certain assets, and some level of rent abatement is negotiated to allow for a ramping of our new tenants' operations. That being said, we are very pleased with our substantial activity on the re-leasing front, as has been discussed in detail. On April fifteenth, we paid a quarterly dividend of $1.82 per share to common stockholders of record as of March twenty-eighth.

As Alan noted, our dividend remained covered by our AFFO during the quarter with a payout ratio of 82%, which is in line with the board's targeted payout ratio of 75%-85% of AFFO. Turning to the balance sheet, at quarter end, we had approximately $2.6 billion in total gross assets and $300 million in fixed-rate debt, consisting solely of $300 million in unsecured bonds, not maturing until May 2026. We continue to maintain credit metrics that are among the best in the entire publicly traded REIT industry, with a debt-to-gross assets ratio of 11% and a debt service coverage ratio in excess of 16 times. On the liquidity front, we ended the first quarter with over $200 million of total liquidity, comprised of our cash, short-term investments, and availability under our revolving credit facility.

We closed on this credit facility last October. At that time, it was a $30 million, three-year facility. We subsequently upsized the facility to $45 million in February and expect to increase the total capacity to $50 million by the end of this month. Our revolver remains undrawn as of today. We are also continuing to source new banking relationships to provide additional capital for the company. With over 800 financial institutions providing services to the cannabis industry, along with recent reports of one of the top 20 largest banks in the U.S. entering the industry, we remain encouraged in our prospects to continue to expand our banking relationships. We are well positioned for growth as we continue to maintain a conservative and low-leverage balance sheet....

generate positive free cash flow, and have continued to enhance our liquidity position through the closing of this new credit facility in Q4 and upsizing that facility in the first part of 2024. Finally, as a result of the investment activity that Ben mentioned, we opportunistically tapped our ATM program by issuing 123,000 shares of common stock for $11.8 million in net proceeds to further bolster our strong liquidity position and invest accretively into the opportunities that Ben discussed in his remarks. With that, I will turn it back to Alan. Alan?

Alan Gold (Executive Chairman)

Thanks, David. I'd like to note the following in closing: We, as a company, are certainly not immune to the macroeconomic factors that have impacted the broader economy and the regulated cannabis industry in particular. But I am proud of our team and what our team has accomplished in continuing to execute on our plan to maximize the value of our portfolio for the benefit of our stockholders through our leasing, investment, and disposition activities, and to continually evaluate capital options with the goal of maintaining a strong balance sheet and liquidity position. We believe this core focus will serve our stockholders well over the long term. With that, I'd like to open it up to questions. Operator, could you please open the call up for questions?

Operator (participant)

Thank you. We will now begin the question and answer session. To ask a question, you may press star, then one on your touchtone phone. If you are using a speakerphone, please pick up your handset before pressing the keys. If at any time your question has been addressed and you would like to withdraw your question, please press star, then two. At this time, we will pause momentarily to assemble our roster. The first question comes from Tom Catherwood with BTIG. Please go ahead.

Tom Catherwood (Analyst)

Thank you, and good morning, everyone. For the U.S. cannabis industry, more broadly, and I want to be cautious here and not sound too overly optimistic, but the bulk of operators reported an uptick in both retail sales and wholesale activity with their fourth quarter earnings, and then there was kind of margin improvement across the board. How are you seeing operators respond to this modestly improved backdrop? And could we see a renewed cycle of CapEx spending on cultivation and manufacturing, given the uptick in wholesale activity?

Alan Gold (Executive Chairman)

Yes, thank you, Tom. It's a good question, and it really goes to, you know, our greater belief that the while we've been going through some difficult macroeconomic environments, that things are looking better, that there are green shoots and opportunities. But I'm going to turn it over to Paul and perhaps Ben to answer that question more directly.

