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Cannabis Real Estate in the United States

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Why Cannabis Real Estate?

 

There are several reasons that investors might want to add cannabis real estate assets to their investment portfolios. The first is that there are barriers to entry to cannabis. The primary barrier to entry in the cannabis space is real estate because you cannot get licensed locally without having a piece of real estate that's properly zoned in the right area. This property will need to meet certain guidelines and restrictions based on whatever community it resides.

 

As a cannabis entrepreneur, you need real estate and there are two ways to get it. One is by leasing it, which is very expensive, or buying it, which is becoming more expensive. From an investment point of view, buying real estate and then finding someone that's licensed to be an operator is an ideal situation. You can make money in a few ways, not only do you make money by having property that's green zoned, but you can also cut deals with operators where you get a percentage of profits from operations.

 

Investors can actually take a different trajectory by not only increasing the value of real estate from an equity perspective, but by actually making money off the lease in addition to rent. That means you have rent plus profit participation so there can be many paths to victory in cannabis real estate.

 

Risks of Cannabis Real Property Investments

 

With any investment comes risk. Investments in the cannabis property markets are no different. That's why choosing your operator is very important. The way regulations are set up right now, the license is attached to the property more than is attached to the operator. You can switch out the operator, but you can't change the location of the property. Some investors set up investment funds where they buy real estate, or they finance real estate and the operators, their tenants, may come and go. The property stays in the same place is easily rentable to the next cannabis operator who perhaps has a slightly different business model than the last tenant.

 

The biggest risk is the risk of the conflict between state and federal law because this remains an illegal activity at the federal level. The worst-case scenario with federal law is the risk of losing your property to federal seizure or criminal risk. Both those risks remain real today, despite the fact that we don't see enforcement at the current time. There are a lot of reasons why we don't see enforcement, part of which is that the federal budget restricts the amount of money that goes to law enforcement to enforce cannabis laws.

 

The biggest risk a cannabis real estate investor has is political risk and obviously the risk of some sort of seizure because your operator tenant is doing something totally outside the law. When setting up a lease or an agreement with a land owner and operator, you want to look for a ‘green rider’ to be attached that sets out a code of conduct enforcing the tenant to comply with local law, state law and, to the extent possible, with federal law as well because there are ways to comply with federal law, despite the fact that it remains illegal. There are so many different pathways that are legal, even under federal law, that you want to make sure that your leases are as compliant as they can be under the current legal system.

There are so many different pathways that are legal, even under federal law, that you want to make sure that your leases are as compliant as they can be under the current legal system.

How to get started as an investor?

 

There are a number of ways to get started as a cannabis real estate investor. The inability of banks to collect rent or even foreclose and possess a cannabis property has created a vacuum. That is a vacuum that is still in desperate need of money to fill.

 

The first way to invest is by traditional real estate lending. Cannabis entrepreneurs will pay a nice premium to a private lender for giving them the financing that a bank won’t give them right now. A first trust deed secured by the real estate is a very easy way to get involved. Your biggest risks financially are that your mortgage doesn't get paid. In this case you’ve got the real estate as your security and in this way it is similar to any other real estate collateralized investment.

 

The other advantage you have is that there are so many people lining up who need to lease real estate for their cannabis business so finding tenants is not that difficult. There are a couple of risks that landlords, owners, and lenders need to be cognizant of. The first is, is that they have to analyze their borrowers' taxes, because taxes are the tail that wags the dog in the cannabis industry. If they're not doing everything they can to maximize their tax returns then they may not be a good borrower because almost 70 percent of their gross revenue goes to different types of taxes.

 

If you're not structured the right way and if you're the landlord or even the lender, you may fall second in priority to the government regardless of how you secure your real estate. You have to be really careful as to the finances and operations of your borrower. Additionally, there's a slight risk of government seizure of that property if they do something that’s federally illegal though that risk has been reduced over the years, but it's still there. For lenders, you want to create a different type of green rider that has other conditions of operations and rights and responsibilities to secure the loan.

 

There are a lot of different tricks of the trade that you can use to protect yourself as a lender to a cannabis real estate owner, but they are not for the faint of heart. Lenders are usually either high net worth individuals, hard money lenders, family offices and a few private equity groups that, separate and apart from the normal activities, will set up a special fund that's a siloed standalone fund to deal with cannabis lending.

If you do become a lender to the cannabis industry, you might also try to find a guarantor of some sort that has some sort of financial wherewithal to at least cover the costs of going through and finding a new tenant for your borrower, or who can cover the cost of bringing in a new operator to the building you’re lending against.

 

The other thing to consider as a lender is to take the ‘UCC times three’ approach. This means that you take three types of additional collateral. The first is the actual cannabis inventory or cannabis product, which as a lender you're probably not authorized to take possession of, but you can sell that to someone who is or you can get a foreclosure agent that's authorized to sell it for you. Additionally, you want to take secured interest in the inventory, things like furniture, fixtures, rolling stock, etc., which you can foreclose on or sell to a foreclosing agent to handle as well.

