ITEM 1.
BUSINESS
General
As used herein, the terms "we",
"us", "our" or the "Company" refer to Innovative Industrial Properties, Inc., a Maryland corporation,
and any of our subsidiaries, including IIP Operating Partnership, LP, a Delaware limited partnership, or our Operating Partnership.
We are a self-advised Maryland corporation
focused on the acquisition, ownership and management of specialized industrial properties leased to experienced, state-licensed
operators for their regulated medical-use cannabis facilities. We lease and expect to continue to lease our properties on a triple-net
lease basis, where the tenant is responsible for all aspects of and costs related to the property and its operation during the
lease term, including structural repairs, maintenance, taxes and insurance. We were incorporated in Maryland on June 15, 2016,
and we intend to elect and to operate our business so as to qualify to be taxed as a REIT for U.S. federal income tax purposes,
beginning with our taxable year ending December 31, 2017. As of December 31, 2016, we had five full-time employees. We conduct
our business through a traditional umbrella partnership real estate investment trust, or UPREIT structure, in which our properties
are owned by our Operating Partnership, directly or through subsidiaries. We are the sole general partner of our Operating Partnership
and own, directly or through a subsidiary, 100% of the limited partnership interests in our Operating Partnership.
Our co-founder and executive chairman,
Alan Gold, is a 30-year veteran of the real estate industry, including co-founding two NYSE-listed REITs: BioMed Realty Trust,
Inc. (formerly NYSE: BMR), or BioMed Realty, a REIT focused on acquiring, developing, owning, leasing and managing laboratory and
office space for the life science industry; and Alexandria Real Estate Equities, Inc. (NYSE: ARE), or Alexandria Real Estate, an
urban office REIT focused on collaborative science and technology campuses. Our senior management team has significant experience
in all aspects of the real estate industry, including acquisitions, dispositions, construction, development, management, finance
and capital markets.
We completed our initial public offering
on December 5, 2016, issuing an aggregate of 3,350,000 shares of common stock and receiving approximately $61.1 million of net
proceeds.
On December 19, 2016, we completed the
acquisition of a 127,000 square foot industrial property, or our Initial Property, located in New York, which we purchased from
PharmaCann LLC, or PharmaCann, for approximately $30.0 million in a sale-leaseback transaction. Concurrent with the closing of
the acquisition, we entered into a triple-net lease with PharmaCann, as tenant, pursuant to which PharmaCann is responsible for
paying for all structural repairs, maintenance expenses, insurance and taxes related to our Initial Property. The lease term is
15 years, with two options to extend the term of the lease for two additional five-year periods. The initial base rent of the PharmaCann
lease is approximately $319,580 per month, subject to annual increases at a rate based on the higher of (i) 4% or (ii) 75% of the
consumer price index, or CPI. The lease also provides that we receive a property management fee equal to 1.5% of the then-current
base rent throughout the term, and supplemental base rent for the first five years of the term of the lease at a rate of $105,477
per month. Together, the annualized initial base rent, property management fee and supplemental base rent equate to approximately
17.2% of the purchase price of our Initial Property. At December 31, 2016, we owned only our Initial Property.
We currently anticipate that the average
size of additional future real estate acquisitions will range from $5 million to $30 million and will involve between 25,000 and
150,000 square feet of space. As of March 22, 2017, we had identified and were in various stages of reviewing approximately $120
million of additional potential properties for acquisition, which amount is estimated based on sellers’ asking prices for
the properties, ongoing negotiations with sellers, our assessment of the values of such properties after taking into account the
current and expected lease revenue, operating history, age and condition of the property, and other relevant factors. There can
be no assurance that we will consummate the acquisition of any of the properties in our current acquisition pipeline on the terms
anticipated, or at all.
In January 2017, we amended and restated
our charter to reclassify all of the shares of our Class A common stock, par value $0.001 per share, and Class B common stock,
par value $0.001 per share, to common stock, par value $0.001 per share. Immediately prior to the effectiveness of the amended
and restated charter, there were no shares of Class B common stock outstanding, as all shares of Class B common stock previously
outstanding were redeemed by us for $0.001 per share (par value) and cancelled immediately before our initial public offering in
December 2016. The reclassification of the shares of our Class A common stock had no impact on the voting powers, preferences,
rights and qualifications, limitations and restrictions of such shares. There were also no changes to the ticker symbol or the
CUSIP number of our common stock.
Our principal offices are located at 17190
Bernardo Center Drive, San Diego, California 92128. Our telephone number at that location is (858) 997-3332. Our website is
located at www.innovativeindustrialproperties.com. We make available through our website our annual report on Form 10-K, quarterly
reports on Form 10-Q, current reports on Form 8-K and amendments to such reports filed or furnished pursuant to Sections 13(a)
or 15(d) of the Exchange Act as soon as reasonably practicable after we electronically file such material with, or furnish it to,
the Securities and Exchange Commission, or the SEC. You can also access on our website our Code of Business Conduct and Ethics,
Corporate Governance Guidelines, Audit Committee Charter, Compensation Committee Charter, and Nominating and Corporate Governance
Committee Charter.
Market Opportunity
The Industrial Real Estate Sub-Market
The industrial real estate sub-market recently
has performed well, with vacancies in several markets at historical lows. According to Colliers, the U.S. industrial property vacancy
rate declined to 5.6% in the fourth quarter of 2016, the lowest vacancy rate on record. Over 302 million square feet of industrial
real estate was absorbed in 2016, which resulted in increased asking rental rates for the 14
th
consecutive quarter,
according to Colliers.
We believe this supply/demand dynamic creates
significant opportunity for owners of industrial facilities, particularly those focused on niche categories, as options are limited
for tenants requiring specialized buildings. We intend to capitalize on this opportunity by purchasing specialized industrial properties,
including buildings that are critical to the medical-use cannabis industry.
The Regulated Medical-Use Cannabis Industry
Overview
We believe that a convergence of changing
public attitudes and increased legalization momentum in various states toward regulated medical-use cannabis creates an attractive
opportunity to invest in the industrial real estate sector with a focus on regulated medical-use cannabis facilities. We also believe
that the increased sophistication of the regulated medical-use cannabis industry and the development of strong business, operational
and compliance practices have made the sector more attractive for investment. Increasingly, state-licensed, medical-use cannabis
cultivation and processing facilities are becoming sophisticated business enterprises that use state-of-the-art technologies and
well-honed business and operational processes to maximize product yield and revenues. Additionally, medical-use cannabis growers
and dispensers have developed a growing portfolio of products into which they are able to incorporate legal medical-use cannabis
in a safe and appealing manner.
In the United States, the development and
growth of the regulated medical-use cannabis industry has generally been driven by state law and regulation, and accordingly, the
market varies on a state-by-state basis. State laws that legalize and regulate medical-use cannabis allow patients to consume cannabis
for medicinal reasons with a doctor's recommendation, subject to various requirements and limitations. States have authorized numerous
medical conditions as qualifying conditions for treatment with medical-use cannabis, which vary significantly from state to state
and may include, among others, treatment for cancer, glaucoma, HIV/AIDs, wasting syndrome, pain, nausea, seizures, muscle spasms,
multiple sclerosis, post-traumatic stress disorder (PTSD), migraines, arthritis, Parkinson's disease, Alzheimer's, lupus, residual
limb pain, spinal cord injuries, inflammatory bowel disease and terminal illness. As of December 31, 2016, 29 states, plus the
District of Columbia, have passed laws allowing their citizens to use medical cannabis.
We believe that the following conditions,
which are described in more detail below, create an attractive opportunity to invest in industrial real estate assets that support
the regulated medical-use cannabis industry:
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significant industry growth in recent years and expected continued growth;
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a shift in public opinion and increasing momentum toward the legalization of medical-use cannabis under state law;
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the federal government's current policy toward medical-use cannabis-related activities that are legal under state law; and
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limited access to capital by industry participants in light of risk perceived by financial institutions of violating federal
laws and regulatory guidelines for offering banking services to cannabis-related businesses.
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Industry Growth and Trends
According to ArcView, sales of legal cannabis
in North America grew to $6.9 billion in 2016, up 34% from 2015, of which approximately $5.1 billion consisted of medical-use sales.
According to the Marijuana Policy Project,
a non-profit organization focused on effecting cannabis policy reform, as of January 3, 2017, an estimated 1.4 million people used
or were registered to use legalized medical cannabis. As the industry continues to evolve, new ways to consume medical-use cannabis
are being developed in order for patients to have the treatment needed for their condition in a safe and appealing manner. In addition
to smoking and vaporizing of dried leaves, cannabis can be incorporated into a variety of edibles, spray products, transdermal
patches and topicals, including salves, ointments, lotions and sprays with no psychoactive effects.
As with any nascent but growing industry,
operational and business practices evolve and become more sophisticated over time. We believe that the quality and experience of
industry participants and the development of sound business, operational and compliance practices have reached a turning point
that makes the regulated medical-use cannabis industry attractive for investment at this time.
Shifting Public Attitudes and State
Law and Legislative Activity
We believe that the growth of the regulated
medical-use cannabis industry has been fueled by changing public attitudes in the United States. A 2016 poll by Quinnipiac University
found that 89% of Americans support patient access to medical-use cannabis, if recommended by a doctor. This follows the 2015 poll
by Harris, which found 81% of Americans support the legalization of cannabis for medical use. Driven in part by this shift in public
opinion, three additional states, Florida, Arkansas and North Dakota, voted to legalize medical-use cannabis in November 2016.
Anticipated expansion of the market opportunity to these states could be significant.
As of December 31, 2016, 29 states, plus
the District of Columbia, have passed laws allowing their citizens to use medical cannabis. The first state to permit the use of
cannabis for medicinal purposes was California in 1996, upon adoption of the Compassionate Care Act. The law allowed doctors to
recommend cannabis for serious medical conditions and patients were permitted to use, possess and grow cannabis themselves. Several
other states adopted medical-use cannabis laws in 1998 and 1999, and the remaining medical-use cannabis states adopted their laws
on various dates through 2016.
Following the approval of medical-use cannabis,
state programs must be developed and businesses must be licensed before commencing cannabis sales. Some states have developed the
necessary procedures and licensing requirements quickly, while other states have taken years to develop their programs for production
and sales of cannabis. According to Marijuana Business Daily, the average amount of time that elapsed between the legalization
of medical-use cannabis sales and the opening of the first dispensaries in six states that recently commenced sales was 27 months.
Also, according to Marijuana Business Daily, there are signs of industry maturation, and states are increasingly demonstrating
an ability to efficiently and quickly establish regulatory frameworks following legalization.
Even where regulatory frameworks for medical-use
cannabis production and sales are in place, states tend to revise these rules over time. These revisions often impact sales, making
it difficult to predict the potential of new markets. States may restrict the number of medical-use cannabis businesses permitted,
limit the medical conditions that are eligible for cannabis treatment or require registration of doctors and/or patients, each
of which can limit growth of the medical-use cannabis industry in those states. Alternatively, states may relax their initial regulations
relating to medical-use cannabis production and sales, which would likely accelerate growth of the medical-use cannabis industry
in such states.
The Federal Legal Landscape
Cannabis is classified as a Schedule I
controlled substance by the Drug Enforcement Agency, or DEA, and the U.S. Department of Justice with no medical use, and therefore
it is illegal to grow, possess and consume cannabis under federal law. The Controlled Substances Act of 1910, or CSA, bans cannabis-related
businesses; the possession, cultivation and production of cannabis-infused products; and the distribution of cannabis and products
derived from it. Moreover, on two separate occasions the U.S. Supreme Court ruled that the CSA trumps state law. That means that
the federal government has the option of enforcing U.S. drug laws, creating a climate of legal uncertainty regarding the production
and sale of medical-use cannabis. Although the CSA's basic prohibition remains in force, the U.S. Department of Justice has issued
memoranda characterizing enforcement of federal cannabis prohibitions under the CSA as an inefficient use of federal investigative
and prosecutorial resources when state regulatory and enforcement efforts are effective with respect to enumerated federal enforcement
priorities under the CSA. In such instances, the U.S. Department of Justice instructs federal prosecutors that enforcement of state
law by state and local law enforcement should remain the primary means of addressing cannabis-related activity, including cultivation
and distribution of cannabis. Congress has also enacted an omnibus spending bill including a provision prohibiting the U.S. Department
of Justice (which includes the DEA) from using funds appropriated by that bill to prevent states from implementing their medical-use
cannabis laws. This provision, however, is effective only until April 28, 2017 and must be renewed by Congress. There is also no
assurance that the new administration under President Trump does not modify its position on the enforcement of federal cannabis
prohibitions. See "— Government Regulation" below.
Cannabis reform has gained the support
of a bipartisan coalition of members of Congress, some of whom have introduced legislation on various reform-related topics. Certain
proposed legislation introduced into the 115
th
Congress is summarized below. If passed, this legislation would
address certain conflicts existing between state and federal law. In addition, there is no assurance that any of these proposals
will be approved, that the funds prohibition will be renewed or that the U.S. Department of Justice's enforcement position will
not change.
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H.R. 331 — The States' Medical Marijuana Property Rights Protection Act.
The bill
denies federal officials from using civil forfeiture laws against owners of properties that have been leased to cannabis dispensaries
and other operations that are in compliance with state medical-use cannabis laws.
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H.R. 714 — Legitimate Use of Medicinal Marijuana Act.
H.R. 714 reschedules cannabis
from Schedule I to Schedule II of the CSA. The bill also allows physicians to prescribe cannabis for medical-use in compliance
with state medical-use cannabis laws, and that provisions of the CSA and Food, Drug and Cosmetics Act of 1938 shall not interfere
with such state laws.
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H.R. 715 — The Compassionate Access Act.
H.R. 715 directs the U.S. Department of Health
and Human Services to submit a recommendation to the DEA that it transfer cannabis from Schedule I to another controlled substances
schedule under the CSA. The bill also excludes cannabidiol (CBD) from coverage under the CSA, amends the CSA to allow states to
set medical-use cannabis laws and sets procedures to allow for more comprehensive medical research.
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H.R. 975 — The Respect State Marijuana Laws Act.
H.R. 975 codifies in federal law
the current position of the U.S. Department of Justice refraining from prosecuting participants in state-authorized cannabis programs
under the CSA. The law amends the CSA by excepting from federal law persons that operate in compliance with state cannabis laws.
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H.R. 1227 — Ending Federal Marijuana Prohibition Act of 2017.
H.R. 1227 de-schedules
marijuana from the CSA, but prohibits shipments of cannabis across state lines.
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Access to Capital
To date, the status of medical-use cannabis
under federal law has significantly limited the ability of state-licensed industry participants to fully access the U.S. banking
system and traditional financing sources. These limitations, when combined with the high costs of maintaining licensed and stringently
regulated medical-use cannabis facilities (including meeting extensive zoning requirements), substantially increase the cost of
production. While we anticipate that future changes in federal and state laws may ultimately open up financing options that have
not been available to date in this industry, we believe that such changes, if they do occur, will take time, thereby creating an
opportunity over the next few years to provide our sale-leaseback and other real estate solutions to state-licensed industry participants
that have limited access to traditional financing sources.
Market Opportunity and Associated Risks
We focus on purchasing specialized industrial
facilities, including medical-use cannabis facilities of state-licensed growers, with emphasis on properties that we believe also
have potential for long-term appreciation in value. We believe that our sale-leaseback and other real estate solutions offer an
attractive alternative to licensed cultivators who have limited access to traditional financing alternatives. We intend to acquire
medical-use cannabis facilities in states that permit medical-use cannabis cultivation.
Notwithstanding the foregoing market opportunity
and trends, and despite legalization at the state level, we continue to believe that the current state of federal law creates significant
uncertainty and potential risks associated with investing in medical-use cannabis facilities, including but not limited to potentially
heightened risks related to the use of such facilities for adult-use cannabis operations, if a state passes such laws. For a more
complete description of these risks, see the sections "Risks Related to Regulation" and "Business — Governmental
Regulation" under Item 1A, "Risk Factors."
