Richard Ormond, Attorney and Shareholder Buchalter
Cannabis CRE
Today's Guest - Richard Ormond, Attorney and Shareholder Buchalter
On today's episode, I welcome the founder of Ejudicate, Inc., shareholder at Buchalter APC, and the nation's first cannabis business law professor, Richard Ormond.
Richard is a thought-leader in cannabis law, high yield debt, commercial law, and real estate disputes. He's also a corporate restructuring guru, focusing on legal and debt-driven solutions.
At Buchalter, Richard founded the firm's "Cannabis Industry Group," so he's the perfect guest with which to explore the rapidly solidifying integration between legalized cannabis and real estate. Our conversation engages the topic from every angle - from why cannabis real estate is a smart investment to how you can set up your own cannabis real estate project. It's a fascinating chat and one that every single forward-looking real estate developer should hear.
What You're Going to Learn
* The Top Reason Why Cannabis Real Estate is a Smart Investment
* How to Assess the Risks of Cannabis Real Estate So You Can Reap the Rewards
* What the Top Opportunities for Investors in Cannabis Real Estate Are
* Some Advice for Investors on How to Screen Your Cannabis Business Owner Prospects
* Understanding the Tax Code Laws that Apply to Cannabis Business Owners
* Suggested Lending Amount, Rates, and How to Leverage Your Cannabis Business Investment
* The Top Types of Property Investments to Look for In the Cannabis Industry
* How to Recognize and Overcome Potential Problem Areas in Cannabis Real Estate Investing
* Some Resources to Help Identify Potential Cannabis Real Estate Opportunities
* How to Set up A Cannabis Real Estate Project
* The Top Considerations and Most Common Questions About Cannabis Real Estate
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Show Highlights
The Top Reason Why Cannabis Real Estate is a Smart Investment
Adam: So, why would anyone invest in cannabis real estate?
Richard: There's a couple of important factors. The first is that while people don't realize that there are barriers to entry to cannabis, there really are. The primary barrier to entry is real estate because you cannot get licensed locally without having a piece of real estate that's properly zoned, and the right area, and meets certain guidelines, and restrictions, based on whatever community you're in. You need that real estate.
There's two ways to get that real estate. One is by leasing it, which is very expensive, or buying it, which is becoming more expensive. Of course, from an investment point of view, buying that 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 in your lease, where you get percentage of profits, operations, things like that. So, you can actually have a different trajectory and not just increase the value of your real estate, from an equity perspective, but actually make money off of the lease in addition to rent. So, you have rent, plus profit participation, and everything else. There's many ways to skin that cat.
Cannabis Real Estate: How to Assess the Risks So You Can Reap the Rewards
Adam: Now, if I was to invest in a cannabis real estate- somebody's putting this deal together, like a producer, right? They're a sponsor; they found the land- I'm sorry, they found the building. They're in a green zone. They've got an operator inside that. The whole business is oriented to a profitable cannabis business.
My biggest concern would be, well, what happens if they lose the license? Presumably, they're overpaying for ... By the way, I'm pulling this out my ear, but I've seen values of properties skyrocket because they have licenses, they're in the right zone, et cetera, and go beyond any real- any other kind of use value. So, I'm paying the high value. Why would I not be concerned that I could lose my shirt, as well, if something goes wrong?
Richard: So, obviously, with any investment comes risk. There is a risk in that regard. That's why choosing your operator is very, very important, as to who's going to be on that property. The license - in most districts - the way that it's geared towards, right now, is that the license really is attached to the property more than it's attached to the operator. You can switch out the operator, but you can't change where the location of the property is.
We actually see folks that do investment funds that they buy real estate, or they finance real estate, and the operators may come and go because one thinks they have a better mousetrap than the other, but the property stays in the same place, and it's easily rentable to the next person that thinks that they have a better mousetrap.
The biggest risk, I still think, in this industry - while I have not seen it come to play in many years now - is that there's still the risk of the conflict of law between state law and federal law, because this remains illegal activity at the federal level. What's the worst case scenario in a federal situation? It's 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.