Paul Smithers (President and CEO)

Yeah. Hey, Tom, this is Paul. So, yeah, I agree with Alan that when we talk to our operators, we are feeling a greater sense of optimism. And there are lots of discussions about expansion. And you know, it's not only pricing stability, but I think you know, we can't understate the excitement about the rescheduling likelihood and the 280 relief. So you know, with those things combined, we are seeing a lot more interest and of course you know, expansion conversations. I know, Ben, if you want to put some more color on the-

Ben Regin (CIO)

Yeah.

Paul Smithers (President and CEO)

What we're seeing pipeline wise.

Ben Regin (CIO)

Yeah, sure. And just to... Hey, Tom, on your question about, you know, what the operators are doing, I think you can hear the optimism if you're listening to any of the earnings calls this quarter, whether that's, you know, Vireo focusing on their improved metrics or, you know, GTI yesterday, talking about being able to play aggressive offense in the market, given what they're seeing out there. You know, I think a lot of these companies are poised to get back into expansion mode, accretive acquisitions, more M&A, and that's translating on our side to the uptick in the pipeline that we mentioned in the prepared remarks.

Tom Catherwood (Analyst)

Got it. Appreciate those thoughts, everyone. Then maybe Ben and David, you know, for the new leases, I know it's hard to predict when tenants will receive full regulatory approval and can take full possession and start paying rent, but at the same time, these are sophisticated operators that you've leased to who are up and running in these states already. Are you able to maybe bucket the leases between those that are more likely to gain regulatory approval and have the tenant take occupancy in 2024, versus those that are, you know, 2025 event, or are there some that could even extend beyond that? Any thoughts would be helpful.

Alan Gold (Executive Chairman)

Yeah, you know, Tom, this is Alan. I mean, I'd first like to start with how, you know, we'll- we agree with you in your analysis that we have some very strong and sophisticated tenants and operators that are operating in a very unique environment, a difficult macro economic environment, and an environment where, you know, the regulatory agencies are still, believe it or not, working through a lot of their own processes.

... Well, with that, turn it over to David and Ben.

Ben Regin (CIO)

Yeah, hey, Tom. You know, just to echo what Alan's saying, I don't think we can, you know, really overstate how pleased we've been with the leasing activity. I mean, not just the speed at which we're able to retenant these properties, you know, the relatively low amount of capital required to retenant these properties. But really, as you noted, it's the strength of the operators and the credit upgrades we feel we got in each of these cases, whether that's Gold Flora in California, or a group like Lume in Michigan, who's the largest operator in the state there. So the regulatory aspects of rent commencement and starting of operations is out of our hands and something that we're tracking.

You know, we feel that we've partnered in each case with the group that can execute on that, as best as they can.

Tom Catherwood (Analyst)

Got it. Well, we will keep that on the front of our radar as we move through the year. And then maybe last for me, Paul, following up on your comments about, you know, operators being more opportunistic, given the commentary about rescheduling. And also, you sounded, I think, somewhat more optimistic on the potential for safer legislation than I've heard you in a while. I know the devil will ultimately be in the details for both of these pieces of legislation, but if we step back and think bigger picture, what risks could IIP's business model face over the near to medium term if we get both rescheduling and more access to financial institutions and services at the same time?

Ben Regin (CIO)

Yeah, I think, you know, Alan, go ahead.

Alan Gold (Executive Chairman)

Yeah, no, I was gonna say before Paul talks about the risks, I, you know, I think there not only are there risks, but there are certainly opportunities. Or every one of those risks are really is a double-edged sword in that, you know, when there is a rescheduling and/or more positive regulatory environment, it also helps with our overall cost of capital and our ability to drive returns to our shareholders. Because, one, we have an extremely strong and a well-established portfolio with a very long-term weighted average lease length and capital that is being deployed at, you know, north of the mid-teens type area.

Ben Regin (CIO)

Okay, but go ahead, Paul. Talk about the risk.

