High Times, Low Times

Brokers say the THC industry could benefit from state and federal government TLC.

The cannabis industry seems to be riding a groundswell of support. At last count, 37 states had legalized medicinal cannabis use and 21 had legalized recreational use. However, the industry faces significant headwinds, including a lack of access to banking and an uneven and lengthy licensing and permitting process. These dynamics, veteran commercial brokers report, have resulted in the most complicated and protracted deals of their careers.

Green Rush for Properties

With state or municipal law changes can come a mad rush by prospective tenants. That’s because most states require prospective cannabis operators to obtain a business address before applying for licenses and permits based on type of operation—cultivation, retail, and so on.

After Oregon voters greenlighted recreational marijuana sales in 2017, “We were inundated with hundreds of calls,” says Zach Francis, executive vice president of Kidder Mathews in Portland. “Some building tours were 20 people deep. It was chaos.”

One property owner went on a buying spree from 2016 to 2020 and purchased vacant warehouses near the Portland airport. “We did 15 to 20 deals and had buildings in escrow at double market rent before sales even closed,” Francis says.

Stephen A. Madigan initially represented clients in the cannabis manufacturing, extraction, distribution and laboratory testing sectors. When Costa Mesa, Calif., passed an ordinance in 2021 legalizing cannabis sales and delivery, “we jumped in and began representing dispensary tenants and owners,” says Madigan, senior vice president of Kidder Mathews in nearby Irvine. “There was competition for spaces and lease rates were driven up … and the cannabis tenants kept coming.”

“If you’re looking to acquire real estate for a dispensary, there will be bidding wars,” says Jason Piazza, director of real estate with WeCann in Santa Ana, Calif. Cities generally limit the number of dispensaries they will license, and this is the most sought-after license to originate in cannabis. WeCann, a full-service cannabis consulting firm that handles entitlements and licensing, has brokered nearly 100 deals valued at $150 million in the last five-and-a-half years and recently merged with CREC, a firm that has nearly an equal number of transactions. “We got our deals [in Costa Mesa] done early and negotiated a 50% premium on leases,” Piazza says. “By the time the application period opened, tenants and buyers were paying 100-plus-percent premium.”

WeCann was hired as the exclusive leasing agent for an old Barstow, Calif., outlet mall, with 23 buildings, 350,000 square feet, parking and a food court. Piazza describes the vibe as a ghost town or a set from the TV series “The Walking Dead.” “We had a vision for our client: ‘Let’s create a cannabis-centric mall with cannabis dispensaries, hemp clothing retailers, head shops, a cannabis museum.’ ” Several letters of intent were fully executed, and WeCann was ready to do leases when a last-minute cannabis tenant leased the entire campus, says Piazza.

Another WeCann premier listing, PowerPlant Park in Richmond, Calif., is an 18.8-acre cannabis campus, vertically integrated from seed to sale for cultivators or retailers. The megasite is slated to open in early 2023. WeCann has signed 18 leases and sales, using tenant-investor and tenant-grower models. This hybrid indoor mixed-light greenhouse model represents the future, says Piazza, where high-quality cannabis—containing 25% to 35% THC—can be purchased through drive-thru windows, allowing growers to sell directly to the consumer and realize better margins.

What If the Federal Government Legalizes Cannabis?

Kidder Mathews’ Zach Francis speculates that federal legalization of cannabis would make the price plummet (“a disaster”), and current tenants who are paying premium lease rates would have few options to renegotiate. On the other hand, federal legalization would allow interstate commerce, and states like Oregon and California with a five- to 10-year jump-start would “have a leg up” on other states. Christopher Stefan at Desarollo Real Estate and Cannabis Capital Advisors says federal reforms will increase the cash flow of the businesses and improve their ability to pay rent and their cap rates, multiple value and sale value.