There's a lot of reasons why we don't see enforcement. Part of it is that the federal budget restricts the amount of money that goes to law enforcement to enforce cannabis laws. That is a complex discussion that would probably take us another hour to go through all the different nuances, and exceptions, and everything else. The other is the Treasury guidelines for how money is handled in that regard. That has become something that is a little bit more fluid these days, and I think it's very difficult for law enforcement to take a strong position on that.
So, that works to the advantage of property owners, because those two factors are very difficult to nail down. That's not to say that with a change in administration, a regime change, or whatever we have in this country coming in the next election, things could change for the better, or they could change for the worse. It's very hard to predict, right now, where that's going to go.
Donald Trump has indicated and given kind of dog whistles to the cannabis industry, saying that he's going to try to normalize it if he gets elected. The Democrats, on the other hand, have not been doing that, which is quite interesting to me that they've taken kind of a non-position on cannabis. They haven't advocated for it. They haven't said no to it, either. But it strikes me as odd, because I think it's an issue that would probably get people to the polls, and they're not using it to their advantage at this point.
Adam: That's interesting. So, actually, one of the risks is a political risk. This is a rare real estate investment opportunity that comes with it a political risk.
Richard: That's right [crosstalk]
Adam: Are there any others, just by way of comparison, other than entitlement risk, and the usual thing?
Richard: No, I think that the biggest risk you have is that political risk and, obviously, the risk of some sort of seizure because your operator's doing something totally outside the law. As a lawyer, I'm very paranoid, so when I set up a lease or an agreement with a landowner and an operator, we have something we call a green rider that we attach to the leases that sets out a code of conduct; that complies with local law, state law, and 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 we make sure that our leases are as compliant as they can be under the current legal system that we have.
The Top Opportunities for Investors in Cannabis Real Estate
Adam: That dovetails very nicely into the next question, which is how does ... If one is looking to invest in cannabis real estate, they're looking at a sponsor, right? Somebody who's buying the real estate, looking for equity from investors. What kind of investing, or what kind of investors are they? What kinds of sponsors are they? I'll run off a few examples here. For example, there's these concepts: first crop - I don't even know what that is; real estate; refinancing of existing properties; lines of credit.
The reason it dovetails in is because my knowledge of this was ... As you know, you and I met when I was working at a bank, and we had to foreclose on a property that had a dispensary. It was really problematic because we were unable, at that time, to accept rent from a federally prohibited tenant, basically.
Richard: That hasn't changed either. That remains the law.
Adam: So, tell me something, then - what are the different complexions of sponsor? How do they actually invest in cannabis?
Richard: There's a number of ways, and because of that inability for banks to be able to collect rent or even foreclose and own a property that has a cannabis connection to it, there- it's created a vacuum that is a vacuum that is still in desperate need of money to fill it. The first is lending; traditional real estate lending. People pay a nice premium to a private lender for giving them the financing that a bank won't give them right now. So, a first trust deed - a very traditional mortgage, or first trust deed secured by the real estate - is a very easy way to get involved.
I always tell people that are interested in doing this, your biggest risks financially are that your mortgage doesn't get paid; but then, you have the real estate as your security. It's very much just like any other real estate investment; but the other advantage you have is that there's so many people lining up that think they have a better mousetrap - the term I used before - in the cannabis industry that finding tenants is actually not that difficult right now.
Advice for Investors on How to Screen Your Cannabis Business Owner Prospects
Richard: What we're going to see, however, is that there is a couple of risks that landlords ... Lenders, landlords, whoever need to be cognizant of. The first is that they have to analyze their borrowers' taxes because taxes are the tail that wags the dog in this industry. If they're not doing everything they can to maximize their returns, literally and figuratively - their tax returns, and then returns to their pocket - they may not be a good borrower because almost 70 percent of your gross revenue goes to different types of taxes, if you're not structured the right way. If you're the landlord, or the lender, for that matter, you may fall second in priority to the government regardless of how secured you are in the real estate. So, you have to be really, really careful as to the finances and operations of your borrower.