Our Competitive Strengths
We believe that we have the following competitive
strengths:
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The Experience of Our Co-Founder and Executive Chairman and Our Senior Management Team.
Mr. Gold and
our senior management team have substantial experience in all aspects of the real estate industry, including acquisitions, dispositions,
construction, development, management, finance and capital markets. In particular, in August 2004, Mr. Gold and Gary Kreitzer,
vice chairman of our board of directors, founded BioMed Realty (formerly NYSE: BMR), an internally-managed REIT focused on acquiring,
developing, owning, leasing and managing laboratory and office space for the life science industry, an industry they believed to
be underserved by commercial property investors and lenders and poised for significant growth. According to public filings with
the SEC, during their tenure at BioMed Realty, Messrs. Gold and Kreitzer oversaw the growth of the company's portfolio of life
science and laboratory real estate from 30 buildings with approximately 2.4 million rentable square feet at the time of the initial
public offering in 2004 to 196 buildings with approximately 18.9 million rentable square feet as of January 2016. Although Messrs.
Gold and Kreitzer, along with the other members of our senior management team, have a demonstrated track record for evaluating
and investing in real estate, they have also experienced significant challenges at times, particularly during the economic downturn
from 2008 through 2010, which saw rising capitalization rates and a corresponding decline in the net asset value of BioMed Realty.
As a result, certain investors, depending on the timing of their investments and holding periods, may not have earned positive
returns on their investments in the company. In early 2016, an affiliate of The Blackstone Group L.P. purchased BioMed Realty in
a transaction valued at approximately $8 billion (including indebtedness that was paid or assumed at the closing).
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Focus on Recurring and Dependable Revenue.
Our business strategy focuses on acquiring real estate
assets from and entering into long-term, triple-net leasing arrangements with licensed medical-use cannabis cultivators, which
we believe will support a recurring and dependable revenue base from our properties.
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Focus on Underserved Industry with Less Competition.
Our focus on specialized industrial real estate
assets leased to tenants in the regulated medical-use cannabis industry may result in significantly less competition from existing
REITs and institutional buyers due to the unique nature of the real estate and its tenants. Moreover, we believe the banking industry's
general reluctance to finance owners of medical-use cannabis facilities, coupled with the owners' need for capital to fund the
growth of their operations, will result in significant opportunities for us to acquire specialized industrial properties that provide
stable and increasing rental revenue along with the potential for long-term appreciation in value.
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Positive Medical-Use Cannabis Industry Trends.
Based on the growth projections for the medical-use
cannabis industry, we expect to see significant spending by state-licensed medical-use cannabis cultivators on their existing and
new medical-use cannabis facilities.
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Our Business Objectives and Growth Strategies
Our principal business objective is to
maximize stockholder returns through a combination of (1) distributions to our stockholders, (2) sustainable long-term growth in
cash flows from increased rents, which we hope to pass on to stockholders in the form of increased distributions, and (3) potential
long-term appreciation in the value of our properties from capital gains upon future sale. Our primary strategy to achieve our
business objective is to acquire and own a portfolio of specialized industrial properties, including medical-use cannabis facilities
leased to tenants holding the requisite state licenses to operate in the regulated medical-use cannabis industry. This strategy
includes the following components:
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Owning Specialized Industrial Properties and Related Real Estate Assets for Income.
We primarily intend
to acquire medical-use cannabis facilities from licensed growers who will continue their cultivation operations after our acquisition
of the property. We expect to hold acquired properties for investment and to generate stable and increasing rental income from
leasing these properties to licensed growers.
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Owning Specialized Industrial Properties and Related Real Estate Assets for Appreciation.
We primarily
intend to lease our acquired properties under long-term triple-net leases. However, from time to time, we may elect to sell one
or more properties if we believe it to be in the best interests of our stockholders. Accordingly, we will seek to acquire properties
that we believe also have potential for long-term appreciation in value.
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Expanding as Additional States Permit Medical-Use Cannabis Cultivation and Production.
We intend to
acquire properties in the United States, with a focus on states that permit cannabis cultivation for medical use. We expect that
our acquisition opportunities will continue to expand as additional states legalize medical-use cannabis and license new cultivators.
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Our Target Markets
Our target markets include states that
permit cannabis cultivation for medical use. As of December 31, 2016, we owned only our Initial Property, a medical-use cannabis
cultivation and processing facility, in New York. According to ArcView, as of
December 31, 2016, 29 states and the District
of Columbia had legalized cannabis for medical use. These states and the District of Columbia had a population of over 200 million
people as of July 1, 2015, according to the U.S. Census Bureau.
Although these states have approved the
medical use of cannabis, the applicable state and local laws and regulations vary widely. For example, most states' laws allow
commercial production and sales through dispensaries and set forth rigorous licensing requirements; in other states the licensing
rules are unclear. In some states, dispensaries are mandated to operate on a not-for-profit basis. Some states permit home cultivation
activities. The states also differ on the form in which cannabis can be sold. For example, some states do not permit cannabis-infused
products such as concentrates, edibles and topicals, while other states ban smoking cannabis.
It is expected that new states that entered
the marketplace in 2016, in addition to states that are in the process of developing regulations in anticipation of entering the
marketplace, may drive industry growth in 2018 and 2019, when medical-use cannabis businesses in such states could begin to generate
revenues. Experience shows that it generally takes one to two years for a state to establish regulations and for medical-use cannabis
businesses to begin to generate revenue from operations. ArcView's projected increase in legal cannabis sales by 2020 is, in part,
attributable to this delay between legalization and revenue generation. In addition, continued development of the regulated medical-use
cannabis industry depends upon continued legislative authorization of medical-use cannabis at the state level. Progress in the
regulated medical-use cannabis industry, while encouraging, is not assured and any number of factors could slow or halt progress
in this area.
Our Target Properties
Generally
We have acquired and intend to continue
to acquire specialized industrial real estate assets operated by state-licensed medical-use cannabis growers through sale-leaseback
transactions and third-party purchases. In sale-leaseback transactions, concurrently upon closing of the acquisition, we will lease
the properties back to the sellers under long-term, triple-net lease agreements. We intend to target properties owned by growers
that have been among the top candidates in the rigorous state licensing process and have been granted one or more licenses to operate
multiple facilities. Based on our Initial Property and ongoing review of potential acquisitions, indoor cultivation facilities
generally appear to have similar shells as standard light industrial buildings. However, based on our diligence, the medical-use
cultivation process typically requires a finely tuned environment to achieve consistent high quality and specificity in cannabinoid
levels and to maximize yields, which translates into certain capital improvements in the building's infrastructure. These improvements
can include enhanced HVAC systems for climate and humidity control, high capacity plumbing systems, specialized lighting systems,
and sophisticated building management, cultivation monitoring and security systems. Through this sale-leaseback strategy, we will
serve as a source of capital to these licensed medical-use cannabis growers, which will allow them to redeploy their sale proceeds
back into their core operations to grow their business and achieve higher returns. In a third-party purchase of a property, we
may also fund the necessary tenant improvements through a long-term lease with the identified tenant, which also serves to free
up capital for the tenant to reinvest in their business.
Our Initial Property
As of December 31, 2016, we owned
only our Initial Property located in New York, which we purchased on December 19, 2016 from PharmaCann for approximately $30.0
million in a sale-leaseback transaction.
Property Description.
Our
Initial Property consists of approximately 37 acres of usable land, which includes three buildings comprising approximately 127,000
square feet. Our Initial Property is also expected to support the future development of additional medical-use cannabis cultivation
facilities totaling approximately 204,000 additional square feet. PharmaCann, the tenant, is licensed by the state of New York
to operate a medical-use cannabis cultivation and processing facility, and has operated such facility at the property since June
2016, when construction of the facility was substantially completed.
Lease Terms.
Upon the
closing of the acquisition, we leased 100% of our Initial Property to PharmaCann to operate a medical-use cannabis cultivation
and processing facility in compliance with applicable state and local law and in compliance with the terms of the tenant's license
from the state of New York. While PharmaCann’s current state license is for medical-use cannabis operations only and adult-use
cannabis is not permitted under current New York law, our lease with PharmaCann does not prohibit adult-use cannabis operations
at the Initial Property, provided such operations are in compliance with applicable state and local laws. As such, the state of
New York may in the future permit adult-use cannabis operations, and PharmaCann may conduct adult-use cannabis operations at the
Initial Property, which in turn could expose PharmaCann, us and our Initial Property to different and greater risks, including
heightened risks of enforcement of federal laws.
PharmaCann is a start-up business that
commenced retail operations in late 2015. PharmaCann secured one of only five licenses granted to date in New York for the cultivation
and dispensing of medical-use cannabis. As of December 31, 2016, PharmaCann operated two cultivation and processing facilities
and four registered medical-use cannabis dispensaries in Illinois, and one cultivation and processing facility and four registered
medical-use cannabis dispensaries in New York.
The lease for our Initial Property is a
triple-net lease, with the tenant responsible for paying all structural repairs, maintenance expenses, insurance and taxes related
to the property. The base rent is approximately $319,580 per month, which shall be increased annually at a rate based on the higher
of (i) 4% or (ii) 75% of the CPI. We also receive a property management fee under the lease equal to 1.5% of the then-current base
rent throughout the term, and supplemental base rent for the first five years of the term at a rate of $105,477 per month. Together,
the annualized initial base rent, property management fee and supplemental base rent equate to approximately 17.2% of the purchase
price of our Initial Property. The lease term is 15 years, with two options to extend the term of the lease for two additional
five-year periods.
As a start-up business, PharmaCann has
not been profitable. During 2017, we expect that PharmaCann will continue to incur losses as its expenses increase in connection
with the expansion of PharmaCann's operations. As a result, at least initially, we expect that PharmaCann will make rent payments
to us from proceeds from the sale of the property or cash on hand, and not funds from operations.
Tenant Concentration
As of December 31, 2016, substantially
all of our revenues were derived from our rent received from PharmaCann at our Initial Property, which was also the only property
that we owned as of December 31, 2016. See each of the discussions under Item 1A, "Risk Factors," under the captions
"We expect that most of our tenants, including the tenant for our Initial Property, will be start-up businesses and may be
unable to pay rent with funds from operations or at all, which could adversely affect our cash available to make distributions
to our stockholders or otherwise impair the value of our common stock," and "Our real estate portfolio currently consists
only of one property and will likely be concentrated in a limited number of properties in the future, which subjects us to an increased
risk of significant loss if any property declines in value or if we are unable to lease a property."
Geographic Concentration
As of December 31,
2016, substantially all of our revenues were derived from our Initial Property, located in New York. See each of the
discussions under Item 1A, "Risk Factors," under the caption "Our properties are, and are expected to continue
to be, geographically concentrated in states that permit medical-use cannabis cultivation, and we will be subject to
social, political and economic risks of doing business in these states and any other state in which we may own
property." New York’s medical-use cannabis market is in its very early stages, and is subject to strict
regulations providing for, among other things, limited medical conditions for treatment with medical-use cannabis,
limitations on the form in which medical cannabis can be consumed and enhanced registration requirements for patients and
physicians, which may result in the New York market not growing and developing in the way that we or our tenant PharmaCann
projected. As of March 15, 2017, according to the New York State Department of Health, there were 14,683 patients certified
for treatment under the state’s medical-use cannabis program.
Our Financing Strategy
We intend to meet our long-term liquidity
needs through cash flow from operations and the issuance of equity and debt securities, including common stock, preferred stock
and long-term notes. Where possible, we also may issue limited partnership interests in our Operating Partnership to acquire properties
from existing owners seeking a tax-deferred transaction. We expect to issue equity and debt securities at times when we believe
that our stock price is at a level that allows for the reinvestment of offering proceeds in accretive property acquisitions. We
may also issue common stock to permanently finance properties that were previously financed by debt securities. However, we cannot
assure you that we will have access to the capital markets at times and on terms that are acceptable to us. Our ability to access
the capital markets and to obtain other financing arrangements is also significantly limited by our Company’s focus on serving
the medical-use cannabis industry. Our investment guidelines initially provide that our aggregate borrowings (secured and unsecured)
will not exceed 50% of the cost of our tangible assets at the time of any new borrowing, subject to our board of directors' discretion.
Our Leases
The following is a general description
of the type of lease we typically expect to enter into with our tenants. The terms and conditions of any actual lease may vary
from those described below. If we determine that the terms of a lease at a property, in the context of the entire investment, are
favorable to us, we may enter into leases with terms that are substantially different from the terms described below.
We intend to acquire industrial medical-use
cannabis facilities and lease them to tenants who are the state-licensed operators of such facilities. While we target the acquisition
of medical-use cannabis facilities, our leases do not prohibit cannabis cultivation for adult-use that is permissible under the
state and local laws where our facilities are located. Consequently, certain of our tenants may subsequently cultivate adult-use
cannabis in our medical-use cannabis facilities, if permitted by such state and local laws now or in the future, which may in turn
subject the tenant, us and our properties to greater and/or different federal legal and other risks than exclusively medical-use
cannabis facilities. While the structure of our leases may vary depending on the type and location of the property, we generally
seek to structure our leases so that the tenant is responsible for taxes, maintenance, insurance, and structural repairs with respect
to the premises throughout the lease term. We expect that our lease structure will offer predictability and stability of our expenses,
which we believe will help us to achieve stable and consistent cash distributions to our stockholders.
We expect to enter into lease agreements
for a term of ten to 15 years with two consecutive five-year renewal options. We expect that the leases will commence concurrent
with the closing of our purchase of the property. We may acquire properties and enter into lease agreements with shorter lease
terms if the property benefits from an attractive location, if the property is difficult to replace or if the property has other
significant and favorable real estate attributes. We also may enter into leases with longer lease terms if we believe the potential
investment yield is particularly attractive.
Under most commercial leases, tenants are
obligated to pay a predetermined annual base rent on a monthly basis. We expect that our leases will contain annual rent adjustments
at the rate based on the higher of (i) a specified percentage rate of increase or (ii) a specified percentage rate of the CPI.
The terms of our leases will require that our tenants make rental payments via check or wire transfer. A tenant may experience
difficulty curing a default of the manner of payment requirement under our lease due to continued reluctance of banks to accept
clients who operate in the medical-use cannabis industry. See the section "We and our tenants may have difficulty accessing
the service of banks, which may make it difficult to contract for real estate needs" under Item 1A, "Risk Factors."
Generally, our leases will require each
tenant to procure, at its expense, commercial general liability insurance. The tenant typically will pay for property insurance
covering the structures for the full replacement value and naming the owner as the additional insured on the policy. In addition,
we generally expect to obtain loss-of-rent (business interruption) insurance in case of property damage, fire, or other instances
which render the property uninhabitable. Tenants will be required to provide proof of insurance by furnishing a certificate of
insurance to us upon request.
We do not typically expect to permit leases
to be assigned or subleased without our prior written consent. If we do consent to an assignment or sublease, generally we expect
the terms of such consent to provide that the original tenant will remain fully liable under the lease unless we release that original
tenant from its obligations.
Certain properties that we acquire may
be subject to ground leases. A ground lease agreement permits a tenant to develop and/or operate a land parcel (property) during
the lease period, after which the land parcel and all improvements revert back to the property owner. Under a ground lease, property
improvements are owned by the property owner unless an exception is created and all relevant taxes incurred during the lease period
are paid for by the tenant. Ground leases typically have a long duration generally ranging from 50 to 99 years with additional
extension options.
Risk Management
We purchased our Initial Property for $30
million in December 2016, and expect to purchase an additional two to four properties with the balance of the net proceeds from
our initial public offering. We will attempt to diversify the investment size and location of our portfolio of properties in order
to manage our portfolio-level risk. Over the long term, we intend that no single property will exceed 25% of our total assets and
that no single tenant will exceed 30% of our total assets. However, we will not achieve these long-term targets with the net proceeds
of our initial public offering.