WeCann’s Jason Piazza favors legalization but believes descheduling cannabis from a Schedule I drug to a Schedule III drug would have more immediate benefits. “That would open up banking and interstate commerce and do away with the 280E IRS tax code,” which he says hamstrings the industry and squeezes operators. As written, IRS 280E states, “No deduction or credit shall be allowed for any amount paid or incurred during the taxable year in carrying on any trade or business if such trade or business (or the activities which comprise such trade or business) consists of trafficking in controlled substances … .” The regulation “prevents any business involved in Schedule I and II from writing off business expenses after cost of goods sold,” says Piazza. A simple carve-out of 280E for legal operators would create profitability, he says. “We also need to incentivize the gray market operators to move into the legal market, and we need to get rid of the excise taxes and let mom-and-pop operators make money on the investment they made into legal cannabis. As it stands, the states and the federal government are punishing these people who are just trying to do the right thing.”

Burning Through Time, Money, Patience

Still, finding a suitable property isn’t easy—and earning a commission on a cannabis sale or lease can require time and patience.

The majority of property owners still won’t consider a cannabis tenant, says Francis. For those that will, you must be familiar with state and local restrictions. Oregon, for instance, doesn’t allow manufacturing and retail operations at the same address and limits the number of plants and canopy size at grow sites.

Costa Mesa’s ordinance includes a 1,000-foot buffer zone for sensitive uses, such as day care centers, homeless shelters, playgrounds and K-12 schools. In fact, most cities want cannabis in a zone, Piazza notes, which skews valuations throughout the commercial real estate sector.

Illinois legalized medicinal marijuana in 2014 and recreational use in 2020. Some Illinois communities quickly embraced cannabis; others rejected the concept. Communities and building owners think a dispensary “is a head shop” and will invite crime, says Deena Zimmerman, vice president with SVN Chicago Commercial, who has represented the medical dispensary space since 2014. “My job is to dispel their misconceptions,” she says. Neighborhoods are won over by “upscale security and aesthetics,” which Zimmerman compares to that of an Apple Store.

Landlords are realizing a dispensary is a great solution to backfill a space. Former banks and restaurants align with tenants’ need for 3,000 to 6,000 square feet. “This is no different than a Starbucks in terms of site selection,” Zimmerman says.

Recreational sales in the state were brisk until a Michigan cannabis cultivator filed a lawsuit challenging Illinois’ lottery-style licensing process, which awarded social equity licenses for groups impacted by the war on drugs. Deals stalled. Many would-be tenants hesitated to pursue properties until the lawsuit was dropped in 2021, Zimmerman says.

Even without legal challenges, getting a cannabis business off the ground takes time. Operators need the correct zoning, enough water and power for cultivation, and local permits. Indoor cannabis facilities require considerable capital outlays and power upgrades, usually at the tenant’s expense. Typically, Francis says, it takes a year to become operational and another six months to start making money. Consequently, tenants are signing long-term leases.

The process can burn through a prospective operator’s capital. So commercial brokers would be wise to vet potential tenants to ensure they have the financial wherewithal, says Christopher Stefan, principal at Desarollo Real Estate in Vail, Colo., and Cannabis Capital Advisors. Stefan, who negotiates the sale of cannabis business licenses and originates equities, says commercial brokers should seek qualified legal advice to ensure a tenant is both financially worthy and not engaged in illegal activity. Otherwise, “you might force [a deal] that hurts your landlord in the long run.”

And then there’s the matter of getting paid. Piazza reports waiting four years to receive a commission on early cannabis deals; he now negotiates commission payment terms into all deals. He lays blame at the city level—cities don’t hire enough staff to process applications or evaluate manufacturing plans. “The licensing process for cannabis is a joke,” he says. “They have made this process so difficult and lengthy that deals just die.”

None of Zimmerman’s recreational-use clients have opened a retail dispensary yet as they are still in various stages of the required process. But she hasn’t let the bureaucratic hurdles get her down. Her clients include Blounts & Moore, a group of Black professional women featured in Rolling Stone magazine in 2021 for their vision of being the first Black-owned cannabis business operating in multiple states. Zimmerman says she’s “thrilled” to have advised and assisted the group with site selection for two years.

Excess Supply, High Tax

Despite the activity that follows cannabis legalization, brokers who specialize in this market say they’ve seen a marked slowdown in business as cannabis businesses struggle to make a profit.

