Rising High: Exclusive talk with cannabis REIT NewLake Capital

In this edition of “Rising High,” The Fly conducted an exclusive interview with Anthony Coniglio, President and Chief Executive Officer of NewLake Capital Partners (NLCP), a provider of real estate capital to state-licensed cannabis operators. Here are some highlights:

CANNABIS REAL ESTATE: NewLake is an internally-managed real estate investment trust that provides capital to cannabis businesses through sale-leaseback transactions, third-party purchases and funding for build-to-suit projects. The company owns a portfolio of 32 cultivation facilities and dispensaries that are leased to single tenants on a triple-net basis. “We want to continue to focus on the elements that have distinguished us in the past and we think will continue to distinguish us,” Coniglio said. “That would be the relationship-oriented approach that we take to the dialogue with our tenants and our prospective tenants, and understanding the complexities that each individual real estate or construction project has.”

NewLake works with clients in a collaborative way to meet the needs of their particular project, he said. “It really is the essence of what we try to do,” the CEO said. “We try to be true to our word, we try to be reliable partners and we try to listen because there really are unique issues in every single deal. If you can be adaptive and responsive, you build stronger relationships and a better reputation across the industry.”

Q1 EARNINGS: In May, NewLake reported first quarter adjusted funds from operations per share of 52c on revenue of $12.6M, which compared to AFFO per share of 45c on revenue of $11.4M for the same period last year. “Growth really comes from three particular areas,” Coniglio said. “One is our annual escalation clauses in our leases. With every one of our leases, payments increase on an annual basis and it’s a leaseback transaction. Every year, lease payments across our portfolio go up about 2.6%.”

The second growth factor is commitments NewLake made in previous periods and during the quarter, he said. “We funded on those commitments, so those additional dollars going out provided additional revenue to the quarter versus previous quarters,” the CEO said. “When you’re funding a project, you start to charge rent immediately when you put those dollars out. That was another part of the growth.”

The third part of the company’s overall growth spectrum is new transactions, he said. “We didn’t have any in the quarter,” Coniglio said. “It’s something you’ll see coming up in the second quarter because we announced a new transaction. But that would be the third leg of growth. Those are the primary reasons versus first quarter of last year plus a favorable compare. We did have difficulty with Revolutionary Clinics in the first quarter of last year, but we we’re able to get that on track during the third quarter of 2023.”

He added because NewLake enters into long-dated leases and has over 14 years of remaining weighted-average lease term, the performance is really a function of the quality underwriting that was done years ago. “The Q1 performance is really a testament to the underwriting,” the CEO said. “The fact that we had 100% of our properties rented and 100% of our rent collected is truly a testament to that quality underwriting, particularly in an environment that continues to be somewhat challenged but coming out of a very difficult 2022 and 2023.”

Looking at the future for NewLake, he said the company is excited about a recent transaction for a property in Connecticut.  “We acquired the existing building for $4M and we’re providing $12M of incremental capital,” the CEO said. “That is certainly going to add to our P&L going forward. We have a lot of operating leverage in our expense structure, we can do additional transactions and layer on additional revenue, with very little incremental expense, if any. That bodes well for growth in our P&L over the near term. We are going to continue to look to deploy the available capital under our $90M credit facility, that has only $4M drawn on it, so we have meaningful capacity to add transactions and we are building our pipeline to look for opportunities to close on new deals.”

CONNECTICUT ACQUISITION: In May, NewLake announced the acquisition of a 58,500 square-foot industrial property in East Hartford, Connecticut and entered a long-term triple net lease with an affiliate of C3 industries. NewLake’s investment will be $16M, consisting of a purchase price of $4M and a $12M construction allowance to retrofit the former cold-storage facility. “This was a second deal with C3 Industries,” Coniglio said. “We were very familiar with the management team and we saw firsthand how they approach projects like this in the Missouri market, which is where we acquired a building and provided a buildout for them as well as incremental capital after adult-use was approved. Having seen the way they approached that market, executed on the construction and been successful, we then saw this opportunity in Connecticut.”

He noted NewLake also saw an opportunity in Connecticut as a limited-license state. “When you look at the undersupply of product in Connecticut, we think it really sets up nice for a group like C3 that will come in and be vertically-integrated,” the CEO said. “They will have a number of dispensaries, but they also can sell into a much-needed wholesale market. For those reasons, we are really excited for the transactions and in the future having additional exposure to Connecticut and C3 is positive for us.”

