INNOVATIVE INDUSTRIAL PROPERTIES, INC. The following discussion should be read in conjunction with the condensed consolidated financial statements and notes thereto appearing elsewhere in this report. We make statements in this report that are "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. In particular, statements pertaining to our capital resources, portfolio performance and results of operations contain forward-looking statements. Likewise, our statements regarding anticipated growth in our funds from operations and anticipated market and regulatory conditions, our strategic direction, demographics, results of operations, plans and objectives are forward-looking statements. Forward-looking statements involve numerous risks and uncertainties, and you should not rely on them as predictions of future events. Forward-looking statements depend on assumptions, data or methods which may be incorrect or imprecise, and we may not be able to realize them. We do not guarantee that the transactions and events described will happen as described (or that they will happen at all). You can identify forward-looking statements by the use of forward-looking terminology such as "believes," "expects," "may," "will," "should," "seeks," "approximately," "intends," "plans," "estimates" or "anticipates" or the negative of these words and phrases or similar words or phrases. You can also identify forward-looking statements by discussions of strategy, plans or intentions. The following factors, among others, could cause actual results and future events to differ materially from those set forth or contemplated in the forward-looking statements: rates of default on leases for our assets, concentration of our portfolio of assets and limited number of tenants; the estimated growth in and evolving market dynamics of the regulated cannabis market inflation dynamics; the impact of the ongoing COVID-19 pandemic, or future pandemics, on us, our business, our tenants, or the economy generally; war and other hostilities, including the conflict inUkraine ; our business and investment strategy; our projected operating results; actions and initiatives of theU.S. or state governments and changes to government policies and the execution and impact of these actions, initiatives and policies, including the fact that cannabis remains illegal under federal law; availability of suitable investment opportunities in the regulated cannabis industry; our understanding of our competition and our potential tenants' alternative financing sources; the demand for regulated cannabis facilities; the expected medical-use or adult-use cannabis legalization in certain states; shifts in public opinion regarding regulated cannabis; the additional risks that may be associated with certain of our tenants cultivating, processing and/or dispensing adult-use cannabis in our facilities; the state of theU.S. economy generally or in specific geographic areas; economic trends and economic recoveries; our ability to access equity or debt capital; financing rates for our target assets; our expected leverage; our level of indebtedness, which could reduce funds available for other business purposes and reduce our operational flexibility; covenants in our debt instruments, which may limit our flexibility and adversely affect our financial condition; our ability to maintain our investment grade credit rating; changes in the values of our assets; our expected portfolio of assets; our expected investments; interest rate mismatches between our assets and our borrowings used to fund such investments; changes in interest rates and the market value of our assets; the degree to which any interest rate or other hedging strategies may or may not protect us from interest rate volatility; the impact of and changes in governmental regulations, tax law and rates, accounting guidance and similar matters; our ability to maintain our qualification as a REIT; our ability to maintain our exemption from registration under the Investment Company Act of 1940; availability of qualified personnel; and market trends in our industry, interest rates, real estate values, the securities markets or the general economy. The risks included here are not exhaustive, and additional factors could adversely affect our business and financial performance, including factors and risks included in other sections of this report. In addition, we discussed a number of material risks in our Annual Report on Form 10-K for the year endedDecember 31, 2021 , in Part II, Item 1A of our Quarterly Report on Form 10-Q for the quarter endedMarch 31, 2022 , and in Part II, Item 1A below. Those risks continue to be relevant to our performance and financial condition. Moreover, we operate in a very competitive and rapidly changing environment. New risk factors emerge from time to time and it is not possible for management to predict all such risk factors, nor can it assess the impact of all such risk factors on our Company's business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements. Any forward-looking statement made by us speaks only of the date on which we make it. The Company undertakes no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise, except as may be required by law. Stockholders and investors are cautioned not to unduly rely on such forward-looking statements when evaluating the information presented in the Company's filings and reports. The purpose of this Management's Discussion and Analysis ("MD&A") is to provide an understanding of the Company's consolidated financial condition, results of operations and cash. MD&A is provided as a supplement to, and should be read in conjunction with, the Company's condensed consolidated financial statements
and accompanying notes. Overview
As used herein, the terms "we", "us", "our" or the "Company" refer to
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We are an internally-managed REIT focused on the acquisition, ownership and management of specialized properties leased to experienced, state-licensed operators for their regulated cannabis facilities. We have leased 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, real estate taxes and insurance. We were incorporated inMaryland onJune 15, 2016 . We conduct our business through a traditional umbrella partnership real estate investment trust, or UPREIT structure, in which our properties are owned by ourOperating Partnership , directly or through subsidiaries. We are the sole general partner of ourOperating Partnership and own, directly or through subsidiaries, 100% of the limited partnership interests in ourOperating Partnership . As ofJune 30, 2022 , we had 22 full-time employees. As ofJune 30, 2022 , we owned 110 properties that were 100% leased to state-licensed cannabis operators and comprising an aggregate of approximately 8.6 million rentable square feet (including approximately 2.5 million rentable square feet under development/redevelopment) in 19 states, with a weighted-average remaining lease term of approximately 16 years. As ofJune 30, 2022 , we had invested approximately$2.1 billion in the aggregate (consisting of purchase price and funding of draws for construction funding and improvements submitted by tenants, if any, but excluding transaction costs) and had committed an additional approximately$225.2 million to fund draws to certain tenants and sellers for construction and improvements at our properties. Of the approximately$225.2 million committed to fund draws to certain tenants and sellers for construction and improvements at our properties, approximately$30.8 million was incurred as ofJune 30, 2022 . These statistics do not include an$18.5 million loan commitment from us to a developer for construction of a regulated cannabis cultivation and processing facility inCalifornia , of which we have funded approximately$17.7 million as ofJune 30, 2022 . Rent collection (calculated as base rent and property management fees collected as a percentage of contractually due base rent and property management fees for the applicable period) was approximately 99% for the six months endedJune 30, 2022 . Subsequent toJune 30, 2022 , Kings Garden defaulted on its obligations to pay any rent at the six properties that Kings Garden leases from us (See Part II, Item 1. Legal Proceedings and Note 12 "Subsequent Events" to our condensed consolidated financial statements included in this report for more information).
