At the tail-end of our recent phone interview, I mentioned to Leonard Tannenbaum, founder, partner, and CEO of West Palm Beach, Florida-based AFC Gamma (NASDAQ: AFCG), that the term “boutique REIT” had popped into my head as he was explaining how AFC goes about its business and how it differentiates itself from other REITs in the industry.
“You’re not wrong,” said Tannenbaum after a beat. “We’re boutique from the standpoint – and my wife says this all the time – that we can customize to the needs of our customers. We’re not Wells Fargo or
That is what I had in mind as Tannenbaum had talked about AFC’s place in the cannabis REIT hierarchy. “As big as we are – we’re a $400 million market cap – my other company is in the billions,” he said, referring to Fifth Street Asset Management, a public company he had founded and built up before it was acquired by Oaktree Capital. “AFC Gamma is just now coming up on mid-size. IIPR, by comparison, is a $5 billion market cap. It’s still apples and oranges.”
IIPR, of course, is the San Diego, California-based 60-pound gorilla of cannabis REITs, but that said, in its relatively brief existence, AFC has secured some pretty big deals of its own, including the recent announcement that AFC Gamma and Viridescent Realty Trust have provided Acreage Holdings with a senior secured credit facility that could with the accordion option total $150 million.
“AFC Gamma has committed $60 million under Acreage’s $100 million senior secured credit facility, with an additional $10 million syndicated to an affiliate and the remaining $30 million committed by Viridescent,” read a press announcement. “The facility is secured by first-lien mortgages on Acreage’s owned real estate properties and other commercial security interests. The senior secured facility also includes a committed accordion option for a further $50 million that is available in future periods once certain predetermined milestones are achieved.”
“I love the Acreage deal,” enthused Tannenbaum at one point. “As we continued to due diligence, we were more impressed with the company, which is not always the case in cannabis.”
The REIT Place at the REIT Time
The irony of Tannenbaum running a real estate investment trust, aka a REIT, is that he’s not a born-and-bred real estate guy. “I am an expert in basically two things,” he said. “One has nothing to do with cannabis, which is global macro. I think I’m very good at money flow analysis and understanding interest rates. It has to do with global credit interest rates on a very large scale, and it was really helpful to family office. The other thing I do is middle market lending. I am one of the top middle market lenders in the country.” He mentioned some of the top institutional investors in the world and said they would vouch for him. “We’re all peers in that same category.”
Tannenbaum founded Fifth Avenue when he was only 27. “Over a short 18-year period, we went from zero, a new concept, to being several public entities to where I closed about a billion dollars of loans every year in the middle market,” he explained. “It started with me and a few founding employees as a concept in a basement in Mount Kisco, New York, and we built it over time into the $5 billion asset manager with lots of public entities and public debt and all sorts of good stuff. What I realized was that with the bigger guys – Aries, Apollo. Oaktree, BlackRock – their cost of capital deal sourcing was very hard to compete with, and so I sold the company a little over four years ago to Oaktree for over $300 million. Oaktree has done really well, the stock is hitting new highs, and I’m still the largest shareholder, so it’s all been a very happy transition. I took a break, became a family office, started investing more for myself, and came upon cannabis alongside a whole lot of family offices.”
The skills Tannenbaum brought with him were ones he did not see in cannabis when he arrived. “When you think about middle market lending, and you think about the ability to be an institutional lender but also a commercial lending partner, cannabis didn’t have it,” he said. “Cannabis had draconian real estate lenders that had sale leasebacks, but they didn’t have any relationship lending. When I called my peers and said, why don’t you do it, they said they were not willing to jeopardize their companies, because it’s still that .0001 percent risk. I’m a family office, I don’t have some big organization, I sold my company. So, I was willing to do this all again, to be that institutional partner to our companies, and they were so happy to see somebody who did what they say.