Paul Smithers (President and CEO)

Yes. Yeah, so you know, you know, as far as rescheduling, Tom, we don't see any, significant risk to our operations should rescheduling go forward. You know, the opposite is true, because remember, we still if we reschedule to three, there's still a federal disconnect between, state law and feds. So it's still, states operating, licensed state operators would still be in conflict with federal law because they'd be selling cannabis without a prescription. So we still have that disconnect that, you know, creates the opportunity for us. So we don't see a lot of players coming into the market when you still have that federal prohibition.

As far as the SAFER Banking Act, you know, there is some optimism because it's getting traction in the Senate, and you've got out of committee, and Schumer says he's gonna put it on a floor vote. That's the good news. It'll still be a challenge in the House because Speaker has said, you know, he's not a fan, so probably won't get a vote in the House. But why there's reason for optimism is it could be part of a negotiated bigger bill, and that's why, you know, there is some renewed energy. But, you know, in its current form, SAFER does not address any capital market access. It's purely, you know, getting the cash out of the banking system. So if SAFER passes as is, we don't see it affecting our business.

To the contrary, it would be better for our operators to take the cash out. So, you know, to answer your question, we just see very minimal risk, if not at all, should rescheduling occur and/or SAFER.

Tom Catherwood (Analyst)

I appreciate all those responses. That's it for me. Thanks, everyone.

Paul Smithers (President and CEO)

Thanks, Tom.

Operator (participant)

The next question comes from Scott Fortune with Roth MKM. Please go ahead.

Scott Fortune (Analyst)

Yes, and thank you for the question. Just kind of want to follow up on that and the risk side of things. You guys have mentioned strong and sophisticated operators, and we're now seeing the top MSOs with significant cash levels, and that could be, you know, additional cash flow if we get rescheduling there. So just wanted to get a sense for the tenants with those strong cash levels on the balance sheet and those discussions. I'm not sure if rescheduling, you know, progress now has opened up more discussions with them, but the opportunity for them to really tap into markets for lower costs of capital.

Obviously, there's a spread here, but just kind of going forward with some of these bigger operators who want to expand the sales lease model regarding the cap rates and working with IIP and what you can offer those top MSOs versus kind of their now lower cost of capital. Just how you kind of look at that risk with lower cap rates and the spread going forward. Kind of address that a little bit. That'd be great.

Alan Gold (Executive Chairman)

Before I turn it over to Ben to kind of talk about our pipeline and how strong our pipeline is, you know, I would, I would- it's gonna ask you to really think through, just because they have more capital on their balance sheet, does not necessarily mean that their cost of capital has gone down. I think that their cost of capital remains elevated. I think it's-- they're still struggling with accessing the broader capital markets, clearly here in the US, maybe not so much, or maybe they have better access up in Canada, where in Can-- where you all have, you know, operations also.

But here in the U.S., their access to capital remains limited, which, well, it goes to the quality and size of our pipeline, which I'll let Ben discuss.

Ben Regin (CIO)

Yeah. Hey, Scott, this is Ben. So, yeah, just to follow up on Alan's comments, you know, we noted the real uptick in activity we're seeing in the pipeline, which has been, you know, great to see. It's very active across multiple markets, and these are at the same cap rates that we've been seeing for the last few years. So we have not seen any, you know, downward pressure on those rates. And I think if, you know, cost of capital generally is going down, that typically impacts us as well, and we can maintain our same spread, potentially at lower cap rates in that environment. But, you know, as of today, with the increased activity in the pipeline, we've not seen any downward movement in any material way on our cap rates.

Scott Fortune (Analyst)

Thank you. Real quick, Ben, have you seen a pickup in discussions since kind of the rescheduling news has hit a week and a half ago here?

Ben Regin (CIO)

Yeah, I mean, I wouldn't say necessarily just rescheduling, though, that certainly has, you know, I think, improved some sentiment in the industry in general. We're seeing a lot of state-level dynamics driving activity in the pipeline, so that could be, you know, potential adult use rollouts in, you know, Ohio, Pennsylvania, Florida. And also just, you know, the industry overall continues to grow, even in more established markets. So we're seeing, you know, activity in states like Arizona, states like California and Michigan.

