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Cannabis REITs May Be Beaten Down, But They Hold Hidden Opportunity

Before I dive into today’s article, I do want to state upfront that I have never smoked, eaten – and/or whatever the other options are – any marijuana. And I don’t plan to in the future.

But I am a proponent of its legalization.

A lot of people scratch their heads at my stance, but when you see what I see in the sector, you’ll get why.

Here’s a picture I took last year while visiting a cannabis-producing property.

Brad visited this Desert Hot Springs, CA, property in 2022

One of my biggest investment winners in 2021 was Power REIT (PW), a small-cap REIT that owns higher-risk cannabis properties.

I wrote about it in my Seeking Alpha blog on November 20, 2021:

We also sold our position in Power REIT (PW) on Friday morning due to valuation, and this made this one of our very best picks of all-time: +168% return in less than 12 months!!!

I’ve learned that you don’t need to personally be involved with something to profit from it. Rational investing means looking for opportunities that may sometimes be outside your comfort zone.

And today I want to share with you the window of opportunity that’s forming to capitalize on some beaten-down cannabis real estate investment trusts (REITs).

I believe 2023 could be an exceptional year for cannabis landlords, and our team is ready to capitalize on it again.

2022 Was a Bad Year

One of the worst property sectors in 2022 was cannabis. Three equity REITs that invest in cannabis returned an average -62%. Meanwhile, the rest of the REIT sector lost approximately 29%.

A category that was “growing like a weed” but flamed out as a result of federal legislation headwinds.

In March 2021, a bill introduced to Congress called the Secure and Fair Enforcement (SAFE) Banking Act got everyone excited. As a result, cannabis-related stocks saw huge spikes in their share prices.

As recently covered by the Seattle Times:

The SAFE Banking Act generally would allow banks and other financial institutions to provide services to legitimate cannabis-related businesses.

Currently, federal law classifies cannabis as a Schedule 1 drug, just as cocaine and heroin, which makes it difficult for federally regulated banks and credit unions to work with cannabis businesses.

But after a year of being on the table, investors lost faith.

As recently as November, there seemed to be some hope that the Democrats would shoehorn the SAFE Banking Act into the $1.65 trillion Omnibus Spending bill.

I recently caught up Paul Smithers. He’s the CEO of Innovative Industrial Properties (IIPR), the leading provider of real estate capital for cannabis-related businesses. Here’s what he told me:

The likelihood [for federal legalization] has gone up… I think that could be a real shot in the arm for the industry going into next year with getting some positive momentum with the SAFE Act, because that could open the door for a lot of really interesting, fun things next year as far as the capital markets and new capital available to the operators.

Unfortunately, it wasn’t to be. It was taken out of the Omnibus Spending Bill before it passed.

Why Cannabis? Why Now?

Now, many investors are taking this as bad news. But I would argue that the cannabis REIT sector has grown as much as it has despite of the lack of federalization.

Let me explain. Currently, there are a limited number of financial institutions that can provide commercial loans to cannabis operators.

So the big players in the field like IIPR and NewLake Capital Partners (NLCP) have little to no competition. If there are a limited number of institutions that can back cannabis, you better believe they’re only going to invest in the best companies.

And IIPR has the first mover advantage as the first and only cannabis REIT to have its initial public offering (IPO) on the New York Stock Exchange.

In fact, I’m still baffled as to how the company was able to list on the exchange, since REITs operate under federal guidelines (Congress created the REIT laws in 1960), and cannabis is still not approved by the federal government for recreation.

NewLake Capital Partners, IIPR’s closest competitor, listed as over-the-counter around a year and a half ago.

I spoke with the CEO, Anthony Coniglio, yesterday and he told me:

It’s going to be a while before legislation passes with Republicans in Congress. It was disappointing that Congress could not get it together, and it now prolongs the opportunity set. We don’t think it would usher in competition.

I agree with his prediction that legalization won’t pass with Republicans as it stands. There is little hope that cannabis will become legal for at least two years, as long as Republicans control the House.

And this makes the current cannabis REITs a lot more attractive, as they have more time to invest properties and generate diversified revenue streams.

However, I disagree that the passing of the SAFE Act would bring no competition.

A Swing is Coming

But as I see it, competition or no competition, these mammoth cannabis REITs are dirt cheap.

Mr. Market was expecting the SAFE legislation, and this has created a terrific buying opportunity for value investors like me.

Currently, IIPR and NewLake Capital, are trading at an average price-to-AFFO (adjusted funds from operations, a common valuation metric for REITs) multiple of 11x. And they have an average dividend yield of 8.5%.

To put that into perspective, IIPR was trading at over 40x in November 2021.

That’s right, shares are trading at a 75% discount from 13 months ago.

Meanwhile, both REITs have kept growing their dividends and their balance sheets are rock-solid.

Think about that for a second. The overall share price went down, and yet the dividend they’re giving shareholders is still increasing. This means the company is unaffected by the flirtatious back and forth of emotion driven by shareholders and lawmakers.

So get ready – this year’s cannabis sector is going to rise back up and keep climbing. Mark my words.

I am not making any official recommendations as I own both IIPR and NLCP. But I thought you would enjoy this hot take.

Our knowledge of the REIT cannabis sector is both unique and – thanks to my many contacts in the space – unmatched. That’s why next week, I plan to interview yet another C-suite cannabis executive.

So if you’re interested in hearing more about this topic, I’d love to hear from you here.

Happy SWAN (sleep well at night) investing,

Brad Thomas
Editor, Intelligent Income Daily