I also think this - there's a slight risk of government seizure of that property if they do something that's [inaudible] illegal. I think that risk has minimized over the years, but it's still there. For lenders, we also create a different type of green rider that has other conditions of operations, and rights, and everything else. In some instances, what we do is we actually have confession of judgment. I don't know if you're familiar with that [crosstalk] judgement ahead of time, so that we can put a receiver into the property right away without having to deal with the illegality issue or anything else. We just kick those people out and put an operator until we find the next tenant.
There's a lot of different tricks of the trade that we use to protect our lending clients, but it's not for the faint of heart. Our lenders are usually either high net worth individuals, hard money lenders, family offices, and a few private equity groups that - separate and apart from their normal activities - will set up a special fund that's kind of in a siloed standalone fund to deal with that type of [lending].
Adam: What was that term that used before? The confession of ... What was it?
Richard: Confession of judgment.
Adam: Confession of judgment; so I do remember those from my days in the bank. It reminds me of Arm & Hammer. Apparently, when Arm & Hammer would hire his top executives, he'd have them sign undated letters of resignation [crosstalk]
Richard: He did do that. He did do that ...
Adam: That's a heck of a way of keeping control of your crew, right?
Richard: That's right. This is very similar in that regard, but because it's such a high-risk environment, and it's such a high-risk business, right now, especially with the conflict of law, I think it's very prudent to consider it ahead of time.
Adam: Yeah, why not, right? [crosstalk]
Richard: People are so desperate for the financing and the capital that they're willing to sign it. They're willing to take that risk [crosstalk] Oh, go ahead. I was just going to add one more thing. I always recommend that, in those types of loans, you 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 finding a new tenant, and everything else, or new operator, or a new borrower, or whatever. I do recommend getting guarantees, where they're available. They're not always available.
The other thing I recommend is, if you're going to be a lender, to take- I call it the UCC X 3. 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 paper to someone who is; or you can get a foreclosure agent that's authorized to do that. I would take a secured interest in the non-cannabis inventory - furniture, fixtures, [inaudible] stock, et cetera - which you can foreclose on, or sell to a foreclosing agent to handle, as well.
The third is controversial, but I recommend it anyway, which is taking a lien on the actual license, itself, because by law the licenses technically are not transferable, but I have transferred licenses through court order. A court has the authority to transfer a license regardless of the statutory restriction. So, you could turn around and sell that 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. We've done it successfully, so it's not something that is abstract at this point. When I did it three years ago, it was abstract. Now, we've proven the concept.
The “Al Capone Law”: Understanding the Tax Code Laws that Apply to Cannabis Business Owners
Adam: I'm pretty sure that you said 70 percent of revenues go to taxes? Is that what you said? Why [crosstalk] are those special cannabis taxes or something?
Richard: Partially but let me- I'll explain it in a way that makes perfect sense. We call it the Al Capone law. There's a special section of the tax code called Section 280E. 280E says that if you make money from something illegal, that you cannot take any deductions, or depreciations, except for cost of goods sold, which is usually a nominal cost. This is what was used to bust Al Capone and other mafia dons back in the day because they would make all this illicit money, and then, they wouldn't pay taxes, or they would try to depreciate or deduct assets that were from ill-gotten gains.
Today, fast forward to today, in the 2020s, the federal government goes to these cannabis businesses and says, "You can't depreciate your property; you can't deduct your rent; you can't deduct your labor; you can't do all these things." So, you end up paying full freight at the federal level, if you're not structured the right way, and you're paying 40 percent. Well, add that to the state tax, which is at 20 percent, and then, most local taxes are between five and 15 percent; you're anywhere between 65 and 75 percent of gross revenue of taxes.
I tell people this - that most cannabis businesses are insolvent before they even start their business because they don't take the tax burden into consideration. It's actually stifling the licensing process because people realize that once they're actually [inaudible] not in the gray market or the black market, their gross revenue is going to go down significantly, if they properly report their monies like they're supposed to.