Factors Impacting Our Operating Results
Our results of operations are affected by a number of factors and depend on the rental revenues we receive from the properties that we acquire, the timing of lease expirations, general market conditions, the regulatory environment in the regulated cannabis industry, and the competitive environment for real estate assets that support the regulated cannabis industry.
Rental Revenues
We receive income primarily from rental revenues generated by the properties that we acquire. The amount of rental revenues depends upon a number of factors, including:
? our ability to enter into leases with increasing or market value rents for the
properties that we acquire; and
? rent collection, which primarily relates to each of our tenant's financial
condition and ability to make rent payments to us on time.
The properties that we acquire consist of real estate assets that support the regulated cannabis industry. Changes in federal law and current favorable state or local laws in the cannabis industry may impair our ability to renew or re-lease properties and the ability of our tenants to fulfill their lease obligations and could materially and adversely affect our ability to maintain or increase rental rates for our properties.
Conditions in Our Markets
Positive or negative changes in regulatory, economic or other conditions,
drought, and natural disasters in the markets where we acquire properties may
affect our overall financial performance. The success of our tenants in
operating their businesses and their ability to pay rent continue to be
significantly influenced by many challenges including the impact of inflation,
labor shortages, supply chain constraints on their cost of doing business, and
the ongoing COVID-19 Pandemic. Additionally, market dynamics and the regulatory
regime in the states where they operate create challenges that may impact our
tenants' businesses and/or decrease future demand for regulated cannabis
cultivation and production facilities. The potential impact of current economic
challenges on the Company's financial condition, results of operations, and cash
flows is subject to change and continues to depend on the extent and duration of
these risks and uncertainties.
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Market Dynamics in Regulated Cannabis State Programs
States vary significantly in their market dynamics, driven by many factors, including, but not limited to, regulatory frameworks, enforcement policies with respect to illicit, unlicensed cannabis operations, taxation and licensing structures. For example, inCalifornia , according to Global Go Analytics, the illicit market for cannabis remains a much larger portion of overall sales in the state, and state and local authorities have assessed significant taxes on regulated cannabis products, both of which have had the impact of significantly limiting the growth and profitability for operators in the state's regulated cannabis market. Recently, many states have experienced significant declines in unit pricing for regulated cannabis products, with that decline more pronounced in certain states than in others. For example, according to New Leaf Data Services, a provider of financial, business and industry data in the cannabis sector, spot wholesale cannabis flower prices inCalifornia andMichigan have each declined more than 30% during the six months endedJune 30, 2022 . Approximately 12% and 13% of our rental revenues for the six months endedJune 30, 2022 , were derived from our properties located inCalifornia andMichigan , respectively.
Inflation and Supply Chain Constraints
Recently, inflation has trended significantly higher than in prior periods, which may be negatively impacting some of our tenants. This inflation has impacted costs for labor and production inputs for regulated cannabis operators, in addition to increasing costs of construction for development and redevelopment projects. Ongoing labor shortages and global supply chain issues, driven in part by the COVID-19 pandemic, geopolitical issues and the war inUkraine , also continue to adversely impact costs and timing for completion of these development and redevelopment projects, which are resulting in cost overruns and delays in commencing operations on certain of our tenants' projects.
Reduced Capital Availability for Tenants and the Company
Recently, financial markets have been volatile, reflecting heightened
geopolitical risks and material tightening of financial conditions since the
Driven in part by overall macroeconomic conditions, capital availability has significantly declined for regulated cannabis operators and for the Company. According toViridian Capital Advisors , total equity and debt capital raising for public and private cannabis companies inNorth America decreased by approximately 64% year-to-date throughJuly 1, 2022 ($2.6 billion ) versus the prior year's period ($7.3 billion ). In addition, debt issuance year-to-date throughJuly 1, 2022 for cannabis companies represents the most significant percentage of capital raised of the comparable periods of the past four years according toViridian Capital Advisors , as equity values of cannabis companies have declined significantly.