SCHEDULING: The U.S. Justice Department recently formalized its process to reclassify cannabis as lower-risk and reschedule the drug from Schedule I to Schedule III. The Drug Enforcement Administration submitted a notice of proposed rulemaking on Thursday, May 16, triggering a 60-day comment period that will allow members of the public to submit remarks regarding the rescheduling proposal. “We at NewLake have always had the perspective that legalization of cannabis in America is a matter of when, not if,” Coniglio said. “It’s probably taking longer than any of us want it too. We think this announcement to reschedule to Schedule III is a milestone on that journey to ultimate descheduling or legalization, so it is an important milestone.”

He noted one of the biggest impacts of rescheduling would be unburdening the industry from the onerous tax consequences of Section 280E. “That in turn will boost the equity valuations of the players in the industry, which we think could set in motion the opportunity for a positive feedback loop,” the CEO said. “The valuations of the operators can be buoyed and those higher equity valuations would allow them to recapitalize the balance sheet, improving upon the balance sheet and the P&L by reducing interest expense, which really sets them up for continued investment and continued buoying of valuations. That gets us in a positive loop of improved financial outlook, improved financial profile, recapitalized debt and reinforcing that.”

Specifically looking at NewLake, the company estimates that its tenant base would save over $500M a year in taxes through elimination of 280E. “We have yet to come across a REIT that has that type of credit improvement to its portfolio, to every one of its tenants, with one fell swoop of a regulatory action,” Coniglio said. “It appears to us to be somewhat unprecedented to have an entire portfolio get this type of a credit improvement and then they’ll be a secondary improvement should the industry embark on that recapitalization. We see this as a real benefit for the industry but also for NewLake.”

He added he believes there is a low likelihood that the final proposed rule gets published in the Federal Register before the U.S. presidential election.  “Then that rule generally doesn’t become effective until thirty days after the publication,” the CEO said. “I think the publication in the Federal Register happens somewhere between mid-November and mid-January. There are a significant amount of comments the DEA needs to work through and we still have three weeks before the deadline to request hearings.”

He said he does believe it is important for the proposed rule to get into the Federal Register in case the U.S. transitions to a new administration. “What could happen if you don’t have the notice of proposed rule done by the time the inauguration happens, you could see a new Attorney General and a new DEA head where the final rule is back-burnered and just sits in the DEA for a prolonged period of time,” Coniglio said. “That’s probably the scenario that the industry would worry about the most. Low likelihood of that happening, but that’s to me the biggest impact that a new administration can have.”

SAFER BANKING: In September, a U.S. Senate committee voted to advance The Secure and Fair Enforcement Regulation Banking Act bill, which seeks to ensure that all businesses, including cannabis businesses, have access to deposit accounts, insurance and other financial services. “I don’t expect that legislation to get any real traction until there is an agreement on Section 10 language,” Coniglio said. “This is language in the bill that pertains to preventing regulators from penalizing banks for doing business with industries that are out of favor with the administration. This is a republican priority, and it is important to the republican caucus. Cannabis legislation is not really a priority for the republican caucus. I don’t believe there is resistance to SAFER Banking that would preclude it from passing, but I don’t think it gets the floor time from the house until you give republicans a reason.”

STATE REGULATION: Ohio recently approved adult-use regulations with sales expected to start in mid-June.  “We’re excited about the Ohio market and we applaud the regulators for the pragmatic approach they’ve taken to get that market launched sooner rather than later,” Coniglio said. “They put a premium on getting the adult-use market up and going as fast as possible to minimize the establishment of an illicit market out in the open. We think they are doing a good job of coming out quickly with regulations and launching a program that can continue to serve the patients of Ohio effectively, but also open up the market quickly to all Ohio residents. It’s setting up to be a really good market, we think it is going to take some time for that growth, but it wouldn’t be hard to see that market triple or potentially quadruple over the next three to five years.”

Meanwhile, the New York market has recently started to crack down on illicit cannabis stores that have been pressuring the adult-use market. “It is going to take a lot of time,” the CEO said. “Most consumers don’t understand the difference between a legal product and an illicit product. They don’t understand which stores are licensed and which stores aren’t licensed. As a result, these illicit retail outlets were able to open up and really become ingrained in the community. It’s going to take a lot of time for the city and the state to get into each one of those stores, close them down with significant fines and they just have to keep at it.”