I think that the only people that will survive the next couple of years while we wait for the business to become more normal, is the ones that are going to be able to put more capital into the business in the hopes that they can stay afloat long enough for the federal government to change the rules. That's a hope that we don't know is going to happen or not, depending on what happens politically.
Suggested Lending Amount, Rates, and How to Leverage Your Cannabis Business Investment
Adam: So, if I'm going to be an investor in one of these deals, and I'm lending debt, which is presumably the safest - we've got a first position loan - what kind of rates and leverage are we talking? You mentioned that they were higher rates, but what about leverage, as well, especially if the value of the asset is inflated from its normal highest and best use?
Richard: In my experience, I wouldn't lend more than 50 percent of the value of the property [crosstalk].
Adam: Which value? [crosstalk] The cannabis-based value? Okay-
Richard: On the non-cannabis-based value, quite frankly. That is probably- the cannabis-based value probably gives you a 30-, to 40-percent increase in market value, at least in the optical view because I think that those numbers are inflated. But there is the non-cannabis valuation, and the cannabis valuation.
What's interesting is this - I actually have one client, right now, that is Chinese-American, and they have found that the properties that they use for their cannabis grow facilities also work for Chinese herbal medicine, which actually sells at about the same rate the cannabis sells for, if not more. What they do is when they have a problem with one of their cannabis growers, they just bring in an herbal grower that grows these- that needs the same type of equipment, and everything else. They're the only ones that I've seen retain a non-cannabis business at a cannabis close to value, in that regard.
Adam: That's really interesting.
Richard: Yeah, it's ... I would say this - if you're a lender, 50 percent is probably your threshold, maybe 60 percent, and I would try to base it on the non-cannabis value. But everything's negotiable, of course, right? And-
Adam: What kind of rates. What kind of [crosstalk].
Richard: Three years ago, I was seeing 18, 20, 22 percent. Now I'm seeing 8 to 12 percent is more of the norm.
Top Types of Property Investments to Look for In the Cannabis Industry
Adam: Let's talk about the kinds of real estate that can be used for both recreational and medical cannabis industries. What are the different kinds of real estate that someone can invest in?
Richard: In the 10 years that I've been working in the cannabis space, I have seen quite a bit. Let's start with the large and go to the small. So, the largest properties we've dealt with are massive outdoor grows; are on acres and acres of land. The recreational laws actually changed the way people can grow because there's limitations on square footage, and things like that.
So, that became kind of an issue because if you were strictly doing medical, you didn't have the same restrictions, but if you wanted to do recreational, where a lot of people thought all the money would be, then you were then restricted on square footage. You'd have these great big farms that had just a third of its 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 the something else because of the drop in price that happened a couple of years ago for cannabis. So, it actually may have worked out to saving them in the end.
The most common types of property investments that I see are what I would call the half-way properties. They're greenhouse properties where these massive super-high-tech greenhouses are being built on large plots of land. Depending on where they're located, they have environment control, sunlight control, all these different things. If they're in northern California, they might not need the sunlight control, 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 all these different things.
Those are high tech. They've gotten a lot of outside investment, especially from Canada. Those are very, very popular, and I think that those will survive any type of economic problems that this 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 have probably the best option, from a grow perspective.
Then, you have what I would call the indoor warehouse grow. That's interesting because that can be in a green zone, in an industrialized area, or in a 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 after room of indoor grow. That's also very predictable, and it creates a very high-quality level of cannabis. But it also has additional costs because you have city water; you're not getting agricultural water. You're getting electricity costs for a city, as well. So, your overhead is different.
Then, you have to have an incredible amount of machinery, HVAC machinery - heating, air conditioning, temperature control, all those types of things - 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.
Then you have what I would call the distribution centers [inaudible] really just warehouses that are repurposed for cannabis distribution. 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.