COVID-19 Pandemic
The ongoing COVID-19 pandemic, or the future outbreak of any other highly infectious or contagious diseases, could materially and adversely impact or cause disruption to our tenants and their operations, and in turn our performance, financial condition, results of operations and cash flows. The extent to which the ongoing COVID-19 pandemic impacts our operations and those of our tenants will depend on future developments, which are highly uncertain and cannot be predicted with confidence, including the scope, severity and duration of the pandemic, the actions taken to contain the pandemic or mitigate its impact, and the direct and indirect economic effects of the outbreak and containment measures, among others. Furthermore, the impacts of a potential worsening of global economic conditions, acts of war or other hostilities, including the conflict inUkraine , and the continued disruptions to, and volatility in, the credit and financial markets, supply chains and consumer spending as well as other unanticipated consequences remain unknown. Our tenants' ability to pay their rent obligations to us depends, in part, on whether our tenants can continue their regulated cannabis operations and the ability and willingness of consumers to visit dispensary businesses. In the large majority of states that have legalized cannabis, state governmental authorities have recognized both medical-use and adult-use cannabis operations, including supply chain activities such as cultivation, processing, distribution and dispensary activities, as "essential businesses", allowing them to remain open and operational. While laws and practices vary from state to state, state and local governmental authorities and regulated cannabis businesses have taken additional measures to ensure the safety and well-being of employees, patients and consumers, including but not limited to restrictions associated with social distancing requirements and additional levels of protection for medical cannabis patients with more vulnerability to health complications from COVID-19. Despite these measures, cannabis dispensaries may experience declines in customer traffic or may be required to close in response to new government regulatory orders, which may result from a prolonged outbreak or resurgence of COVID-19 cases, and could have a significant adverse financial impact on certain of
our
tenants.
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Significant Tenants and Concentrations of Risk
As ofJune 30, 2022 , we owned 110 properties located in 19 states. Many of our tenants are tenants at multiple properties. We seek to manage our portfolio-level risk through geographic diversification and by minimizing dependence on any single property or tenant. AtJune 30, 2022 , none of our properties accounted for 5% or more of our net real estate held for investment. See Note 2 in the notes to the condensed consolidated financial statements for further information regarding the tenants in our portfolio that represented the largest percentage of our total rental revenues for the three and six months endedJune 30, 2022 . See Note 12 "Subsequent Events" in the notes to the condensed consolidated financial statements regarding the status of the Kings Garden Leases. Competitive Environment We face competition from a diverse mix of market participants, including but not limited to, other companies with similar business models, independent investors, hedge funds, lenders and other real estate investors, as well as potential tenants (cannabis operators themselves), all of whom may compete with us in our efforts to acquire real estate zoned for regulated cannabis operations. Competition from others may diminish our opportunities to acquire a desired property on favorable terms or at all. In addition, this competition may put pressure on us to reduce the rental rates below those that we expect to charge for the properties that we acquire, which would adversely affect our financial results. Operating Expenses Our operating expenses include general and administrative expenses, including personnel costs, stock-based compensation, and legal, accounting and other expenses related to corporate governance, public reporting and compliance with the various provisions ofU.S. securities laws. We generally 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. Increases or decreases in such operating expenses will impact our overall financial performance.
Our Qualification as a REIT
We have been organized and operate our business so as to qualify to be taxed as a REIT forU.S. federal income tax purposes. Shares of our common stock and Series A Preferred Stock are subject to restrictions on ownership and transfer that are intended, among other purposes, to assist us in qualifying and maintaining our qualification as a REIT. 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 Series A Preferred 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. 27 Table of Contents Results of Operations
Investments in Real Estate
See Note 6 in the notes to the condensed consolidated financial statements for
information regarding our investments in real estate activity and property
portfolio activity during the six months ended
Comparison of the Three and Six Months Ended
The following table sets forth the results of our operations (in thousands):
For the Three Months Ended For the Six Months Ended
June 30, June 30,
2022 2021 2022 2021Revenues:
Rental (including tenant reimbursements)
516 - 906 -
Total revenues 70,511 48,867 135,015 91,752
Expenses:
Property expenses 2,427 482 4,409 1,252 General and administrative expense 8,707 5,604 17,484 11,204 Depreciation and amortization expense 15,233 9,841 29,101 18,680 Total expenses 26,367 15,927 50,994 31,136 Income from operations 44,144 32,940 84,021 60,616 Interest and other income 581 91 638 215 Interest expense (4,504) (3,692) (9,270) (5,565) Loss on exchange of Exchangeable Senior Notes (7) - (125) - Net income 40,214 29,339 75,264 55,266 Preferred stock dividends (338) (338) (676) (676) Net income attributable to common stockholders$ 39,876 $ 29,001 $ 74,588 $ 54,590 Revenues. Rental Revenues. Rental revenues for the three months endedJune 30, 2022 increased by approximately$21.1 million , or 43%, to approximately$70.0 million , compared to approximately$48.9 million for the three months endedJune 30, 2021 . Approximately$1.3 million of the increase in rental revenues was generated by the properties acquired during the three months endedJune 30, 2022 . The remaining approximately$19.8 million increase in rental revenues was generated by properties we acquired in prior periods, including contractual rent escalations and amendments to leases for additional improvement allowances and construction funding at existing properties that resulted in adjustments to rent. Rental revenues for the three months endedJune 30, 2022 and 2021 included approximately$2.5 million and$498,000 , respectively, of tenant reimbursements for property insurance premiums and property taxes. Rental revenues for the six months endedJune 30, 2022 increased by$42.3 million , or 46%, to approximately$134.1 million , compared to approximately$91.8 million for the six months endedJune 30, 2021 . Approximately$3.0 million of the increase in rental revenues was generated by the properties acquired during the six months endedJune 30, 2022 . The remaining approximately$39.3 million increase in rental revenues was generated by properties we acquired in prior periods, including contractual rent escalations and amendments to leases for additional improvement allowances and construction funding at existing properties that resulted in adjustments to rent. Rental revenues for the six months endedJune 30, 2022 and 2021 included approximately$4.4 million and$1.2 million , respectively, of tenant reimbursements for property insurance premiums and property taxes. Other Revenues. Other revenues for the three and six months endedJune 30, 2022 consists of interest revenue related to leases for property acquisitions that did not satisfy the requirements for sale-leaseback accounting.
