Could AFC Gamma become the next innovative industrial property?

IIf you’re a dividend lover or a cannabis investor, you’ve probably heard of Innovative industrial properties (NYSE: IIPR), the would-be owner of the entire marijuana industry in the United States Over the past five years, its total stock return has exceeded 1,140% and its dividend has increased by 900%. And there is another stock that looks a lot like it, which may soon be on the rise for the first time.

Gamma CAF (NASDAQ: AFCG) is still quite small, with a market cap close to $387 million, compared to IIP’s $4.8 billion. That means investors might just be able to hitch their wagon to the company’s rising star – assuming she can actually take off.

Let’s take a look at AFC Gamma and compare it to Innovative Industrial Properties to see if it could be the next cannabis finance company to enrich shareholders.

Image source: Getty Images.

It pays to go where traditional financial institutions don’t go

Both IIP and AFC Gamma exist because it is difficult for cannabis companies to raise funds from traditional lenders like banks. As long as cannabis remains illegal in the United States at the federal level, it is simply too risky for these financial institutions to face regulatory wrath by dealing with marijuana companies. And that means there is money to be made for those who can offer money in exchange for any durable assets (like real estate) that cannabis companies may have.

For its part, IIP earns money by carrying out sale-leaseback transactions, in which he buys real estate and then rents the new property to the former owner, who is usually also the former occupant of the space. It’s a great business model because each new transaction grants cash flow in the form of rent as well as equity in the form of property rights.

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

For the lien, AFC Gamma charges an annual interest rate of between 12% and 20%, and the weighted average yield to maturity of its loans is 20%. Of the 15 loans in its portfolio in the third quarter of 2021, all will mature before the end of 2026. It will therefore make quite a few interest payments by then, not to mention issuing new loans with the accumulated cash.

At present, his war chest stands at nearly $70 million on top of his $342 million in outstanding loans. That’s enough to generate several new loans at the lower end of its target range of $10 million to $100 million. And that means its $11.4 million in revenue over the past 12 months is set to grow significantly 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 key differences that make its stock unlikely to rival the returns of the larger company.

More importantly, it only has the right to claim the assets held as collateral in the event of default by its borrowers. This means that its business model does not necessarily generate ownership of additional real estate over time. In today’s high inflation environment, owning real estate is better than owning another company’s debt. And so, holding other people’s debt could 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 variable rate, further reducing its ability to offset inflation. In contrast, IIP can simply increase its tenants’ rent as needed in response to inflation, and its revenue was under no pressure recently.

Finally, AFC Gamma will likely continue to issue new shares to raise funds to issue loans, as it did with a $61.5 million offering that closed on January 10. This will dilute its shareholders, making them unlikely to realize massive gains over time, especially if more shares are issued in future years.

Nevertheless, the company could do very well due to the boom in the cannabis industry and the continued lack of legalization which could make it easier to obtain financing. In my opinion, AFC Gamma is likely to be a strong growth stock for the next few years, even if it will not become as important as IIP.

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Alex Carchidi owns Innovative Industrial Properties. The Motley Fool owns and recommends innovative industrial properties. The Motley Fool has a disclosure policy.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.