What's interesting is that distribution never took off. The rules and regulations that the state released didn't promote having distributors the way other industries have; like in alcohol, for example. You have the brewery, and then you have the distributor, and it gets to the retailers; the distributor deals with the shelving, deals with the regularity of the shipments. They deal with the retailer directly in getting those products on the shelf.
Cannabis is different. The distribution can be done by the grower, itself. You have a lot of growers who are saying, "Why am I going to have this middle man that's just gonna raise the price of my product, when I can go and distribute it myself?" So, you're seeing a lot of direct distribution. That may change in the future, but a lot of people lost out that bought properties that they thought would be perfect distribution hubs and centers. They bought them, of course, in prime locations where they thought there would be a lot of demand. A lot of them are sitting virtually empty, so it was a really bad move. Will it change? Who knows? I don't see that changing anytime soon.
Then, of course, there's the retail aspect. Retail is finding a green zone that allows you to put a retail shop. That is not easy because every single municipality - and just think, California has about 435 different local municipalities - has its own different rules and regulations. Newport Beach, for example, doesn't allow it, but Costa Mesa, right next door, does. Then, you have the issue of whether they're going to allow delivery or not allow delivery. So, you have those challenges.
Then, the one that I think is the belle of the ball, and the one that people are not looking at, right now, is the extraction, and the testing. Extraction is a lab process, really, 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, highly regulated. It requires a special kind of property, and it requires a special kind of knowledge. If you can get the right person with that biology knowledge and that chemical knowledge - I would say it's biochemistry knowledge - and get the right real estate to go hand-in-hand, that's a place where money can be made.
The other one, though, that is really, really- there's a dearth right now of people doing it. It's the testing, which doesn't require a lot of space; it just requires the right lab equipment. So, if you can hire the right biochemists to do your testing, there are not enough testing facilities live, right now.
The last I read, which was a couple months ago, the state needed 500-plus testing agencies. There are only 30 that are online right now. So, if you can team up with a biochemist and find a property that's zoned for testing, I think you can hit a home run very easily, if you get yourself out there quickly, because I think that that's not going to last, that opportunity. But there's a short-term opportunity there for the next couple of years because there's just not enough people looking at that as being a viable business. I actually think that that could be one of the more viable businesses, because without that testing, they can't go to market. You cannot sell your product [crosstalk]
Adam: -do you have to have a license for the real estate to have a testing facility?
Richard: Yes [crosstalk] special license. It's a cannabis testing license. I forget what category it is, but there's a special category for testing, and it's the category that has the least number of issuances right now.
How to Recognize and Overcome Potential Problem Areas in Cannabis Real Estate Investing
Adam: You already talked about the cost of real estate, of cannabis real estate being 3X. Are there any other rules of thumb for the relative cost of cannabis real estate?
Richard: There's one thing that I didn't expect, and I should have expected it, that really surprised me. I always know that dealing with local governments is difficult, but there have been so many local governments that the dealings with them have led to- have bordered on corruption. I would stay far away from those, obviously; but there are some places where there's all these under-the-table deals that are taking place that are just despicable.
So, you need to be really aware of where you're deciding to put your business, because even if you go through all the processes, one, that local municipality, if you don't grease the right palms, will deny you, or you'll get approved. Then later, they're going to show up and say, "You have to hire my brother as a contractor. You have to hire my cousin as a specialist." I didn't expect California to have kind of this Latin-American style - and I say that, being Argentinean [crosstalk] Latin-American style corruption where ... Yeah, from the local, to the city, and everything else is [inaudible].
Now, there are more municipalities that are not corrupt, but I have had the misfortune of clients coming to me and saying, "I'm not understanding what's going on here," and it's because those city council members couldn't be trusted. If you look at the- even just the local papers, you'll see that the feds have clamped down on a few local city council members, and everything else in local cities around here, and the greater L.A. area for just that, for taking bribes on cannabis licenses, and things like that. So, it's making the papers, and it's becoming more public.
Resources to Help Identify Potential Cannabis Real Estate Opportunities
Adam: So, how do you find cannabis real estate? How does an investor find it? What kind of resources are there to identify real estate you can use it for.
