Year-to-Date, Cannabis REITs Provide Key Source of Financing for Businesses
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Year-to-Date, Cannabis REITs Provide Key Source of Financing for Businesses

In 2022, falling equity prices have had a chilling effect on capital raises, particularly on large equity issues, which have been confined to non-plant-touching sectors.

Over $75 million of cannabis sale-leaseback transactions priced in the second quarter of 2022, spanning Massachusetts, Maryland and Texas. Specialized cannabis real estate investment trusts (REITs) have filled the financing need in the cannabis space thus far, and we’ve not yet seen traditional sale-leaseback investors exhibit comfort with the sector. 

Leading up to the first quarter of 2022, the cannabis sector exhibited a general trend of cap rate compression (i.e., increases in the prices of cannabis-related real estate), largely due to increasing confidence of legalization at the federal level as well as the growing strength of credits in the space. 

However, that compression momentum may be slowing due to inflation and interest rate movements affecting the broader market.

That being said, the cost of sale-leaseback capital, while high relative to the overall sale-leaseback universe, still provides for attractive financing levels for cannabis operators due to sector-specific capital constraints. We continue to evaluate the cannabis sale-leaseback landscape as we see the narratives of increasing interest rates and an inflationary environment go up against secular positive drivers of growing multi-national operators and increasing legalization initiatives.

The broader sale-leaseback environment has exhibited significant movement year-to-date. Late 2021 into early 2022 provided for one of the best pricing and execution sale-leaseback environments in sale-leaseback history. However, buyer caution began to creep into the beginning of Q2 ’22 and continued into early Q3 ’22. Many buyers struggled to lock in debt financing, which in turn led to challenges in pricing assets appropriately.

Despite the noise of interest rate hikes, inflation headlines, and pullback in M&A activity, the second quarter of 2022 exhibited 236 discrete transactions and aggregate dollar volume of $10.2 billion (over half of which was a single transaction).

Let’s take a look at how the first two quarters of 2022 played out in the cannabis business financing landscape.

First Half of 2022 in Review

  • Cannabis equity prices continued on the downward trajectory that began in February 2021, as hopes for federal legalization dimmed. YTD, the $MSOS ETF is down 51%.
  • Falling equity prices have had a chilling effect on capital raises, particularly on large equity issues, which have been confined to non-plant-touching sectors.
  • Still, prices have seemingly bottomed out and have risen over the last 10 weeks as investors are beginning to believe the SAFE+ Act has solid chances for passing in the lame-duck session.
  • Viridian believes the impact of SAFE+ could be enormous. The potential indirect impacts, spurring institutional investor interest in the sector and fostering up-listing, are likely to be larger than the direct impacts of allowing banks to service the industry

Capital Raise Summary

  • The number of capital raise transactions in H1 ‘22 is down 47%, and volume is off by 64%.
  • Large capital raises (over $100 million) are off more sharply, down 78%.
  • The U.S. accounted for a record 77.5% of funds raised.
  • Debt was a record 54.6% of capital raised, exceeding all comparable periods.
  • Cultivation and Retail, the largest subsector, was down a more significant 70%, with a 90% decline in U.S. Cultivation & Retail equity raises.
  • Uncertainty over potential federal regulatory changes has stifled capital raise activity. No CFO wants to raise equity and historically low prices, particularly with the hope of SAFE+ Act passage looming.
  • SPAC IPOs have virtually ceased as the SEC applies greater scrutiny and investors recoil from the poor post-deSPAC performance.
  • The Real Estate subsector, which encompasses cannabis lenders and sale-leaseback providers, is bucking the trend with a record Q2 ‘22 capital raise of $455 million.
  • Psychedelics have begun to raise capital again with small raises in Q2 ‘22 and accelerating capital raise activity in Q3 ‘22.

M&A Summary

  • Worldwide M&A transaction values were off 82.9% in H1 ‘22 relative to H1 ’21.
  • A significant part of the decline is the absence of deals over $500 million in 2022 that accounted for $14.4 billion of H1 ‘21’s $21.4-billion total.
  • Significant deals set to close in H2 ‘22, including Cresco/Columbia Care, and Verano/Goodness Growth, should reduce the apparent discrepancy.
  • 2022 YTD, in a broader historical context, appears to be a roughly normal M&A year, overshadowed by a record 2021.
  • The tightened capital markets, which differentially punish smaller competitors with more difficult and expensive access to capital, is pushing smaller competitors to sell out to larger concerns. We expect to see an uptick in M&A activity in the remainder of 2022.
  • We are expecting a wave of distressed sellers in California, as many companies find they can no longer hold out for improved market conditions.