High Times, Low Times

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.