Finance Real Estate / 06.21.2019

Your State Has Legalized Marijuana – Now What? Analyzing Marijuana in a Financial and Real Estate Context

By Amanda Lauer

Marijuana Business FinancingWhile the legalization of marijuana has become a hot topic in the news – in both a medicinal and recreational context – little attention has been given to how this legalization is impacted by both the financial and real estate industries. As the trend toward state legalization continues to grow, states in which marijuana has not yet been legalized are carefully keeping an eye on its impact. But there are many behind-the-scenes factors that will determine how successful legalization will develop, both now and in the future.

Once a cannabis business is granted a license by the state to begin operating, the biggest hurdle it faces is financing. Banks are reluctant to lend funds to the cannabis industry due to federal regulations. As it currently stands, marijuana is still considered a Schedule 1 drug by the DEA. Schedule 1 drugs are those with a “high abuse potential,” that, in addition to marijuana, include heroin, LSD, ecstasy and “magic” mushrooms. Banks also take into consideration the risks and consequences of a marijuana-focused business, including the smell, theft potential, fire hazards and moisture issues. Once marijuana – in either a medicinal or recreational capacity – is legalized and a municipalities’ zoning laws permit marijuana-related businesses, the trending result is that the price of the land, warehouse and industrial buildings capable of housing such use skyrocket, making the start-up costs for a cannabis business even more pricey. Often, cannabis business owners find themselves needing to turn to private investors, including marijuana focused REITS. Alternatively, they may need to rely on help from applicable local governmental entities, in the form of TIFs and other tax incentives.

In considering how to finance their cannabis business, owners also need to consider whether it is more feasible to lease or purchase land. Not only do financing issues arise, but finding a suitable location for the business can be challenging in and of itself. Landlords are still working through the legal kinks of how to lease space to cannabis businesses without putting themselves in danger of violating federal laws. Specifically, if the property is encumbered by a mortgage, a majority of banks require language in the property owner’s mortgage that states that the property owner shall comply with all applicable laws and ordinances, including federal law, in connection with the mortgaged property. The federal “crack house statute” makes it a felony to knowingly lease or rent property for the manufacturing, distribution or use of any controlled substance. As mentioned above, marijuana is still considered a Schedule 1 drug. In the event that the bank discovers that the property owner has leased the mortgaged property to such a tenant, the bank – depending on the terms of the mortgage – may declare the tenant in default of their mortgage, and potentially demand payment in full of the funds advanced by the mortgage. This can lead to foreclosure of the mortgaged property if the property owner cannot pay the mortgage in full.

If a landlord decides to take the risk and proceed with leasing space to a cannabis business, additional problems may arise, especially if the space is in a multi-tenant building. The operation of the cannabis business itself within the building could potentially have a negative impact on the building’s other tenants.  The smell of marijuana, as well as customers coming and going and even lingering around the business, could give rise to complaints by other tenants. There are also considerations to take into account when a cannabis business is put into a building with other uses. For example, if a daycare and a cannabis business are in the same building, it could be detrimental for the daycare’s business and profitability. A cannabis business in a multi-tenant building could very well lead to those tenants vacating their spaces early or at the end of their lease terms, instead of renewing their leases. This would lead to vacancies in the building and a loss of profits for the landlord.

Although legalization of cannabis is a huge victory in a specific state for some, it also brings many hurdles that the cannabis industry has to overcome in order to thrive and even open for business. The cannabis industry is a risky business, given that federal law still prohibits marijuana in any context. Business owners starting off in the cannabis industry need to not only be aware of the potential downfalls of going into the cannabis business, but also of the potential for instant change in the industry depending on what, if any, new stance that the federal government takes on marijuana in the future.

If you have any questions, please reach out to Amanda Lauer at adl@kjk.com or 216.736.7231, or contact any of KJK’s Real Estate or Finance professionals.

 

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