 

The third, which is controversial, is taking a lien on the actual license itself. By law the licenses technically are not transferable but it is possible to transfer licenses through a court order and a court has the authority to transfer a license regardless of the statutory restriction. You can turn around and sell the paper to someone that really wants the license and they can go through the process of going to court and petitioning the court to transfer the license to them.

 

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There are also a variety of property types that can be used for the medical cannabis industry, these include:

 

There are quite a few different property types used for cannabis operations. Let's start with the large and work our way down to the small.

 

    • Outdoor Grows

 

The largest properties are massive outdoor grows on acres and acres of land. The recreational laws actually changed the way people can grow because there are limitations on square footage. It became an issue because if you were strictly doing medical, you didn't have the same restrictions. However, if you wanted to do recreational in competitive markets, then you were then restricted in your square footage. You'd have these great big farms that had just a third of that space or less being used for cannabis, and the rest being used for something else.

 

What's interesting is that some of those farms actually made more money on something else because of the drop in price that happened a couple of years ago for cannabis. It actually may have ended up saving them in the end. The most common types of property investments are the ‘half-way’ properties where massive super high-tech greenhouses are being built on large plots of land. Depending on where they're located, they have environment control, artificial sun and light control etc. If they're in Northern California, they might not need artificial controls, but if they're in central or southern California, then they have these special curtains that close and special windows that open and close and other additions to help the marijuana grow.

 

Systems like that are very high tech. They've received a lot of outside investment, especially from Canada, and they’re very popular. These kinds of operations have a higher chance of surviving any type of economic problems the industry is going to face over the next couple of years, simply because the amount of investment and time and the quality of goods that comes out of those hyper controlled environments is predictable and regular. They are probably the best option from a growth perspective.

 

    • Indoor Warehouse Grows

 

Then there are the indoor warehouse grow which is perhaps the most interesting type of 420 real estate. They can be in a green zone in an industrialized area, or the downtown of a major city like Los Angeles. All of a sudden you walk into a little door and behind that door is room after room of indoor grow. That's also very predictable and it creates a very high quality level of cannabis.

 

Keep in mind that it also has additional costs because you have to pay for city water –you're not getting agricultural water which you can usually buy at a discounted rate. You're getting electricity costs for a city as well, which tend to be higher. Additionally, you have to have an incredible amount of machinery, HVAC machinery, temperature control, all of those types of things because where you don't get any advantage from the outside elements one way or the other- you have to control all of the environment inside.

 

    • Distribution Centers

 

Distribution centers are really just warehouses that are repurposed for cannabis distribution. Early in the game, there was a lot of movement for people to invest in these warehouse type properties, where they would simply act as a conduit between the grower and the retailer. Interestingly, that distribution never took off. The rules and regulations the state released didn't promote having distributors the way you do other industries, like liquor distribution. With alcohol, you have the brewery and then you have the distributor that gets the product to the retailers. The distributor deals with the shelving, ensuring the regularity of the shipments, dealing with the retailer directly and getting those products on the shelves.

 

Cannabis is different. The distribution can be done by the grower themselves. You have a lot of growers wondering why they need a middleman who is just going to raise the price of their product when they can distribute it directly themselves. You're seeing a lot of direct distribution. Now that may change in the future, but a lot of people lost out that bought 420 properties that they thought would be perfect distribution hubs and centers.

 

Investors bought them in prime locations where they thought there would be a lot of demand and a lot of them are sitting virtually empty, so it was a really bad move.

 

    • Retail Cannabis Properties

 

And then, of course, there's the retail aspect. Retail is finding a green zone that allows you to put up a retail shop. That is not as easy as one would think, because every single municipality has different rules and regulations. California alone has about four hundred and thirty five different local municipalities so there is this patchwork of laws and regulations that investors need to be hyper aware of. For example, Newport Beach doesn't allow cannabis while Costa Mesa right next door does. Then you have the issue of whether they're going to allow delivery or not allow delivery.

 

    • Extraction/Testing Facilities

 

The belle of the ball, and the one that people are not looking at right now, is extraction and the testing. Extraction is a lab process where they extract the oils from the cannabis itself. There are a number of extractors, but because of the vape crisis that happened recently and because of the way the regulations are written, it's not an easy process and it's highly regulated and requires a special kind of property and requires a special kind of knowledge.

 

If you can get the right person with biochemistry knowledge and get the right real estate to go hand-in-hand, that's a place where money can be made. Another option with a dearth right now of people doing it is cannabis product testing, which doesn't require a lot of space, just the right lab equipment. If you can hire the right biochemists to do your testing, there are not enough testing facilities available right now. As of early 2020, the state needed 500+ testing agencies at a time when there were only 30 actively online.

 

If you can team up with a biochemist and find a property that's fit for testing there may be an opportunity there if you if you get yourself out of there quickly, because it’s not going to last forever. The opportunity is that there are just not enough people looking at testing as being a viable business but without testing, no-one can go to market; you cannot sell product without going through one of these testing facilities.

 

To open one of these facilities you need a special license, essentially a cannabis testing license. There's a special category for testing and it's the category that has the least number of issuances right now.

