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   ARTICLE   |   From Scotsman Guide Commercial Edition   |   April 2015

Are Lenders Ready to Cross the Line?

Despite legal risks, jumping early into marijuana business lending could pay off

Are Lenders Ready to Cross the Line?

With recreational marijuana available in four states — two of them, Oregon and Alaska, newly arrived on the scene as of 2014 — and medical marijuana available in another 23, there appears to be a gold rush developing in the U.S. centered around the drug. But with marijuana being illegal at the federal level, there are still big drawbacks to investing in the industry.

The question now is whether lenders will cross the line and take a chance on a potentially lucrative opportunity despite the potential that the federal government could step in at some point in the future and take action against clients, thus impacting their ability to repay loans. Lenders and brokers interested in partaking in the legal marijuana business will need to find ways to guard their businesses legally and financially.

The top issue around banking and the marijuana industry is federal law. Marijuana is illegal under federal law, although top law enforcement officials have stated they will not meddle in the marijuana trade in most circumstances. The U.S. Department of Justice (DOJ) issued a memo to that effect in 2013 stating, “The Department makes clear that marijuana remains an illegal drug under the Controlled Substances Act and that federal prosecutors will continue to aggressively enforce this statute. To this end, the Department identifies eight enforcement areas that federal prosecutors should prioritize.” Those eight enforcement  areas include not selling to minors, keeping gangs and cartels out of the business and stopping large-scale interstate trafficking.

Risk of prosecution

There is a definite risk of federal prosecution for  lenders or banks if they — even unknowingly — assist an unscrupulous marijuana business. That DOJ memo and another from the Financial Crimes Enforcement Network provides guidance to lenders on how they can work with marijuana businesses, but these memos do not give reassurance that the feds will not prosecute them.

To many in the marijuana industry, having an actual bank account is a closely guarded secret and a competitive advantage. Unfortunately, the sentiment among many mainstream banks is that they will avoid the industry barring a change in federal law.

“The only real solution is an act of Congress, which isn’t likely in the near future, although it is needed,” said Don Childears, CEO of the Colorado Bankers Association, in February 2014. “Put simply: banks need the permanence of law versus changeable guidance.”

The absence of traditional banking leaves a void in the marijuana industry. These businesses need checking accounts, and they need credit to build grow houses and retail stores. So far, private hard money lenders are providing a majority of credit. Those lenders are typically privately funded, do not have bank charters and can make loans that do not fit traditional guidelines. The current focus in the marijuana industry is on real estate at the moment, as they need first mortgages on commercial properties.

Political and practical issues

Aside from federal prosecution, there are numerous political and practical concerns lenders should consider before experimenting with the marijuana industry:

  • Property values: Space for marijuana businesses is tight. In Colorado and other states, marijuana businesses are usually located in industrial areas. Industrial properties have the necessary heavy-duty utility connections and meet zoning requirements that often require marijuana businesses to operate away from churches and schools. As a result, demand for industrial properties has been insatiable. Industrial properties in Colorado are leasing for triple the amount a normal tenant would pay, and sometimes selling for double. Those expensive leases might be unsustainable as the industry matures and supply floods the market.
  • Federal political changes: Because marijuana  is still a controlled substance, future federal law  enforcement officials might suddenly reprioritize enforcement and shut down the industry. Congress or future presidents also might choose to reprioritize enforcement and try to supersede state laws. Conversely, a future president or Congress might decide to legalize marijuana.
  • Local regulations: Just because marijuana is legal in a state doesn’t mean it is welcome in every city or town there. Some local governments in Colorado and Washington have tried to ban marijuana farms and stores. In Oregon, where voters approved  recreational use this past year, some cities are already passing moratoriums on marijuana businesses.
  • States fighting states: Earlier this year, law enforcement officials in Nebraska and Oklahoma attempted to sue Colorado to void its marijuana law. The plaintiffs claimed that marijuana was flooding into their states, driving up law enforcement costs. The plaintiffs filed the suit in U.S. Supreme Court, which means a decision could have repercussions for marijuana legalization across the U.S.

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It is no surprise that marijuana legalization took hold out west first (California was the first state to allow medical marijuana). The marijuana industry is wild with possibilities and pitfalls. This new marijuana gold rush could draw investors looking to make a profit, but like other gold rushes, the vast majority will break even or lose money, and only a few — typically those who cross the line and take a chance early — will get rich from the venture.


 
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