So it's really varied, and I think it's, you know, the strength and the health that we're seeing in the industry overall, the recovery, and wholesale pricing in many markets, the optimism around rescheduling and a potential adult use markets rolling out, you know, all contributes to the strength of the pipeline that we're seeing.

Scott Fortune (Analyst)

I appreciate that color. And then one more little follow-up quick one for me. Just provide a little color on that Los Angeles property. I know it wasn't fully built out, but the disposition there, how that came about with Holistic and what type of buyer kind of bought the property? Just a little bit more color on that. And do you guys even disclose what the net carry value was of that property?

Alan Gold (Executive Chairman)

Yeah, I mean, I think our supplement has some information, but we're pretty excited about our ability to continue to recycle capital. Ben, why don't you, Ben or Kat, do you guys want to elaborate?

Ben Regin (CIO)

Sure. Yeah, I can, I can give a little more color. You know, as we mentioned, that was not built out for cannabis, and I think it, you know, really showed, you know, our ability to work positively with our tenant partners on a, a solution that we felt was a win-win. We're able to take that capital and recycle it into other opportunities that we've been describing in our pipeline, that we think will provide superior risk-adjusted returns. So, you know, very, very happy, I think, on, on both sides on that deal with the, the execution, the ability to recycle that capital into other deals.

Scott Fortune (Analyst)

Thanks, I appreciate it. Thanks for all the color.

Alan Gold (Executive Chairman)

Thanks, Scott.

Operator (participant)

The next question comes from Alexander Goldfarb with Piper Sandler. Please go ahead.

Alexander Goldfarb (Analyst)

Hey, morning out there. So first question is, yeah, your comment about a top, you know, 20 bank getting involved in cannabis sort of leads to the, I guess, support for some for the courts to get involved. What's an update on there? I mean, it seems like the government's in a pretty indefensible position of, on one hand, continuing to make cannabis federally legal, but obviously allowing, you know, larger banks to get involved, letting the states get involved and participate. So what is... I think, Paul, a while back, you mentioned about potential court cases. Just want to get an update there.

Alan Gold (Executive Chairman)

Paul, go ahead.

Paul Smithers (President and CEO)

Sure. So, hi, Alex. There is an ongoing case, as you know, we talked about it last quarter, about challenging the federal government's position and basically saying that since the government has failed to actively enforce the prohibition and let states get away with it, as you described, that they've waived the rights. And that's probably gonna get a hearing, we think, within the next six to nine months at the trial level, then we'll probably go right up to the DCA and eventually up to the Supreme Court. So they've got a very experienced legal team, and it's a legitimate case. So, you know, that's that. But, you know, in the meantime, the better solution, of course, would be a legislative solution. So, you know, why is rescheduling important?

I think it does, create that momentum, to get to a descheduling, position, you know, maybe in the next two-three years. And-

Alexander Goldfarb (Analyst)

And what

Paul Smithers (President and CEO)

... that'll take at least that long for the court case to get its way through the Supreme Court.

Alexander Goldfarb (Analyst)

... You know, I was going to ask, what district, is this out of the D.C. courts, or what district is this in?

Paul Smithers (President and CEO)

I think it's Maryland, but I have to get back to you on that.

Alexander Goldfarb (Analyst)

Oh, so it's in the fourth?

Paul Smithers (President and CEO)

I believe so. I'll-

Alexander Goldfarb (Analyst)

Okay.

Paul Smithers (President and CEO)

Get back to you on that.

