With Changes Likely in Banking Regulations, Can This Cannabis REIT Still Prosper?

Raising money is a challenge for many marijuana producers because they can't easily obtain banking services. Even just getting a checking account is no easy task. In order to set up their manufacturing facilities, some have turned to sale-and-leaseback agreements with a real estate investment trust (REIT) like Innovative Industrial Properties (IIPR 0.06%). And that has allowed the REIT to generate fantastic growth, with sales of $117 million in 2020 more than doubling from the previous year.

But if the Secure and Fair Enforcement (SAFE) Banking Act, which recently passed the House, can make it through the Senate, it would make it easier for cannabis companies to go through the banks to raise money. And if that's the case, would that hurt Innovative Industrial Properties' growth potential?

Image source: Getty Images.

Will companies simply load up on debt if they need cash?

If the SAFE Banking Act passes into law (or a similar provision that provides cannabis companies legal access to the banking industry), one opportunity that would open up is for cannabis producers to take out more loans and raise money through debt. That would potentially lessen their need to raise cash through share issues or sale-and-leaseback agreements.

An easy way to gauge that possibility is by looking north of the border, as cannabis is legal in Canada and companies there have a much easier time accessing the banking industry. Here's a look at the debt-to-equity ratios of some of the bigger names in the Canadian pot sector:

Data source: Company filings.

Although some companies like Tilray and Aphria (which have now merged into one entity under Tilray's name) are certainly loading up on debt, that doesn't mean it is the preferred course of action for everyone. It ultimately depends on a company's strategy. Debt, after all, will lead to interest payments that weigh down a company's bottom line. Lenders could also impose restrictive debt covenants that may limit what a company can do. And so it's no surprise that a company like Aurora Cannabis that has burned through 281 million Canadian dollars over the past 12 months isn't carrying a ton of debt on its books and prefers to raise money through the equity markets.

Here is a look at how that compares to the other cannabis producers listed earlier, and how they have all preferred to raise cash over the past year: 

Data source: Company filings. All figures in Canadian dollars.

Aside from Canopy Growth, which benefits from having loads of money on its books thanks to billions of dollars worth of investments from Constellation Brands, all the companies listed above raised money through the stock market. Aphria was the only one that didn't raise at least as much money through stock raises as it did through debt. And that tell us cannabis companies aren't eager to take on debt even if they can -- both Aurora and HEXO look to have a limited appetite for that.

What does this all mean for Innovative Industrial Properties?

Looking at the numbers from the Canadian cannabis producers above, it is evident that even if multistate operators in the U.S. have access to the full services of the banking sector, that doesn't mean they will become knee-deep in debt. There will likely continue to be a need for sale-and-leaseback agreements because those deals give companies flexibility. By utilizing those agreements, companies can raise cash without the need for debt or equity issues. Plus, they aren't tied down to a location should they want to move their operations in the future.

Although companies may have more options available to them if the SAFE Banking Act passes, Innovative Industrial Properties won't need to worry about running out of tenants anytime soon. The one caveat is that the agreements it makes with cannabis producers may not be as lucrative if its tenants aren't as desperate for cash anymore.

However, a change in banking provisions may make it more attractive for prospective growers to get into the industry if they don't have to worry about handling tons of cash. Passing reform in banking or anywhere else in the cannabis sector is going to be a positive development for the industry as a whole. Anything that stimulates more growth is going to be great news for Innovative Industrial Properties, which is why the stock will continue to be a fantastic investment for many years to come.