That was four years ago. It took another six months before Tannenbaum finally agreed to put a small
The company in question had built a massive indoor grow that was fully automated. “What they realized was that by automating everything, you have massive mold problems, and it doesn’t work,” said Tannenbaum. “By the way, when we visited them, it was the coolest thing you ever saw. Why do everything the old-fashioned way when you can automate everything, and intuitively, it kind of made sense. You see all these machines, systems, screens, but it failed.” Today, added Tannenbaum, that same company trades at four cents as a public company. “But at the time,” he added, “less sophisticated me was listening to all these people and listening to what they thought and realizing that they didn’t really understand what they were doing.”
Tannenbaum’s next deal was a vast improvement. “It was a company called Curaleaf, which is of course a leader in the industry,” he said. “I didn’t know that much about cannabis, but as we researched it and did due diligence, and got to see the models and the state-by-state dynamics and what their plans were, I started learning the landscape, the margins, and what amazed me about the whole thing was how every state was different. It’s not one United States; this is an industry where every state is a microcosm unto itself. I realized this is even a better potential arbitrage, because you need to understand not only cannabis in general, but you also have to understand every state separately. That’s really interesting. I kept peeling back the layers, and in the third deal, I teamed up with another partner and we did a deal with Harvest. I didn’t agent that one, but we were one of the few lenders in it. By this time, I’m getting more comfortable, starting to understand the state-by-state dynamics, the nuances to the lending environment, difference in cultivation, dispensaries, and verticals.”
Not All REITS Are the Same
I asked Tannenbaum to explain the different types of cannabis REITs, and where AFC Gamma falls on the spectrum. “Initially,” he replied, “all cannabis REITs were sale leasebacks. What that means is, if you have a cultivation site on which you’re growing cannabis, and you say,’ Okay, I need $50 million to continue to expand this and maybe extend some other sides of the business.” You sell that facility to another company – let’s call it the industry leader, IIPR – and they give you $50 million. You no longer own that facility, and the rent you pay is secured by your entire company anyway. Basically, you have to pay your rent, otherwise you’ve got big problems. And once you choose that partner, it’s a 15-year lease with escalators, and every year your lease goes up by two-and-a-half to 3 percent. It gets very expensive over time because there’s no money in the market. Those leases used to start at like 12-13 percent and then they went higher, so you ended up paying 18-19-20 percent over 10 years because of the escalators.
“Those deals and our entire market have shifted as we and some other people have entered the market and provided competition for that source of capital,” he added. “That [rate] is probably down to 10 percent with escalators down from 13 [percent]. Loans that I did at 22 or 23 percent are probably down to 18 [percent]. Loans that I did at 15 are 12 percent. Everything is down by about 300 basis points in the past year and a half since we and some others have provided a little more competition in the space.”
I asked Tannenbaum to elaborate. “The difference with the 15-year lease is that you’re married for life, is the way I describe it,” he said. “With me, we’re just dating. You can break up with me any time you want, and it’ll cost you two points. It’s very easy. I don’t have hooks in your company. It’s a five-year loan or a four-year loan, you can pay me back in two years or one year, whatever you want; you can owe me a couple of points on the way out. I have some of the lowest prepayments in the industry because we’re the leading institutional relationship lender in the market. I think we’re the largest lender, actually, but we’re certainly the largest public lender.
“All REITs are the same,” he added, “but we’re characterized as a mortgage REIT, while the other ones are characterized as land REITs, so they own the land of the buildings. We, like a mortgage on your house, give you a mortgage on your property, we give you a mortgage on your company, but you can pay your mortgage just like you could pay a JP Morgan mortgage back, and that’s it. You can end the relationship with JPMorgan if you want, but if you like JP Morgan and they do a good job, when you want to refinance your mortgage to buy another house, you go back to JPMorgan, and that’s why our customers continue to come back to us.”
