➤ There is ever-greater demand for real estate capital in the legal cannabis arena, but Innovative Industrial Properties Inc. will likely remain the only player in the space as long as cannabis is illegal at the federal level.

➤ Innovative Industrial's investor base is now about half retail, half institutional, reflecting investors' increasing comfort with cannabis investment.

➤ M&A among cannabis operators is likely to continue.

S&P Global Market Intelligence caught up with Paul Smithers, the company's president and CEO, earlier in May at IMN's Institutional Capital and Cannabis Conference in Los Angeles to hear his views on the rapidly growing legal cannabis market. What follows is an edited transcript of that conversation.

S&P Global Market Intelligence: Roughly 60% of the capital flowing into the cannabis space today reportedly is intended for infrastructure, which would include cannabis real estate. In a few words, would you define the outlines of the company's strategy as of May 2019?

Smithers: For now, we'll continue to do what we've been doing: Raise money in the public capital markets and execute sale-leaseback deals. We're seeing increased demand every month for our product, at above-market yields. I think we've got a good two to four years at least before that strategy changes, before we see meaningful change around the legalization of cannabis at the federal level.

People think the SAFE Banking Act will drastically change the landscape, and it likely will improve the cash flow issue to a degree. But what we're hearing from the national banks is, even if the SAFE Banking Act passes, they still won't get actively involved as long as cannabis is prohibited at the federal level.

So from your vantage, it's going to take federal legalization to substantially change the dynamic of your business?

Yes, because the major banks have covenants in their lender agreements that stipulate, if you engage in illegal activity then the loan is due. No matter what the SAFE Banking Act says, as long as cannabis is a Schedule 1 narcotic, that's an issue.

You have about $145 million in your coffers to deploy. Has your view of particular U.S. markets evolved in the last few months?

Things have changed a bit because of the ongoing M&A among cannabis operators, which brings bigger opportunities to the table. A lot of those are portfolio opportunities. A multistate operator — MSOs, which make up the bulk of our tenant base — may want to take over a smaller grower and execute a sale-leaseback deal for those new assets.

There's a greater need for capital in the marketplace, broadly. Prospective buyers may have substantial capital locked up in real estate that they want to free up. MSOs make ideal tenants from a credit perspective. They're typically more experienced, better capitalized and cash-flowing.

We're also still looking at new operators in new states where the powers that be might not want out-of-state MSO players. We're open to working with those smaller "homegrown" startups because they're the new MSOs.

Do you have your eyes on any state in particular?

Florida is really attractive. We're in Pennsylvania already but looking closely there now, too. We like Michigan. And the last would probably be Ohio. People there are finally getting comfortable with the program.

How is your investor base evolving?

It's growing at both ends, retail and institutional. Last time I looked, those two were about in balance, which is a nice place to be, I think, because it's a way of hedging our investor base. I would think most REITs' investor bases are skewed toward the institutional side.

We have more than 50,000 retail investors, which makes sense because retail investors are interested in the cannabis space and want to get involved. And being listed on the NYSE makes things even more comfortable for them.

Since we're in California and it's thought of as the crown jewel of the U.S. market, what is your take on it at present?

We closed on a few assets in California in the last three or four months. We're based there and have been keeping a close eye on the market for the last three years, really. We were hesitant to get in at first because we saw — correctly — that the regulatory environment in the aftermath of the 2016 election would pose problems. There's been a lot of growing pains, but it seems to have shaken itself out. We're now comfortable looking at very select assets in California with select growers.

But you can't ignore California, in any case. It's a huge market.

Do you expect many others to follow in your footsteps into the public arena?

I think we're going to be the only public REIT doing what we do for a while. There are some private REITs out there looking to do what we do. Some will likely try to go public, and we'll see if they're successful. But most of the competition we have today is in private equity.

You've been a public company for about two and a half years. Have the responsibilities and obligations that come with that been worth the reward?

If you'd have asked me six months after our IPO, I would have hesitated. But now that we're two and a half years in, and we've had some successful capital raises, and we've developed a really strong investor base, I'm really happy where we are. Most of our management team comes from the public space, so we're used to quarterly reporting, and it wasn't that large an adjustment. But I will say for companies that aren't used to the scrutiny and public reporting, it can be an eye-opener.

Any final thoughts on the remainder of 2019?

It's been an exciting year so far, and I think the back half will see more M&A among the operators. We'll see if any large deals get done. We need to keep an eye on the Canadian market. We've looked at opportunities up there, but since we're a public company in the U.S., moving into that market would create some complications.

But, bottom line, there are plenty of opportunities in the U.S.