During the pandemic, cultivator-operators were considered essential workers, says Madigan. “I thought it would jump-start the industry.” Instead, he observes, there’s an oversupply of product, which cannot be sold across state lines, and “the price has plummeted.” Some growers have resorted to burning their harvest in the state. “Demand is there,” Madigan says, but he believes “people are buying it black market,” which is a market undertow in California.

“We have a massive oversupply of cannabis flower as it relates to legal shelf space,” agrees Piazza, “because cities haven’t embraced retail, but allow unlimited cultivation, manufacturing, distribution. … It doesn’t work.”

Cannabis produced indoors sells for $700 to $1,200 per pound, but costs about $700 to $800 per pound to grow. The margins are worse for outdoor-grown cannabis, says Piazza. “Farms are failing, and nobody will buy.” Again, Piazza says government is the problem. “The consumer is being forced into the illegal cannabis market, because of inflation and state and local excise taxes,” he says. For example, the 7% excise tax in Costa Mesa plus state sales and excise taxes amount to a 30% levy for purchasers.

Desarollo Real Estate’s Stefan observes that in states without license caps—California, Colorado, Oregon and Oklahoma, to name a few—“inevitably it’ll lead to oversupply and business and tenant failures.” California has issued more than 12,000 cannabis licenses; facilities are issued non-conveyable licenses, and individuals then obtain a license to operate at a site, resulting in rent payments on vacant buildings. Cap rates—typically in the mid-teens but as high as 20—are indicative of the risk in the sector.

All this can spells trouble for property investors hoping to cash in on legalization. One property owner recently reached out to Madigan for advice on how to collect late fees. Another buyer of a leased investment told Madigan he hadn’t received rent for three or four months. All this raises the specter of how a broker re-tenants a C1D1 laboratory built out to make edibles and extraction products, upgrades that are useless to a conventional tenant. Stefan reports seeing an increase in distressed sales of businesses or tenants walking away, and new tenants simply signing a lease with the [owner] without paying for the license or assets. “It’s becoming more frequent.”

Zimmerman praises what she calls “Illinois’ thoughtful approach” to licensing. The state has granted fewer than 200 retail dispensary licenses and allots 25 percent of cannabis tax revenues to communities harmed by disparate enforcement of drug policy. The industry generated a $1.5 billion windfall in tax revenue from adult-use sales in fiscal year 2022.

She is confident the SAFE Banking Act will pass and remains optimistic about the cannabis sector. Cannabis legalization, she says, “has been really good for the state.

SAFE Banking Act

At press time, Congress was considering action on the Secure and Fair Enforcement Banking Act. The bill would make it possible for cannabis businesses to work with federally insured financial institutions by prohibiting federal banking regulators from penalizing those financial institutions that serve legitimate cannabis-related business. Because current law prohibits the possession, distribution and sale of cannabis, holding monies in a federally insured institution that can be traced back to a state marijuana operation could be considered aiding and abetting a federal crime and money laundering. The National Association of REALTORS® supports passage of the SAFE Banking Act. “Denying these businesses and the businesses that provide them with goods and services, including real estate professionals and property managers with cannabis business clients, access to national banks presents significant challenges both to the businesses and the communities they are in,” says Erin Stackley, NAR director of commercial and policy oversight.


Marijuana Terms

  • Cannabis (Marijuana): Dried leaves, flowers, stems and seeds from the cannabis sativa or cannabis indica plant.
  • Cannabidiol (CBD): Nonaddictive active ingredient in the hemp plant; does not cause a high. Available as oils, extracts, capsules, patches, vapes and topical skin preparations.
  • Dispensary: A store that can legally sell cannabis products—either medical, recreational or both.
  • Hemp: This variety of cannabis is grown for its seeds and fiber and contains minute amounts of THC.
  • Schedule I drug: Drugs, substances or chemicals that the federal government deems to have no currently accepted medical use and to have a high potential for abuse. Schedule I drugs include peyote, heroin, LSD, marijuana (cannabis) and ecstasy.
  • THC: Psychoactive compound in marijuana that causes a “high.”

Sources: National Environmental Health Association and the Drug Enforcement Administration

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