The changes he’s seen in the market were the result of a few factors. “It’s a combination of a couple of things that have caused yields to come down a little bit,” said Tannenbaum. “I think companies have gotten a lot healthier, so that’s one thing. These companies started out almost in venture, and then they started getting some cash flow, and now some of them have a lot of cash flow. As they’ve grown up and matured, of course the cost of borrowing should go down. The second thing that happened is they have been able to access the market on the big side through Canaccord [Genuity] and Seaport [Global Securities], who in some cases are partners, in some cases are competitors, but Canaccord and Seaport have attracted lots of hedge funds. And I know a lot of them have institutions and family in order to invest in the bigger players through them, so they feel like it’s safe. And therefore, because there’s an additional supply of capital, of course that compresses yield.”
That compression causes ripple effects throughout the industry. “At the high end of the market, the most mature and robust multistate operators are borrowing 300-400 basis points cheaper than they were two years ago,” said Tannenbaum. “At the same time, all the smaller people, single state, two states, three states, new license with equity, construction builds, they’re still getting very good returns.
“There are three buckets of return,” he added. “The big MSOs are borrowing between 10 and 12 percent. The second bucket or second tier, are borrowing between 13 and 15 or 16 percent. And the bottom bucket, which is single state operators that haven’t established their businesses and don’t really have the cash flow, are borrowing over 17 percent, sometimes as high as 25 percent. So, it’s three buckets of risk, and we service all of them, secured by cash flow (sometimes there is, sometimes there isn’t), licenses (we operate 90 percent of the time in limited-license states where the license actually has value and you can trade it), and real estate.”
Assets also have become more expensive. “Let’s talk about some actual numbers because I’m an actual number type person,” said Tannenbaum. “When we started in Arizona, a license was about $5-6 million; this is about two, three years ago. We then started to think about going rec, and a license cost about $11 million. Today, a license cost upwards of $20 million, and you saw Curaleaf just bought four licenses for $210 million.”
And that’s just Arizona. “I believe a New York fully vertical license – and we know some of the bidders – could be worth over $200 million,” added Tannenbaum. “I think the Georgia license Nature’s Medicines won could be worth over $100 million. Could be. We don’t know because it hasn’t been sold.” The point, he added, was that as each state opened up, they tended to change different rounds as they were challenged. “My job is to stay on top of state-by-state dynamics, license value, supply and demand, and changing landscape in order to continue to monitor and make these loans.”
Regarding AFC’s credo to only operate in limited-license states, Tannenbaum noted that they are not in California, Oregon, or Washington. “I try to follow Warren Buffett’s rule and only invest in things I understand,” he said. “I do not understand the California market. It’s got very good high-end grows that do really well, and Cookies does really well in California, but there are a lot of people it’s just wiped out. I mean, there’s sub-$300/pound pricing this year, there’s a flood of product, there’s 25 percent taxes, and there’s a huge black market. I just don’t understand it.”
Still, like almost everyone else, Tannenbaum considers California an essential market. “The vast majority of top brands have come out of California, maybe Colorado, but the really good brands, the high-end recognized brands, and the best growers. I see California as having some of the best growers. We’re hiring California growers because they’ve been doing it forever. Them and the Colorado growers are really, really, really good.”
In addition to certain states he likes, were there sectors of the industry Tannenbaum preferred over others? “As I talk to some of the smartest people in the industry to sort of verify where it’s going – and I have my 10 people that I will bounce things off of – we all have the same view that we’re in the fourth or fifth inning of the industry,” he said. “We’re not in the beginning Wild West days that had a lot of money to be made, and we’re not in the end where there is no money can be made. We’re kind of in the middle, where the industry has reached a certain level of maturity.”
At this point in the industry’s evolution, he added, balance is the objective. “You really want to own both cultivation and distribution, and you want to be vertically integrated,” advised Tannenbaum. “What’s going to happen – and I totally agree with all of [my friends] – is that distribution will become more important because ultimately, it’s going to be about shelf space, branding, and distribution, which is why I don’t lend to real estate. I lend to companies.
“To qualify as a REIT,” he further explained, “you have to have enough real estate. So, we do have a first lien on the real estate, but we also have a first lien on the company, and that to me is the big difference with us. We have all the genetics, all of the distribution, all of the company and its people and what’s generating the brand and brand images. That’s all part of brand IP, and it’s all part of my collateral. So, as distribution becomes more important or retail more important, I don’t really care as long as the companies that I picked up the management team to their vision do well. And that’s a very different way to approach it than it had been approached before the lenders came into the market.”