We expect that single tenants will occupy
our properties pursuant to triple-net lease arrangements in general and, therefore, the success of our investments will be materially
dependent on the financial stability of these tenants. We expect that most of our tenants will be start-up businesses that have
little or no revenue and, at least initially, will make rent payments to us from the sale proceeds of a sale-leaseback transaction
with us or cash on hand. We also expect the success of our tenants, and their ability to make rent payments to us, to significantly
depend on the projected growth and development of the applicable state market; as many of these state markets have a very limited
history, and other state markets are still forming their regulations, issuing licenses and otherwise establishing the market framework,
significant uncertainty exists as to whether these markets will develop in the way that we or our tenants project.
We expect to evaluate the credit quality
of our tenants and any guarantors on an ongoing basis by reviewing, where available, the publicly filed financial reports, press
releases and other publicly available industry information regarding our tenants and any guarantors. In addition, we will monitor
the payment history data for all of our tenants and, in some instances, we intend to monitor our tenants by periodically conducting
site visits and meeting with the tenants to discuss their operations. In many instances, we will generally not be entitled to financial
results or other credit-related data from our tenants. See the section "Risks Related to Our Business" under Item 1A,
"Risk Factors."
Competition
The current market for properties that
meet our investment objectives is limited. In addition, we believe finding properties that are appropriate for the specific use
of allowing medical-use cannabis growers may be limited as more competitors enter the market, and as medical-use cannabis growers
obtain greater access to alternative financing sources, including but not limited to equity and debt financing sources. We face
significant competition from a diverse mix of market participants, including but not limited to, other companies with similar business
models, independent investors, hedge funds and other real estate investors, hard money lenders, and cannabis operators themselves,
all of whom may compete with us in our efforts to acquire real estate zoned for medical-use cannabis facilities. Several competitors
have recently entered the marketplace, including Kalyx Development, Inc., AmeriCann, Inc., Zoned Properties, Cannabis-RX, Inc.,
The CannaBusiness Group, Inc., MJ Holdings, Inc., MJ Real Estate Investors, Home Treasure Finders, Inc., Advanced Cannabis Solutions,
Inc. and Grow Condos, Inc. In some instances, we will be competing to acquire real estate with persons who have no interest in
the cannabis industry, but have identified value in a piece of real estate that we may be interested in acquiring.
These competitors may prevent us from acquiring
desirable properties or may cause an increase in the price we must pay for properties. Our competitors may have greater financial
and operational resources than we do and may be willing to pay more for certain assets or may be willing to accept more risk than
we believe can be prudently managed. In particular, larger companies may enjoy significant competitive advantages that result from,
among other things, a lower cost of capital and enhanced operating efficiencies. Our competitors may also adopt transaction structures
similar to ours, which would decrease our competitive advantage in offering flexible transaction terms. In addition, due to a number
of factors, including but not limited to potential greater clarity of the laws and regulations governing medical-use cannabis by
state and federal governments, the number of entities and the amount of funds competing for suitable investment properties may
increase, resulting in increased demand and increased prices paid for these properties. If we pay higher prices for properties,
our profitability may decrease, and you may experience a lower return on our common stock. Increased competition for properties
may also preclude us from acquiring those properties that would generate attractive returns to us.
Governmental Regulation
Agricultural Regulation
The medical-use cannabis properties that
we acquire will be used primarily for cultivation and production of medical-use cannabis and will be subject to the laws, ordinances
and regulations of state, local and federal governments, including laws, ordinances and regulations involving land use and usage,
water rights, treatment methods, disturbance, the environment, and eminent domain.
Each governmental jurisdiction has its
own distinct laws, ordinances and regulations governing the use of agricultural lands. Many such laws, ordinances and regulations
seek to regulate water usage and water runoff because water can be in limited supply, as is the case in certain locations including
New York, where our Initial Property is located. In addition, runoff from rain or from irrigation is governed by laws, ordinances
and regulations from state, local and federal governments. Additionally, if any of the water used on or running off from our properties
flows to any rivers, streams, ponds, the ocean or other waters, there may be specific laws, ordinances and regulations governing
the amount of pollutants, including sediments, nutrients and pesticides, that such water may contain.
We expect that the properties in our portfolio
will, at the time of acquisition, have sources of water, including wells and/or surface water, that will provide sufficient amounts
of water necessary for the current operations at each location. However, should the need arise for additional water from wells
and/or surface water sources, we may be required to obtain additional permits or approvals or to make other required notices prior
to developing or using such water sources. Permits for drilling water wells or withdrawing surface water may be required by federal,
state and local governmental entities pursuant to laws, ordinances, regulations or other requirements, and such permits may be
difficult to obtain due to drought, the limited supply of available water within the districts of the states in which our properties
are located or other reasons.
In addition to the regulation of water
usage and water runoff, state, local and federal governments also seek to regulate the type, quantity and method of use of chemicals
and materials for growing crops, including fertilizers, pesticides and nutrient rich materials. Such regulations could include
restricting or preventing the use of such chemicals and materials near residential housing or near water sources. Further, some
regulations have strictly forbidden or significantly limited the use of certain chemicals and materials. Licenses, permits and
approvals must be obtained from governmental authorities requiring such licenses, permits and approvals before chemicals and materials
can be used at grow facilities. Reports on the usage of such chemicals and materials must be submitted pursuant to applicable laws,
ordinances, and regulations and the terms of the specific licenses, permits and approvals. Failure to comply with laws, ordinances
and regulations, to obtain required licenses, permits and approvals or to comply with the terms of such licenses, permits and approvals
could result in fines, penalties and/or imprisonment.
The use of land for agricultural purposes
in certain jurisdictions is also subject to regulations governing the protection of endangered species. When agricultural lands
border, or are in close proximity to, national parks, protected natural habitats or wetlands, the agricultural operations on such
properties must comply with laws, ordinances and regulations related to the use of chemicals and materials and avoid disturbance
of habitats, wetlands or other protected areas.
Because properties we own may be used for
growing medical-use cannabis, there may be other additional land use and zoning regulations at the state or local level that affect
our properties that may not apply to other types of agricultural uses. For example, New York requires stringent security systems
in place at grow facilities, and also require stringent procedures for disposal of waste materials.
As an owner of agricultural lands, we may
be liable or responsible for the actions or inactions of our tenants with respect to these laws, regulations and ordinances.
Environmental Matters
Our properties and the operations thereon
are subject to federal, state and local environmental laws, ordinances and regulations, including laws relating to water, air,
solid wastes and hazardous substances. Our properties and the operations thereon are also subject to federal, state and local laws,
ordinances, regulations and requirements related to the federal Occupational Safety and Health Act, as well as comparable state
statutes relating to the health and safety of our employees and others working on our properties. Although we believe that we and
our tenants are in material compliance with these requirements, there can be no assurance that we will not incur significant costs,
civil and criminal penalties and liabilities, including those relating to claims for damages to persons, property or the environment
resulting from operations at our properties.
Real Estate Industry Regulation
Generally, the ownership and operation
of real properties is subject to various laws, ordinances and regulations, including regulations relating to zoning, land use,
water rights, wastewater, storm water runoff and lien sale rights and procedures. These laws, ordinances or regulations, such as
the Comprehensive Environmental Response and Compensation Liability Act and its state analogs, or any changes to any such laws,
ordinances or regulations, could result in or increase the potential liability for environmental conditions or circumstances existing,
or created by tenants or others, on our properties. Laws related to upkeep, safety and taxation requirements may result in significant
unanticipated expenditures, loss of our properties or other impairments to operations, any of which would adversely affect our
cash flows from operating activities.
While we would not take over any
direct operations of our tenants, our property management activities, to the extent we are required to engage in them due to
lease defaults by tenants or vacancies on certain properties, will likely be subject to state real estate brokerage laws
and regulations as determined by the particular real estate commission for each state.
State Laws Applicable to the Medical-Use Cannabis Industry
In most states that have legalized medical-use
cannabis in some form, the growing and/or dispensing of cannabis generally requires that the operator obtain one or more licenses
in accordance with applicable state requirements. In addition, many states regulate various aspects of the growing and/or dispensing
of medical-use cannabis. For example, New York limits the types of treatable medical conditions, requires registration of both
patients and recommending physicians, limits the types of strains that can be grown, sets prices through the State Program Commissioner,
requires that a registered pharmacist be on the premises of all dispensaries during hours of operation, and prohibits both flower
and edibles. Local governments in some cases also impose rules and regulations on the manner of operating cannabis businesses.
As a result, applicable state and local laws and regulations vary widely. As a result of licensing requirements, if our tenants
default under their leases, we may not be able to find new tenants that have the requisite license to engage in the cultivation
of medical cannabis on the properties.
Federal Laws Applicable to the Medical-Use Cannabis Industry
Cannabis is a Schedule I controlled substance
under the CSA. Even in those jurisdictions in which the manufacture and use of medical cannabis has been legalized at the state
level, the possession, use, cultivation, and transfer of cannabis remains a violation of federal law. Federal law criminalizing
the use of cannabis preempts state laws that legalize its use for medicinal or adult-retail purposes, and therefore strict enforcement
of federal law regarding cannabis would likely result in our inability to execute our business plan.
The U.S. Department of Justice, under the
Obama administration, has issued memoranda, including the so-called "Cole Memo" on August 29, 2013, characterizing enforcement
of federal cannabis prohibitions under the CSA to prosecute those complying with state regulatory systems allowing the use, manufacture
and distribution of medical cannabis as an inefficient use of federal investigative and prosecutorial resources when state regulatory
and enforcement efforts are effective with respect to enumerated federal enforcement priorities under the CSA. In the "Cole
Memo," the U.S. Department of Justice provided guidance to all federal prosecutors indicating that federal enforcement of
the CSA against cannabis-related conduct should be focused on eight priorities, which are to prevent: (1) distribution of cannabis
to minors; (2) revenue from sale of cannabis to criminal enterprises, gangs and cartels; (3) transfer of cannabis from states where
it is legal to states where it is illegal; (4) cannabis activity from being a pretext for trafficking of other illegal drugs or
illegal activity; (5) violence or use of firearms in cannabis cultivation and distribution; (6) drugged driving and adverse public
health consequences from cannabis use; (7) growth of cannabis on federal lands; and (8) cannabis possession or use on federal property.
In addition, as it did for the fiscal year
2015, Congress enacted an omnibus spending bill for fiscal year 2016 including a provision prohibiting the U.S. Department of Justice
(which includes the DEA) from using funds appropriated by that bill to prevent states from implementing their medical-use cannabis
laws, which was further extended to April 28, 2017. This provision, however, is effective only until April 28, 2017 and must be
renewed by Congress. In
USA vs. McIntosh
, the United States Circuit Court of Appeals for the Ninth Circuit held that
this provision prohibits the U.S. Department of Justice from spending funds from relevant appropriations acts to prosecute individuals
who engage in conduct permitted by state medical-use cannabis laws and who strictly comply with such laws. However, the Ninth Circuit's
opinion, which only applies in the states of Alaska, Arizona, California, Hawaii and Idaho, also held that persons who do not strictly
comply with all state laws and regulations regarding the distribution, possession and cultivation of medical-use cannabis have
engaged in conduct that is unauthorized, and in such instances the U.S. Department of Justice may prosecute those individuals.
Furthermore, while we target the acquisition of medical-use cannabis facilities, our leases do not prohibit cannabis cultivation
for adult-use that is permissible under the state and local laws where our facilities are located. Consequently, certain of our
tenants may subsequently cultivate adult-use cannabis in our medical-use cannabis facilities, if permitted by such state and local
laws now or in the future, which may in turn subject the tenant, us and our properties to greater and/or different federal legal
and other risks than exclusively medical-use cannabis facilities, including not providing protection under the above Congressional
spending provision.
We do not intend to acquire properties
from or lease properties to companies whose activities involve or support those enumerated in the Cole Memo, but federal prosecutors
have significant discretion in their interpretation of these priorities. Therefore, no assurance can be given that the federal
prosecutor in each judicial district where we purchase a property will agree that the activities of our tenant on the property
located in such prosecutor's district do not involve those enumerated in the Cole Memo. There is also no guarantee that the current
Trump administration or future administrations will not revise the federal enforcement priorities enumerated in the Cole Memo or
otherwise choose to strictly enforce the federal laws governing cannabis production or distribution. Any such change in the federal
government's current enforcement posture with respect to state-licensed cultivation of medical-use cannabis would result in our
inability to execute our business plan and we would likely suffer significant losses with respect to our investment in medical-use
cannabis facilities in the United States.
Laws Applicable to Banking for Medical-Use Cannabis Industry
All banks are subject to federal law, whether
the bank is a national bank or state-chartered bank. At a minimum, all banks maintain federal deposit insurance which requires
adherence to federal law. Violation of federal law could subject a bank to loss of its charter. Financial transactions involving
proceeds generated by cannabis-related conduct can form the basis for prosecution under the federal money laundering statutes,
unlicensed money transmitter statutes and the Bank Secrecy Act. For example, under the Bank Secrecy Act, banks must report to the
federal government any suspected illegal activity, which would include any transaction associated with a cannabis-related business.
These reports must be filed even though the business is operating in compliance with applicable state and local laws. Therefore,
financial institutions that conduct transactions with money generated by cannabis-related conduct could face criminal liability
under the Bank Secrecy Act for, among other things, failing to identify or report financial transactions that involve the proceeds
of cannabis-related violations of the CSA.
The Financial Crimes Enforcement Network,
or FinCen, issued guidance in February 2014 which clarifies how financial institutions can provide services to cannabis-related
businesses consistent with their obligations under the Bank Secrecy Act. Concurrently with the FinCen guidance, the U.S. Department
of Justice issued supplemental guidance directing federal prosecutors to consider the federal enforcement priorities enumerated
in the Cole Memo with respect to federal money laundering, unlicensed money transmitter and Bank Secrecy Act offenses based on
cannabis-related violations of the CSA. The FinCen guidance sets forth extensive requirements for financial institutions to meet
if they want to offer bank accounts to cannabis-related businesses, including close monitoring of businesses to determine that
they meet all of the requirements established by the U.S. Department of Justice, including those enumerated in the Cole Memo. This
is a level of scrutiny that is far beyond what is expected of any normal banking relationship.
As a result, many banks are hesitant to
offer any banking services to cannabis-related businesses, including opening bank accounts. While we currently have a bank account,
our inability to maintain that account or the lack of access to bank accounts or other banking services in the future, would make
it difficult for us to operate our business, increase our operating costs, and pose additional operational, logistical and security
challenges. Similarly, if our proposed tenants are unable to access banking services, they will not be able to enter into triple-net
leasing arrangements with us, as our leases will require rent payments to be made by check or wire transfer.
Seasonality
Our business has not been, and we do not
expect it to become subject to, material seasonal fluctuations.
Available Information
The Company makes available to the public
free of charge through its internet website the Company’s Definitive Proxy Statement, Annual Report on Form 10-K, Quarterly
Reports on Form 10-Q, Current Reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a)
or 15(d) of the Exchange as soon as reasonably practicable after the Company electronically files such reports with, or furnishes
such reports to, the SEC. The Company’s internet website address is www.innovativeindustrialproperties.com.
The public may read and copy any materials
that the Company files with the SEC at the SEC’s Public Reference Room located at 100 F Street, NE, Washington, DC 20549.
The public may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC also
maintains electronic versions of the Company’s reports on its website at www.sec.gov.
ITEM IA.
RISK FACTORS
Risks Related to Our Business
We were recently formed, have a very limited operating
history, and may not be able to operate our business successfully or generate sufficient cash flow to make or sustain distributions
to our stockholders.
We were formed on June 15, 2016 and have
a very limited operating history. We owned only one property as of December 31, 2016, which is our Initial Property that we purchased
for $30 million in a sale-leaseback transaction on December 19, 2016. We are subject to many of the business risks and uncertainties
associated with any new business enterprise. We cannot assure you that we will be able to operate our business successfully or
profitably, find suitable investments or implement our operating policies. Our ability to provide attractive risk-adjusted returns
to our stockholders over the long term is dependent on our ability both to generate sufficient cash flow to pay an attractive dividend
and to achieve capital appreciation, and we cannot assure you we will do either. There can be no assurance that we will be able
to generate sufficient revenue from operations to pay our operating expenses and make distributions to stockholders. The results
of our operations and the implementation of our business plan depend on several factors, including the availability of opportunities
for investment, the availability of adequate equity and debt financing, the federal and state regulatory environment relating to
the medical-use cannabis industry, conditions in the financial markets and economic conditions.