Alexander Goldfarb (Analyst)

Okay. No, I mean, that's a favorable district, I would think, for this, for this stuff. And then can you talk a little bit, you know, we all see the new states, obviously, live here in New York. You know, we can see what's going on with the attempted rollout here. But as you look at the market, what is your experience on the conversion of illicit to the regulated market? Meaning, you know, people are already using cannabis across the country. A state legalizes. How many, like, incremental users does your experience show that the states get? And then what's the conversion ratio of people who switch from the illicit to the regulated? Because that's ultimately what the industry needs, is for more people in the regulated and then the regulated to grow users.

I'm just trying to understand what your experience so far from the operators has shown as far as, one, conversion of illicit, you know, buying from their guy, no longer doing that, to buying legally, and then, two, new people who weren't users before but are now coming in?

Alan Gold (Executive Chairman)

Yeah, Alex, this is Alan. You know, and before Paul perhaps addresses that question directly, you know, I just want to remind everybody that we're a real estate provider. We're not a direct operator.

Alexander Goldfarb (Analyst)

No, no, I know, I know.

Alan Gold (Executive Chairman)

Okay.

Alexander Goldfarb (Analyst)

Yeah.

Alan Gold (Executive Chairman)

And so our-

Alexander Goldfarb (Analyst)

Yeah, perfect

Alan Gold (Executive Chairman)

... commentary really comes from, from the industry, from the industry in general. And, you know, perhaps talking about the growth in total revenue, things like that might have relevance to answer your question. Go ahead, Paul.

Paul Smithers (President and CEO)

Yeah. Well, that's right. I mean, I'm not aware of any data that that's out there that talks about, you know, when you put a legal program in place in the state, you know, how many new users are there? Because, of course, you'd have to get a base of how many illicit users there were to begin with. But we can tell you that, history's shown that when a medical program converts to a medical and adult use, revenues go up significantly, as much as, you know, three times. And the difference between medical and adult use is, you know, one third medical and two thirds recreational.

So when a state does adopt adult use, it's a significant impact on revenues for the operators, and that's why, you know, that's why so many of the operators gravitate towards adult use states. But-

Alan Gold (Executive Chairman)

Oh

Paul Smithers (President and CEO)

... as far as you know, the illicit users, we just don't have that data to talk to.

Alexander Goldfarb (Analyst)

Okay, and just a final one for David. I don't want to leave the accounting guy, the CFO, behind. Sales-type accounting, lease accounting, obviously, that's what we all, you know, aspire to and train for. Do you see this as coming up with other, you know, other properties as you, as you restrike leases and or do you view that this, the two leases that got caught up in this are sort of very unique relative to the other other assets in your portfolio?

David Smith (COO)

Yeah, sure, Alex. David, you know, one, I think, in your notes, sounds like you, you've gotten very experienced in this, but, you know, I'd just say, you know, it's two properties out of 108, so it's very, very immaterial piece of our portfolio. It, it can happen, but I think it's, not very likely to happen, in, in the future, and if it does, again, on a very limited basis. So I think it's something that, you know, given the, given the very strong yields that we have in this sector, can, can impact that. But again, obviously, that's a, a good problem to have, that our portfolio generates, you know, twice the yields of, of typical commercial real estate. So that, that can be one of the, one of the, items that, that trips that.

But yeah, look, at the end of the day, while it's not in our GAAP revenues, as you know, we're including our AFFO. It's cash rent received. It's, as you noted, the IRS considers it good rental income, and it's in our taxable income, and that's what we distribute off of.

Alexander Goldfarb (Analyst)

Okay, listen, thank you. Thank you, David.

David Smith (COO)

Thanks, Alex.

Operator (participant)

This concludes our question and answer session. I would like to turn the conference back over to Alan Gold for any closing remarks.

Alan Gold (Executive Chairman)

Well, thank you, and thank you all for joining us today. Again, I'd like to thank our team for such hard and dedicated work over the last quarter and certainly the last six plus years. So thank you all. With that, the call should end. Thank you.

Operator (participant)

The conference is now concluded. Thank you for attending today's presentation. You may now disconnect