What risks should investors be aware of as they consider cannabis retail sites?
By: James Schaff, President & Cliff Hockley, CPM, CCIM, Principal Broker, and Senior Advisor
Bluestone and Hockley Real Estate Services
SVN | Bluestone and Hockley
Are cannabis grows, or cannabis retailers good investments? Potentially they are, but they carry risks that more traditional uses do not, and it is important to evaluate the full risk profile of the property. These include banking and lending risks, insurance costs, and issues in dealing with the physical environment and co-tenancy. Buildings with tenancies that involve Cannabis have been trading at a significantly higher cap rate to attract investors. Should some or all of the risk change as laws evolve, there may be significant variations on the available returns.
Demand for legal cannabis increased markedly over the recent past, as evidenced by the increase in Marijuana tax revenues collected by the Oregon Department for Revenue from FY 2016 of $20,652,983 to $178,262,488 in FY 2021, representing an 863% growth in tax revenue over a 5-year period. (1) That being said, a recent article by Peter Danko in the March 9, 2022 edition of the Portland Business Journal has indicated that the retail price of Cannabis has dropped due to the oversupply in the cannabis market.
The demand for the products is likely to continue to increase as society accepts cannabis use. An indication of the acceptance of cannabis by mainstream society are the new laws passed to make the ownership and use of cannabis more flexible (i.e., Oregon HB 300 and SB 408).
Beginning January 1, 2022, consumers can buy two ounces of usable marijuana — up from one ounce. Edible concentration limits increased from 50 mg THC to 100 mg per package as of April 1, 2022 and single-serving portions of no more than 10 mg THC will need to be scored to make the portion sizes obvious. In addition, home delivery will now be allowed across city and county lines if local authorities approve of it. Previously, delivery was limited only to the city or county where a cannabis retailer was located.
What does this mean to real estate investors? It means that users will be able to buy marijuana online, retailers will feel additional pressure and growers may be able to broaden their markets.
The Current Situation
Starting with Colorado in 2012, the sale of marijuana was made legal on a state-by-state basis in the below states. Over the next few years several states followed suit and now retail marijuana could be available in Vermont in the fall of 2022 and the District of Columbia as soon as August 2022.
However, the sale of marijuana is still illegal on a federal basis. In other words, it is illegal to send, sell or carry marijuana from state to state.
The current list of states with legal marijuana include:
- Washington, D.C.
- New Jersey
- New York
- New Mexico
This list reflects significant growth in the legalization of the use of Cannabis over the last twenty years.
What are the threats to the industry?
Currently, the Regulatory threats on a federal level are the most challenging. Cannabis companies cannot work with federally chartered banks, struggle to obtain insurance and are basically a cash industry, with the risks associated therewith. This makes it difficult to operate and grow a business.
Costs are two to three times greater when cannabis is involved. In addition, many insurers do not underwrite properties with cannabis ownership or tenancies, which means that the quality of the insurers may be spotty. Most of the mainstream companies have prohibitions against cannabis refiners, retailers, and producers.
Most FDIC-insured institutions will not take deposits from tenants that produce or sell cannabis-related products. Cannabis tenants have a very hard time maintaining bank accounts. To comply with federal regulations some banks are even monitoring direct debits, such as ACH transactions from a website that facilitates the sale of cannabis. In one case, this monitoring triggered a bank to close all of the cannabis company’s business accounts. This ultimately led to the tenant being late with their rental payments due to difficulty in depositing checks from their customers. The question is how far removed do the deposits have to be? Many conservative institutions consider rent from Cannabis tenants to be drug money and will not accept the deposits.
Loans Available to Buy Buildings with Cannabis Tenants
Most banks will not finance real estate purchases where a cannabis-related tenant is involved. But we have not only identified a bank and a credit union, but we have also identified an escrow company that will close a real estate transaction with cannabis tenants. This is a huge step, if you can get the insurance as well to close the deal.
Growers Require Significant Oversight and and Power
Growers tend to have a do-it-yourself approach to buildouts. Permits and safety may not be paramount because they are hard to get. Motivation exists to get permits at lease inceptions, not so much as renovations need to occur to adjust to changes in operations, to adjust to security, humidity, and high heat environments.
Retail operations and grow facilities tend to capture and expel the smell of the cannabis. In retail and grow settings with neighbors nearby, the spaces need to have additional air filtration/sealing to contain the smell in the suites. Most neighbors simply don’t want to be next to that smell regularly. It can impact leasing of space adjacent and sometimes the entire building. Grows are especially fragrant when the plants bloom.
A lot of national tenants as well as property owners do not appreciate cannabis stores as part of a property’s tenant mix. Many national tenant leases have clauses that prohibit cannabis-related tenants from occupying retail centers that they occupy and/or avoid locating in properties with cannabis sales or production.
Who are the owners of Cannabis-related businesses?
The business attracts different types of operators such as:
- Very sophisticated operators, who are trying to be on the ground floor of an industry that they perceive as having a lot of growth/promise, generally backed by significant capital, and may even be public companies (i.e., primarily on the Canadian Exchange);
- Small business people that believe that they can make money quickly;
- The people who are just into cannabis and may have operated in the illicit side of the business before moving to the legal side. For these people, financing is questionable, they don’t have a solid capital base or secure banking relationships.
Growers seem to currently suffer from an oversupply of cannabis. This economic condition of “oversupply” is making it difficult for many of them to survive, particularly in the fall when the outdoor grows have been harvested through January. With the current supply/demand imbalance, it appears that some of the “legal” crop disappears into the black market.
This phenomenon may be good for the retailer and bad for the growers. In 2022 the oversupply of cannabis has been particularly pronounced. This has created challenges for growers and processors who seem to be falling behind in rent.
Fundamentally real estate that is leased to businesses that sell or grow cannabis is still a risky investment. If you buy a property with a cannabis retailer, a manufacturer of cannabis edibles or a grow, you need to understand the market, the players, and ensure that the tenants can withstand a downturn, like any other business.
In some cases, Cannabis production and sales attract those that want to make a quick buck or enjoy their inventory and may not be the best tenants. On the other hand, the growth in state marijuana tax revenues shows there is huge demand for medicinal and recreational use and the derivatives (CBD) have become very mainstream.
If the legal and social perception of cannabis sales and growth continue to change rapidly, there is a chance that above market returns could be achieved by investing in these assets now. Just be cautioned that with excessive return potential comes risk.
(1) State of Oregon: Government & Researchers – Oregon marijuana tax statistics