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So here we go again, another hedge fund shorting a REIT.
Let me be succinct: You should never short a REIT.
Unless you have a rock-solid short thesis….
Back in 2018, I wrote an article titled Lesson Learned: Don't Short A Blue Chip REIT , which included this:
I find it amazing that some of the wealthiest REIT investors - the hedge funds - claim to have a vast knowledge and understanding as to the nature of their complex strategies. Yet (their) overall performance often turns into fool's gold.
... hedge funds by nature are opportunistic… designed to pool people's money to invest in a diverse range of assets. Because hedge funds are lightly regulated (and are not sold to retail investors), they typically buy riskier positions and they often employ the use of short selling and leverage.
Remember that the outcome of a short sale is basically the opposite of a regular buy transaction. But the mechanics behind it result in extremely volatile risks.
It's somewhat like the law of gravity.
But the law of investing is inflation, which means that betting against upward momentum is inherently risky.
When you do - and you keep that position for a long period of time - your odds get worse. You also don't enjoy the same infinite returns a long buyer would.
A short sale loses when the stock price rises. And since a stock is (theoretically, at least) unlimited in how high it can go - which means the potential losses on a short sale also are unlimited. You can lose more than you initially invest.
Whereas the best you can earn is 100% if the company goes out of business and its stock loses its entire value.
Finally, the most concerning risk is leverage or margin trading.
When short selling, you open a margin account, which allows you to borrow money from the brokerage firm using your investment as security.
Just as when you go long on margin, it's easy for losses to get out of hand. You must meet the minimum maintenance requirement of 25%, after all. And if your account slips below this, you'll be subject to a margin call…
Which means you'll be forced to either put in more cash or liquidate your position.
Most important is the fact that the borrower of the stock is responsible for paying any dividends to the lenders.
So, investors who short a stock are never entitled to dividends, and that includes those short a stock on its dividend record date. Rather, short sellers owe any declared dividend payments to the shares' lenders.
Yesterday morning I woke up to see comments on the iREIT on Alpha chat board related to Blue Orca Capital's short thesis on Innovative Industrial Properties (IIPR). After watching this video, I posted this on Twitter:
As I explain in my tweet, you should never short a REIT, unless you have a rock-solid thesis-which Blue Orca Capital doesn't.
First off, IIPR is not a "cannabis REIT masquerading as a REIT"….
IIPR is, plain and simple, a REIT.
In fact, IIPR, founded in 2016, was the first cannabis REIT, so it has the first-mover advantage, and is the only equity REIT (with a cannabis business model) to list on the New York Stock Exchange.
The company's moat is wide in many different ways, and its entire mousetrap is designed to deliver sustainable and growing dividends.
I truly believe that Blue Orca is confused with the sale/leaseback mechanism in which a property seller (and new lessee) can convert an illiquid fixed asset into cash and increase its working capital.
This concept is nothing new, as many REITs including W.P. Carey (WPC), Realty Income (O), STORE Capital (STOR), VICI Properties (VICI), and Medical Properties (MPW) use sale/leasebacks on a frequent basis.
The sale/leaseback alternative provides the occupier 100% of the value of the property, whereas traditional mortgage financing usually offers around 65% loan-to-value.
In addition, the gain realized from a sale/leaseback transaction can be amortized on the corporation's income statement. This then increases reported earnings, which can potentially improve the firm's financial ratios and margins.
Blue Orca suggests that IIPR is somehow inflating IIPR's sale/leaseback transactions, and specifically references the fact that the company is somehow cooking the books with one of its top tenants, Parallel.
According to its website, Parallel is a "nationwide vertically-integrated, multi-state cannabis company" with "ongoing operations in five high-growth medical and adult-use markets under its distinct retail brands." Currently, it "operates approximately 50 locations nationwide, including 42 retail stores, cultivation and manufacturing sites in five states."
Blue Orca references a lawsuit in which Parallel is a defendant. While I have not looked closely into the allegations set forth in the lawsuit, the fact of the matter is that Parallel cannot file bankruptcy (since cannabis is not regulated at a federal level), and more importantly, IIPR has collected 100% of its rents from Parallel.
In fact, IIPR has collected 100% of all of its rents - before, during, and after the pandemic.
Parallel was funded by chewing gum billionaire Beau Wrigley, and even if the pending lawsuit does impact IIPR's ability to collect rent, the facilities are immensely valuable because Parallel can easily sell the licenses associated with the built-out real estate.
Also, these locations (leases) with Parallel are located in Florida, Pennsylvania, and Texas.