We may suffer from delays in locating suitable investment
properties, which could adversely affect the return on our common stock.
Our ability to achieve our investment objectives
and to make distributions to our stockholders depends upon our senior management team's ability to identify suitable properties
for acquisition and then negotiating and consummating the acquisition and triple-net leasing arrangement. The current market for
properties that meet our investment objectives may be limited. We intend to conduct due diligence with respect to each investment
and may suffer delays in locating suitable investment opportunities. Until appropriate investment properties can be identified
and acquired, we have invested the net proceeds of our initial public offering in interest-bearing short-term investments, including
money market accounts and/or funds that are consistent with our intention to qualify as a REIT. These investments are expected
to provide a lower net return than we seek to achieve from investments in our target assets. Any significant delay in investing
the net proceeds of our initial public offering or any future financings would have a material adverse effect on our ability to
generate cash flow and make distributions to our stockholders.
As a public company, we are subject to
the ongoing reporting requirements under the Exchange Act. Pursuant to the Exchange Act, we may be required to file with the SEC
financial statements of properties we acquire or financial statements of our tenants who have entered into triple-net leasing arrangements
with us for a significant portion of our properties. To the extent any required financial statements are not available or cannot
be obtained, we will not be able to acquire the property. As a result, we may be unable to acquire certain properties that otherwise
would be a suitable investment. We could suffer delays in our acquisition of suitable properties due to these reporting requirements.
Furthermore, our stockholders will not
have the opportunity to evaluate the terms of transactions, the creditworthiness of our tenants or other economic or financial
data concerning our acquisition of properties, and our stockholders have to rely entirely on the ability of our senior management
team to select suitable and successful investment opportunities. These factors increase the speculative nature of an investment
in our common stock.
We own only our Initial Property, and have not entered
into binding contracts or commitments to acquire any other specific properties and, therefore, are dependent on PharmaCann until
we further diversify our portfolio.
We currently own only our Initial Property,
and have not yet committed the balance of the net proceeds of our initial public offering to any other specific medical-use cannabis
facilities. As of December 31, 2016, our lease to PharmaCann represented substantially all of our revenues. Lease payment defaults
by PharmaCann would materially adversely affect our business, financial position and results of operations, including our ability
to make distributions to our stockholders.
In addition, failure by PharmaCann to comply
with the terms of its lease agreement with us could require us to find another lessee for our Initial Property. We may experience
delays in enforcing our rights as landlord and may incur substantial costs in protecting our investment and re-leasing our Initial
Property. Furthermore, we cannot assure you that we will be able to re-lease the property for the rent we currently receive, or
at all, or that a lease termination would not result in our having to sell the property at a loss. The result of any of the foregoing
risks could materially and adversely affect our business, financial condition and results of operations and our ability to make
distributions to our stockholders.
Our real estate portfolio currently consists only of
our Initial Property and will likely be concentrated in a limited number of properties in the future, which subjects us to an increased
risk of significant loss if any property declines in value or if we are unable to lease a property.
Based on the purchase of our Initial Property,
the expected investment size of future investments and our senior management team's experience in the marketplace, we estimate
that we will purchase approximately three to five properties with the net proceeds of the initial public offering. However, currently
a substantial portion of the net proceeds of the initial public offering is not committed to specific properties and we currently
only own one property, our Initial Property.
One consequence of a limited number of
investments is that the aggregate returns we realize may be substantially adversely affected by the unfavorable performance of
a small number of leases or a significant decline in the value of any single property. Lack of diversification will increase the
potential that a single underperforming investment could have a material adverse effect on our cash flows and the price we could
realize from the sale of our properties. Currently, we have invested approximately half of the net proceeds of our initial public
offering in one property, which is leased by a tenant, PharmaCann, that recently commenced operations. Any adverse change in the
financial condition of PharmaCann, including but not limited to the state medical-use cannabis markets not developing and growing
in ways that we or PharmaCann projected, or any adverse change in the political climate regarding medical-use cannabis where our
Initial Property is located would subject us to a significant risk of loss.
In addition, because we expect that the
additional properties we initially acquire will be geographically concentrated in states that permit medical-use cannabis cultivation,
we will be subject to any adverse change in the political or regulatory climate in those states or specific counties where our
properties are located, which could adversely affect our properties and our ability to lease properties.
Competition for the acquisition of properties suitable
for the cultivation and production of medical-use cannabis may impede our ability to make acquisitions or increase the cost of
these acquisitions, which could adversely affect our operating results and financial condition.
We compete for the acquisition of properties
suitable for the cultivation and production of medical-use cannabis with other entities engaged in agricultural and real estate
investment activities, including corporate agriculture companies, cultivators and producers of medical-use cannabis, private equity
investors, and other real estate investors (including public and private REITs). We also compete as a provider of capital to medical-use
cannabis operators with alternative financing sources to these companies, including both equity and debt financing alternatives.
These competitors may prevent us from acquiring desirable properties or may cause an increase in the price we must pay for properties.
Our competitors may have greater financial and operational resources than we do and may be willing to pay more for certain assets
or may be willing to accept more risk than we believe can be prudently managed. In particular, larger companies may enjoy significant
competitive advantages that result from, among other things, a lower cost of capital and enhanced operating efficiencies. Our competitors
may also adopt transaction structures similar to ours, which would decrease our competitive advantage in offering flexible transaction
terms. In addition, due to a number of factors, including but not limited to potential greater clarity of the laws and regulations
governing medical-use cannabis by state and federal governments, the number of entities and the amount of funds competing for suitable
investment properties may increase, resulting in increased demand and increased prices paid for these properties. If we pay higher
prices for properties, our profitability and ability to generate cash flow and make distributions to our stockholders may decrease.
Increased competition for properties may also preclude us from acquiring those properties that would generate attractive returns
to us.
Our growth will depend upon future acquisitions of medical-use
cannabis facilities, and we may be unable to consummate acquisitions on advantageous terms.
Our growth strategy is focused on the acquisition
of specialized industrial real estate assets on favorable terms as opportunities arise. Our ability to acquire these real estate
assets on favorable terms is subject to the following risks:
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competition from other potential acquirers or increased availability of alternative debt and equity financing sources for tenants
may significantly increase the purchase price of a desired property;
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we may not successfully purchase and lease our properties to meet our expectations;
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we may be unable to obtain the necessary equity or debt financing to consummate an acquisition on satisfactory terms or at
all;
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agreements for the acquisition of properties are typically subject to closing conditions, including satisfactory completion
of due diligence investigations, and we may spend significant time and money and divert management attention on potential acquisitions
that we do not consummate; and
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we may acquire properties without any recourse, or with only limited recourse, for liabilities, whether known or unknown, against
the former owners of the properties.
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Our failure to consummate acquisition on
advantageous terms without substantial expense or delay would impede our growth and negatively affect our results of operations
and our ability to generate cash flow and make distributions to our stockholders.
There may only be a limited number of medical-use cannabis
facilities operated by suitable tenants available for us to acquire, which could adversely affect the return on our common stock.
We target medical-use cannabis facilities
for acquisition and leasing to licensed growers under triple-net lease agreements. We also target properties owned by growers that
have been among the top candidates in the rigorous state licensing process and have been granted one or more licenses to operate
multiple facilities. In light of the current regulatory landscape regarding medical-use cannabis, including but not limited to,
the rigorous state licensing processes, limits on the number of licenses granted in certain states and in counties within such
states, zoning regulations related to medical-use cannabis facilities, the inability of potential tenants to open bank accounts
necessary to pay rent and other expenses and the ever-changing federal and state regulatory landscape, we may have only a limited
number of medical-use cannabis facilities available to purchase that are operated by licensees that we believe would be suitable
tenants. These tenants may also have increased access to alternative equity and debt financing sources, which may limit our ability
to negotiate leasing arrangements that meet our investment criteria. Our inability to locate suitable investment properties and
tenants would have a material adverse effect on our ability to generate cash flow and make distributions to our stockholders.
We expect that most of our tenants, including the tenant
for our Initial Property, will be start-up businesses and may be unable to pay rent with funds from operations or at all, which
could adversely affect our cash available to make distributions to our stockholders or otherwise impair the value of our common
stock.
We expect that single tenants will occupy
our properties and, therefore the success of our investments will be materially dependent on the financial stability of these tenants.
We expect that our future tenants will be independent medical-use cannabis cultivation operators about which there is generally
little or no publicly available operating and financial information. As a result, we will rely on our management team to perform
due diligence investigations of our potential tenants and their properties, operations and prospects. We may not learn all of the
material information we need to know regarding these businesses through our investigations. As a result it is possible that we
could enter into a sale-leaseback arrangement with tenants or otherwise lease properties to tenants that ultimately are unable
to pay rent to us, which could adversely impact our cash available for distributions.
We expect that most of our tenants, including
the tenant for our Initial Property, will be start-up businesses that have little or no revenue when they enter triple-net leasing
arrangements with us and therefore, may be unable to pay rent with funds from operations. For example, PharmaCann, the tenant for
our Initial Property, is not profitable and has experienced losses since inception. As a result, we expect that our tenants (including
PharmaCann) will make initial rent payments to us from proceeds from the sale of the property, in the case of sale-leaseback transactions,
or other cash on hand.
In addition, in general, as start-up businesses,
we expect our tenants will be more vulnerable to adverse conditions resulting from federal and state regulations affecting their
businesses or industries and will have limited access to traditional forms of financing. The success of our tenants, including
PharmaCann, will also heavily depend on the growth and development of the state markets in which the tenants operate, many of which
have a very limited history or are still in the stages of establishing the regulatory framework. For example, New York’s
medical-use cannabis market is in its very early stages, and is subject to strict regulations providing for, among other things,
limited medical conditions for treatment with medical-use cannabis, limitations on the form in which medical cannabis can be consumed
and enhanced registration requirements for patients and physicians, which may result in the New York market not growing and developing
in the way that we or our tenant PharmaCann projected. As of March 15, 2017, according to the New York State Department of Health, there were 14,683 patients certified for treatment
under the state's medical-use cannabis program.
In our evaluation of our lease with PharmaCann
at our Initial Property, we determined to record associated revenue on a cash basis due to the uncertainty of collectability of
lease payments from PharmaCann due to their lack of operating history (see the section entitled "Critical Accounting Policies
— Revenue Recognition and Accounts Receivable" in Item 7, "Management's Discussion and Analysis of Financial Condition
and Results of Operations" for more information).
Some of our tenants may also be subject
to significant debt obligations. Tenants that are subject to significant debt obligations may be unable to make their rent payments
if there are adverse changes in their business plans or prospects, the regulatory environment in which they operate or in general
economic conditions. In addition, the payment of rent and debt service may reduce the working capital available to tenants for
the start-up phase of their business. Furthermore, we may be unable to monitor and evaluate tenant credit quality on an on-going
basis.
In addition, many states issue licenses
for medical-use cannabis operations for a limited time period, which must be renewed periodically, including for PharmaCann at
our Initial Property in New York. If one or more of our tenants is unable to renew or otherwise maintain its license, or if it
is unable to renew or otherwise maintain other requisite authorizations on state and local levels for business operations, that
tenant will not be able to operate its business, and may default on its lease payments to us.
Any lease payment defaults by a tenant
could adversely affect our cash flows and cause us to reduce the amount of distributions to stockholders. In the event of a default
by a tenant, we may also experience delays in enforcing our rights as landlord and may incur substantial costs in protecting our
investment and re-leasing our property as operators of medical-use cannabis cultivation and production facilities are generally
subject to extensive state licensing requirements. Furthermore, we will not operate any of the facilities that we purchase.
We acquired our Initial Property, and may acquire other
properties, "as-is," which increases the risk of an investment that requires us to remedy defects or costs without recourse
to the prior owner.
We acquired our Initial Property, and may
acquire other real estate properties, "as is" with only limited representations and warranties from the property seller
regarding matters affecting the condition, use and ownership of the property. There may also be environmental conditions associated
with properties we acquire of which we are unaware despite our diligence efforts. In particular, medical-use cannabis facilities
may present environmental concerns of which we are not currently aware. If environmental contamination exists on properties we
acquire or develops after acquisition, we could become subject to liability for the contamination. As a result, if defects in the
property (including any building on the property) or other matters adversely affecting the property are discovered, including but
not limited to environmental matters, we may not be able to pursue a claim for any or all damages against the property seller.
Such a situation could harm our business, financial condition, liquidity and results of operations.
Our properties are, and are expected to continue to
be, geographically concentrated in states that permit medical-use cannabis cultivation, and we will be subject to social, political
and economic risks of doing business in these states and any other state in which we may own property.
We expect that the properties that we initially
acquire will be geographically concentrated in states that permit medical-use cannabis cultivation. Our Initial Property, which
is the only property we owned as of December 31, 2016, is located in New York. Circumstances and developments related to operations
in these markets that could negatively affect our business, financial condition, liquidity and results of operations include, but
are not limited to, the following factors:
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the responsibility of complying with multiple and likely conflicting state and federal laws in the United States, including
with respect to cultivation and distribution of medical-use cannabis, licensing, banking and insurance;
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difficulties and costs of staffing and managing operations;
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unexpected changes in regulatory requirements and other laws;
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potentially adverse tax consequences;
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the state medical-use cannabis market fails to develop and grow in ways that we or our tenants projected;
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the impact of national, regional or state specific business cycles and economic instability; and
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access to capital may be more restricted, or unavailable on favorable terms or at all in certain locations.
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Because our real estate investments will consist of
primarily industrial properties suitable for cultivation and production of medical-use cannabis, our rental revenues will be significantly
influenced by demand for these facilities generally, and a decrease in such demand would likely have a greater adverse effect on
our rental revenues than if we owned a more diversified real estate portfolio.
Because our portfolio of properties will
consist of industrial properties used in the regulated medical-use cannabis industry, we will be subject to risks inherent in investments
in a single industry. A decrease in the demand for medical-use cannabis cultivation facilities would have a greater adverse effect
on our rental revenues than if we owned a more diversified real estate portfolio. Demand for medical-use cannabis cultivation facilities
has been and could be adversely affected by changes in current favorable state or local laws relating to cultivation and production
of medical-use cannabis or any change in the federal government's current enforcement posture with respect to state-licensed cultivation
of medical-use cannabis, among others. To the extent that any of these conditions occur, they are likely to affect demand and market
rents for medical-use cannabis cultivation facilities, which could cause a decrease in our rental revenue. Any such decrease could
impair our ability to make distributions to you. We do not expect to invest in other real estate or businesses to hedge against
the risk that industry trends might decrease the profitability of our medical-use cannabis cultivation facilities.
If our properties' access to adequate water and power
supplies is interrupted, it could harm our ability to lease the properties for medical-use cannabis cultivation and production,
thereby adversely affecting our ability to generate returns on our properties.
In order to lease the properties that we
intend to acquire, these properties will require access to sufficient water and power to make them suitable for the cultivation
and production of medical-use cannabis. Although we expect to acquire properties with sufficient access to water, should the need
arise for additional wells from which to obtain water, we would be required to obtain permits prior to drilling such wells. Permits
for drilling water wells are required by state and county regulations, and such permits may be difficult to obtain due to the limited
supply of water in areas where we expect to acquire properties. Similarly, our properties may be subject to governmental regulations
relating to the quality and disposition of rainwater runoff or other water to be used for irrigation. In such case, we could incur
costs necessary in order to retain this water. If we are unable to obtain or maintain sufficient water supply for our properties,
our ability to lease them for the cultivation and production of medical-use cannabis would be seriously impaired, which would have
a material adverse impact on the value of our assets and our results of operations.