Expenses.
Property Expenses. Property expenses for the three and six months endedJune 30, 2022 increased by approximately$1.9 million and$3.2 million respectively, compared to the three and six months endedJune 30, 2021 . The increase was
due
to property insurance
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premiums and property taxes paid for newly acquired properties and the completion of development or redevelopment of existing properties.
General and Administrative Expense. General and administrative expense for the three months endedJune 30, 2022 increased by approximately$3.1 million to approximately$8.7 million , compared to approximately$5.6 million for the three months endedJune 30, 2021 . General and administrative expense for the six months endedJune 30, 2022 increased by approximately$6.3 million to approximately$17.5 million , compared to approximately$11.2 million for the six months endedJune 30, 2021 . The increase in general and administrative expense was primarily due to higher compensation to employees, the hiring of additional employees and higher public company costs, travel and occupancy costs. Compensation expense for the three and six months endedJune 30, 2022 included approximately$4.4 million and$8.8 million , respectively, of non-cash stock-based compensation. Compensation expense for the three and six months endedJune 30, 2021 included approximately$2.1 million and$4.2 million , respectively of non-cash stock-based compensation. Depreciation and Amortization Expense. The increase in depreciation and amortization expense was related to depreciation on properties that we acquired and the placement into service of construction and improvements at certain of our properties. Interest and Other Income. Interest and other income for the three months endedJune 30, 2022 increased by approximately$490,000 compared to the three months endedJune 30, 2021 . The increase was due to higher balances of interest-bearing investments resulting from proceeds from our common stock offerings and higher interest rates on our interest-bearing investments. Interest and other income for the six months endedJune 30, 2022 increased by approximately$423,000 compared to the six months endedJune 30, 2021 . The increase was due to higher balances of interest bearing investments resulting from proceeds from our common stock offerings and higher interest rates on our interest-bearing investments. Interest Expense. Interest expense consists of interest on our Exchangeable Senior Notes issued inFebruary 2019 and our Notes due 2026 issued inMay 2021 . Interest expense for the three months endedJune 30, 2022 and 2021 included approximately$324,000 and$649,000 , respectively, of non-cash interest expense; and interest expense for the six months endedJune 30, 2022 and 2021 included approximately$689,000 and$1.2 million , respectively, of non-cash interest expense.
Cash Flows
Comparison of the Six Months Ended
Six Months Ended
2022 2021 Change
Net cash provided by operating activities $ 121,981 $ 89,392 $ 32,589
Net cash used in investing activities (426,970) (287,153) (139,817)
Net cash provided by financing activities 264,532 228,069 36,463
Ending cash, cash equivalents and restricted cash 45,962 156,314 (110,352) Operating Activities Cash flows provided by operating activities for the six months endedJune 30, 2022 and 2021 were approximately$122.0 million and$89.4 million , respectively. Cash flows provided by operating activities were generally from contractual rent and security deposits from our properties, partially offset by our general
and administrative expense. Investing Activities Cash flows used in investing activities for the six months endedJune 30, 2022 were approximately$427.0 million , of which approximately$442.9 million related to investments in real estate and funding of draws for a portion of the improvement allowances, construction funding at our properties and other investments, partially offset by approximately$15.9 million related to net maturities of short-term investments. Cash flows used in investing activities for the six months endedJune 30, 2021 were approximately$287.2 million , of which approximately$257.3 million primarily related to the purchase of investment in real estate and funding of draws for a portion of the improvement allowances and construction funding at our properties. The remaining approximately$29.9 million related to net purchases and maturities of short-term investments.
Financing Activities
Net cash provided by financing activities of approximately$264.5 million during the six months endedJune 30, 2022 was the result of approximately$352.0 million in net proceeds from the issuance of our common stock, partially offset by dividend payments 29 Table of Contents of approximately$85.1 million to common and preferred stockholders and approximately$2.4 million related to net share settlement of equity awards to pay the required withholding taxes upon vesting of restricted stock for certain employees. Net cash provided by financing activities of approximately$228.1 million during the six months endedJune 30, 2021 was the result of approximately$293.5 million in net proceeds from the issuance of our Notes due 2026, partially offset by dividend payments of approximately$62.0 million to common and preferred stockholders and approximately$3.4 million related to net share settlement of equity awards to pay the required withholding taxes upon vesting of restricted stock for certain employees.
Liquidity and Capital Resources
Liquidity is a measure of our ability to meet potential cash requirements. We expect to use significant cash to acquire additional properties, develop and redevelop existing properties, pay dividends to our stockholders, fund our operations, service our Exchangeable Senior Notes and Notes due 2026, and meet other general business needs.