I'm very confident that IIPR underwrote these transactions (with Parallel) in such a way as to protect the principal, and the funds that IIPR invests in its properties are utilized to create value (not destroy it).
Keep in mind that whenever IIPR purchases a facility (under a sale/leaseback structure), it provides capital for qualifying infrastructure. In other words, the funding must be used for "real estate" purposes, and as a publicly-traded REIT, IIPR provides investors with visibility.
Thus, it's very important to remember that IIPR's properties are not just industrial properties… they are super-amenitized assets built to suit the needs of the tenants. The notion that IIPR is "masquerading as a REIT" is silly - it's not masquerading as a REIT, it is a REIT.
A good one at that!
Yesterday, IIPR commented on the short thesis as follows:
… it is aware of a short-seller report released earlier today, that contains numerous false and misleading statements about IIP. Similar to a short-seller report previously issued in 2020, this short-seller report is flawed and demonstrates a basic lack of understanding of commercial real estate generally, the regulated cannabis industry and IIP's straightforward, simple business model.
In particular, it is IIP's opinion that this short seller fails to have any comprehension of the scope of significant infrastructure improvements that are needed for the transformation of a standard industrial building to a mission-critical facility with the enhanced environmental controls and other building systems necessary for regulated cannabis cultivation and processing.
In addition, the writers do not understand the process that IIP employs for underwriting those improvements, and that any IIP reimbursements relate only to verified, qualified improvements to the buildings for these purposes, and never as funding for any type of "loan" to be utilized for any other purpose.
Now withstanding the disingenuous short attack yesterday, I find IIPR to be one of the best buys in the REIT sector.
IIPR shares are now trading at $169.68 with a P/AFFO multiple of 23.4x and a dividend yield of 4.1%.
Compare that multiple to these industrial peers:
What's crazy is that IIPR is one of the worst-performing REITs YTD…
Yet, it has doubled AFFO per share and is expected to grow by at least 30% per year…
Nobody really knows what will happen with regard to federal legislation.
Senate Majority Leader Chuck Schumer has a proposal to legalize federal cannabis, but it appears to be dead on arrival as there's a deadlock in the Senate, with more of the status quo for now.
As I have suggested on a number of occasions, I don't consider federalization a bad thing, as it will provide more transparency and liquidity for operators. And if you're going to own a cannabis REIT, you want to own the best of the best, which happens to be IIPR.
In terms of fundamentals, IIPR recently issued capital for the first time in two years: It underwrote 1,578,948 shares at $190 per share for around $300 million. It has around $2.2 billion in gross assets, and modest debt of $334 million (solely unsecured with no debt maturities in 2022 and 2023).
The debt-to-gross assets stood at 15% at the end of 2021, which makes IIPR's balance sheets one of the best in the REIT sector.
One way for IIPR to climb is to split the stock (4:1) which will open up the floodgates for retail investors. In addition, a monthly dividend would be nice.
Perhaps my Reddit friends also will read my article and recognize that IIPR is growing like a weed, and I expect the dividend to follow that very same path (we estimate $2.00 per quarter in 2022).
As I said earlier, shorting REITs is not recommended, especially when you're attempting to profit from a well-managed firm that provides tremendous transparency and rock-solid fundamentals.
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This article was written by
Brad Thomas is the CEO of Wide Moat Research ("WMR"), a subscription-based publisher of financial information, serving over 6,000 investors around the world. WMR has a team of experienced multi-disciplined analysts covering all dividend categories, including REITs, MLPs, BDCs, and traditional C-Corps.
The WMR brands include: (1) The Intelligent REIT Investor (newsletter), (2) The Intelligent Dividend Investor (newsletter), (3) iREIT on Alpha (Seeking Alpha), and (4) The Dividend Kings (Seeking Alpha). Thomas is also the editor of The Forbes Real Estate Investor and the Property Chronicle North America.
Thomas has also been featured in Forbes Magazine, Kiplinger’s, US News & World Report, Money, NPR, Institutional Investor, GlobeStreet, CNN, Newsmax, and Fox. He is the #1 contributing analyst on Seeking Alpha in 2014, 2015, 2016, 2017, 2018, and 2019 (based on page views) and has over 96,000 followers (on Seeking Alpha). Thomas is also the author of The Intelligent REIT Investor Guide (Wiley).
Disclosure: I/we have a beneficial long position in the shares of IIPR either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: Author’s Note: Brad Thomas is a Wall Street writer, which means he's not always right with his predictions or recommendations. Since that also applies to his grammar, please excuse any typos you may find. Also, this article is free —: written and distributed only to assist in research while providing a forum for second-level thinking.