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What Investors Need to Know Before Entering the Cannabis Real Estate Market

Cannabis-related industrial real estate offers investors a new opportunity with lots of profit potential. But investors need to understand the risks before moving forward.

With 10 states plus the District of Columbia legalizing cannabis for recreational use and medical marijuana legal in another 23 states, cannabis sales are projected to grow from $10.8 billion today to about $100 billion over the next five years, according to the National Institute for Cannabis Investors.

As a result, investors in cannabis-related industrial real estate can expect exceptional returns on investment (ROI). In a 2018 survey by Denver-based PropTech developer Apto, 76 percent of commercial real estate brokers handling cannabis deals in all states where the drug is legal in some form reported cannabis deals pricing above market.

Cannabis property deals may be more lucrative than other industrial transactions, but they are also more complicated, according to survey respondents. When asked to compare the difficulty of cannabis transactions with traditional industrial deals, they answered with an average of eight on a scale of one to 10, with 10 being “most difficult.” Even so, 85 percent of brokers surveyed said they are willing to do more cannabis deals.

Investors willing to take a property through local licensing and entitlement processes prior to putting it on the block or leasing space will realize the greatest boon in value, however, because there is a limited number of opportunities in any location, according to Rick Frimmer, managing director and head of the national cannabis advisory group at EisnerAmper, an accounting and advisory firm based in New York City.

Cannabis real estate values are likely to continue rising due to the supply-demand imbalane, says Clint Callan, a Bay Area-based partner at the national law firm of Duane Morris LLP. “With cannabis, there are only so many spaces and opportunities available, which runs up the price,” he adds.

When asked how well the supply of industrial cannabis real estate in their market aligns with demand for space, respondents answered with an average of four on a scale of one to 10, with one being “not in balance” and 10 being “in perfect balance.”

Commenting on survey results, Apto founder Tanner McGraw says that legalization of marijuana across more states is beginning to impact real estate markets, as local jurisdictions grapple with zoning and other issues that affect availability of sites. “Survey results suggest there is somewhat of a shortage of sites available, likely because allowable zoning has not caught up with demand,” he notes.

Local jurisdictions may limit zoning for cannabis uses to specific industrial areas and impose strict security, fire and safety requirements for cannabis operations, because cannabis products are at high risk for theft and manufacturing processes use chemicals to extract compounds, such as THC and CBD oil, according to Frimmer.

In California, for instance, securing a local cannabis license is more important than a state license, as the state offers unlimited licensing for cannabis production, while local jurisdictions limit the number of local cannabis licenses and locations allowed.

An example is San Diego, which has a population of nearly 1.5 million, but only offers 40 cannabis licenses for production facilities (growing, manufacturing or distribution and storage), 13 of which have already been issued. In addition, the city restricts operations to industrial zones in the Sorrento Valley-Miramar area in northern San Diego and Kearny Mesa, a district about 10 miles east of downtown.

Cannabis production and dispensary facilities must also be located at least 100 feet from residential neighborhoods and 1,000 feet from sites or facilities frequented by children or minors, including city parks, schools, churches, childcare centers, playgrounds, libraries, and residential care facilities.

Under federal law, cannabis is still a Schedule 1, illegal drug, which makes cannabis real estate risker than other industrial uses. It also further diminishes space availability for cannabis operations, according to Callan. He notes that master leases for industrial assets often prohibit cannabis uses, particularly if the master landlord is an institutional investor.

The illegal status of cannabis presents other challenges for investors as well, he adds—banks, which are federally insured, and institutional lenders will not finance cannabis real estate acquisitions or construction projects. As a result, all cannabis real estate deals require cash upfront or private lending sources, such as family office investment funds.

Additionally, few insurers are willing to insure cannabis real estate or provide title insurance, Callan adds, noting that only one company in California offers title insurance for cannabis real estate assets. “Orange Coast (Title Company) is the only game in town and is probably making a killing,” he says, suggesting that once the Congress legalizes cannabis, “others will scramble to catch up.”

Local jurisdictions may also impose equity requirements for obtaining a cannabis license, according to Callan, who says that San Francisco is a prime example. To level the cannabis playing field and lower barriers to cannabis licensing, the city established a Cannabis Equity Program.

This program is aimed at protecting local cannabis cultivators, who may have been growing pot illegally for years or started in medicinal marijuana, but lack the financial resources to go legal or expand production output for the recreational cannabis market, Callan notes.

The program allows verified equity applicants, which must meet an income threshold, to obtain a cannabis permit without paying the $5,000 license fee and offers them incubator partnerships with established cannabis businesses.

To obtain a cannabis business permit, cannabis growers from outside the Bay Area must partner with a verified equity applicant to serve as a cannabis incubator, which means they must provide the equity partner support in the form of free operational space or technical business assistance, “This is a symbiotic relationship that essentially provides the equity applicant a financial backer,” Callan says, noting that the partners must formalize the relationship with an agreement that meets the city’s Equity Incubator Rules.

Frimmer also offers a bit of advice for investors considering entering the cannabis real estate market: Before even starting a property search, employ a team that includes a real estate broker, attorney and accountant with knowledge and experience in handling cannabis transactions in the market where you plan to invest.

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