Meeting Demand
I inquired about the current demand for capital. “We currently have a $700 million pipeline, and we
To reinforce his point, Tannenbaum listed the factors shared by AFC’s four largest deals – Acreage, Justice Grown, Nature’s Medicines, and Verano. “With each one of them we hold about $60 to $70
Can these relationships grow to become more like marriages than dating? “They can,” he said, “but the difference is divorce doesn’t cost you too much.”
If a company defaulted on its loan, would AFC Gamma take it over operationally? “The deal is, the REIT cannot own real estate or operate companies,” said Tannenbaum. “However, because the REIT is externally managed and has a separate agent, the agent could own the company if it had to and/or manage it and realize the assets. The REIT won’t hold equity either, so that’s the separation for our investors from the flower, which is one of the reasons we are able to list on NASDAQ. We agreed not to own equity, not to own real estate, not to own plant-touching assets, but the way around that is we’re managed by an outside vehicle, and an outside vehicle can do what it wants. And so, we can do that, but we don’t want to ever own our clients’ assets. And really, 95 percent of the time, if they get into trouble, we force them to sell.
“The way I think about companies and investing is on enterprise value,” he added. “What would I buy the company for, and what would somebody else buy the company for? Then I lend to a fraction of that, so I know at the time – because life changes and situations change – that I can get my money out in the sale process. And then, to give us more experience as we evolved from credit and started raising money from family offices and finally took [AFC] public a year ago March, we had equity positions. So, we now have equity positions in a number of companies in a different fund. I personally have a very large equity position in Nature’s Medicines, where I’ve learned a lot about how the sausage is made on the inside. It’s also one of our largest loan, but I have no control over the loan. It’s all my board of directors because I have an equity stake in the company as well.”
A Consolidating Market
With 2022 earmarked as another year of consolidation in the cannabis industry, I asked Tannenbaum about increased M&A activity, and what it means for AFC’s portfolio going forward. Will it continue to support small, medium, and large companies? What will that look like over the next couple of years?
“I think you’re right, there are a ton of mergers and acquisitions as what I call the Monopoly board gets filled up,” he answered. “The big MSOs are filling up all the lead states to the extent that 11 are already in Ohio. To my smaller clients, I would say find your dancing partner quickly, because soon there won’t be any more, and you just need a dancing partner. Ayr [Wellness] has been very acquisitive, Curaleaf has been very acquisitive, Trulieve, GTI, and Verano, all the big guys that really built their businesses up through acquisition. And that should continue, noting that once the states fill up, they fill up, except for a state like Arizona, where there is not the limitation [on licenses] that the other limited-license states have.
“From everything that we’re seeing,” he added, “you’ll see another 12 months of very high M&A activity, which is great for the market, and is also why some of our loans may get repaid out and we may loan even bigger to the new thing to buy them, and that’s really good for our earnings and philosophy. But I think what I still want to do, when I find the right management team that has the grow experience, that has the right vision in the right limited-licensed state, is to support that. I’d still want to support a state like Texas, where they only have three licenses and it’s eventually going to be one of the biggest [markets] in the country. I want to support a state like Georgia. I want to support a state in the Carolinas, which will eventually open up. You have to sort of look at the next Florida, and you have to get ahead of the curve and find who’s going to win, because they’re going to be big. At the same time, [AFC has] moved up-market. We’re supporting the larger MSOs and the second tiers, and so, when we talk about how much of my capital I deploy, the four largest deals in a $400 million portfolio are over half the portfolio.”
