Could AFC Gamma Become the Next Innovative Industrial Properties?

If you’re a dividend lover or a cannabis investor, you’ve probably heard of Innovative Industrial Properties ( IIPR -2.67% ), the aspiring landlord for the entire marijuana industry in the U.S. Over the last five years, the total return of its shares topped 1,140%, and its dividend has grown by a cool 900%. And there’s another stock that’s a lot like it, which soon could be on the rise for the first time.

AFC Gamma ( AFCG -0.76% ) is still quite small, with a market cap near $387 million, compared to IIP’s $4.8 billion. That means investors just might be able to hitch their wagon to the company’s ascending star — assuming that it can actually take off.

Let’s examine AFC Gamma and compare it to Innovative Industrial Properties to see whether it might be the next cannabis-finance business to make shareholders rich. 

It pays to go where traditional financial institutions won’t

Both IIP and AFC Gamma exist because it’s hard for cannabis businesses to raise money from traditional lenders like banks. As long as cannabis remains illegal in the U.S. at the federal level, it’s simply too risky for these financial institutions to face regulatory wrath by dealing with marijuana enterprises. And that means there’s money to be made for those who can offer cash in exchange for whatever durable assets (like real estate) that cannabis companies are likely to have.

For its part, IIP makes money by performing sale-leaseback transactions, in which it buys real estate and then leases out the new property to the prior owner, which is typically also the prior occupant of the space. That’s a great business model, because each new deal grants a cash flow in the form of rent as well as equity in the form of property rights.

Much like Innovative Industrial, AFC Gamma is structured as a real estate investment trust (REIT). But it doesn’t actually own the total right to any real estate in the way that IIP does. Instead, it offers loans to cannabis companies, using their property as collateral. Then, it gets paid when the borrower makes interest payments on the loan. 

For the privilege, AFC Gamma charges an annual interest rate between 12% and 20%, and the weighted average yield to maturity of its loans is 20%. Of the 15 loans in its portfolio as of the third quarter of 2021, all will be mature before the end of 2026. So it’ll be realizing quite a lot of interest payments between now and then, not to mention issuing more loans with the accrued cash.

Right now, its war chest is nearly $70 million on top of its $342 million in outstanding loans. That’s enough to originate several new loans at the lower end of its target range of $10 million to $100 million. And that means its trailing-12-month revenue of $11.4 million is highly likely to grow considerably over the next few years.

Don’t get your hopes up

AFC Gamma’s business model makes for a natural comparison to IIP, but there are a few important differences that make its shares somewhat unlikely to rival the returns of the larger company. 

Most important, it only has the right to claim the property held in collateral if its borrowers default. That means its business model doesn’t necessarily generate ownership of additional property holdings over time. In the context of our current high-inflation environment, owning property is preferable to owning another company’s debt. And so, holding others’ debt might end up being a headwind for AFC Gamma’s growth.

Then there’s the fact that many of its loans are fixed rate rather than floating rate, thereby reducing its ability to compensate for inflation even further. In contrast, IIP can just raise the rent on its tenants as needed in response to inflation, and its income hasn’t been under any pressure as of late.

Finally, AFC Gamma is likely to keep issuing new shares to raise cash to issue loans, like it did with an offering of $61.5 million that closed Jan. 10. That’ll dilute its shareholders, making them unlikely to experience massive gains over time, especially if more shares are issued in the coming years. 

Nonetheless, the company could do quite well as a result of the cannabis industry boom and the continued lack of legalization that might make financing easier to come by. In my view, AFC Gamma is likely to be a strong growth stock for the next few years, even if it won’t become as large as IIP.