Description

We believe that Chicago Atlantic Real Estate Finance (REFI) is a high yielding, low leverage investment with ample security that can return 12-15% cash return for investors.

Initial Disclaimer Alert:  This company lends to cannabis companies.  If you have reservations about legalization etc. this is not right for you.  If you think that cannabis will remain legal at the state level, and are looking for a steady return that avoids the fluctuations of pricing competition etc., this may be a great fit.  We believe that the “cannabis” risk is mitigated, and actually provides competitive protection and future catalysts.

Current Cannabis Industry Analysis (Rant)

There is a lot of information about the cannabis industry.  More and more states have legalized it over the past several years, and we expect more states to legalize it in the future.  We feel there is little risk for a re-criminalization of cannabis in the states that have legalized it.  In fact, we think it more likely that the states who have partially legalized it medically, to fully legalize it for recreational use.  

The fact is that cannabis is growing in sales across the country.  It is becoming mainstream.  The risk of states making it illegal again or the federal government enforcing federal laws is extremely low.    

The cannabis industry is here to stay, and each state is on its own specific journey in the legalization.  For that reason, the economics of operating in cannabis in each of the states are unique as well.  Some states have matured, some are growing rapidly.  Some states force limited competition while others are completely open.

All cannabis companies regardless of what state they are in are taxed too much.  Cannabis companies are not allowed to take standard deductions as an ordinary company.

For all the various reasons (growing industry, lack of capital, regulation, high taxes, lack of banking, lack of experienced management), it's not easy for an operator to succeed.  Just looking at the basket of public cannabis stocks and you can tell that they are all turds.  The public cannabis companies (for the most part) were in a rush to capture licenses and spent money quickly (and irrationally) to generate sales quickly.  They (for the most part) ignored prudent capital raising and allocation, and didn’t focus on generating profit.  

That being said, legal cannabis sales in the US are still growing 20% and more states are rolling out legalization. There is a continued need for infrastructure built during this green rush, specifically high end indoor cultivation in industrial buildings.  Also, the limited licenses that the MSO’s acquired still have a lot of value.  So while the MSOs businesses may have failed by taking on too much debt and business risk, a lot of the assets they have still have a lot of value.

Business Description

REFI is a commercial real estate finance company or mortgage REIT that manages a diversified portfolio of real estate credit investments in the cannabis space.  The Company is externally managed by Chicago Atlantic Group.

REFI went public in December of 2021. REFI seeks to lend to cannabis operators at compelling risk adjusted returns.  

REFI has originated $1.9 billion of cannabis loans on its platform since inception.

The types of loans that REFI makes are typically senior secured term loans that are secured with a combination of real property and equipment, and carry a maturity term of about 3 years.  Credit can be enhanced by securing the business and its licenses, not just the property.  The loan portfolio is diversified from a geographical and operator perspective.  The loans also have various credit enhancements including guarantees and liens on business licenses etc.

Loan Portfolio Metrics

The loan portfolio is covered by both real estate AND business assets.  These business assets are certainly not worth zero.  They can include cannabis licenses and expensive equipment and tennant improvements that have signficant value in the event the operator fails.

As mentioned, the cannabis industry is very different depending on the state that you operate in.  While REFI has some concentration in Michigan, 20% it is worth noting that these loans carry signficant asset protection through real estate.  The LTV for these loans is 31%.

Limited Competition

Demand for financing in the cannabis market is expected to continue to rise due to recent and future state legalization of cannabis for recreational and medical use as well as increased consumer adoption, with both trends requiring significant capital expenditures by operators.

At the same time, there are very few entities that have the willingness and expertise to lend to the cannabis industry.  Only smaller banks would bank cananbis operators, and usually they would only give them checking accounts, not loans.  And given the economic backdrop of banks pulling back from lending in general we do not see banks as being a competive threat.  This creates a lack of competition and higher returns.

Financial Metrics

REFI's financials are very straightforward.  They have a portfolio of loans and borrow a little against the loans, collect interest, pay interest and operating expenses to generate profits for investors which must be fully distributed due their REIT status.

Dividends/Yields

REFI pays a regular .47/quarter which is equivalent to 12.1%, however it is over earning its dividend and will pay a special dividend on distributable earnings in excess of its regular dividends on a yearly basis.  We project that REFI will earn $2.40 per share in Distributable Earnings equivalent to a 15.5% yield.

Risks

Cannabis is STILL Federally illegal.  There is always a chance that new federal leadership will enforce the illegality of cannabis on states.  This seems highly unlikely as cannabis legalization has been rolling through the country and it is one of the few things that both sides of the aisle can agree upon.

Loan Defaults and the inability to recover principal.

More competion from other lenders

Federal Legalization.  While this would be a positive catalyst too, longer run, you could see tighter spreads, however the stock price would be up 100%.

Catalyst

Federal legalization.  If there was some federal legalization, you would see more capital go into the space and tighten spreads.  With essentially no leverage, generating and ROE of 12%-15%, we could see its yield trade down to an 8% and the stock could go up 100%.