Sources and Uses of Cash
We derive all of our revenues from the leasing of our properties and collecting rental income, which includes operating expense reimbursements, based on contractual arrangements with our tenants. This source of revenue represents our primary source of liquidity to fund our dividends, interest payments on Exchangeable Senior Notes and Notes due 2026, general and administrative expenses, property development and redevelopment activities, property operating expenses and other expenses incurred related to managing our existing portfolio and investing in additional properties. Because substantially all our leases are triple net, our tenants are generally responsible for the maintenance, insurance and property taxes associated with the properties they lease from us. If a tenant defaults on one of our leases or the lease term expires with no tenant renewal, we would incur the property costs not paid by the tenant during the time it takes to re-lease or sell the property. As ofJune 30, 2022 , the weighted-average remaining terms of our leases was approximately 16 years and we owned 110 properties that were 100% leased. Rent collection (calculated as base rent and property management fees collected as a percentage of contractually due base rent and property management fees for the applicable period) was approximately 99% for the six months endedJune 30, 2022 . Subsequent toJune 30, 2022 , Kings Garden defaulted on its obligations to pay any rent at the six properties that Kings Garden leases from us (See Part II, Item 1. Legal Proceedings and Note 12 "Subsequent Events" to our condensed consolidated financial statements included in this report for more information). We expect to incur some property-level operating costs from time to time in periods during which properties that become vacant are being remarketed. In addition, we may recognize an expense for certain property costs, such as insurance premiums and real estate taxes billed in arrears, if we believe the tenant is likely to vacate the property before making payment on those obligations or may be unable to pay such costs in a timely manner. Property costs are generally not significant to our operations, but the amount of property costs can vary quarter to quarter based on the number of property vacancies and whether we have any underperforming properties. We may advance certain property costs on behalf of our tenants but expect that the majority of these costs will be reimbursed by the tenant and do not anticipate that they will be significant to our operations. To the extent additional resources are needed, we expect to fund our investment activity generally through equity or debt issuances either in the public or private markets. Where possible, we also may issue limited partnership interests in ourOperating Partnership to acquire properties from existing owners seeking a tax-deferred transaction. InMay 2021 , we received an investment grade rating from a ratings agency. We sought to obtain an investment grade rating to facilitate access to the investment grade unsecured debt market as part of our overall strategy to maximize our financial flexibility and manage our overall cost of capital. OnMay 25, 2021 , ourOperating Partnership issued$300.0 million aggregate principal amount of Notes due 2026. The Notes due 2026 are theOperating Partnership's general unsecured and unsubordinated obligations, are fully and unconditionally guaranteed by us and all of the direct and indirect subsidiaries of theOperating Partnership , and rank equally in right of payment with all of theOperating Partnership's existing and future senior unsecured indebtedness, including the Exchangeable Senior Notes. The terms of the Notes due 2026 are governed by an indenture, which requires compliance with various financial covenants including limits on the amount of total leverage and secured debt maintained by theOperating Partnership and which require theOperating Partnership to maintain minimum levels of debt service coverage. Management believes that it was in compliance with those covenants as ofJune 30, 2022 . Subject to the terms of the indenture, any new subsidiary of theOperating Partnership will also guarantee the Notes due 2026. In addition, the terms of the indenture provide that if the debt rating on the Notes due 2026 is downgraded or withdrawn entirely, interest on the Notes due 2026 will increase to a range of 6.0% to 6.5% based on such debt rating. InApril 2022 , we issued 1,815,790 shares of common stock in an underwritten public offering, which includes the exercise in full of the underwriters' option to purchase an additional 236,842 shares, resulting in net proceeds of approximately$330.9 million . 30 Table of Contents
During the three and six months ended
We are party to equity distribution agreements with six sales agents, pursuant to which we may offer and sell from time to time through an "at-the-market" offering program, or ATM Program, up to$500.0 million in shares of our common stock. InMarch 2022 , we sold 117,023 shares of our common stock for net proceeds of approximately$21.1 million under the ATM Program. As ofJune 30, 2022 , the remaining amount available to be sold under the ATM Program was approximately$209.9 million . We have filed an automatic shelf registration statement, which may permit us, from time to time, to offer and sell common stock, preferred stock, warrants and other securities to the extent necessary or advisable to meet our liquidity needs. We expect to meet our liquidity needs through cash and short-term investments on hand, cash flows from operations and cash flow from sources discussed above. We believe that our liquidity and sources of capital are adequate to satisfy our cash requirements. We cannot, however, be certain that these sources of funds will be available at a time and upon terms acceptable to the Company in sufficient amounts to meet our liquidity needs. Our investment guidelines also 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. In recent months, financial markets have been volatile in general, which has also significantly reduced our access to capital. If sustained, this would have a material adverse effect on our business, financial condition and results of operations, including our ability to continue to make acquisitions of new properties and fund investments for improvements at existing properties.
Dividends
The Company is required to pay dividends to its stockholders at least equal to 90% of its taxable income in order to qualify and maintain its qualification as a REIT. As a result of this distribution requirement, ourOperating Partnership cannot rely on retained earnings to fund its ongoing operations to the same extent that other companies whose parent companies are not REITs can. Our ability to continue to pay dividends is dependent upon our ability to continue to generate cash flows, service any debt obligations we have, including our Exchangeable Senior Notes and Notes due 2026, and make accretive new investments.