Richard: There's a few. One is that the state keeps a list of all the municipalities that have cannabis and medical licenses. So, that's an easy place to go. But I'll tell you, the people that have had most success were the people that looked at places that didn't have a big cannabis scheme yet and went and met with the city council members to create a cannabis scheme. They got themselves first in line and being part of that city's efforts to put together a comprehensive plan.
That requires some money upfront, and there's some risk that the city won't approve it, but cities that weren't online a couple years ago, like Desert Hot Springs, are now online and thriving, and a great place to do business in the cannabis world because of a few landowners that went to the city and said, "We think this zone, which has no industry whatsoever and is just lying fallow, is a perfect place to do this." The city ultimately agreed, and they've pitched in to help pay for disposal, sewage, trash, water, power, et cetera. It required some upfront investing, but the fruits of their labor are now paying off. Other cities, like Adelanto have done that; Cathedral City have done that ... That's a really good play.
I know someone that worked very hard to lobby the city of Burbank, and Burbank, now, is going to go online and have dispensaries. I think they're going to offer indoor grow, and things like that. But 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 is, and they're going to be the first ones to get licensed.
How to Set up A Cannabis Real Estate Project
Adam: How do cannabis sponsors finance their operations? What's the process for them? How are they setting- are they doing crowdfunding? How are they setting about doing it?
Richard: All of the above. Crowdfunding is hard, though, because it crosses state lines, in a lot of respects, so it becomes a federal jurisdiction. I would be cautious in doing that. A lot of it is friends and family, and a lot of it is this - a lot of the people that - especially at the beginning - were applying for those licenses and trying to start up those legitimate businesses were illegitimate businesses before that. They had cash that they were sitting on for years that they were now able to deploy in a legal manner instead of an illegal manner.
I see most people getting capital from doing traditional investments, though. I've seen a lot of securities offerings in the industry that are offered only to people in California. So, it doesn't go outside of state lines. They have to prove their residency. They have to do all these things. We help them put those things together because it's very complicated to do a fundraise and limit yourself to one state. We make sure that the paperwork is as buttoned up as possible.
It's not easy to get that working capital. There are, though, however, some outliers there that are just amazing at raising money. One of the ones that I think of, off the top of my head, is Gold Flora that's run by a woman named Laurie Holcomb. She's brilliant, and she has raised money from investors, and a lot of them from institutional investors. I wouldn't call them institutional, but private equity groups that are well known 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, but usually I see the traditional- just like any other startup - friends and family first, then maybe a Series A, and then maybe something that follows a Series A; or you'll see a safe, or you'll see a some sort of convertible note that they take out. That has worked really well for a lot of my clients, particularly in the convertible note.
That is something that people are willing to do because they get interest on their money, and if things don't go as well as they think, they can always convert it into equity or take some sort of other enforcement measure. The other thing we've done is something called preferred equity, where we have springing liens. So, if things go sideways, we can start recording liens on real estate. That's also something that is helpful, and you can do, so there are a lot of options.
Adam: Are there any big players other than this lady that you mentioned, who are kind of go-to for cannabis business loans, for example?
Richard: My clients that are lending money in this industry like to stay under the radar. They find deals more than deals find them, if that makes sense. There are people that are known on the real estate side that have done investments, and there are people that are known, and putting together fund raises, or sponsors. Most of the money that I see that is big money is being raised on the Canadian stock market. They're doing investment funds that are raising money there and then doing cross-border investment into California. So, the biggest money plays that I've seen have all come out of Canada.
Adam: That's interesting. Now, what about cannabis real estate consultants? I don't want to say agents because agents implies broker/agent buying and selling houses. I mean, consultants, kind of as consultants. How do they get involved, what do they do, and how do they help investors?
Richard: I wish there were more, quite frankly. There are a few trusted go-to people that I know in the industry, and they help mostly with dealing with the municipal government, or the local government. They deal with the zoning aspects, identifying the properties, and things like that. But they're really consultants that deal with how to get yourself legally compliant, locally, and then, at the state level; but not from a lawyer's perspective, but more of a real estate perspective - how to get the real estate buttoned up and ready to go, so you can apply for your license; how to acquire it, and those types of things.