In April, Florida’s Supreme Court’s decided to allow an adult-use cannabis bill to proceed to the ballot this November. “We love the Florida market, another limited license state and we think the vote is going to be close,” Coniglio said. “60% is a high threshold but we are optimistic about it passing, because the industry is really organized around that singular objective. It doesn’t help that the governor has come out against it and he is going to run an anticampaign. For Florida it is going to come down to a turnout vote and here is where the abortion ballot initiative is important. You tend to see harmony between the abortion ballot and the vote on 3, the cannabis initiative. If you get enough voter turnout to support one of these causes, the other one will benefit from it.”

He said he believes the market has a very significant growth runway for the future. “Even though that medical market has good penetration and has a lot of dispensaries, we think that there is meaningful room for growth, particularly given the tourism angle in the state,” the CEO said. “Having adult-use stores open to be able to feed into that tourism market is going to be a meaningful area of growth for the industry.”

CHALLENGES: When asked about the largest hurdles facing the cannabis space, Coniglio pointed to custody of securities as one of the biggest challenges facing the industry. “Those restrictions on custody severely limit the available investor pool for the sector,” he said. “The limited investor base puts negative pressure on valuations and that gets us into a little bit of a negative feedback loop, low liquidity, lower valuation and fewer people that can focus or want to focus on the sector. Getting the public facing part of this industry to have investor access to normalized custody of their securities would allow increased investor interest, which would bring in liquidity to the marketplace, support equity valuations and put us in that positive feedback loop.”

OPPORTUNITIES: As the cannabis sector develops, the CEO said the space still has opportunities in a number of populous states that have either no cannabis market or a nascent medical market. Examples I would give would be Texas and Georgia,” he said. “You also have a state like North Carolina. When you think about the growth in the next five to ten years, it will be these types of states having a more robust medical program and then converting to adult use and it’ll be large medical states today that convert to adult-use like a Florida. I think you are going to continue to see this industry grow from the state expansions as well as from growth in the addressable market and you’re going to see continued consumer adoption of the product. Both of those key factors will drive the growth in that tangible addressable market.”

All the industry growth will require an expansion of infrastructure and NewLake is prepared to bolster that growth, Coniglio said. “Whether it be cultivation facilities or retail facilities, we’re excited to be there to partner with the industry and provide capital to support that growth.”

CANNABIS/PSYCHEDELIC STOCKS: Publicly-traded companies in the space include Acreage (ACRHF), Ascend Wellness (AAWH), Atai Life Sciences (ATAI), Aurora Cannabis (ACB), Ayr Wellness (AYRWF), Avant Brands (AVTBF), BZAM (BZAMF), Cannabist Company (CBSTF), Cannara Biotech (LOVFF), Canopy Growth (CGC), Chicago Atlantic (REFI), Clearmind (CMND), Clever Leaves (CLVR), Compass Pathways (CMPS), CordovaCann (LVRLF), Cresco Labs (CRLBF), Cronos Group (CRON), Curaleaf (CURLF), CURE Pharmaceutical (CURR), CV Sciences (CVSI), Cybin (CYBN), Delta 9 (DLTNF), Entourage Health (ETRGF), Enveric (ENVB), Fire & Flower (FFLWF), Flora Growth (FLGC), Trees Corporation (CANN), Goodness Growth (GDNSF), Greenlane (GNLN), Green Thumb (GTBIF), GrowGeneration (GRWG), Hemp (HEMP), Heritage Cannabis (HERTF), High Tide (HITI), IM Cannabis (IMCC), India Globalization Capital (IGC), Indiva (NDVAF), Innovative Industrial Properties (IIPR), InterCure (INCR), Lotus Ventures (LTTSF), Lowell Farms (LOWLF), Lucy Scientific Discovery (LSDI), MediPharm (MEDIF), MedMen (MMNFF), MindMed (MNMD), Numinus (NUMIF), Organigram (OGI), Optimi Health (OPTHF), Planet 13 (PLNHF), Red White & Bloom (RWBYF), Relmada Therapeutics (RLMD), Reunion Neuroscience (REUN), Revitalist (RVLWF), RIV Capital (CNPOF), RYAH Group (RYAHF), Safe Harbor Financial (SHFS), SNDL (SNDL), Sproutly (SRUTF), Skye Biosciences (SKYE), Stem Holdings (STMH), Sunniva (SNNVF), TerrAscend (TRSSF), Tetra Bio-Pharma (TBPMF), Tilray (TLRY), Trulieve (TCNNF), Tryp Therapeutics (TRYPF), Verano (VRNOF), Village Farms (VFF), Zynerba (ZYNE) and 4Front Ventures (FFNTF).