The following table describes the dividends declared by the Company during the
six months ended
Amount
Declaration Per Dividend
Date Security Class Share Period Covered Paid Date Dividend Amount
(In thousands)
January 1, 2022 to
March 14, 2022 Common stock $ 1.75 March 31, 2022 April 14, 2022 $ 45,830
Series A
preferred January 15, 2022 to
March 14, 2022 stock $ 0.5625 April 14, 2022 April 14, 2022 $ 338
March 1, 2022 to
June 15, 2022 Common stock $ 1.75 June 30, 2022 July 15, 2022 $ 49,101
Series A
preferred April 15, 2022 to
June 15, 2022 stock $ 0.5625 July 14, 2022 July 15, 2022 $ 338
Contractual Obligations
The following table summarizes our contractual obligations as of June 30, 2022
(in thousands):
Payments Due Exchangeable
by Year Notes due 2026 Senior Notes Interest Office Rent Total
2022 (six months
ending December 31) $ - $ - $ 8,371 $ 241 $ 8,612
2023 - - 16,742 496 17,238
2024 - 6,453 16,534 511 23,498
2025 - - 16,500 526 17,026
2026 300,000 - 6,646 543 307,189
Thereafter - - - 45 45
Total $ 300,000 $ 6,453 $ 64,793 $ 2,362 $ 373,608
Additionally, as of June 30, 2022 , we had approximately $194.4 million
outstanding in commitments related to improvement allowances, which generally
may be requested by the tenants at any time up until a date that is near the
expiration of the initial term of the applicable lease. As of June 30, 2022 , we
also had approximately $802,000 outstanding in commitments to fund a
construction
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loan, which the developer is required to complete by December 1, 2022 , subject
to extension in certain circumstances. The commitments discussed in this
paragraph are excluded from the table of contractual obligations above, as
improvement allowances generally may be requested by the tenants at any time up
until a date that is near the expiration of the initial term of the applicable
lease and construction loan funding generally may be requested by the borrower
from time to time, subject to satisfaction of certain conditions.
Non-GAAP Financial Information
In addition to the required GAAP presentations, we use certain non-GAAP performance measures as we believe these measures improve the understanding of our operational results. We continually evaluate the usefulness, relevance, limitations, and calculation of our reported non-GAAP performance measures to determine how best to provide relevant information to the public and thus such reported measures could change.
Funds from Operations, Normalized Funds from Operations and Adjusted Funds from Operations
Funds from operations ("FFO") and FFO per share are operating performance
measures adopted by the National Association of Real Estate Investment Trusts,
Inc. ("NAREIT"). NAREIT defines FFO as the most commonly accepted and reported
measure of a REIT's operating performance equal to net income (computed in
accordance with GAAP), excluding gains (or losses) from sales of property,
depreciation, amortization and impairment related to real estate properties, and
after adjustments for unconsolidated partnerships and joint ventures.
Management believes that net income, as defined by GAAP, is the most appropriate
earnings measurement. However, management believes FFO and FFO per share to be
supplemental measures of a REIT's performance because they provide an
understanding of the operating performance of our properties without giving
effect to certain significant non-cash items, primarily depreciation expense.
Historical cost accounting for real estate assets in accordance with GAAP
assumes that the value of real estate assets diminishes predictably over time.
However, real estate values instead have historically risen or fallen with
market conditions. We believe that by excluding the effect of depreciation, FFO
and FFO per share can facilitate comparisons of operating performance between
periods. We report FFO and FFO per share because these measures are observed by
management to also be the predominant measures used by the REIT industry and by
industry analysts to evaluate REITs and because FFO per share is consistently
reported, discussed, and compared by research analysts in their notes and
publications about REITs. For these reasons, management has deemed it
appropriate to disclose and discuss FFO and FFO per share.
We compute normalized funds from operations ("Normalized FFO") by adjusting FFO,
as defined by NAREIT, to exclude certain GAAP income and expense amounts that we
believe are infrequent and unusual in nature and/or not related to our core real
estate operations. Exclusion of these items from similar FFO-type metrics is
common within the equity REIT industry, and management believes that
presentation of Normalized FFO and Normalized FFO per share provides investors
with a metric to assist in their evaluation of our operating performance across
multiple periods and in comparison to the operating performance of other
companies, because it removes the effect of unusual items that are not expected
to impact our operating performance on an ongoing basis. Normalized FFO is used
by management in evaluating the performance of our core business operations.
Items included in calculating FFO that may be excluded in calculating Normalized
FFO include certain transaction-related gains, losses, income or expense or
other non-core amounts as they occur.
Management believes that adjusted funds from operations ("AFFO") and AFFO per
share are also appropriate supplemental measures of a REIT's operating
performance. We calculate AFFO by adjusting Normalized FFO for certain non-cash
items.
For the three and six months ended June 30, 2022 and 2021, FFO (diluted),
Normalized FFO and AFFO, and FFO, Normalized FFO and AFFO per diluted share
include the dilutive impact of the assumed full exchange of the Exchangeable
Senior Notes for shares of common stock. As a result, for purposes of
calculating FFO (diluted), cash and non-cash interest expense of the
Exchangeable Senior Notes was added back to FFO, and the total diluted
weighted-average common shares outstanding increased by 103,742 shares and
304,348 shares for the three and six months ended June 30, 2022 , respectively,
which were the potentially issuable shares as if the Exchangeable Senior Notes
were exchanged at the beginning of the period.
For the three and six months ended June 30, 2021 , for purposes of calculating
FFO (diluted), cash and non-cash interest expense of the Exchangeable Senior
Notes was added back to FFO, and the total diluted weighted-average common
shares outstanding increased by 2,182,691 shares for both periods, which were
the potentially issuable shares as if the Exchangeable Senior Notes were
exchanged at the beginning of the period.
