2023-08-31 09:12:27 ET
Summary
- Chicago Atlantic Real Estate Finance, Inc. is a REIT offering credit to licensed operators in the cannabis industry and has seen significant growth in its loan portfolio.
- The lack of federal legalization of cannabis sales in the U.S. limits liquidity for the industry, but the market is still expected to grow steadily.
- There are risks associated with mortgage REITs that finance cannabis operators, including regulatory challenges and potential competition from traditional lenders in the future.
~ by Snehasish Chaudhuri, MBA (Finance).
Chicago Atlantic Real Estate Finance, Inc. (REFI) is a mortgage real estate investment trust aka mREIT that originates, structures, and invests in first mortgage loans and alternative structured financings secured by commercial properties. It offers credits to licensed operators in the cannabis industry. Its proprietary sourcing network and robust direct originations team sourced and closed over $1.0 billion in credit facilities since 2019. At the end of Q2, 2023, REFI's gross portfolio yield stood at 19.2 percent. With 1.5x real estate collateral coverage in current portfolio, REFI successfully grew its loan portfolio since it became public 20 months back, and also hiked its quarterly payout manifold since that time. However, by its very nature, REFI will always be a high-risk stock.
As Legal Cannabis Sales Remain Illegal at a Federal Level, Liquidity Gets Impacted
Legalized cannabis production and consumption is an ever-growing market, due its utility as well as increasing leniency towards this sector. However, various legal prohibitions and federal regulations limit the cultivators and distributors of cannabis access to traditional sources of banking. U.S. cannabis sales still remain illegal at a federal level.
In the long-run, legalization of cannabis on the federal level would create greater opportunities for mainstream lenders to finance those cannabis operators. Chicago Atlantic Real Estate Finance, Inc. only went public in December 2021 and has built an effective shareholder base with a strong and steady payout history. This has helped maintain its valuation against the broader market volatility. However, the cannabis industry is starved of liquidity in the short term, and lack of approval or structural deficiency present some serious roadblocks for mREITs in the field.
Even Without Federal Reforms, U.S. Cannabis Industry Is Expected To Grow Steadily
According to Marijuana Business Daily, U.S. legalized marijuana production is predicted to grow in excess of 20 percent annually, and regulated cannabis sales are expected to grow to over $57 billion by 2028. However, only 1/4th of that market will be medical sales. Arcview Market Research and BDS Analytics have projected that by then, all U.S. states will authorize cannabis for medical use and nearly half of these states will authorize cannabis for adult use. Adult-use legalization in states from the East Coast and the Midwest seems imminent.
Mortgage REITs like Chicago Atlantic Real Estate Finance, Inc. thus possess strong growth potential, acting as a source of capital to the licensed operators that acquire and lease back their real estate properties across various operators of cannabis - cultivators, processors, distributors, and retailers. However, there is a need to dig deeper into the growth prospects of the cannabis sector before taking a bullish view. Public cannabis companies are facing liquidity crunch due to both systematic challenges and also due to a continuous decline in value of their stocks. REFI, for instance, has lost 3 percent of its value during the past 12 months, and 8 percent over the last 20 months.
REFI's Portfolio & Ties To Financial Sponsors Active In Cannabis Is Quite Impressive
Chicago Atlantic Real Estate Finance, Inc. is a market-leading commercial mortgage REIT that originate senior secured loans primarily to state-licensed cannabis operators in limited-license states in the U.S. The company utilizes its real estate, credit and cannabis expertise and implements a "credit-first" underwriting process with stringent criteria with regards to operator's financial strength, regulatory and market environments, collateral, and other factors. REFI has an efficient deal making process in place, has in-depth industry knowledge, and strong ties to financial sponsors active in the cannabis space.
Since its inception in 2019, Chicago Atlantic Real Estate Finance, Inc. has sourced and closed 55 cannabis loans with established operators, including the REITs, and closed over $1 billion in credit facilities. REFI has $329.2 million current commitments with substantial pipeline and $400 million near-term pipeline under evaluation. It has a sizable, growing loan portfolio that offers compelling risk-adjusted returns. REFI has also taken adequate steps to diversify its loan portfolio, with no single loan accounting for more than 11 percent of its entire portfolio, thus avoiding any substantial concentration risk.
As the company has been in operation for only 20 months, an analysis of its financials may not be quite conclusive. However, from the early trends, it can be said that its per share revenue and earnings are showing an increasing trend. Chicago Atlantic Real Estate Finance, Inc. has offered almost a static payout of $0.47 for the past six quarters. Average earnings per share ((EPS)) during that period stood out at $0.493. Thus, we can say that REFI's payout has been covered so far. It also has a positive trailing 12 months ((TTM)) cash flow .
With Respect To Price Multiple, REFI Seems Better Than Its Much Established Peers
Comparing a 20-month-old credit mortgage REIT with established mREITs such as AFC Gamma, Inc. ( AFCG ), BrightSpire Capital, Inc. ( BRSP ), Sachem Capital Corp. ( SACH ), Great Ajax Corp. ( AJX ), KKR Real Estate Finance Trust Inc. ( KREF ), Redwood Trust, Inc. ( RWT ) may not provide us a very fair picture, but from the early trends it can be concluded that when it comes to financing cannabis operators, REFI stands out among its peers. REFI has a Price to Earnings ratio of 7.3, whereas the average P/E of the six above-mentioned mREITs are 7.5. When it comes to delivering returns in terms of their book value, REFI scores quite high. REFI has a price to book value (P/BV) ratio of 0.98 while those six established mREITs recorded an average P/BV of 0.72.
Risks Associated With mREITs That Are Engaged In Financing Cannabis Operators
There are obvious risks in any business that is related to cannabis. There surely are structural deficiencies in the path of raising capital for all types of cannabis operators. Various political and non-political lobbies are against the liberalization of cannabis cultivation and use. Cannabis-focused REITs are also very new to the market. So, the long-term prospects are not known to us.
Legal prohibitions is a double-edged sword for mREITs associated with financing cannabis operators. On one hand, such regulations stop REFI from providing more financing. So, statutory prohibition does not allow REFI to realize its full potential. On the other hand, once cannabis is eventually legalized, such an event would be detrimental to REFI in the long run, as more traditional and established financiers would be able to provide such loans, which will create massive pressure on the margins of Chicago Atlantic Real Estate Finance, Inc.
Investment Thesis
Various states have authorized medical-use cannabis in numerous medical conditions such as treatment of HIV/AIDS, cancer, arthritis, alzheimer's, muscle spasms, seizures, multiple sclerosis, chronic pain, nausea, spinal cord injury, migraine, post-traumatic stress disorder ((PTSD)), parkinson's disease, lupus and terminal illness. Further legalization of cannabis will lead to better access to capital to the operators, which will enable them to develop their own facilities. But even without federal reforms, the U.S. cannabis industry is expected to grow manifold. Thus, Chicago Atlantic Real Estate Finance, Inc. stands a very strong potential to register strong growth and sustain its yield.
All these will obviously help this mREIT cover its dividends and to sustain its strong yield. Currently, its trailing-12-months yield stands at 16.9 percent. If REFI can continue its quarterly payouts, there is no substantial reason why income-seeking investors won't be lured towards this fund. However, REFI is externally managed. Moreover, legal risk related to cannabis operators will always remain. These may deter long-term investors. For these reasons, I'd assign a hold (instead of buy) on Chicago Atlantic Real Estate Finance, Inc. stock.
For further details see:
Chicago Atlantic Real Estate Finance: High-Yielding mREIT Backing Cannabis Industry