 

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How much does cannabis real estate cost?

 

The cost of cannabis real estate varies by property type, location, and all of the other features that contribute to the valuation of standard real property. With that being said, there are a few costs that are unique to this space, the most significant of which is the underlying structure of dealing with governments in relation to cannabis. 

 

Dealing with local governments is normally difficult, but dealings with local governments on cannabis issues have bordered on the impossible. If you don't reach the right officials or stakeholders, and handle the situation properly, you can be denied for no apparent reason or have impossible terms imposed to get your license. 

 

Some of the problems have it's making the news and it's becoming more public, which will hopefully swing things in the right direction. Regardless, there are still plenty of localities where the processes are more traditional, just make sure you do your due diligence deeper than you would for a multifamily, retail, or other type of standard CRE property.

 

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Where to find cannabis real estate?

 

There's a few ways to find 420 real estate. One is that the state keeps a list of all the municipalities that have candidates, events, licenses, so that's an easy place to start. However, the people who have had most success were the people that looked at places that didn't have a cannabis scheme yet and went and met with the city council members to create a scheme. By doing this they got themselves first in line. Now, being part of that city's efforts to put together a comprehensive plan requires some money upfront and there's some risk that the city won't approve it.

 

Cities that weren't online a couple years ago, like Desert Hot Springs, are now online and thriving and has become a great place to do business in the cannabis world. This all happened because a few landowners went to the city and lobbied to make it happen. The area had no industry whatsoever and was just lying fallow and so, they claimed, it was a perfect place for cannabis industry – and the city ultimately agreed. These investors pitched in to help pay for disposal, sewage, trash, water, power, all which required some sort of upfront investing. But the fruits of their labor are now paying off.

 

That's a really good play. One outfit lobbied the city of Burbank and they are now going to go online and have dispensaries as well as offer indoor grow opportunities. Three years ago, that was something that was not even on their radar, and a group of people went there and worked with the city and now it’s a burgeoning industry. Those investors are going to be the first ones to get licensed and bask in all of the benefits offered by being in first place.

How to find listings for real estate that is approved for cannabis delivery business?

In most states, cannabis delivery licenses are approved by a combination of state and local authorities, although many of the kinks are still being worked out. Each state, city, and county has different requirements for operating a cannabis delivery business, so be sure to check local regulations as part of your due diligence into a 420/cannabis real estate investment.

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How to get investment in cannabis real estate? How are sponsors finding capital for their deals?

 

Many other CRE projects utilize crowdfunding, which is not as common in the cannabis real estate markets. Crowdfunding is hard because it crosses state lines and which makes it a federal jurisdiction so as an investor you should be cautious about doing that. Other sources of capital come from friends and family, and a lot of the people at the beginning of the opening up of the industry now have cash to invest.

 

With that being said, people are getting capital from traditional investments like securities offerings in the industry that are offered only to people in California so it doesn't go outside of state lines. Investors have to prove their residency. It's very complicated to fundraise and limit yourself to one state, and you have to make sure that the paperwork is as buttoned up as possible.

 

There are, however, some outliers out there that are just amazing at raising money. One of them is Gold Flora, a shop that's run by a woman named Laurie Holcomb. She's a brilliant businessperson and she has raised money from investors with a lot of them being private equity groups that are willing to take a risk on her because she's just managed these businesses in an amazing way. So it can be done.

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Cannabis Real Estate Agents

 

Though the industry is still in its infancy, or slightly more developed, there are professionals that can assist investors and developers with their projects. These folk help mostly with dealing with the municipal government or the local government, with the zoning aspects and identifying the properties.

 

They're actually consultants who deal with how to become legally compliant locally and at the state level, but not from a lawyer's perspective, but more from a real estate perspective. They assist investors with items like how to get the real estate buttoned up and ready to go, applying for your license, etc. These folk are good to hire to navigate the local issues, state issues, and let your attorney deal with the investment structure, acquisitions, and other legal and transactional issues.

 

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Things to be aware of:

 

You need to know your operator. Whoever is using the property, you need to understand who they are and what they are and how they account for their money, because we're dealing with an industry that can't be banked right. You need to know how you are going to collect your monthly payments, how you’re going to monitor how much money is coming into the business.

 

Additionally, you need to set up protocols ahead of time and make sure that processes are strictly followed. That is probably the biggest challenge if you're lending money in this field. The other thing is that you've got to make sure is that your collateral is buttoned up and you're protected from the extreme circumstances which arise from government seizures, bad actors, criminal prosecutions and other worst case scenarios.

Conclusion

 

The cannabis industry is relatively new and working in this field has its share of risks, but the ability to get in on the ground floor of a new industry on this scale isn’t something that happens all too often. For serious investors, who are cognizant of the risks, and who have the ability to navigate the regulatory and legal issues that come with the territory, cannabis properties can be an excellent way to generate returns.

 

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*This article is based on a podcast conversation I had with attorney Richard Ormond at the law firm Buchalter.  You can listen to the podcast here and find Richard here.

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