Innovative Industrial’s, ETF’s Exposure To Parallel Cannabis

Parallel Cannabis’s debt issues have been exposed in the company’s lawsuit with some disgruntled investors. The lawsuit outlined the company’s defaults on its debt obligations and Curaleaf (OTC: CURLF) also noted in its filings that Parallel was no longer buying its Illinois properties saying it had “received correspondence from Parallel’s attorneys indicating that it will not be in a position to complete the acquisition of the Illinois Assets due to lack of financing and seeking to terminate its agreement to purchase the Illinois Assets. The company has asserted that Parallel’s actions have constituted material breaches of its agreement with Parallel and is exploring its options.” In other words, Curaleaf could sue Parallel or just shop the properties to someone else.

The money troubles at Parallel could spell problems with other companies it has agreements with and one of those is the cannabis REIT (real estate investment trust) Innovative Industrial Properties (NYSE: IIPR). 10% of the REIT’s rental revenues in 2021 came from Parallel. That makes it the second-largest tenant on the books for IIP, with PharmaCann being number one accounting for 12% of the rental revenue.

“These properties are located in some of the largest and strongest growth markets (PA and FL), in addition to TX, one of the largest states by population and estimated illicit cannabis consumption, where there continue to be significant inroads toward expansion of the existing program.  Note that Parallel is one of only three license holders in the entire state of Texas, vertically integrated for cultivation, processing, and dispensing.  We feel very comfortable with the demand for these properties in these states.,” said a spokesperson from IIP.

The company noted in its annual report that in June 2021, it amended its lease with a subsidiary of Parallel at one of its Florida properties, increasing the improvement allowance under the lease by $8.0 million to a total of $16.2 million, which also resulted in a corresponding adjustment to the base rent for the lease at the property.

IIP warns investors in its filing that “Lease payment defaults by any of our tenants or a significant decline in the value of any single property 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 any of our tenants to comply with the terms of its lease agreement with us could require us to find another lessee for the applicable property.”

ETF Exposure

Not only is IIP exposed to Parallel, but so are all the ETF’s holding the shares of IIP. In other words, if IIP feels any pain from Parallel, then so will the ETF’s holding IIP. According to ETF.com, “The largest holder of IIPR is the iShares Core S&P Small-Cap ETF (IJR), with approximately 1.71M shares. Investors may also find of interest that the ETF with the largest allocation to IIPR stock is AdvisorShares Pure Cannabis ETF (YOLO), with a portfolio weight of 16.94%. On average, U.S. ETFs allocate 1.08% of IIPR to their portfolios. Additionally, IIPR is a favorite stock for Vanilla and Active ETFs. It is also most likely to belong to Broad-based ETFs. The best-performing ETF in the past 12 months with IIPR as a holding is the Pacer Benchmark Industrial Real Estate SCTR ETF (INDS), with a return of 30.65%.” ETF.com lists the following cannabis ETF’s with exposure to IIPR.

Bankruptcy?

IIP also tells investors that “If a bankrupt tenant decides to give up (reject) a lease, any claim for breach of the lease is treated as a general unsecured claim in the tenant’s bankruptcy case, subject to certain exceptions for collateral and guarantees. In the event one of our tenants is permitted to seek bankruptcy protection in the U.S., our general unsecured 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 the 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 sufficient 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. Any bankruptcy, if allowed, 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.”

In Closing

To be sure, Parallel has lots of incoming revenue, and bankruptcy hasn’t even entered the conversation, but if the debts can’t be paid, can the rent be paid? Having said that, IIP can likely find another tenant to take over a facility but how long would that take and what amount of disruption would that cause until that happens?  In the case of Texas, with only three license holders, there is a limited audience for the property within the cannabis industry. The other states would have an easier time finding another tenant quickly, but if the worst happened and the company chose to restructure, could IIP be left mired in the courts? Or Parallel may be able to compartmentalize its financial problems and continue making the rent payments while it attempts to solve its debt issues. Either way, the domino effect on the ETF’s is likely to be felt if things go horribly wrong.