Description

Newlake Capital Partners (OTCQX: NLCP), is a newly listed REIT specializing in real estate leased to cannabis tenants.  We believe it is materially undervalued, trading at an attractive ~7.5% forward cap rate, nearly double the yield projected by its closest competitor, Innovative Industrial Properties, Inc (Nasdaq:IIPR), despite having a best in class credit portfolio.  The Company is currently putting additional capital to work at a roughly 11% cap rate, well above market compared to other more traditional types of real estate.  Additionally, the Company claims to be the only REIT that didn’t miss any rent payments from tenants or have to defer or restructure any of its leases during lockdown, and has never had any such issues in its history, including zero vacancy today. New Lake is led by an extremely strong management team, with deep public REIT experience, and a board that is highlighted by Pete Kadens, the former CEO and one of the founders of one of the largest multi-state operating cannabis Companies, Green Thumb Industries. The Company considers this to be a huge advantage, and credits Kadens with helping them underwrite only the best credit tenants in the space.

The Company went public on August 20, 2021, and raised roughly $93 MM of new capital after fees.  However, due to the current federally illegal status of cannabis sales, NLCP was forced to list on OTCQX, rather than their preferred destination of the NYSE or Nasdaq, and as a result, the Company remains under the radar of most institutional investors. At the time of the IPO, the Company had deployed $312 million into 28 owned properties, 11 for cultivation and processing, and 17 for dispensary use, comprising 1.7 million square feet in total across 10 states. Management has indicated that their newly raised capital can be put to work over the next 6-9 months, at an expected blended cap rate north of 11%.  Note that their portfolio includes a $40 MM building that closed June 30th, so rent from this property is not reflected in trailing revenue.  Additionally, they have been able to include escalators in their leases to date, which are currently averaging roughly 2.5% / year.

Source:  Company Presentation

The growth in AFFO shown in the below estimates is almost entirely due to simply putting to work their existing balance sheet, and gives very little credit to expectations of future capital raises or price increases.  We recognize that IIPR has larger scale and is NYSE listed, so we apply a 10% discount to their multiple, to arrive at our price target of ~$42.5 / share, representing ~44% upside from today’s price.

Company strengths:

• NLCP has a best in class track record and portfolio of credit exposures.  Since inception, their portfolio has had zero defaults or deferrals.  We have not been able to identify a single material competitor that can match this, particularly over the last year and a half during the Covid-19 pandemic.  Their portfolio of rents is now nearly 80% composed of the highest quality publicly traded MSOs. Below is a list of current tenant composition and exposure by state from the Company’s presentation.

• A strong management team and Board.  We would highlight the following Board members and executives:

• Gordon DuGan, Chairman of the Board:  Former CEO of Gramery Property Trust, a NYSE-listed REIT, which he guided from $400 MM when he joined to a $7.6 billion exit to Blackstone.

• Peter Kadens, Board of Directors:  Co-founder and retired as CEO of Green Thumb Industries (GTII CN), one of the largest and most successful publicly listed MSOs.

• David Weinstein, CEO:  Former CEO of MPG Office Trust, a NYSE-listed REIT.

• Anthony Coniglio, President and CIO:  Former CEO of Primary Capital Mortgage, a residential mortgage company that was sold to Blackstone.

• The Company has previewed that they are putting the capital raised via the IPO to work at cap rates north of 11%.  This is significantly above the prevailing rates in any traditional real estate sector, and we believe they have a best in class management team to continue to deploy capital at optimal risk adjusted returns

• The Company will likely raise additional debt or equity capital once they have exhausted their existing war chest.  Whether they raise debt or equity will be dependent on prevailing market conditions, including stock price as compared to traditional debt costs, but we are confident that barring a major change to market conditions, both on the leasing and financing side, any such raise will be significantly accretive.  IIPR was recently able to raise $300 MM of debt at a 5.5% coupon, which they will in turn also be able to invest at cap rates north of 11% themselves, creating a significantly accretive spread.

• It is difficult to predict when the multiple may begin to converge, but in the meantime, we are comfortable holding NLCP.  The Company has guided that their dividend payout is going to be 75+% of AFFO, so we would expect a 5-6% yield once they are fully invested.  This compares very favorably to most other sources of yield, particularly from a Company we believe is materially undervalued.

Company risks / weaknesses

• The Company was forced to list on OTCQX, as opposed to a more traditional venue like NYSE or NASDAQ, due to the current legal status of cannabis federally.  This has resulted in limited trading liquidity since the IPO. We believe this explains some of the discount, but see this as an opportunity as the Federal Government changes major laws around cannabis over time.

• The Company has significant customer concentration, with ~1/3 of their square footage leased to Curaleaf, and another ~1/6 to Cresco.  Although this is a risk, due to consolidation there are relatively few reputable participants in the legalized cannabis business, and Curaleaf and Cresco are two of the most successful, well capitalized publicly traded players.

• Over time, particularly if there is significant forward progress on federal cannabis legalization, we would expect cap rates to compress.  NLCP’s current lease portfolio does not have any expirations until 2029, so at a minimum they will be earning above market rates for the next decade, but this would hamper their ability to put additional capital to work at attractive rates.

We have chosen to hedge some of our exposure by shorting IIPR through sold calls when implied volatility is elevated, but the majority of our position remains unhedged.  The Company has a world class management team, and a track record of best in class credit underwriting, and should benefit over the short and medium term from significantly above market cap rates on newly deployed capital. While we wait for others in the market to recognize how undervalued NLCP is, we will be getting paid a very nice cash yield of 5-6% at current prices.  Currently trading just below $30 / share, we believe NLCP represents an extremely attractive investment on both a relative and absolute basis.

Catalyst

• Institutional recognition