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For the three and six months endedJune 30, 2022 and 2021, as the performance thresholds for vesting of the PSUs were not met as measured as of the respective dates, they were excluded from the calculation of weighted average common shares outstanding - diluted for all periods presented. Our computation of FFO, Normalized FFO, and AFFO may differ from the methodology for calculating FFO, Normalized FFO and AFFO utilized by other equity REITs and, accordingly, may not be comparable to such REITs. Further, FFO and AFFO do not represent cash flow available for management's discretionary use. FFO, Normalized FFO and AFFO should not be considered as an alternative to net income (computed in accordance with GAAP) as an indicator of our financial performance or to cash flow from operating activities (computed in accordance with GAAP) as an indicator of our liquidity, nor is it indicative of funds available to fund our cash needs, including our ability to pay dividends or make distributions. FFO, Normalized FFO and AFFO should be considered only as supplements to net income computed in accordance with GAAP as measures of operations.
The table below is a reconciliation of net income attributable to common
stockholders to FFO, Normalized FFO and AFFO for the three and six months ended
For the Three Months Ended For the Six Months Ended
June 30, June 30,
2022 2021 2022 2021
Net income attributable to common
stockholders $ 39,876 $ 29,001 $ 74,588 $ 54,590
Real estate depreciation and
amortization 15,233 9,841 29,101 18,680
FFO attributable to common stockholders
(basic) 55,109 38,842 103,689 73,270
Cash and non-cash interest expense on
Exchangeable Senior Notes 68 1,879 402 3,752
FFO attributable to common stockholders
(diluted) 55,177 40,721 104,091 77,022
Acquisition-related expense - 11 95 19
Financing expense 104 - 104 -
Loss on exchange of Exchangeable Senior
Notes 7 - 125 -
Normalized FFO attributable to common
stockholders (diluted) 55,288 40,732 104,415 77,041
Stock-based compensation 4,437 2,132 8,816 4,233
Non-cash interest expense 311 118 618 118
Above-market lease amortization 23 - 46 -
AFFO attributable to common stockholders
(diluted) $ 60,059 $ 42,982 $ 113,895 $ 81,392
FFO per common share - diluted $ 1.97 $ 1.56 $ 3.83 $ 2.94
Normalized FFO per common share -
diluted $ 1.97 $ 1.56 $ 3.84 $ 2.94
AFFO per common share - diluted $ 2.14 $ 1.64 $ 4.19 $ 3.11
Weighted average common shares
outstanding - basic 27,850,561 23,889,761 26,741,568 23,889,580
Restricted stock and RSUs 82,387 96,230 113,858 94,223
PSUs - - - -
Dilutive effect of Exchangeable Senior
Notes 103,742 2,182,691 304,348 2,182,691
Weighted average common shares
outstanding - diluted 28,036,690 26,168,682 27,159,774 26,166,494
Critical Accounting Estimates
Our condensed consolidated financial statements have been prepared in accordance
with GAAP, which requires us to make estimates and assumptions that affect the
reported amounts of assets and liabilities and disclosure of contingent assets
and liabilities at the date of the condensed consolidated financial statements
and the reported amounts of revenues and expenses during the reporting periods.
Actual results could differ materially from those estimates and assumptions.
We continually evaluate the estimates and assumptions we use to prepare our
consolidated financial statements. Our critical accounting estimates are defined
as accounting estimates or assumptions made in accordance with GAAP, which
involve a significant level of estimation uncertainty or subjectivity and have
had or are reasonably likely to have a material impact on our financial
condition or results of operations. The following critical accounting estimates
discussion reflects what we believe are the most significant estimates and
assumptions used in the preparation of our consolidated financial statements.
This discussion of our critical accounting estimates is intended to supplement
the description of our accounting policies in the footnotes to our consolidated
financial statements and to provide additional insight into the information used
by management when evaluating significant estimates and assumptions. For further
discussion of our significant accounting policies, see Note 2 "Significant
Accounting Policies and Procedures" to our condensed consolidated financial
statements included in this report.
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Acquisition of Rental Property, Depreciation and Impairment
All of our acquisitions of rental properties to date were accounted for as asset acquisitions and not business combinations because substantially all of the fair value is concentrated in a single identifiable asset or group of similar identifiable assets (i.e., land, buildings, and related intangible assets). The accounting model for asset acquisitions requires that the acquisition consideration (including acquisition costs) be allocated to the individual assets acquired and liabilities assumed on a relative fair value basis. We exercise judgement to determine key assumptions used in each valuation technique. For example, we are required to use judgment and make a number of assumptions, including those related to projected growth in rental rates and operating expenses, anticipated trends and market/economic conditions. The use of different assumptions can affect the amount of consideration allocated to the acquired depreciable/amortizable asset, which in turn can impact our net income due to the recognition of the related depreciation/amortization expense in our condensed consolidated statements of income. We depreciate buildings and improvements and tenant improvements where we are considered the owner for accounting purposes based on our evaluation of the estimated useful life of each specific asset, not to exceed 40 years. Determining whether expenditures meet the criteria for capitalization and the assignment of depreciable lives requires management to exercise significant judgment. The determination of whether we are or the tenant is the owner of tenant improvements for accounting purposes is subject to significant judgment. In making that determination, we consider numerous factors and perform a detailed evaluation of each individual lease. No one factor is determinative in reaching a conclusion. The factors we evaluate include but are not limited to the following:
whether the lease agreement requires landlord approval of how the tenant
? improvement allowance is spent prior to installation of the tenant
improvements;
whether the lease agreement requires the tenant to provide evidence to the
? landlord supporting the cost and what the tenant improvement allowance was
spent on prior to payment by the landlord for such tenant improvements;
? whether the tenant improvements are unique to the tenant or reusable by other
tenants;
whether the tenant is permitted to alter or remove the tenant improvements
? without the consent of the landlord or without compensating the landlord for
any lost utility or diminution in fair value; and
? whether the ownership of the tenant improvements remains with the landlord or
remains with the tenant at the end of the lease term.