Historically, states that have legalized
medical-use cannabis cultivation have typically required that such cultivation take place indoors. Indoor cultivation of medical-use
cannabis requires significant power for growing lights and ventilation and air conditioning to remove the hot air generated by
the growing lights. While outdoor and greenhouse cultivation is gaining acceptance in many states with favorable climates for such
growth, we expect that a significant number of our properties will continue to utilize indoor cultivation methods. Any extended
interruption of the power supply to our properties, particularly those using indoor cultivation methods, would likely harm our
tenants' crops, which could result in their inability to make lease payments to us for our properties. Any lease payment defaults
by a tenant could adversely affect our cash flows and cause us to reduce the amount of distributions to stockholders.
Some of our tenants could be susceptible to bankruptcy,
which would affect our ability to generate rents from them and therefore negatively affect our results of operations.
In addition to the risk of tenants being
unable to make regular rent payments, certain of our tenants who may depend on debt could be especially susceptible to bankruptcy
in the event that their cash flows are insufficient to satisfy their debt. Any bankruptcy of one of our tenants would result in
a loss of lease payments to us, as well as an increase in our costs to carry the property.
Additionally, under bankruptcy law, a tenant
who is the subject of bankruptcy proceedings has the option of continuing ("assuming") or giving up ("rejecting")
any unexpired lease of non-residential real property. If a bankrupt tenant decides to give up (reject) a lease with us, any claim
we might have for breach of the lease, excluding a claim against (1) collateral securing the lease, or (2) a guarantor guaranteeing
lease obligations, would be treated as a general unsecured claim in the tenant's bankruptcy case. The laws governing bankruptcy
cases would impact the treatment of our general unsecured claim. Our claim would likely be capped at the amount the tenant owed
us for unpaid rent prior to the bankruptcy unrelated to the termination, plus the greater of one year of lease payments or 15%
of lease payments payable under the remaining term of the lease, but in no case more than three years of lease payments. In addition
to the cap on our damages for breach of the lease, even if our claim is timely submitted to the bankruptcy court, there is no guaranty
that the tenant's bankruptcy estate would have funds to satisfy the claims of general unsecured creditors. Finally, a bankruptcy
court could re-characterize a net lease transaction as a disguised secured lending transaction. If that were to occur, we would
not be treated as the owner of the property, but might have additional rights as a secured creditor. This would mean our claim
in bankruptcy court could be limited to the amount we paid for the property, which could adversely impact our financial condition.
Our real estate investments will consist of primarily
industrial properties suitable for cultivation and production of medical-use cannabis, which may be difficult to sell or re-lease
upon tenant defaults or early lease terminations, either of which would adversely affect returns to stockholders.
While our business objectives consist of
principally acquiring and deriving rental income from industrial properties used in the regulated medical-use cannabis industry,
we expect that at times we will deem it appropriate or desirable to sell or otherwise dispose of certain properties we own. These
types of properties are relatively illiquid compared to other types of real estate and financial assets. This illiquidity could
limit our ability to quickly dispose of properties in response to changes in regulatory, economic or other conditions. Therefore,
our ability at any time to sell assets may be restricted and this lack of liquidity may limit our ability to make changes to our
portfolio promptly, which could materially and adversely affect our financial performance. We cannot predict the various market
conditions affecting the properties that we expect to acquire that will exist in the future. Due to the uncertainty of regulatory
and market conditions which may affect the future disposition of the real estate assets we expect to acquire, we cannot assure
you that we will be able to sell these assets at a profit in the future. Accordingly, the extent to which we will realize potential
appreciation on the real estate investments we expect to acquire will depend upon regulatory and other market conditions. In addition,
in order to qualify as a REIT and maintain our REIT status, we may not be able to sell properties when we would otherwise choose
to do so, due to market conditions or changes in our strategic plan.
Furthermore, we may be required to make
expenditures to correct defects or to make improvements before a property can be sold and we cannot assure you that we will have
funds available to correct such defects or to make such improvements. With these kinds of properties, if the current lease is terminated
or not renewed, we may be required to make expenditures and rent concessions in order to lease the property to another tenant.
In addition, in the event we are forced to sell or re-lease the property, we may have difficulty finding qualified purchasers who
are willing to buy the property or tenants who are willing to lease the property. These and other limitations may affect our ability
to sell or re-lease properties, which may adversely affect returns to our stockholders.
Liability for uninsured losses could adversely affect
our financial condition.
While the terms of our leases with our
tenants generally will require that they carry property and casualty insurance, losses from disaster-type occurrences, such as
earthquakes, floods and weather-related disasters, may be either uninsurable or not insurable on economically viable terms. Should
an uninsured loss occur, we could lose our capital investment or anticipated profits and cash flows from one or more properties.
Contingent or unknown liabilities could materially and
adversely affect our business, financial condition, liquidity and results of operations.
We acquired our Initial Property and may
in the future acquire properties, subject to liabilities and without any recourse, or with only limited recourse, with respect
to unknown liabilities. As a result, if a claim were asserted against us based on ownership of any of these properties, we may
have to pay substantial amounts to defend or settle the claim. If the magnitude of such unknown liabilities is high, individually
or in the aggregate, our business, financial condition, liquidity and results of operations would be materially and adversely affected.
The assets we will acquire may be subject to impairment
charges.
We periodically evaluate the real estate
investments we acquire and other assets for impairment indicators. The judgment regarding the existence of impairment indicators
is based upon factors such as market conditions, tenant performance and legal structure. For example, the termination of a lease
by a tenant may lead to an impairment charge. If we determine that an impairment has occurred, we would be required to make an
adjustment to the net carrying value of the asset which could have an adverse effect on our results of operations in the period
in which the impairment charge is recorded.
We may purchase properties subject to ground leases
that expose us to the loss of such properties upon breach or termination of the ground leases.
A ground lease agreement permits a tenant
to develop and/or operate a land parcel (property) during the lease period, after which the land parcel and all improvements revert
back to the property owner. Under a ground lease, property improvements are owned by the property owner unless an exception is
created and all relevant taxes incurred during the lease period are paid for by the tenant. Ground leases typically have a long
duration generally ranging from 50 to 99 years with additional extension options. As a lessee under a ground lease, we would be
exposed to the possibility of losing the property upon termination, or an earlier breach by us, of the ground lease, which could
have a material adverse effect on our business, financial condition and results of operations, our ability to make distributions
to our stockholders and the trading price of our common stock.
Due to our involvement in the regulated medical-use
cannabis industry, we may have a difficult time obtaining the various insurance policies that are desired to operate our business,
which may expose us to additional risk and financial liabilities.
Insurance that is otherwise readily available,
such as workers' compensation, general liability, and directors' and officers' insurance, is more difficult for us to find and
more expensive, because we lease our properties to companies in the regulated medical-use cannabis industry. There are no guarantees
that we will be able to find such insurance in the future, or that the cost will be affordable to us. If we are forced to go without
such insurance, it may prevent us from entering into certain business sectors, may inhibit our growth, and may expose us to additional
risk and financial liabilities.
The occurrence of cyber incidents could disrupt our
operations, result in the loss of confidential information and/or damage our business relationships and reputation.
We rely on technology to run our business,
and as such we are subject to risk from cyber incidents, including attempts to gain unauthorized access to our systems to disrupt
operations, corrupt data or steal confidential information, and other electronic security breaches. While we have implemented
measures to help mitigate these threats, such measures cannot guarantee that we will be successful in preventing a cyber incident.
The occurrence of a cyber incident could disrupt our operations, compromise the confidential information of our employees
or tenants, and/or damage our business relationships and reputation.
We cannot predict every event and circumstance that
may affect our business, and therefore, the risks and uncertainties discussed herein may not be the only ones you should consider.
We are not aware of any other publicly-traded
REIT that focuses on the acquisition, ownership and management of medical-use cannabis facilities. Therefore, as we commence the
operation of our business, we may encounter risks of which we are not aware at this time, which could have a material adverse impact
on our business.
Risks Related to Regulation
Medical-use cannabis remains illegal under federal law,
and therefore, strict enforcement of federal laws regarding medical-use cannabis would likely result in our inability and the inability
of our tenants to execute our respective business plans.
Cannabis is a Schedule I controlled substance
under the CSA. Even in those jurisdictions in which the manufacture and use of medical cannabis has been legalized at the state
level, the possession, use and cultivation all remain violations of federal law that are punishable by imprisonment and substantial
fines. Moreover, individuals and entities may violate federal law if they intentionally aid and abet another in violating these
federal controlled substance laws, or conspire with another to violate them. The U.S. Supreme Court has ruled in
United
States v. Oakland Cannabis Buyers' Coop.
and
Gonzales v. Raich
that it is the federal government that
has the right to regulate and criminalize cannabis, even for medical purposes. We would likely be unable to execute our business
plan if the federal government were to strictly enforce federal law regarding cannabis.
The U.S. Department of Justice, under the
Obama administration, issued memoranda, including the so-called "Cole Memo" on August 29, 2013, characterizing enforcement
of federal cannabis prohibitions under the CSA to prosecute those complying with state regulatory systems allowing the use, manufacture
and distribution of medical cannabis as an inefficient use of federal investigative and prosecutorial resources when state regulatory
and enforcement efforts are effective with respect to enumerated federal enforcement priorities under the CSA. In the "Cole
Memo," the U.S. Department of Justice provided guidance to all federal prosecutors indicating that federal enforcement of
the CSA against cannabis-related conduct should be focused on eight priorities, which are to prevent: (1) distribution of cannabis
to minors; (2) revenue from sale of cannabis to criminal enterprises, gangs and cartels; (3) transfer of cannabis from states where
it is legal to states where it is illegal; (4) cannabis activity from being a pretext for trafficking of other illegal drugs or
illegal activity; (5) violence or use of firearms in cannabis cultivation and distribution; (6) drugged driving and adverse public
health consequences from cannabis use; (7) growth of cannabis on federal lands; and (8) cannabis possession or use on federal property.
In addition, Congress enacted an omnibus
spending bill for fiscal year 2016 including a provision prohibiting the U.S. Department of Justice (which includes the DEA) from
using funds appropriated by that bill to prevent states from implementing their medical-use cannabis laws. This provision, however,
is effective only until April 28, 2017 and must be renewed by Congress. In
USA vs. McIntosh
, the United States Court
of Appeals for the Ninth Circuit held that this provision prohibits the U.S. Department of Justice from spending funds from relevant
appropriations acts to prosecute individuals who engage in conduct permitted by state medical-use cannabis laws and who strictly
comply with such laws. However, the Ninth Circuit's opinion, which only applies to the states of Alaska, Arizona, California, Hawaii,
and Idaho, also held that persons who do not strictly comply with all state laws and regulations regarding the distribution, possession
and cultivation of medical-use cannabis have engaged in conduct that is unauthorized, and in such instances the U.S. Department
of Justice may prosecute those individuals. Furthermore, while we target the acquisition of medical-use cannabis facilities, our
leases do not prohibit cannabis cultivation for adult-use that is permissible under the state and local laws where our facilities
are located. Consequently, certain of our tenants may subsequently cultivate adult-use cannabis in our medical-use cannabis facilities,
if permitted by such state and local laws now or in the future, which may in turn subject the tenant, us and our properties to
greater and/or different federal legal and other risks than exclusively medical-use cannabis facilities, including not providing
protection under the above Congressional spending provision.
Additionally, financial transactions involving
proceeds generated by cannabis-related conduct can form the basis for prosecution under the federal money laundering statutes,
unlicensed money transmitter statutes and the Bank Secrecy Act. However, supplemental guidance from the U.S. Department of Justice
directs federal prosecutors to consider the federal enforcement priorities enumerated in the "Cole Memo" when determining
whether to charge institutions or individuals with any of the financial crimes described above based upon cannabis-related activity.
Federal prosecutors have significant discretion
and no assurance can be given that the federal prosecutor in each judicial district where we purchase a property will agree that
the activities of our tenant on the property located in such prosecutor's district do not involve those enumerated in the Cole
Memo. There is also no guarantee that the current administration or future administrations will not revise the federal enforcement
priorities enumerated in the Cole Memo or otherwise choose to strictly enforce the federal laws governing cannabis production or
distribution. At this time, it is unknown whether the Trump administration will change the federal government's current enforcement
posture with respect to state-licensed medical-use cannabis. Any such change in the federal government's current enforcement posture
with respect to state-licensed cultivation of medical-use cannabis would result in our inability to execute our business plan and
we would likely suffer significant losses with respect to our investment in medical-use cannabis facilities in the United States.
Furthermore, if our tenants were to continue the cultivation and production of medical-use cannabis on properties that we own following
any such change in the federal government's enforcement position, we could be subject to criminal prosecution, which could lead
to imprisonment and/or the imposition of penalties, fines, or forfeiture.
If our tenants engage in operations for the adult-use
cannabis industry in addition to or in lieu of operations for the medical-use cannabis industry, our tenants, we and our properties
may be subject to additional risks associated with such adult-use cannabis operations.
Our existing lease at our
Initial Property does not and we expect that leases that we enter into with future tenants at other properties we acquire will
not prohibit cannabis cultivation for adult-use that is permissible under state and local laws where our facilities are located,
which may subject our tenants, us and our properties to different and greater risks, including those related to enforcement of
federal laws. In addition, while we may purchase properties in states that only permit medical-use cannabis at the time of acquisition,
such as New York, such states may in the future authorize by state legislation or popular vote the legalization of adult-use cannabis,
thus permitting our tenants to engage in adult-use cannabis operations at our properties.
New laws that are adverse to the business of our tenants
may be enacted, and current favorable national, state or local laws relating to cultivation and production of medical-use cannabis
may be modified or eliminated in the future.
We have acquired and are targeting for
acquisition properties that are owned by state-licensed cultivators and producers of medical-use cannabis. Relevant state or local
laws may be amended or repealed, or new laws may be enacted in the future to eliminate existing laws permitting cultivation and
production of medical-use cannabis. If our tenants involved in the cultivation and production of medical-use cannabis were forced
to close their operations, we would need to replace those tenants with tenants who are not engaged in the cannabis industry, who
may pay lower rents. Moreover, any changes in state or local laws that reduce or eliminate the ability to cultivate and produce
medical-use cannabis would likely result in a high vacancy rate for the kinds of properties that we seek to acquire, which would
depress our lease rates and property values. In addition, we would realize an economic loss on any and all improvements made to
properties that were specific to the medical-use cannabis industry.
Our ability to grow our business depends on state laws
pertaining to the cannabis industry.
Continued development of the medical-use
cannabis industry depends upon continued legislative authorization of cannabis at the state level. The status quo of, or progress
in, the regulated medical-use cannabis industry, while encouraging, is not assured and any number of factors could slow or halt
further progress in this area. While there may be ample public support for legislative action permitting the manufacture and use
of cannabis, numerous factors impact the legislative process. For example, states that voted to legalize medical and/or adult-use
cannabis in the November 2016 election cycle have seen significant delays in the drafting and implementation of regulations related
to the industry. In addition, burdensome regulation at the state level could slow or stop further development of the medical-use
cannabis industry, such as limiting the medical conditions for which medical cannabis can be recommended by physicians for treatment,
restricting the form in which medical cannabis can be consumed, imposing significant registration requirements on physicians and
patients or imposing significant taxes on the growth, processing and/or retail sales of cannabis, which could have the impact of
dampening growth of the cannabis industry and making it difficult for cannabis businesses, including our tenants, to operate profitably
in those states. Any one of these factors could slow or halt additional legislative authorization of medical-use cannabis, which
could harm our business prospects.
FDA regulation of medical-use cannabis and the possible
registration of facilities where medical-use cannabis is grown could negatively affect the medical-use cannabis industry, which
would directly affect our financial condition.
Should the federal government legalize
cannabis for medical-use, it is possible that the U.S. Food and Drug Administration, or the FDA, would seek to regulate it under
the Food, Drug and Cosmetics Act of 1938. Additionally, the FDA may issue rules and regulations including certified good manufacturing
practices, or cGMPs, related to the growth, cultivation, harvesting and processing of medical cannabis. Clinical trials may be
needed to verify efficacy and safety. It is also possible that the FDA would require that facilities where medical-use cannabis
is grown register with the FDA and comply with certain federally prescribed regulations. In the event that some or all of these
regulations are imposed, we do not know what the impact would be on the medical-use cannabis industry, including what costs, requirements
and possible prohibitions may be enforced. If we or our tenants are unable to comply with the regulations or registration as prescribed
by the FDA, we and or our tenants may be unable to continue to operate their and our business in its current form or at all.
