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Bengal Capital’s Julian Lin and Jerry Dereviani discuss NewLake Capital and cannabis REITs (0:20). Ratings are high. Low returns – should investors be told something? (3:00) Redistribution Risk in IIPR and Other REITs (5:50). This is an excerpt from a recent episode of The Cannabis Investing Podcast.
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Rina Scherbel: Jerry Dereviani and Julian Lin, it’s always great to talk to you one-on-one. Excited about this united effort.
Jerry Dereviani: I had a question for Julian.
Julian Lin: definitely.
Jordanian Dinar: We’ve discussed some REITs and some debt providers, publicly traded debt providers in this space. Do you have a current view on what their dividend yields look like and how do you view those opportunities?
majority: Yeah, I think the main thing we were talking about before was NewLake Capital (OTCQX:NLCP). Sure enough, it now trades at around 8% dividend yield. I would say from a valuation perspective, it’s still interesting, right?
Especially when traditional REITs are trading more around the 5.5% range, but it will certainly be less compelling than what we were talking about before.
I think we were talking before the yield hit 12%. One of the interesting points at the time was that it was so cheap that they could have written off their assets, but if it was 50% and the shareholders would still be good to go.
Those kinds of dynamics aren’t quite the same now. So, the interesting thing about these REITs, these net lease REITs, especially NewLake Capital, is that as their valuations expand, the risks they face change, right? We’re not there yet, but when (New York Stock Exchange: IBR) It was trading at a 1% or 2% yield, and ironically the big risk was just rationing and this idea that more capital could flow into the sector, just because that would stop its growth.
But when the stock is trading, even if it’s trading at an 8% yield, slowing growth is probably not really a big deal, just because that yield is already high enough, but what I can say about NewLake Capital is that it’s definitely a team to look at. in.
Just look at how they’ve executed the last several quarters. You don’t typically see, even outside of the cannabis sector with REITs, you don’t typically see these management teams do what they did where their stock was down, and what NewLake Capital did is instead of just buying more investments at the same time after their stock was valued, they were buying back shares. With returns of 12%, 10%, 11%. They were resistant at first, but at some point they started doing it and then they got more and more into it. This is unbelievable.
So you have to assume they are focused on being very lean. They generate actual cash flow margins of 80% which are not adjusted for inventory or anything else. And then they were deploying all the excess capital into stock buybacks instead of trying to grow the business.
This is exactly what you want to see a company do when its shares are really cheap. But yeah, I mean the short answer to your question would be, obviously opinion will change as the valuation goes up.
Jordanian dinar: this is funy. Yes, it makes perfect sense. I’ve noticed that valuations have gone up, so returns have gone down. I guess my question would be, not at all different, but doesn’t that tell you something?
If NewLake Capital is trending now, if you look at their portfolio returns, I’m sure it’s somewhere between 13% and 14%, right? In terms of what their leases bring in, it’s just raw with no expenses, right?
If they tell you that, instead of taking on more leases, which are going to yield 13%, 14%, whatever the raw percentage is, we’re just going to buy back our shares at that implied return of 12%, that tells you something about how much they’re seeing in the market and what the returns look like.
I think one of the ways that I’m also thinking about, which you’re talking about when legalization comes, they’ll probably see — it’ll be interesting to see if they take price hits and what that changes because the other thing that happens is they get the leverage available to them at prices. Probably cheaper than what they have now.
And so, you might start to see it become as leveraged as other REITs, as is the case with similar REITs, because a lot of REITs are, there’s a very large layer of debt and then a smaller layer of equity. And this cannabis is unique in that almost all of it, I think, is fair.
IIPR in particular has debt as a very small portion of the capital that went into that company. And so, your ROE might still be pretty good since they’re adding leverage, but anyway, I just wanted your opinion on it because I think you’re pretty educated. I was wondering what you thought.
GL: Yes, I think you’re right. Of course, if there’s going to be some repricing, as you mentioned, as ratification happens, it’s important to note that the leases aren’t expiring yet, and I think there’s still another 10 or 11 years left.
Typically in these net lease situations, these leases are strict unless the company goes bankrupt. Even then, the new operator still has to assume the lease.
But yeah, as you mentioned, even if they have to repricing, when those leases expire, that will be offset by leverage. I think we may have underestimated the amount of influence that these companies typically exercise.
For example, Realty Income (O) is one of the least leveraged companies in the sector, at 5x or 5.5x debt-to-EBITDA, while NewLake has no leverage at all. So, they have a lot of ways to get there, but I think they still look attractive, compared to a traditional net lease REIT, but yeah, my conviction is certainly much lower than it was when it was yielding 12%.
Jordanian dinar: I think for me the biggest risk, not the biggest, but one of the big risks with IIPR is that, or REITs in general, I should say, is that redistribution risk, right? As that money comes back, eventually, like everything, your leases will come due and the market needs to take a look at what the return will be on your next leases.
All of this will be reflected in your net present value at some point. And so, I’m concerned about if the market takes the view that your redistribution returns are going to be much lower, how that will reflect and then the leverage. I don’t think so, there are too many moving pieces. I don’t know if you can get into it. Do you look at any other debt providers like AFC Gamma (AFCG), Silver Spike (SSIC), do you have opinions on those?
GL: So I tend not to look at something like AFC Gamma just because it’s managed externally and that tends to change the game for the investor. But yeah, so you bring up a good point. This is very important, as is this redeployment process.
In this case, this isn’t really a redistribution of assets, it’s more like the lease is expiring and if everything becomes legal, just the assets all of a sudden, the rent might be reduced by half or something, right? This could come as a big shock to investors. So, as I mentioned before, when a stock is much cheaper, this risk is not so important.
For example, when New Lake was yielding 12%, and you were thinking, oh, maybe in 12 years, if cannabis is legalized and they have to cut the rent in half, that might be bad, but at the same time okay, even if We assume that if they cut the rent in half right now, it will still be cheaper than the traditional net rent of REITs like Realty Income, in which case, well, that horrific scenario isn’t so bad at all, is it?
But when the yield suddenly drops to 8%, that’s still attractive, but it’s the same idea, well, if they cut it in half, it wouldn’t be quite the same, right? Suddenly, it will actually become more expensive than a traditional REIT.
Therefore, this type of risk appears as the valuation rises more and more. So, it’s definitely something to keep in mind if someone has ignored you before, it’s not something you can keep ignoring forever.
Related articles:
My top picks: NewLake Capital returns 12% with net cash balance sheet and built-in growth
Bengal Capital FY2023 letter
Cannabis Investing Masterclass with Julian Lin + Jerry Dereviani
Editor’s Note: This article discusses one or more securities that are not traded on a major U.S. exchange. Please be aware of the risks associated with these stocks.
