Credit Tracker

Weekly Credit Report – The Lease vs Loan Decision

• The Pharmacann/IIPR saga led us to reflect on the capital structure decision that MSOs face: take on long-term sales leasebacks or borrow secured debt against the real estate. Each choice has its advantages:
• LEASE ADVANTAGES:
  • A more permanent solution. Sale leasebacks have extended terms of over 15 years. Having this money locked up allows the MSO to concentrate on its operations without the distractions of having to roll shorter-term financing more frequently. A number of MSOs have significant debt maturities in 2026, and unfortunately, those maturities coincide with a period of subpar growth and profitability. When you have to roll your debt every 3-5 years, you take the risk of going through a trough in earnings at the time of the roll.
  • Higher LTV – Sale leasebacks often cover the entire value of the real estate and may even provide for tenant improvements. This amounts to over 100% loan-to-value. A company borrowing against the same real estate may only get 70% LTV and then have to finance the building improvements as well. For this reason, the apparent cost advantage of borrowing is often illusory by the time you account for the mezzanine debt and/or additional equity required.
  • Leases often contain fewer maintenance covenants that restrict corporate operations.
• DEBT ADVANTAGES:
  • More flexibility: A shorter-term loan secured by real estate and corporate value can be prepaid or refinanced much more readily. If the company’s credit quality improves dramatically or market lending conditions improve, there may be an opportunity to refinance at lower rates and better terms. We were advising clients to focus on prepayment terms because we anticipated a rescheduling-driven opportunity to sell equity and reduce leverage. We all know what happened there!
  • Sales leaseback agreements often contain automatic 3% rent escalators that, over time, can make the lease less affordable. The lessor may have less flexibility in responding to tenant needs for cash flow relief. We are seeing this drama play out with Pharmacann / IIPR right now. IIPR might be willing to grant some reductions in rental rates to Pharmacann because the alternative of having to release a substantial portion of IIPR’s portfolio at a time when asset values are depressed is not a pleasant one. Failure to release the properties fairly quickly could cause the company to reduce its dividends. However, IIPR has to be concerned that if it grants rental reductions to Pharmacann, a slew of other tenants will be lined up at the door.
• WHAT CHOICES ARE MSOs MAKING?
  • The chart below shows the debt structure of 15 MSOs. The blue bars represent the percentage of the debt + lease total that is debt. The orange bars represent the lease percentage of the mix.
  • There are clearly vast differences in the choices the MSOs are making. Some companies, like Glass House and Vext, have less than 10% of their debt in leases, while others, like Ascend, Green Thumb, and Planet 13, have 50% or more of their debt represented by leases.
  • Investors need to be cognizant of the tradeoffs. For companies with debt-heavy structures, investors need to be concerned about refinancing risk. For lease-heavy structures, investors need to consider whether the escalated lease rates are restricting company profitability.