The anticipation for U.S. federal legalization of marijuana has multi-state cannabis operators (MSOs) expanding footprints across the country. Demand for cannabis has grown over the past three years, with legal cannabis sales in the U.S. going from $12 billion in 2019 to a projected $24 billion in 2021.

But did you know there are multiple ways to make money in the cannabis market without touching a single plant, and without operating any dispensaries? Real estate investment trusts (REITs) including NewLake Capital Partners (NLCP 0.52%) are looking to cash in on sale-leaseback agreements for cannabis real estate.

Person standing in cannabis greenhouse full of plants.

Image source: Getty Images.

How it works

Following a similar model to the first and only of its kind to be listed on the New York Stock Exchange, the wildly successful Innovative Industrial Properties (IIPR 0.92%)(more on Innovative later), NewLake generates rental revenue by purchasing industrial properties and dispensaries from state-licensed cannabis operators, and then leases the property back to the original owner. This keeps NewLake out of the plant growing and daily operation of a dispensary while providing the company with a foundation on which to generate revenue from the massively growing cannabis market. 

NewLake generates its monthly rental revenue based on long term lease agreements with the cannabis producers. Those producers benefit from this arrangement because it allows them to free up capital to use toward further expansion and to improve the look of the company's balance sheet, since it would only represent the current year's obligations rather than the full commitment of expenses related to loans on the property.

Think of it as a "help-me-help-you", mutually beneficial arrangement. NewLake takes on the upfront costs of the building structure. The cannabis producer frees up cash and uses it to expand and generate additional revenue. Then that revenue helps the producer continue with its operations, and meet its long term obligations which results in revenue for NewLake, with the potential for extended leases.

Innovative Industrial Properties has been successful using this model since its IPO in December 2016, realizing stock price gains of around 1,250%, going from an IPO list price of $20 to a recent $244 in only five years. As of Oct. 18, 2021, the company owned 76 properties across 19 states in the U.S. with 100% of properties currently leased, and each having a weighted average lease term of 16.7 years.

The properties being purchased by NewLake and leased back to the operators might include grow facilities, manufacturing plants, or dispensaries. Where this provides some stability and confidence for investors is that it purchases and leases properties with a primary focus on vertically integrated multi-state operators in states that offer limited licenses. This tends to be more established MSOs with a history of revenue growth and expanded footprints.

Having these established operators as tenants minimizes the risk that you might have with lesser established operators, and provides growth opportunity for NewLake, based on the expansion efforts of the MSOs. A downside to this approach, if there is one, could be that by focusing on a primary set of MSOs it may limit its opportunity to build a larger client list and become more reliant on the success of a few.

Who are NewLake's tenants?

On Aug. 20, NewLake celebrated its IPO, bringing in $102 million in gross proceeds. At the time of its IPO, it boasted a tenant list including top names in multi-state vertically integrated cannabis operators with footprints spread across the U.S., such as Curaleaf Holdings, Cresco Labs, Trulieve Cannabis Corp., and Columbia Care.

In addition to agreements with these four, NewLake holds a right of first offer with Columbia Care and Acreage Holdings. This means that as those two companies expand and start exploring sale-leaseback options, NewLake gets first crack at being the landlord, which has the potential to lead to more revenue over a sustained period of time.

The long-term leases are an important factor in the success of NewLake because they allow the company to project revenue into the future. Regardless of the success of its tenants, the revenue generated is based on its its tenant agreements, giving some protection against potential cannabis market volatility. If NewLake can muster up additional agreements and expand its portfolio of clients, it too has the opportunity to experience the growth that Innovative has. As of its IPO date, NewLake owned 27 properties -- 100% leased -- across 10 states, with eight tenants, utilized for cannabis operations that were leased to single tenants on a long-term basis.

Is it worth my hard-earned money?

If investors consider Innovative Industrial Properties a leader by example, the future looks bright for NewLake. Innovative brought in $48.9 million in revenue for the second quarter of this year, a 101% increase over the same quarter last year. By comparison, NewLake brought in a much lower $6.7 million in the second quarter, but saw a 219% increase over the $2.1 million brought in last year for the same period.

If the 19 (of 27 total) properties acquired during the second quarter alone are any indication, it intends to ramp up its property portfolio quickly, leading to higher revenue and better gains for investors. So far investors appear to be impressed, as the stock share price from its IPO of $20 has grown by about 50%, and analysts have an average 12-month price target set at $44, representing a 45% premium to today's $30 price tag.

And as an added bonus, the company pays a small quarterly dividend at a yield of 0.39%, equating to $0.12 per share. A $5,000 investment would buy an investor 166 shares and $80 in dividends annually for investors. That money could be used as a little extra spending cash, or if reinvested could add 2.6 extra shares of stock per year to your holdings based on today's share price.

NewLake is playing catch-up in terms of revenue when compared to Innovative, but as the legal marijuana market continues on its projected growth path to $70 billion by 2028, it provides this company with the potential to reach new heights, and makes for a very compelling reason for long-term investors to get in early.