Appetite Strong But Cautious for Cannabis Real Estate

The legalization of cannabis in California has been followed—and in some ways even preceded by—a rush of real estate investment to supply the new demand. However, while there is excitement and strong appetite for cannabis-related assets—which includes retail storefronts as well as industrial facilities for manufacturing—investors are also preceding with caution as the new asset class also poses significant challenges.

“Appetite is strong but cautious,” Seth Weissman, a partner at law firm Jeffer Mangels Butler & Mitchell, tells GlobeSt.com. “There are substantial challenges that can counterbalance some of the opportunities. First, cannabis uses are heavily regulated. These start at the land use level.  In many places, cannabis uses require a conditional use permit or other similar entitlements. Such CUPs can be saddled with numerous conditions of approval. Grow operations need a lot of power, so operators may need to upgrade their amperage. There can be substantial costs to build out appropriate space, including canopy systems.”

In addition to challenges prepping the physical building, there are also challenges concerning permits that can impact lease terms. “Operators also need to obtain local operating permits and a state license,” says Weissman. “These take time to obtain and are subject to substantial background investigation. Potential tenants do not want to commit to long-term leases without assurances that they will be able to operate. So the tenants seek options to lease, or leases with termination rights, and/or substantially reduced rent for the first 6 to 12 months.”

While landlords face challenges navigating this new use and understanding the operational and legal nuances, they can protect themselves against the risk of owning cannabis-related assets. “Landlord’s should seek some protection against tenant non-performance and/or bankruptcy, including guarantees and/or substantial security deposits or letters of credit,” adds Weissman. “There are also challenges transacting with tenants that still have trouble creating normalized banking relationships.”

Despite the challenges, there are still strong opportunities in the cannabis-use market. “From the landlord side, investors looking to take advantage of the cannabis marketplace see potentially higher rents for properties that are suitable for cannabis businesses,” says Weissman. “These include retail storefronts, but also industrial facilities that can be adapted for cultivation, extraction, manufacturing, distribution and warehousing.”

And, investors that can find properties in permitted areas are seeing strong rents and rent growth. “For properties that are located in areas that permit operations, rents are higher relative to other permitted uses and cap rates are lower, subject to the ability to obtain approvals and build out appropriate space,” says Weissman.