How a Sale-Leaseback Acquisition Works

Departments - Upfront | M&A Monthly

Innovative Industrial Properties has been steadily building its real estate portfolio, infusing cannabis operators with much-needed capital.

April 26, 2021

A digital mockup of Kings Garden's expansion.
Photo courtesy Kings Garden

In February, Innovative Industrial Properties (IIP) expanded its real estate partnership with Kings Garden, a licensed cultivator based in the Coachella Valley in southern California. The move followed San Diego-based IIP’s original acquisition of several Kings Garden facilities in 2019, a sale-leaseback deal that turned Kings Garden from owner to tenant, providing Kings with $27.1 million in cash.

The sale-leaseback model has become a steady and consistent feature of the cannabis M&A landscape. It’s a real estate transaction in which an owner sells property with the intention of remaining a tenant and leasing the space, freeing up capital while still running the on-site operations. IIP, founded in 2016, is known as a real estate investment trust (REIT), and is among the most visible companies using this strategy in the cannabis industry, allowing IIP to invest in properties with built-in tenants and cashflow. The company owns properties operated by dozens of licensed cannabis businesses in 18 states, each one structured as a triple-net lease with IIP’s partner on the ground. (A triple-net lease is a property agreement in which the tenant pays all property expenses, including real estate taxes, insurance, maintenance, utilities, etc.)

In the case of Kings Garden, it’s been a symbiotic relationship. The February transaction expanded Kings Garden’s footprint into adjacent land parcels. Because IIP, which invests in medical-use facilities, regards its tenants as partners, the company worked with Kings Garden to identify suitable opportunities, resulting in this case in a $1.4-million purchase, imminent building construction and a new lease. IIP acquires more real estate, and Kings Garden acquires the room it needs to grow.

“We greatly value the long-term relationship we’ve built with our industry-leading partners at IIP over the past years,” said Michael King, Chairman and CEO of Kings Garden, in a press release about the deal. “Between the deal we closed in November 2020 and this one, IIP is expected to provide reimbursement to Kings Garden for construction for just over $76 million. This is significant, as it sets the path to 665,000 square feet of indoor operations and over $300 million in revenue for 2023.”

This latest transaction will supply Kings Garden with another 180,000 square feet of industrial space, building on its goal to produce 140,000 pounds of finished cannabis product annually, according to the press release.

“Our successive transactions with Kings Garden really exemplify the focus of our business model—to be the go-to, flexible, long-term real estate capital partner to our tenants, moving quickly and on their timelines to provide flexible capital solutions as they continue to grow their businesses,” IIP CEO and President Paul Smithers told CBT.

As M&A trends floundered throughout 2020, REITs like IIP offered an alternative way for cannabis operators to raise cash and offload liabilities from their balance sheets.

“In the end,” Smithers said, “the tenant-operator retains full operational control of their mission-critical facility, while at the same time unlocking the real estate capital that was previously invested in their facilities, providing them the opportunity to re-deploy that non-dilutive capital back into their business with the goal of achieving substantially higher returns.”

This is not necessarily an arm’s-length deal. Smithers said that IIP is focused on understanding its tenant partners’ needs, “and then tailoring real estate capital solutions to meet those requirements.” This might include investing in more properties on behalf of cultivation companies over time to increase on-site production capacity, for instance, as in Kings Garden’s case earlier this year.

“We look at each transaction holistically, with specific focus on the tenant and its management, financial profile and track record, while also analyzing specific state market and regulatory dynamics,” Smithers said.

Most of IIP’s properties are specialized industrial (indoor cultivation facilities), though the company does hold greenhouses in its portfolio, which includes assets from companies like Cresco Labs, GTI, Curaleaf and Trulieve.

From January 2020 through February 2021, IIP made 22 acquisitions across 11 states, while also amending 23 existing leases across 10 states. It’s an ongoing process, like just about everything else in the cannabis space.

Eric Sandy is digital editor for Cannabis Business Times.