When we conclude that we are the owner of tenant improvements for accounting purposes using the factors discussed above, we record the cost to construct the tenant improvements as our capital asset. We evaluate our real estate assets for potential impairment whenever events or changes in circumstances indicate that the carrying amount of a given asset may not be recoverable. We evaluate our real estate assets for impairment on a property-by-property basis. Indicators we use to determine whether an impairment evaluation is necessary include:
? deterioration in rental rates for a specific property;
? deterioration of a given rental submarket;
significant change in strategy or use of a specific property or any other event
? that could result in a decreased holding period, including classifying a
property as held for sale, or significant development delay;
? evidence of material physical damage to the property; and
? default by a significant tenant when any of the other indicators above are
present.
When we evaluate for potential impairment our real estate assets to be held and
used, we first evaluate whether there are any indicators of impairment. If any
impairment indicators are present for a specific real estate asset, we then
perform an undiscounted cash flow analysis and compare the net carrying amount
of the real estate asset to the real estate asset's estimated undiscounted
future cash flow over the anticipated holding period. If the estimated
undiscounted future cash flow is less than the net carrying amount of the real
estate asset, we perform an impairment loss calculation to determine if the fair
value of the real estate asset is less than the net carrying value of the real
estate asset. Our impairment loss calculation compares the net carrying amount
of the real estate asset to the real estate asset's estimated fair value, which
may be based on estimated discounted future cash flow calculations or
third-party valuations or appraisals. We recognize an impairment loss if the
amount of the asset's net carrying amount exceeds the asset's estimated fair
value. If we recognize an impairment loss, the estimated fair value of the asset
becomes its new cost basis. For a depreciable long-lived asset, the new cost
basis would be depreciated (amortized) over the remaining useful life of that
asset. If a real
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estate asset is designated as real estate held for sale, it is carried at the
lower of the net carrying value or estimated fair value less costs to sell, and
depreciation ceases.
Our undiscounted cash flow and fair value calculations contain uncertainties
because they require management to make assumptions and to apply judgment to
estimate future cash flow and property fair values, including determining our
estimated holding period and selecting the discount or capitalization rate that
reflects the risk inherent in future cash flow. Estimating projected cash flow
is highly subjective as it requires assumptions related to future rental rates,
tenant allowances, operating expenditures, property taxes, capital improvements,
and occupancy levels. We are also required to make a number of assumptions
relating to future economic and market events and prospective operating trends.
Determining the appropriate capitalization rate also requires significant
judgment and is typically based on many factors including the prevailing rate
for the market or submarket, as well as the quality and location of the
properties. Further, capitalization rates can fluctuate resulting from a variety
of factors in the overall economy or within regional markets. If the actual net
cash flow or actual market capitalization rates significantly differ from our
estimates, the impairment evaluation for an individual asset could be materially
affected.
For each property where such an indicator occurred, we completed an impairment
evaluation. After completing this process, we determined that for each of the
operating properties evaluated, undiscounted cash flows over the holding period
were in excess of carrying value and, therefore, we did not record any
impairment losses for these properties for the three and six months ended June
30, 2022 and 2021.
Stock-Based Compensation
Compensation cost for all share-based awards requires an estimate of fair value
on the grant date and compensation cost is recognized on a straight-line basis
over the service vesting period, which represents the requisite service period.
The grant date fair value for compensation programs that contain market
conditions, like modifiers based on total stockholder return (a "market
condition"), are performed using complex pricing valuation models that require
the input of assumptions, including judgments to estimate expected stock price
volatility, expected life, and forfeiture rate. See Note 10 "Common Stock
Incentive Plan" to our condensed consolidated financial statements included in
this report for further discussion the assumptions and estimates.
Impact of Real Estate and Credit Markets
In the commercial real estate market, property prices generally continue to fluctuate. Likewise, during certain periods, theU.S. credit markets have experienced significant price volatility, dislocations, and liquidity disruptions, which may impact our access to and cost of capital. We continually monitor the commercial real estate andU.S. credit markets carefully and, if required, will make decisions to adjust our business strategy accordingly.
Interest Rate Risk
As ofJune 30, 2022 , we had$300.0 million principal amount of Notes due 2026 and approximately$6.5 million principal amount of Exchangeable Senior Notes outstanding at fixed interest rates, and therefore, if interest rates decline, our required payments may exceed those based on current market rates. It is possible that a property we acquire in the future would be subject to a mortgage, which we may assume.
Impact of Inflation
TheU.S. economy has experienced an increase in inflation rates recently. We enter into leases that generally provide for fixed increases in rent. During times when inflation is greater than the fixed increases in rent, as provided for in the leases, rent increases may not keep up with the rate of inflation.
Seasonality
Our business has not been, and we do not expect our business in the future to be, subject to material seasonal fluctuations.
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