That kind of begs the question, if AFC had an unlimited amount of money at its disposal, are there an innumerable numbers of deals it could do? “We have in an unlimited amount of money,” shot back Tannenbaum. “The money is not our problem, because not only do I have a large family office, but we also have another pocket of capital that’s led by very large institutional investors. We have all these other pockets of capital, and they have almost limitless appetites, because we’re sourcing such great deals; we underwrite them, we portfolio manage them, we partner with them, and we know enough people in the industry do background checks, but also reference checks. So, everybody wants to invest with us, including my family office, but I let all our investors eat first. If you think about that, we could write $200 million checks if it were to a credit that I would write it to, like Verano. If Verano needed a $500 million credit line, I would say we’re going to hold $251 million of your credit line.”
What qualities does AFC look for in a company interested in a loan or other financial support? Is it mostly management? “It’s not all management,” said Tannenbaum. “You’re looking for three basic pillars: do they have cash flows, and do you believe their cash flows, because everything’s adjusted EBITDA today. What is the quality of their cash flows? Is it coming out of wholesale? Is it a vertical operator and limited license state? Licenses. What is the license value we ascribe to the license the company has? Take Acreage’s Ohio C1 license; it’s one of the more valuable licenses, but even more valuable is a New York vertical license. So, I think people don’t really understand license value and its importance, but we ascribe a lot of attention to what that value is. And then third, you have to have real estate, of course. For AFC the REIT, the value of the real estate [is important] because we have to follow the REIT rules and have enough qualified real estate assets and qualified real estate income, because our shareholders get a discount. When you own a REIT, it gets a REIT dividend, which is taxed differently, and you get a pass-through entity, which is terrific. But in order to get those additional qualities, we have to make sure it fits the box.”
As our time wound down, I asked Tannenbaum about the equity markets, and whether any of AFC’s large deals will impact the company’s yield or dividends. “Last reported, which was very recently, we did an equity offering where we raised at least another $61 million of fresh equity cash,” he replied. “We’ve had $100 million debt issuance with Seaport that was very successful, with the five- and three-quarter coupon, so we can always tap the debt markets. We’re constantly accessing the equity and debt markets to fulfill the demand that we’re seeing, so I feel very good about balancing that against these clients.
“You also asked about yield,” he continued. “The last time we reported yield was right before the equity offering, with a 19 percent yield to maturity in the portfolio, which is very healthy, which is I think higher than our competitors. We’ll probably back go down over time, but is it going down very rapidly? Not really. You can see our reported yield started maybe at 21 percent, then it became 20, then it became 19, but that accounts for Verano and everything in the portfolio.”
Dividends have been on the rise. “Dividend has increased from 38 cents to 43 cents,” said Tannenbaum, “and recently we increased it again and made a big jump to 50 cents, which is on a quarterly basis. With every single quarter, we’ve either earned or out earned our dividends, and I hope and expect the dividend to continue on the upward trajectory over the course of the year. The analysts are predicting mid-$2 dividends by the end of the year.”
Tannenbaum also mentioned how positive he feels about 2022. “I’m excited for this year, and I’m excited for the progress we’ve made,” he said. “I’m excited for how well our clients are doing and how they’re progressing, and I’m excited when they win some really good licenses. One of our clients just won a New Jersey license, and now we’re going to help them think about financing. And so, we have a very exciting year ahead of us. If you ask me what keeps me up at night, it’s do we have enough people. We’re very methodical about our approach and we need to hire a ton of people, so if you put in your article that we have a lot of open positions for associates and underwriting and portfolio management, that would be very helpful, because we do, and we’d like some really smart applications.”
Those smart new hires will continue on a path Tannenbaum set out when he started AFC Gamma. “There’s a big difference between being with a syndicate and being with a partner,” he pointed out just before we hung up. “For us, we have the capital to go do it, and we have the knowledge and team to really take them to that next level, which is institutional partnership with the lender. I think that’s what we’re hopefully delivering to the market, and as we do, we’ve gotten a lot of compliments over it. ‘You’re helping professionalize and give credibility to the marketplace,’ and people sometimes pick us just for that. I hope that continues at least until the big boys come in – Apollo, Oaktree, BlackRock – but until they do, we’re going to continue to be the institutional lenders for this market.”
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