We and our tenants may have difficulty accessing the
service of banks, which may make it difficult to contract for real estate needs.
Financial transactions involving proceeds
generated by cannabis-related conduct can form the basis for prosecution under the federal money laundering statutes, unlicensed
money transmitter statute and the Bank Secrecy Act. Recent guidance issued by FinCen, a division of the U.S. Department of the
Treasury, clarifies how financial institutions can provide services to cannabis-related businesses consistent with their obligations
under the Bank Secrecy Act. Furthermore, supplemental guidance from the U.S. Department of Justice directs federal prosecutors
to consider the federal enforcement priorities enumerated in the "Cole Memo" when determining whether to charge institutions
or individuals with any of the financial crimes described above based upon cannabis-related activity. Nevertheless, banks remain
hesitant to offer banking services to cannabis-related businesses. Consequently, those businesses involved in the regulated medical-use
cannabis industry continue to encounter difficulty establishing banking relationships. Our inability to maintain our current bank
accounts would make it difficult for us to operate our business, increase our operating costs, and pose additional operational,
logistical and security challenges and could result in our inability to implement our business plan.
The terms of our leases will require that
our tenants make rental payments via check or wire transfer. The inability of our potential tenants to open accounts and continue
using the services of banks may make it difficult for them to enter into triple-net lease arrangements with us or may result in
their default under our lease agreements, either of which could materially harm our business.
Laws and regulations affecting the regulated cannabis
industry are constantly changing, which could materially adversely affect our proposed operations, and we cannot predict the impact
that future regulations may have on us.
Local, state and federal cannabis laws
and regulations are broad in scope and subject to evolving interpretations, which could require us to incur substantial costs associated
with compliance or alter our business plan. In addition, violations of these laws, or allegations of such violations, could disrupt
our business and result in a material adverse effect on our operations. It is also possible that regulations may be enacted in
the future that will be directly applicable to our proposed business. We cannot predict the nature of any future laws, regulations,
interpretations or applications, nor can we determine what effect additional governmental regulations or administrative policies
and procedures, when and if promulgated, could have on our business.
Applicable state laws may prevent us from maximizing
our potential income.
Depending on the laws of each particular
state, we may not be able to fully realize our potential to generate profit. Colorado and Washington have residency requirements
for those directly involved in the medical-use cannabis industry, which may impede our ability to contract with cannabis businesses
in those states. Furthermore, cities and counties are being given broad discretion to ban certain cannabis activities. Even if
these activities are legal under state law, specific cities and counties may ban them.
Assets leased to cannabis businesses may be forfeited
to the federal government.
Any assets used in conjunction with the
violation of federal law are potentially subject to federal forfeiture, even in states where cannabis is legal. If the federal
government decides to initiate forfeiture proceedings against cannabis businesses, such as the medical-use cannabis facilities
that we have acquired and intend to acquire, our investment in those properties may be lost.
The properties that we expect to acquire will be subject
to extensive regulations, which may result in significant costs and materially and adversely affect our business, financial condition,
liquidity and results of operations.
Our Initial Property is and other properties
that we expect to acquire will be subject to various local laws and regulatory requirements. Local property regulations may restrict
the use of properties we acquire and may require us to obtain approval from local authorities with respect to the properties that
we expect to acquire, including prior to acquiring a property or when developing or undertaking renovations. Among other things,
these restrictions may relate to cultivation of medical-use cannabis, the use of water and the discharge of waste water, fire and
safety, seismic conditions, asbestos-cleanup or hazardous material abatement requirements. We cannot assure you that existing regulatory
policies will not materially and adversely affect us or the timing or cost of any future acquisitions, developments or renovations,
or that additional regulations will not be adopted that would increase such delays or result in additional costs. Our failure to
obtain such regulatory approvals could have a material adverse effect on our business, financial condition, liquidity and results
of operations.
Compliance with environmental laws could materially
increase our operating expenses.
There may be environmental conditions associated
with properties we acquire of which we are unaware. If environmental contamination exists on properties we acquire, we could become
subject to liability for the contamination. The presence of hazardous substances on a property may materially and adversely affect
our ability to sell the property and we may incur substantial remediation costs. In addition, although we may require in our leases
that tenants operate in compliance with all applicable laws and indemnify us against any environmental liabilities arising from
a tenant's activities on the property, we could nonetheless be subject to liability by virtue of our ownership interest and we
cannot be sure that our tenants would satisfy their indemnification obligations to us. Such environmental liability exposure associated
with properties we acquire could harm our business, financial condition, liquidity and results of operations.
Risks Related to Financing Our Business
Our growth depends on external sources of capital, which
may not be available on favorable terms or at all. In addition, banks and other financial institutions may be reluctant to enter
into lending transactions with us, particularly secured lending, because we intend to acquire properties used in the cultivation
and production of medical-use cannabis. If this source of funding is unavailable to us, our growth may be limited and our levered
return on the properties we purchase may be lower.
We intend to grow by acquiring additional
real estate assets, which we intend to finance primarily through newly issued equity or debt. We may not be in a position to take
advantage of attractive investment opportunities for growth if we are unable, due to global or regional economic uncertainty, changes
in the state or federal regulatory environment relating to the medical-use cannabis industry, our own operating or financial performance
or otherwise, to access capital markets on a timely basis and on favorable terms or at all. In addition, U.S. federal income tax
law generally requires that a REIT distribute annually at least 90% of its REIT taxable income, without regard to the deduction
for dividends paid and excluding net capital gain and that it pay U.S. federal income tax at regular corporate rates to the extent
that it annually distributes less than 100% of its taxable income. Because we intend to grow our business, this limitation may
require us to raise additional equity or incur debt at a time when it may be disadvantageous to do so.
Our access to capital will depend upon
a number of factors over which we have little or no control, including general market conditions and the market's perception of
our current and potential future earnings. If general economic instability or downturn leads to an inability to borrow at attractive
rates or at all, our ability to obtain capital to finance the purchase of real estate assets could be negatively impacted. In addition,
banks and other financial institutions may be reluctant to enter into lending transactions with us, particularly secured lending,
because we intend to acquire properties used in the cultivation and production of medical-use cannabis. If this source of funding
is unavailable to us, our growth may be limited and our levered return on the properties we purchase may be lower.
If we are unable to obtain capital on terms
and conditions that we find acceptable, we likely will have to reduce the number of properties we can purchase. In addition, our
ability to refinance all or any debt we may incur in the future, on acceptable terms or at all, is subject to all of the above
factors, and will also be affected by our future financial position, results of operations and cash flows, which additional factors
are also subject to significant uncertainties, and therefore we may be unable to refinance any debt we may incur in the future,
as it matures, on acceptable terms or at all. All of these events would have a material adverse effect on our business, financial
condition, liquidity and results of operations.
Any future indebtedness reduces cash available for distribution
and may expose us to the risk of default under debt obligations that we may incur in the future.
Payments of principal and interest on borrowings
that we may incur in the future may leave us with insufficient cash resources to operate the properties that we expect to acquire
or to pay the distributions currently contemplated or necessary to satisfy the requirements for REIT qualification. Our level of
debt and the limitations imposed on us by these debt agreements could have significant material and adverse consequences, including
the following:
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our cash flow may be insufficient to meet our required principal and interest payments;
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we may be unable to borrow additional funds as needed or on favorable terms, or at all;
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we may be unable to refinance our indebtedness at maturity or the refinancing terms may be less favorable than the terms of
our original indebtedness;
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to the extent we borrow debt that bears interest at variable rates, increases in interest rates could materially increase our
interest expense;
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we may be forced to dispose of one or more of the properties that we expect to acquire, possibly on disadvantageous terms;
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we may default on our obligations or violate restrictive covenants, in which case the lenders may accelerate these debt obligations;
and
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our default under any loan with cross default provisions could result in a default on other indebtedness.
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If any one of these events were to occur,
our financial condition, results of operations, cash flow, and our ability to make distributions to our stockholders could be materially
and adversely affected.
Risks Related to Our Organization and Structure
We are dependent on our key personnel for our success.
We depend upon the efforts, experience,
diligence, skill and network of business contacts of our senior management team, and our success will depend on their continued
service. The departure of any of our executive officers or key personnel could have a material adverse effect on our business.
If any of our key personnel were to cease their employment, our operating results could suffer. Further, we do not intend to maintain
key person life insurance that would provide us with proceeds in the event of death or disability of any of our key personnel.
We believe our future success depends upon
our senior management team's ability to hire and retain highly skilled managerial, operational and marketing personnel. Competition
for such personnel is intense, and we cannot assure you that we will be successful in attracting and retaining such skilled personnel.
If we lose or are unable to obtain the services of key personnel, our ability to implement our investment strategies could be delayed
or hindered, and the value of our common stock may decline.
Furthermore, we may retain independent
contractors to provide various services for us, including administrative services, transfer agent services and professional services.
Such contractors have no fiduciary duty to us and may not perform as expected or desired.
Our senior management team manages our portfolio subject
to very broad investment guidelines.
Our senior management team has broad discretion
over our investments, and our stockholders will have no opportunity to evaluate the terms of transactions or other economic or
financial data concerning our investments that are not described in periodic filings with the SEC. Furthermore, currently a substantial
portion of the net proceeds of our initial public offering is not committed to specific properties. We will rely on the senior
management team's ability to execute acquisitions and dispositions of medical-use cannabis facilities, subject to the oversight
and approval of our board of directors. We acquired our Initial Property in December 2016; otherwise, our senior management team
has not previously invested in medical-use cannabis facilities. Our senior management team will be authorized to pursue acquisitions
and dispositions of real estate investments in accordance with very broad investment guidelines, subject to approval of our board
of directors.
Our board of directors may change our investment objectives
and strategies without stockholder consent.
Our board of directors determines our major
policies, including with regard to financing, growth, debt capitalization, REIT qualification and distributions. Our board of directors
may amend or revise these and other policies without a vote of the stockholders. Under our charter and the MGCL, our stockholders
generally have a right to vote only on the following matters:
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the election or removal of directors;
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the amendment of our charter, except that our board of directors may amend our charter without stockholder approval to:
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change the name or other designation or the par value of any class or series of stock and the aggregate par value of our stock;
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increase or decrease the aggregate number of shares of stock that we have the authority to issue;
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increase or decrease the number of our shares of any class or series of stock that we have the authority to issue; and
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effect certain reverse stock splits;
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our liquidation and dissolution; and
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our being a party to a merger, consolidation, sale or other disposition of all or substantially all of our assets or statutory
share exchange.
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All other matters are subject to the discretion
of our board of directors.
Certain provisions of Maryland law could inhibit changes
in control.
Under the Maryland General Corporation
Law, or MGCL, "business combinations" (including a merger, consolidation, statutory share exchange or, in certain circumstances,
an asset transfer or issuance or reclassification of equity securities) between a Maryland corporation and an "interested
stockholder" or an affiliate of an interested stockholder are prohibited for five years after the most recent date on which
the interested stockholder becomes an interested stockholder. An interested stockholder is defined as: (a) any person who beneficially
owns 10% or more of the voting power of the then-outstanding voting stock of the corporation; or (b) an affiliate or associate
of the corporation who, at any time within the two-year period prior to the date in question, was the beneficial owner of 10% or
more of the voting power of the then-outstanding stock of the corporation.
A person is not an interested stockholder
under the statute if the board of directors approved in advance the transaction by which the person otherwise would have become
an interested stockholder. A Maryland corporation's board of directors may provide that its approval is subject to compliance with
any terms and conditions determined by the board of directors prior to the time that the interested stockholder becomes an interested
stockholder.
Thereafter, any such business combination
must generally be recommended by the board of directors of such corporation and approved by the affirmative vote of at least:
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80% of the votes entitled to be cast by holders of outstanding voting stock of the corporation; and
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two-thirds of the votes entitled to be cast by holders of voting stock of the corporation, other than shares held by the interested
stockholder with whom (or with whose affiliate) the business combination is to be effected, or held by an affiliate or associate
of the interested stockholder unless, among other conditions, the corporation's common stockholders receive a minimum price (as
defined in the MGCL) for their shares and the consideration is received in cash or in the same form as previously paid by the interested
stockholder for its shares.
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A Maryland corporation's board of directors
may provide that its approval is subject to compliance with any terms and conditions determined by it. These provisions of the
MGCL do not apply, however, to business combinations that are approved or exempted by a Maryland corporation's board of directors
prior to the time that the interested stockholder becomes an interested stockholder.
The "control share" provisions
of the MGCL provide that, subject to certain exceptions, a holder of "control shares" of a Maryland corporation (defined
as shares which, if aggregated with all other shares of stock owned by the acquirer or in respect of which the acquirer is able
to exercise or direct the exercise of voting power (except solely by virtue of a revocable proxy), entitle the stockholder to exercise
one of three increasing ranges of voting power in electing directors) acquired in a "control share acquisition" (defined
as the direct or indirect acquisition of ownership or control of issued and outstanding "control shares") has no voting
rights with respect to such shares except to the extent approved by our stockholders by the affirmative vote of at least two-thirds
of all the votes entitled to be cast on the matter, excluding votes entitled to be cast by the acquirer of control shares, our
officers and our personnel who are also our directors. Our bylaws contain a provision exempting from the control share acquisition
statute any and all acquisitions by any person of shares of our stock. Our bylaws contain a provision exempting from the control
share acquisition statute any and all acquisitions by any person of shares of our stock. There can be no assurance that such provision
will not be amended or eliminated at any time in the future by our board of directors.
The "unsolicited takeover" provisions
of Title 3, Subtitle 8 of the MGCL, or Subtitle 8, permit our board of directors, without stockholder approval and regardless of
what is currently provided in our charter or bylaws, to implement certain takeover defenses, some of which (for example, a classified
board) we do not yet have. Our charter provides that vacancies on our board may be filled only by the remaining directors and for
the remainder of the full term of the directorship in which the vacancy occurred. Through provisions in our charter and bylaws
unrelated to Subtitle 8, we already (i) require the affirmative vote of stockholders entitled to cast not less than two-thirds
of all of the votes entitled to be cast generally in the election of directors for the removal of any director from the board,
only with cause, (ii) vest in the board of directors the exclusive power to fix the number of directorships and (iii) require,
unless called by our chairman of the board, our chief executive officer or our board of directors, the written request of stockholders
entitled to cast not less than a majority of all votes entitled to be cast at such a meeting to call a special meeting of our stockholders.
These provisions may have the effect of
inhibiting a third party from making an acquisition proposal for us or of delaying, deferring or preventing a change in control
of us under the circumstances that otherwise could provide the holders of shares of common stock with the opportunity to realize
a premium over the then current market price.
Our authorized but unissued shares of common and preferred
stock may prevent a change in our control.
Our charter permits our board of directors
to authorize us to issue additional shares of our authorized but unissued common or preferred stock. In addition, our board of
directors may, without stockholder approval, amend our charter to increase the aggregate number of our shares of stock or the number
of shares of stock of any class or series that we have the authority to issue and classify or reclassify any unissued shares of
common or preferred stock and set the terms of the classified or reclassified shares. As a result, our board of directors may establish
a class or series of shares of common or preferred stock that could delay or prevent a transaction or a change in control that
might involve a premium price for shares of our common stock or otherwise be in the best interest of our stockholders.
Severance agreements with our executive officers could
be costly and prevent a change in our control.
The severance agreements that we entered
into with our executive officers provide that, if their employment with us terminates under certain circumstances (including upon
a change in our control), we may be required to pay them significant amounts of severance compensation, including accelerated vesting
of equity awards, thereby making it costly to terminate their employment. Furthermore, these provisions could delay or prevent
a transaction or a change in our control that might involve a premium paid for our common stock or otherwise be in the best interests
of our stockholders.