As a matter of fact, as lawyers, we don't have boots on the ground like these guys do. So, for us, it's easier to recommend to our clients to hire this outside consultant to navigate the local issues, or the state issues, and let us deal with the investment structure - the real estate acquisition, the things that lawyers know and know how to do well.
The Top Considerations and Most Common Questions About Cannabis Real Estate
Adam: What are the key things that investors should be aware of, in terms of buying buildings, or state, and municipal rules, et cetera; zoning? I mean, you've touched on some of these things. What would be the top three things?
Richard: Zoning is important, obviously, o I don't think we need to talk about that more because everyone realizes you have to be zoned for the business. I think that you need to know your operator. So, 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 now, or in very limited circumstances can be banked.
So, how are you going to collect your monthly payments? How are you going to monitor how much money is coming into the business? You need to set up protocols ahead of time and make sure that those protocols are strictly followed. That is probably the biggest challenge if you're lending money in this field. The other thing is this - you've got to make sure that your collateral is buttoned up, and you're protected from the extreme circumstances - the government seizures, the bad actors, those types of things.
I'll give you a really short example. We had a client who made a loan to a business; took the real estate as security. There was an operator who had no idea that their business partner was laundering money and not doing what they're supposed to do and being transparent about it. Well, there was an investigation, and the Feds wanted to seize the property. Well, part of the blame lay with our client not setting up protocols in advance as to how to manage incoming cash, how to manage deposits, how to manage payments, all those types of things. We were able to work with the government to not have them seize the property, and retain our rights, and everything else, but it was something that could have been avoided, I think, had we set up protocols ahead of time; but we got the client after they had done the deal, not before. So, those are the things that scare me the most as a lawyer.
Then, I think you need to understand your local government, and the consultants help with that because ... I'll give you a great example: Calaveras County had allowed for outdoor grow. Then, two years later, there was an election, and the entire county council was replaced, and they voted against it. So, all these people that had invested a ton of money, a ton of resources, and everything else were now sitting there holding an empty bag because the county changed its mind on allowing cannabis to flourish; to even exist in their county.
A year later, there was another election, and then they went back to being cannabis-friendly. So, you have this flip flop. I think, if you would have known ahead of time how Calaveras County has a history of going between left and right, left and right, left and right, you may have thought twice about investing in that county. I think, now, the county is married to cannabis, and they'll continue forward; but a few years ago, it was really up in the air.
Adam: Well, this kind of gets back to this first point that we were talking about - this political risk; even not just on the national level, on the local level, as well. All right, let me ask you one final question - what are the most common questions that you get when somebody walks in the door, and they're interested, somehow, in investing in cannabis or getting involved in the industry in some way?
Richard: It's a funny thing that you ask because this happens to me almost regularly, which is the question I get is usually in some sort of backwards negative. "There really is no risk for me, if I do this, right?" I have to be very blunt and say, "Look, this is a risky industry. Not only do you have the risk of a bad investment [inaudible] but you have a risk of your freedom, and your property. If things really go sideways, and there's a political change, you are now aiding and abetting a federal crime, and you have to be really cognizant of that. You are also now putting your property at risk for federal seizure, if you don't do things properly, so there is huge risk. Now, as lawyers, we can help you mitigate that risk, but we can't eliminate it altogether. There is no silver bullet right now to eliminate those two risks."
I'm very clear about that. The last thing I want to have anyone ever come back to me and say is, "You said that I could do X, and now I'm in trouble." I am telling you, you mostly can't do X, and you can't do Y. You can't do Z. But there is a narrow path between those three letters that you can navigate to be as safe as you possibly can. The federal government has laws that allow for that kind of narrow path, but you have to follow it just with such discipline, and you have to just make sure that every time you turn your head, you're turning your head in the right direction.
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