Publications

- June 1, 2017: Vol. 4, Number 6

How to Invest in Cannabis

by Barbara Halper

Commercial real estate professionals and investors are taking advantage of the opportunities being created by the legalization and growth of the cannabis market. Legalized cannabis businesses have created a new market of tenants and increased demand for properties specific to cannabis operations.

Eleven states passed significant medical or recreational cannabis measures in 2016. While lawmakers in those states are drafting rules to provide for the launch of cannabis businesses, it is anticipated that at least eight of those states will start sales in 2018. The Canadian government has made it clear that it will be universally supportive of medical and recreational cannabis across its provinces. Canada’s financial institutions and securities market have also supported this movement.

According to a report by Arcview Market Research, North America’s cannabis sales grew to $6.9 billion in 2016, up 34 percent from 2015. Marijuana Policy Project, a nonprofit focused on promoting cannabis policy reform, estimated that as of January 2017, 1.4 million people used or were registered to use legalized medical cannabis. With the increased number of states legalizing recreational use and the increasing number of medical conditions for which medical use is allowed, the demand will increase exponentially. With voter pressure and user demand increasing, there is realistic anticipation of accelerated development of U.S. markets.

Although there are daily news articles and social media postings warning the U.S. cannabis sky could fall at any moment because of enforcement of federal law, the alarms are fading with each passing day because demand for cannabis production and the revenue it produces make elimination of this vast new industry politically untouchable. The medical benefits from cannabis have been substantiated. In addition to medical use, recreational use is being legalized by an increasing number of states. The reality is there is a lot of money to be made by the government, business owners and real estate investors from the legalization and growth of cannabis businesses. In the face of government debt and deficit spending, the taxes and fees generated by federal, state and local governments are hard to turn away.

To share in the profits from the legalization of cannabis, investors and entrepreneurs have escalated their investment in real estate that is suitable and in demand by cannabis-related tenants. Many would-be competitors for those real estate properties have made themselves irrelevant as they sit on the sidelines and ponder the risk of federal intervention versus the rewards of financial participation. What do the active investors know that they don’t?

With states and municipalities limiting the geographic areas where cannabis companies can operate, there has been a growing demand for properties zoned for cannabis businesses. According to CBRE research, in Denver in 2015 cannabis growers and manufacturers accounted for at least 3.7 million square feet of occupied industrial space. That space was primarily class B and class C warehouse space because Colorado required cultivation of cannabis to be done in enclosed spaces in areas zoned for plant husbandry. As a result, prices for the buildings in cannabis-zoned areas spiked with rent levels substantially escalated.

Fast forward to 2017. The types and uses of cannabis products have expanded. The products, systems and technology for producing and using cannabis have changed and increased. Industry growth has directly impacted the number and types of properties in demand for cannabis production and distribution. That impact drives the development of new properties as well as repurposing existing properties. As an example, commercial growers have added large greenhouses to the types of facilities they are seeking. Jim Fitzpatrick, a former Costa Mesa, Calif., planning commissioner has stated that industrial properties in Orange County, Calif., have nearly doubled over the past 12 months in areas where cannabis businesses are allowed.

There is a strong market for cannabis tenants. With local ordinances regulating the structure and equipment for cannabis operations, license fees, state required cash reserves and the lack of the availability of bank loans, it is difficult for cannabis companies to purchase their own real estate properties. Those reasons also drive the demand by tenants for the financing of equipment, technology and operations, which creates another opportunity for real estate investors.

Flowhub, a technology company that offers platforms for retail and cultivation that automatically reports mandatory compliance data to state regulators, closed an oversubscribed $3.25 million Series A round of equity financing. BDS Analytics successfully completed investor fundraising of $2.1 million. Wurk, another technology company, raised $2 million to fund expansion.

In addition to direct real estate investments, cannabis real estate investments of varying types have become available to public and limited private investors through mainstream types of investments. These may be pooled direct investments or securitized investments, such as real estate funds. There also has been capital raised for cannabis-related companies in more broad-based investor channels such as REITs.

For example, in 2014 the Securities and Exchange Commission approved registration of shares for Terra Tech Corp., which, according to its registration statement, was seeking to raise funds, in part, to finance three majority-owned subsidiaries for the purposes of cultivation or production of medical cannabis and/or dispensary facilities in various locations in Nevada. Other REITs include Pre-Kalyx, which was incorporated in 2014 and is now known as Kalyx Development, a private New York–based REIT, and Innovative Industrial Properties, a publicly traded REIT on the New York Stock Exchange.

Innovative Industrial Properties targets medical-use cannabis facilities for acquisition, including sale-leaseback transactions, with tenants that are licensed growers under long-term triple-net leases. The REIT’s management says it believes the industry is poised for significant growth in coming years, and the firm is aiming to be a “creative capital provider” to the industry through the long-term ownership of cultivators’ facilities.

While states continue to legalize cannabis production and use, the federal government has been a holdout, maintaining that cannabis is still a Schedule I drug and therefore its sale and use is illegal except as specifically authorized. Although, strictly speaking, the sale and use of cannabis is a federal crime, there have been memos from the attorney general’s office providing recommendations for forbearance of enforcement except under certain situations. In its guidance to financial institutions, the U.S. Department of Treasury references the attorney general’s office restrictions, yet provides guidelines for financial institutions to service legal marijuana businesses. The SEC also has weighed in by issuing investor alerts related to cannabis investment offerings. However, the focus of the alerts was not on the illegality of cannabis investments, but rather on the sufficiency of disclosures and avoiding scams related to those offerings.

The shadow of the federal government over these investments appears to be thinning. What’s more, President Donald Trump ran on a platform of reinforcing state’s rights. There also has been post-election activity to modify or eliminate risk of federal action. In February, a bipartisan group of congressmen launched the Congressional Cannabis Caucus in order to develop a united front to promote the interests of the legal cannabis industry. Its goal is to bridge the gap between the federal laws prohibiting cannabis and the growing cannabis industry. This is in addition to a developing number of congressional bills that are designed to either modify or end federal intervention in the cannabis industry. While the demand for legalization is increasing, it is pushing the debate between states’ rights and the federal government. If that sounds familiar, substitute the word “state” with “colony,” and replace “federal” with “British.” Draw your own conclusions.

So, where are we today? All investments involve risk of loss as well as the potential for returns. In most instances, risk can be mitigated to some degree. For example, attorneys in the cannabis space have been developing lease provisions such as nullification of a lease upon notice by the federal government of action related to a tenant. Higher returns generally come with higher risk. In the case of cannabis, the financial rewards are driven by the documented medical benefits, the demands of U.S. citizens, and the undeniable tax revenue and economic benefits from a legalized cannabis industry. It is an opportunity not to be ignored.

 

Barbara Halper (barbara.halper@Decisionpointnow.com) is CEO of DecisionPoint Now.

 

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