Because of our holding company structure, we depend
on our Operating Partnership and its subsidiaries for cash flow and we will be structurally subordinated in right of payment to
the obligations of such operating subsidiary and its subsidiaries.
We are a holding company with no business
operations of our own. Our only significant asset is and will be the general and limited partnership interests in our Operating
Partnership. We conduct, and intend to conduct, all of our business operations through our Operating Partnership. Accordingly,
our only source of cash to pay our obligations is distributions from our Operating Partnership and its subsidiaries of their net
earnings and cash flows. We cannot assure our stockholders that our Operating Partnership or its subsidiaries will be able to,
or be permitted to, make distributions to us that will enable us to make distributions to our stockholders from cash flows from
operations. Each of our Operating Partnership's subsidiaries is or will be a distinct legal entity and, under certain circumstances,
legal and contractual restrictions may limit our ability to obtain cash from such entities. In addition, because we are a holding
company, your claims as stockholders will be structurally subordinated to all existing and future liabilities and obligations of
our Operating Partnership and its subsidiaries. Therefore, in the event of our bankruptcy, liquidation or reorganization, our assets
and those of our Operating Partnership and its subsidiaries will be able to satisfy your claims as stockholders only after all
of our and our Operating Partnership's and its subsidiaries' liabilities and obligations have been paid in full.
Our Operating Partnership may issue additional limited
partnership interests to third parties without the consent of our stockholders, which would reduce our ownership percentage in
our Operating Partnership and would have a dilutive effect on the amount of distributions made to us by our Operating Partnership
and, therefore, the amount of distributions we can make to our stockholders.
We are the sole general partner of our
Operating Partnership and own, directly or through a subsidiary, 100% of the outstanding partnership interests in our Operating
Partnership. We may, in connection with our acquisition of properties or otherwise, cause our Operating Partnership to issue additional
limited partnership interests to third parties. Such issuances would reduce our ownership percentage in our Operating Partnership
and affect the amount of distributions made to us by our Operating Partnership and, therefore, the amount of distributions we can
make to our stockholders. Because our stockholders will not directly own any interest in our Operating Partnership, our stockholders
will not have any voting rights with respect to any such issuances or other partnership level activities of our Operating Partnership.
If we issue limited partnership interests in our Operating
Partnership in exchange for property, the value placed on such partnership interests may not accurately reflect their market value,
which may dilute your interest in us.
If we issue limited partnership interests
in our Operating Partnership in exchange for property, the per unit value attributable to such interests will be determined based
on negotiations with the property seller and, therefore, may not reflect the fair market value of such limited partnership interests
if a public market for such limited partnership interests existed. If the value of such limited partnership interests is greater
than the value of the related property, your interest in us may be diluted.
Our rights and the rights of our stockholders to take
action against our directors and officers are limited, which could limit your recourse in the event of actions not in your best
interests.
We have entered into indemnification agreements
with each of our executive directors and officers that provide for indemnification to the maximum extent permitted by Maryland
law. Maryland law permits us to include in our charter a provision eliminating the liability of our directors and officers and
our stockholders for money damages except for liability resulting from:
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actual receipt of an improper benefit or profit in money, property
or services; or
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active and deliberate dishonesty that was established by a final judgment
and was material to the cause of action.
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Our charter authorizes us to obligate ourselves
and our bylaws obligate us, to the fullest extent permitted by Maryland law in effect from time to time, to indemnify and, without
requiring a preliminary determination of the ultimate entitlement to indemnification, pay or reimburse reasonable expenses in advance
of final disposition of a proceeding to:
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any present or former director or officer who is made or threatened
to be made a party to or witness in the proceeding by reason of his or her service in that capacity; or
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any individual who, while a director or officer of our company and
at our request, serves or has served as a director, officer, partner, manager, member or trustee of another corporation, REIT,
partnership, limited liability company, joint venture, trust, employee benefit plan or any other enterprise and who is made or
threatened to be made a party to or witness in the proceeding by reason of his or her service in that capacity.
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Our charter contains provisions that make removal of
our directors difficult, which could make it difficult for our stockholders to effect changes to our management.
Our charter provides that, subject to the
rights of holders of any series of preferred stock, a director may be removed only with cause upon the affirmative vote of stockholders
entitled to cast at least two-thirds of the votes entitled to be cast generally in the election of directors. Vacancies may be
filled only by a vote of the majority of the remaining directors in office, even if less than a quorum. These requirements make
it more difficult to change our management by removing and replacing directors and may prevent a change in control of our company
that is in the best interests of our stockholders.
Ownership limitations may restrict change in control
or business combination opportunities in which our stockholders might receive a premium for their shares.
In order for us to qualify as a REIT under
the Internal Revenue Code of 1986, as amended, or the Code, shares of our stock must be owned by 100 or more persons during at
least 335 days of a taxable year of 12 months (other than the first year for which an election to be a REIT has been made) or during
a proportionate part of a shorter taxable year. Also, not more than 50% of the value of the outstanding shares of our stock may
be owned, directly or indirectly, by five or fewer individuals (as defined in the Code to include certain entities) during the
last half of a taxable year (other than the first year for which an election to be a REIT has been made). In order for us to qualify
as a REIT under the Code, the relevant sections of our charter provide that, subject to certain exceptions, no person or entity
may own, or be deemed to own, by virtue of the applicable constructive ownership provisions of the Code, more than 9.8% (in value
or number of shares, whichever is more restrictive) of the aggregate of our outstanding shares of stock or more than 9.8% (in value
or number of shares, whichever is more restrictive) of our outstanding common stock or any class or series of our outstanding preferred
stock. These ownership limits and other restrictions could have the effect of discouraging a takeover or other transaction in which
holders of our common stock might receive a premium for their shares over the then prevailing market price or which holders might
believe to be otherwise in their best interests.
The requirements of being a public company impose costs
and demands upon our management, which could make it difficult to manage our business, particularly after we are no longer an “emerging
growth company.”
Complying with the reporting and other
regulatory requirements of the Exchange Act and the requirements of the Sarbanes-Oxley Act is time-consuming and costly and could
have a negative effect on our business, financial condition and results of operations. The Exchange Act requires that we file annual,
quarterly and current reports with respect to our business and financial condition. The Sarbanes-Oxley Act requires that we maintain
effective disclosure controls and procedures and internal controls over financial reporting. To maintain and improve the effectiveness
of our disclosure controls and procedures and internal control over financial reporting, we have committed additional resources
and provided additional management oversight. We expect these resources and management oversight requirements to continue. These
activities may divert management’s attention from other business concerns, which could have a material adverse effect on
our business, financial condition and results of operations.
As an “emerging growth company”
as defined in the Jumpstart Our Business Startups Act of 2012, or the JOBS Act, we benefit from certain temporary exemptions from
various reporting requirements, including, but not limited to, not being required to comply with the auditor attestation requirements
of Section 404 of the Sarbanes-Oxley Act and reduced disclosure obligations regarding executive compensation in our periodic reports
and proxy statements. In addition, we have elected under the JOBS Act to delay adoption of new or revised accounting pronouncements
applicable to public companies until such pronouncements are made applicable to private companies. When these exemptions cease
to apply, we expect to incur additional expenses and devote increased management effort toward ensuring compliance with them. We
cannot predict or estimate the amount of additional costs we may incur as these exemptions cease to apply.
We plan to continue to operate our business so that
we are not required to register as an investment company under the Investment Company Act.
We engage primarily in the business of
investing in real estate and we have not and do not intend to register as an investment company under the Investment Company Act.
If our primary business were to change in a manner that would require us register as an investment company under the Investment
Company Act, we would have to comply with substantial regulation under the Investment Company Act which could restrict the manner
in which we operate and finance our business and could materially and adversely affect our business operations and results.
Risks Related to Our Common Stock
The market price and trading volume of our common stock
has been and may continue to be volatile.
We completed our initial public offering
in December 2016, and the market price for our common stock has been, and may continue to be, volatile. In addition, the trading
volume in our common stock has fluctuated and may continue to fluctuate, resulting in significant price variations.
Some of the factors that could negatively
affect the share price or result in fluctuations in the price or trading volume of our common stock include:
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our actual or projected operating results, financial condition, cash
flows and liquidity or changes in business strategy or prospects;
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our ability to make acquisitions on preferable terms or at all;
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the performance of our Initial Property and additional properties
that we acquire;
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equity issuances by us, or share resales by our stockholders, or the
perception that such issuances or resales may occur;
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actual or anticipated accounting problems;
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publication of research reports about us or the real estate industry;
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changes in market valuations of similar companies;
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adverse market reaction to any increased indebtedness we may incur
in the future;
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additions to or departures of our senior management team;
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speculation in the press or investment community;
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our failure to meet, or the lowering of, our earnings estimates or
those of any securities analysts;
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changes in governmental policies, regulations or laws;
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failure to qualify, or maintain our qualification, as a REIT;
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refusal of securities clearing firms to accept deposits of our securities;
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a delisting of our common stock from the NYSE;
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the realization of any of the other risk factors presented in this
report;
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actions by institutional stockholders;
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price and volume fluctuations in the stock market generally; and
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market and economic conditions generally, including the current state
of the credit and capital markets and the market and economic conditions.
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Market factors unrelated to our performance
could also negatively impact the market price of our common stock. One of the factors that investors may consider in deciding whether
to buy or sell our common stock is our distribution rate as a percentage of our stock price relative to market interest rates.
If market interest rates increase, prospective investors may demand a higher distribution rate or seek alternative investments
paying higher dividends or interest. As a result, interest rate fluctuations and conditions in capital markets can affect the market
value of our common stock.
Common stock and preferred stock eligible for future
sale may have material and adverse effects on our share price.
Subject to applicable law, our board of
directors, without stockholder approval, may authorize us to issue additional shares of our common stock or to raise capital through
the issuance of preferred stock (including equity or debt securities convertible into preferred stock), options, warrants and other
rights, on terms and for consideration as our board of directors in its sole discretion may determine. Any such issuance could
result in dilution of the equity of our stockholders. Sales of substantial amounts of shares of our common stock in the public
market, or the perception that such sales might occur, could adversely affect the market price of our common stock.
Our charter also authorizes our board of
directors, without stockholder approval, to designate and issue one or more classes or series of preferred stock (including equity
or debt securities convertible into preferred stock) and to set or change the voting, conversion or other rights, preferences,
restrictions, limitations as to dividends or other distributions and qualifications or terms or conditions of redemption of each
class of shares so issued. If any preferred stock is publicly offered, the terms and conditions of such preferred stock (including
any equity or debt securities convertible into preferred stock) will be set forth in a registration statement registering the issuance
of such preferred stock or equity or debt securities convertible into preferred stock. Because our board of directors has the power
to establish the preferences and rights of each class or series of preferred stock, it may afford the holders of any series or
class of preferred stock preferences, powers, and rights senior to the rights of holders of common stock or other preferred stock.
If we ever create and issue additional preferred stock or equity or debt securities convertible into preferred stock with a distribution
preference over common stock or preferred stock, payment of any distribution preferences of new outstanding preferred stock would
reduce the amount of funds available for the payment of distributions on the common stock and junior preferred stock. Further,
holders of preferred stock are normally entitled to receive a preference payment if we liquidate, dissolve, or wind up before any
payment is made to the common stockholders, likely reducing the amount common stockholders would otherwise receive upon such an
occurrence. In addition, under certain circumstances, the issuance of additional preferred stock may delay, prevent, render more
difficult or tend to discourage a merger, tender offer, or proxy contest, the assumption of control by a holder of a large block
of our securities, or the removal of incumbent management.
Additionally, from time to time we also
may issue shares of our common stock or operating partnership units of our Operating Partnership in connection with property acquisitions.
We may grant additional demand or piggyback registration rights in connection with these issuances. Sales of substantial amounts
of our common stock or operating partnership units of our Operating Partnership, or the perception that these sales could occur,
may adversely affect the prevailing market price of our common stock or may adversely affect the terms upon which we may be able
to obtain additional capital through the sale of equity securities.
We cannot assure you of our ability to make distributions
in the future. We may be unable to pay or maintain cash dividends, and may borrow money, sell assets or use offering proceeds to
make distributions to our stockholders, if we are unable to make distributions from cash flows from operations.
U.S. federal income tax law generally requires
that a REIT distribute annually at least 90% of its REIT taxable income, determined without regard to the deduction for dividends
paid and excluding net capital gain (which does not equal net income as calculated in accordance with U.S. generally accepted accounting
principles, or GAAP), and that it pay U.S. federal income tax at regular corporate rates to the extent that it annually distributes
less than 100% of its taxable income. We intend to make quarterly distributions of all or substantially all of our taxable income
so as to satisfy the requirements to qualify as a REIT and generally not be subject to U.S. federal income tax. However, we cannot
assure you that distributions will be made or sustained. Any distributions we make will be at the direction of our board of directors
and will depend upon a number of factors, including our actual results of operations, economic conditions and other factors that
could differ materially from our current expectations. In addition, we may borrow money, sell assets or use offering proceeds to
make distributions to our stockholders, if we are unable to make distributions from cash flows from operations.
Our charter permits us to pay distributions from any
source and, as a result, the amount of distributions paid at any time may not reflect the performance of our properties or as cash
flow from operations.
Our organizational documents permit us
to make distributions from any source. To the extent that our cash available for distribution is insufficient to cover our distributions,
we expect to use our cash on hand, the proceeds from the issuance of securities in the future, the proceeds from borrowings or
other sources to pay distributions. It is possible that in our initial years of operation, any distributions declared will be paid
from our cash on hand or future issuances of shares of our common stock, which would constitute a return of capital to our stockholders.
If we fund distributions from borrowings, sales of properties, future issuances of securities or cash on hand, we will have fewer
funds available for the acquisition of additional properties resulting in potentially fewer investments, less diversification of
our portfolio and a reduced overall return to our stockholders. In addition, the value of our shares of common stock may be diluted
because funds that would otherwise be available to make investments would be diverted to fund distributions.
The market price of our common stock could be materially
and adversely affected by our level of cash distributions.
The market value of our common stock is
based primarily upon the market's perception of our growth potential and our current and potential future cash distributions, whether
from operations, sales or re-financings, and is secondarily based upon the real estate market value of our underlying assets. For
that reason, our common stock may trade at prices that are higher or lower than our net asset value per share. To the extent we
retain operating cash flow for investment purposes, working capital reserves or other purposes, these retained funds, while increasing
the value of our underlying assets, may not correspondingly increase the market price of our common stock. Our failure to meet
the market's expectations with regard to future earnings and cash distributions likely would materially and adversely affect the
market price of our common stock.
Future offerings of debt or preferred equity securities,
which may rank senior to our common stock, may materially and adversely affect the market price of our common stock.
If we decide to issue debt securities in
the future, which would rank senior to our common stock, it is likely that they will be governed by an indenture or other instrument
containing covenants restricting our operating flexibility. Additionally, any preferred equity securities or convertible or exchangeable
securities that we issue in the future may have rights, preferences and privileges more favorable than those of our common stock
and may result in dilution to owners of our common stock. We and, indirectly, our stockholders will bear the cost of issuing and
servicing such securities. Because our decision to issue debt or preferred equity securities in any future offering will depend
on market conditions and other factors beyond our control, we cannot predict or estimate the amount, timing or nature of our future
offerings. Thus, holders of our common stock will bear the risk of our future offerings reducing the market price of our common
stock and diluting the value of their stock holdings in us.
We are an “emerging growth company” and
we cannot be certain if the reduced disclosure requirements applicable to emerging growth companies will make our common stock
less attractive to investors.
We are an “emerging growth company,”
and we benefit from certain exemptions from various reporting requirements that are applicable to other public companies that are
not “emerging growth companies” including, but not limited to, not being required to comply with the auditor attestation
requirements of Section 404 of the Sarbanes-Oxley Act, which may increase the risk that weaknesses or deficiencies in our internal
control over financial reporting go undetected, and reduced disclosure obligations regarding executive compensation in our periodic
reports and proxy statements, which may make it more difficult for investors and securities analysts to evaluate our company. In
addition, we have elected under the JOBS Act to delay adoption of new or revised accounting pronouncements applicable to public
companies until such pronouncements are made applicable to private companies. As a result of this election, our financial statements
may not be comparable to companies that comply with public company effective dates. If some investors find our common stock less
attractive as a result, there may be a less active trading market for our common stock and our stock price may be more volatile.
