Warning: Don't Inhale That Cannabis Play

If you’re thinking of rolling your own cannabis play now that 19 states and DC have legalized recreational weed (and twice as many say medical weed is okay), think again.

A pure-play investor in retail weed dispensaries and purpose-built industrial cultivation facilities—what, you thought this stuff came from Yasgur’s farm?—delivered a buzz kill of a message at GlobeSt.’s annual Net Lease Spring conference in NYC this week: now is the time to keep your powder dry.

According to Anthony Coniglio, CEO of New Canaan, CT-based NewLake Capital Partners—dude, you need to put “no free samples” on your biz card—that weed dispensary play you got high on last night with visions of $600 per SF pricing, cap rates as high as 14% and 20-year leases with 3% annual bong hits may have you waking up tomorrow morning with a $75 per SF “alternative investment.”

If you didn’t do your homework on the most viable dispensary locations, you might find yourself stuck inside of Denver—where there are more weed dispensaries than there are McDonald’s and Starbucks franchises, combined—with those Morristown, NJ blues again.

Sorry, but it turns out that “anchor tenant” you bonded with over 28.9% THC-laced Kilimanjaro Sunset pre-rolls last night is as creditworthy as Artis the Spoon Man was at Woodstock—and he just traded his highly fungible dispensary license for the world’s last Yugo with a working engine and a fake NYC taxi medallion nailed to its hood.

The logistics carrier who was supposed to be truckin’ your product to your new national portfolio like the Doo Dah Man? He just got arrested in an 18-wheeler loaded with weed crossing the Missouri state line—because, according to federal law, that’s still akin to bringing a kilo of fentanyl or heroin across the Mexican border.

Coniglio, who has developed 32 weed facilities (evenly split between dispensaries and industrial cultivation facilities), gave us a sobering primer on the state of the cannabis market—a market that’s been nodding off in what he called “a nuclear winter.”

“It’s a very difficult time for the operators,” he said. “They’re not focused on expansion—it’s about optimizing cash flow.”

“The people in the sector, they piled on debt thinking rates were always going to go down. Now they have debt service 300-400 bps higher than where they were. Do you want to go sleep at night knowing your cost of occupancy has risen in the morning?” Coniglio said.

“[NewLake] probably has more available capital than anyone in the  sector, but right now we’ve really turned up the dial from a credit perspective,” he said. “There’s a short list of companies that we’d be comfortable with from a credit perspective.”

As in every other CRE sector, the rising cost of debt—in addition to prospective tenants who are smoking their own product—is inhibiting growth, even in states that are new to legal weed.

“There are some opportunities, but what we’re finding is they’re moving into these states in a much more muted way. So, you’re not seeing 15% yields as new states get turned on. The problem is raising equity capital that’s necessary to get them up and going,” Coniglio told us.

The weed sector is not for timid players (Coniglio said he relies on regional banks) and the risks are great, but so are the potential rewards:

“Mean average yield right now is 12.6%. If you’re going to do a deal today, you’re looking at a low-end cap of 11 and high-end of 14 with 2.5% to 3% annual escalators,” the NewLake CEO told us.

“Today, the cheapest we would consider doing is an 11% cap rate. Dispensaries would be a little bit less because the dispensaries tend to be closer to your alternative use value,” Coniglio said.

“If you need $600 per square feet for a dispensary and you’re getting a 10% or 11% cap rate and you need to pivot into an alternative use, you’re losing more than you would for an industrial location. For the retail space, the average (pivot) is $257 per SF,” he said.

Still want to play? Okay, chill and listen to the pure-play guru:

“Because the cannabis industry is subject to state and federal law, you have to replicate your real estate infrastructure in every state you go into on a state-by-state basis,” he told GlobeSt.

[The US government’s official position on the cannabis sector since Colorado voted to legalize it in 2000 is to “look the other way” and pretend half the country hasn’t gone to pot without decriminalizing weed. So you can’t transport weed across state lines, which is still a federal crime.]

Much of what is sold in legal channels is grown in purpose-built 100K SF cultivation facilities that need lots of power and water (not vertical farming—think medium-sized data centers, a farm with boxes of plants on the floor replacing racks filled with servers).

Because the industrial space needed to grow weed is large and expensive, prepare to devote 92% of your capital to developing it.

Pick your tenants and structure the deal carefully, making sure you can recoup your investment by converting the property if things don’t work out. Look at the tenant’s cash flow and ask yourself, will this company still be around next year?

Location is the most important part of your analysis of the deal, Coniglio said. You’ll need to examine the “ecosystem” for cannabis retail in each location you consider.

“In states like California, Oregon, Colorado and Washington, they’re giving out dispensary licenses like PEZ dispensers, literally thousands of them,” he said. “If you have a property in Los Angeles and your tenant goes out of business, anybody can go get a license, so why would anybody care about this property?”

You want to be in a state like New Jersey, he said, where you have to buy liquor in a liquor store (and you can’t pump your own gas) and the state has decided there will be a finite number of weed dispensary licenses—and only where the Garden State’s 564 municipalities haven’t exercised their home-rule right to reject them.

Or a city like San Diego, which has limited the number of licenses and is located between La Jolla and Pacific Beach, two communities that have banned cannabis sales. “With a much more limited number of licenses, there’s much less competition and better credit competence of clients,” Coniglio said.

“But with fewer licenses, there’s an intrinsic value of licenses in of themselves,” he added. “So, if your operator goes under they’re unlikely to give you the keys, but they’ll sell the license for a loss to generate the value for the license.”

Kind of like a taxi medallion.

“They still have lease obligations,” he said. “We won’t take licensing risks, so what we do is sell them back the property, turn the lease over to them. Or, we’ll work with them to find another location and we’ll swap that. We’ve done that a number of times.”