We may take advantage of these reporting exemptions until we are no longer an “emerging growth company,” which in certain
circumstances could be up to five years.
Risks Related to Our Taxation as a REIT
Our failure to qualify or remain qualified as a REIT
would subject us to U.S. federal income tax and applicable state and local taxes, which would reduce the amount of cash available
for distribution to our stockholders and have significant adverse consequences on the market price of our common stock.
We have been organized and we intend to
operate in a manner that will enable us to qualify as a REIT for U.S. federal income tax purposes commencing with our taxable year
ending December 31, 2017. We have not requested and do not intend to request a ruling from the Internal Revenue Service, or the
Service, that we qualify as a REIT, and the statements in this report are not binding on the Service or any court. Qualification
as a REIT involves the application of highly technical and complex Code provisions and regulations promulgated by the U.S. Treasury
Department, or the Treasury Regulations, thereunder for which there are limited judicial and administrative interpretations. Accordingly,
we cannot provide assurance that we will qualify or remain qualified as a REIT.
To qualify as a REIT, we must meet, on
an ongoing basis, various tests regarding the nature and diversification of our assets and our income, the ownership of our outstanding
stock, and the amount of our distributions to stockholders. Our ability to satisfy these asset tests depends upon the characterization
and fair market values of our assets, some of which are not susceptible to a precise determination, and for which we will not obtain
independent appraisals. Our compliance with the REIT income and quarterly asset requirements also depends upon our ability to manage
successfully the composition of our income and assets on an ongoing basis. Moreover, new legislation, court decisions or administrative
guidance, in each case possibly with retroactive effect, may make it more difficult or impossible for us to qualify as a REIT.
Thus, while we intend to operate in a manner to qualify as a REIT, in view of the highly complex nature of the rules governing
REITs, the ongoing importance of factual determinations, and the possibility of future changes in our circumstances, we cannot
provide assurance that we will so qualify for any particular year. These considerations also might restrict the types of income
we can realize, or assets that we can acquire in the future.
If we fail to qualify as a REIT in any
taxable year, and we do not qualify for certain statutory relief provisions, we would be required to pay U.S. federal income tax,
including any applicable alternative minimum tax, on our taxable income at regular corporate rates. We will not be able to deduct
distributions to our stockholders in any year in which we fail to qualify, nor will we be required to make distributions to our
stockholders. In such a case, we might need to borrow money, sell assets, or reduce or even cease making distributions in order
to pay our taxes. Our payment of income tax would reduce significantly the amount of cash available for distribution to our stockholders.
If we fail to qualify as a REIT, all distributions to stockholders, to the extent of current and accumulated earnings and profits,
will be taxable to the stockholders as dividend income (which may be subject to tax at preferential rates) and corporate distributions
may be eligible for the dividends received deduction if they satisfy the relevant provisions of the Code. Furthermore, if we fail
to qualify as a REIT, we no longer would be required to distribute substantially all of our net taxable income to our stockholders.
In addition, unless we were eligible for certain statutory relief provisions, we could not re-elect to qualify as a REIT until
the fifth calendar year following the year in which we failed to qualify. We might not be entitled to the statutory relief described
in this paragraph in all circumstances.
The REIT distribution requirements could adversely affect
our ability to execute our business plan, require us to borrow funds during unfavorable market conditions or subject us to tax,
which would reduce the cash available for distribution to our stockholders.
To qualify as a REIT, we must distribute
to our stockholders, on an annual basis, at least 90% of our REIT taxable income, determined without regard to the deduction for
dividends paid and excluding net capital gain. In addition, we will be subject to U.S. federal income tax at regular corporate
rates to the extent that we distribute less than 100% of our net taxable income (including net capital gain) and will be subject
to a 4% nondeductible excise tax on the amount by which our distributions in any calendar year are less than a minimum amount specified
under U.S. federal income tax laws. We intend to distribute our net income to our stockholders in a manner intended to satisfy
the REIT 90% distribution requirement and to avoid U.S. federal income tax and the 4% nondeductible excise tax. However, we can
provide no assurances that we will have sufficient cash or other liquid assets to meet these requirements. Difficulties in meeting
the distribution requirements might arise due to competing demands for available funds or timing differences between tax reporting
and cash receipts. In addition, if the Service were to disallow certain of our deductions, such as employee salaries, depreciation
or interest expense, by alleging that we, through our rental agreements with our state-licensed medical cannabis tenants, are primarily
or vicariously liable for "trafficking" a Schedule 1 substance (cannabis) under Section 280E of the Code or otherwise,
we would be unable to meet the distribution requirements and would fail to qualify as a REIT. Likewise, if any governmental entity
were to impose fines on us for our business involvement in state-licensed medical-use cannabis, such fines would not be deductible
and the inability to deduct such fines could also cause us to be unable to satisfy the distribution requirement.
We may also generate less cash flow than
taxable income in a particular year. In such event, we may be required to use cash reserves, incur debt or liquidate assets at
rates or times that we regard as unfavorable or, to the extent possible, make a taxable distribution of our stock in order to satisfy
the REIT 90% distribution requirement and to avoid U.S. federal income tax and the 4% nondeductible excise tax in that year. Under
certain circumstances, we may be able to rectify a failure to meet the distribution requirement for a year by paying "deficiency
dividends" to stockholders in a later year, which may be included in our deduction for dividends paid for the earlier year.
Thus, we may be able to avoid being taxed on amounts distributed as deficiency dividends; however, we will be required to pay penalties
and interest based upon the amount of any deduction taken for deficiency dividends. If we do not have sufficient cash to distribute,
we may incur U.S. federal income tax, U.S. federal excise tax and/or our REIT status may be jeopardized.
If we are deemed to be subject to Section 280E of the
Code because of the business activities of our tenants, the resulting disallowance of tax deductions could cause us to incur U.S.
federal income tax and jeopardize our REIT status.
Section 280E of the Code provides that,
with respect to any taxpayer, no deduction or credit is allowed for expenses incurred during a taxable year "in carrying on
any trade or business if such trade or business (or the activities which comprise such trade or business) consists of trafficking
in controlled substances (within the meaning of Schedule I and II of the CSA) which is prohibited by federal law or the law of
any State in which such trade or business is conducted." Because cannabis is a Schedule I controlled substance under the CSA,
Section 280E by its terms applies to the purchase and sale of medical-use cannabis products. Although we will not be engaged in
the purchase, sale, growth, cultivation, harvesting, or processing of medical-use cannabis products, we will lease our properties
to tenants who will engage in such activities, and therefore our tenants will likely be subject to Section 280E. If the Service
were to take the position that, through our rental agreements with our state-licensed medical-use cannabis tenants, we are primarily
or vicariously liable under federal law for "trafficking" a Schedule 1 substance (cannabis) under section 280E of the
Code or for any other violations of the CSA, the Service may seek to apply the provisions of Section 280E to our company and disallow
certain tax deductions, including for employee salaries, depreciation or interest expense. If such tax deductions are disallowed,
we would be unable to meet the distribution requirements applicable to REITs under the Code, which could cause us to incur U.S.
federal income tax and fail to qualify as a REIT. Because we are not engaged in the purchase and/or sale of a controlled substance,
we do not believe that we will be subject to the disallowance provisions of Section 280E, and neither we nor our tax advisors are
aware of any tax court cases or guidance from the Service in which a taxpayer not engaged in the purchase or sale of a controlled
substance was disallowed deductions under Section 280E. However, there is no assurance that the Service will not take such a position
either currently or in the future.
Complying with REIT requirements may cause us to forego
otherwise attractive business opportunities or liquidate otherwise attractive investments.
To qualify as a REIT, we must ensure that
we meet the REIT gross income tests annually. In addition, we must ensure that, at the end of each calendar quarter, at least 75%
of the value of our total assets consists of cash, cash items, government securities and qualified REIT real estate assets, including
certain mortgage loans, certain kinds of mortgage-backed securities and certain securities issued by other REITs. The remainder
of our investment in securities (other than government securities, securities of corporations that are treated as TRSs, and qualified
REIT real estate assets) generally cannot include more than 10% of the outstanding voting securities of any one issuer or more
than 10% of the total value of the outstanding securities of any one issuer. In addition, in general, no more than 5% of the value
of our assets (other than government securities and qualified real estate assets) can consist of the securities of any one issuer,
no more than 25% (20% for taxable years beginning after December 31, 2017) of the value of our total securities can be represented
by securities of one or more TRSs, and, the aggregate value of debt instruments issued by public REITs held by us that are not
otherwise secured by real property may not exceed 25% of the value of our total assets. If we fail to comply with these asset requirements
at the end of any calendar quarter, we generally must correct the failure within 30 days after the end of the calendar quarter
or qualify for certain statutory relief provisions to avoid losing our REIT qualification and suffering adverse tax consequences.
To meet these tests, we may be required
to take or forgo taking actions that we would otherwise consider advantageous. For instance, in order to satisfy the gross income
or asset tests applicable to REITs under the Code, we may be required to forego investments that we otherwise would make. Furthermore,
we may be required to liquidate from our portfolio otherwise attractive investments. In addition, we may be required to make distributions
to stockholders at disadvantageous times or when we do not have funds readily available for distribution. These actions could have
the effect of reducing our income and amounts available for distribution to our stockholders. Thus, compliance with the REIT requirements
may hinder our investment performance.
The tax on prohibited transactions could limit our ability
to engage in certain transactions or subject us to a 100% penalty tax.
We are subject to a 100% tax on any income
from a prohibited transaction. "Prohibited transactions" generally include sales or other dispositions of property (other
than property treated as foreclosure property under the Code) that is held as inventory or primarily for sale to customers in the
ordinary course of a trade or business by a REIT, either directly or indirectly through certain pass-through subsidiaries. Although
we do not intend to hold a significant amount of assets as inventory or primarily for sale to customers in the ordinary course
of our business, the characterization of an asset sale as a prohibited transaction depends on the particular facts and circumstances.
The Code provides a safe harbor that, if met, allows a REIT to avoid being treated as engaged in a prohibited transaction. It is
likely that we may sell certain properties that have not met all of the requirements of such safe harbor if we believe the transaction
would not be a prohibited transaction based on a facts and circumstances analysis. If the Service were to successfully argue that
such a sale was in fact a prohibited transaction, we would be subject to a 100% penalty tax with respect to such sale.
If we were considered to actually or constructively
pay a "preferential dividend" to certain of our stockholders, our status as a REIT could be adversely affected.
In order to qualify as a REIT, we must
annually distribute to our stockholders at least 90% of our REIT taxable income (which does not equal net income, as calculated
in accordance with GAAP), determined without regard to the deduction for dividends paid and excluding net capital gain. In order
for distributions to be counted as satisfying the annual distribution requirements for REITs, and to provide us with a REIT-level
tax deduction, the distributions must not be "preferential dividends." A dividend is not a preferential dividend if the
distribution is pro rata among all outstanding shares of stock within a particular class, and in accordance with the preferences
among different classes of stock as set forth in our organizational documents. Currently, there is uncertainty as to the Service's
position regarding whether certain arrangements that REITs have with their stockholders could give rise to the inadvertent payment
of a preferential dividend (e.g., the pricing methodology for stock purchased under a distribution reinvestment program inadvertently
causing a greater than 5% discount on the price of such stock purchased). There is no de minimis exception with respect to preferential
dividends; therefore, if the Service were to take the position that we inadvertently paid a preferential dividend, we may be deemed
to have failed the 90% distribution test, and our status as a REIT could be terminated for the year in which such determination
is made if we were unable to cure such failure. While we believe that our operations will be structured in such a manner that we
will not be treated as inadvertently paying preferential dividends, we can provide no assurance to this effect.
The "preferential dividend" prohibition
described above does not apply to a "publicly offered REIT," which generally is a REIT that is required to make regular
filings with the SEC under the Exchange Act. While we intend to qualify as a "publicly offered REIT" and therefore expect
that the preferential dividend prohibition will not apply to us, we cannot provide you with assurance that we will so qualify and,
accordingly, we may be subject to the prohibition.
The ability of our board of directors to revoke our
REIT election without stockholder approval may cause adverse consequences to our stockholders.
Our charter provides that the board of
directors may revoke or otherwise terminate our REIT election, without the approval of our stockholders, if the board of directors
determines that it is no longer in our best interest to attempt to, or continue to, qualify as a REIT. If we cease to qualify as
a REIT, we would become subject to U.S. federal income tax on our net taxable income and we generally would no longer be required
to distribute any of our net taxable income to our stockholders, which may have adverse consequences on our total return to our
stockholders.
Dividends payable by REITs do not qualify for the reduced
tax rates on dividend income from regular corporations, which could adversely affect the value of our common stock.
The maximum U.S. federal income tax rate
for certain qualified dividends payable to U.S. stockholders that are individuals, trusts and estates is 20%. Dividends (other
than capital gain dividends) payable by REITs, however, generally are not eligible for the reduced rates and therefore may be subject
to a 39.6% maximum U.S. federal income tax rate on ordinary income when paid to such stockholders. Although the reduced U.S. federal
income tax rate applicable to dividend income from regular corporate dividends does not adversely affect the taxation of REITs
or dividends paid by REITs, the more favorable rates applicable to regular corporate dividends could cause investors who are individuals,
trusts and estates to perceive investments in REITs to be relatively less attractive than investments in the stocks of non-REIT
corporations that pay dividends, which could adversely affect the value of the shares of our common stock.
Complying with REIT requirements may limit our ability
to hedge our liabilities effectively and may cause us to incur tax liabilities.
The REIT provisions of the Code may limit
our ability to hedge our liabilities. Any income from a hedging transaction we enter into to manage risk of interest rate changes,
price changes or currency fluctuations with respect to borrowings made or to be made to acquire or carry real estate assets, if
properly identified under applicable Treasury Regulations, does not constitute "gross income" for purposes of the 75%
or 95% gross income tests. To the extent that we enter into other types of hedging transactions, the income from those transactions
will likely be treated as non-qualifying income for purposes of both of the gross income tests. As a result of these rules, we
may need to limit our use of advantageous hedging techniques or implement those hedges through a TRS. This could increase the cost
of our hedging activities because our TRSs would be subject to tax on gains or expose us to greater risks associated with changes
in interest rates than we would otherwise want to bear. In addition, losses in a TRS generally will not provide any tax benefit,
except for being carried forward against future taxable income of such TRS.
Non-U.S. stockholders will generally be subject to withholding
tax with respect to our ordinary dividends.
Non-U.S. stockholders generally will be
subject to U.S. federal withholding tax on ordinary dividends received from us at a 30% rate, subject to reduction under an applicable
treaty or a statutory exemption under the Code.
Legislative or regulatory tax changes related to REITs
could materially and adversely affect our business.
At any time, the U.S. federal income tax
laws or Treasury Regulations governing REITs or the administrative interpretations of those laws or regulations may be changed,
possibly with retroactive effect. We cannot predict if or when any new U.S. federal income tax law, regulation or administrative
interpretation, or any amendment to any existing U.S. federal income tax law, regulation or administrative interpretation, will
be adopted, promulgated or become effective or whether any such law, regulation or interpretation may take effect retroactively.
The recent U.S. presidential election, coupled with a Republican-controlled Congress, makes tax reform more likely in the near-term.
New legislation, Treasury Regulations, administrative interpretations or court decisions could significantly and negatively affect
our ability to qualify as a REIT
,
the federal income tax consequences of such qualification, or the federal income
tax consequences of an investment in us. Also, the law relating to the tax treatment of other entities, or an investment in other
entities, could change, making an investment in such other entities more attractive relative to an investment in a REIT. We and
our stockholders could be adversely affected by any such change in, or any new, legislation, Treasury Regulations, administrative
interpretations or court decisions.