Commercial Magazine

Hitting the Jackpot

The cannabis industry offers risks and rewards for commercial real estate stakeholders

By Bryan McLaren

When Arizona legalized the recreational use of cannabis in November 2020, few expected retail sales would go into effect a few months later. The Southwest state achieved one of the fastest regulated cannabis rollouts of any U.S. marijuana program and set a new standard for how to safely transition from a medical marijuana patient base to a broader consumer market.

More than a year later, Arizona offers some lessons on the impacts of legalization and how adult-use policy changes may play out in other cannabis markets across the country. All of this will impact the commercial mortgage industry and its ability to provide financing for these businesses.
The Arizona Department of Revenue reported that more than $1.2 billion was spent statewide on cannabis sales over the course of 2021. But this is likely to be only the beginning.
According to MJBizDaily, California’s cannabis sales rose to more than $4 billion in 2020 while Colorado’s topped $2 billion. Total sales for 2021 were still being counted as of this past January, but they were expected to eclipse 2020 numbers.

Vertically integrated

Prior to cannabis legalization, Arizona had established itself as a leader in the medical marijuana economy — and a wise investment for industry stakeholders. Unlike an open cannabis market with unlimited operational licenses, Arizona is a closed market with a cap on the number of available licenses. The number of dispensaries has been capped at roughly 130, or about one dispensary for every 10 pharmacies in the state, according to cannabis technology provider Cure8.

Today, the residents of 47 states and the District of Columbia have access to some form of cannabis, including recreational use, medical use or CBD oil products.

A majority of the state’s marijuana licenses are vertically integrated, which allows a single license holder to cultivate, manufacture, process and distribute cannabis through dispensary sales. Being limited, these lucrative licenses became even more valuable with the advent of legalization. This market also became more desirable to investors, as reflected by further merger and acquisition activity — including the $211 million purchase of Bloom Dispensaries by Curaleaf Holdings Inc., a leading multistate cannabis operator.
The impressive growth rate of Arizona’s cannabis industry has resulted in an influx of commercial development projects as well as more traditional capital investments. The industry’s expansion has led to expectations of major real estate developments and investments, which would mean an increase in business for mortgage originators and lenders that work with the nascent cannabis industry.
Another attractive aspect for investors has been the opening of off-site cannabis manufacturing and cultivation sites in Arizona. These licenses require a smaller investment in comparison to acquiring a vertically integrated license, which are now valued in the range of $15 million to $20 million.

Economic power

Today, the residents of 47 states and the District of Columbia have access to some form of cannabis, including recreational use, medical use or CBD oil products. Eighteen of these states have adult-use markets that allow marijuana sales to individuals 21 or older.

Until there is federal reform of the banking laws, traditional loan providers won’t be able to interact with the cannabis industry.

Legal cannabis sales across the U.S. increased by 48% from 2019 to 2020 to reach $21.3 billion, according to the National Cannabis Industry Association. Estimates for 2021 place last year’s total sales in the neighborhood of $37 billion. According to MJBizDaily, the overall economic impact of the marijuana industry (including tourism, real estate activity and tax revenue) is estimated to rise to as much as $130 billion by 2024.
The industry’s economic power is only expected to grow now that the states of New York and New Jersey have legalized recreational use. They are expected to generate multibillion-dollar sales revenues in a span of a few short years after implementing their programs.
Part of this economic impact involves commercial real estate associated with the cannabis industry. Real property has always been a sound investment and even though cannabis has some risk, it brings greater rewards.

Cannabis real estate

As the cannabis industry continues to grow, companies are expected to buy an increasing amount of commercially and industrially zoned properties in markets where these products are legal. Business owners will look to expand their grow operations, storage facilities and dispensaries.
Beyond a rise in property acquisitions, mortgage lenders and brokers should be aware that there may be additional investments in facility upgrades and expansion projects. Many retail businesses moved away from brick-and-mortar sites during the COVID-19 pandemic, but cannabis dispensaries saw some of their largest sales increases during the height of the health crisis.
Many cannabis dispensary owners are now rethinking their retail environments to meet consumer demands. Drive-throughs are one of the newer trends that offer efficient pickup and enhance contactless shopping options. VIP rooms and one-on-one consultation areas also are being added to enrich the retail cannabis experience.
It requires significant capital to retrofit these facilities with new service designs while also meeting compliance standards and zoning regulations. Arizona development projects are expected to exceed $100 million for a single facility in the adult-use era. This number more than doubles the $40 million capital investment on one of the largest medical marijuana projects in the state.

Banking troubles

Despite the phenomenal growth, there are major hurdles to entering this industry. This starts with the problem that traditional commercial financing is in short supply for cannabis projects, with the exception of a few lenders in each state that may be willing to take a chance. This is due to federal laws that recognize cannabis as a Schedule 1 narcotic. Banks that provide services to cannabis businesses could be subject to criminal charges and penalties.
In the past, much of the capital to develop these operations originated from cannabis real estate investment trusts (REITs). More recently, private capital has begun to invest in tangible cannabis-based assets, primarily commercial real estate projects. For loan originators or servicers, the most common cannabis real estate financing scenarios occur when an existing client adds a cannabis project into their portfolio or acquires a large portfolio that includes a cannabis project.
Until there is federal reform of the banking laws, traditional loan providers won’t be able to interact with the cannabis industry. Cannabis REITs are doing so well because they are currently the largest source of capital for this type of real estate. When cannabis becomes legal on the federal level, much of this could change.
These issues — when paired with an industry that is evolving in real time with new rules, regulations and codes being created at the state and local levels — can make many prospective stakeholders wary. Those that are well prepared, well financed and properly positioned to mitigate the risks, however, will be able to build the right brain trust to find success.

Industrial upgrades

In addition to investments in new brick-and-mortar retail services, cannabis also is driving community improvements in urban and rural areas. Operators are investing significant resources to repurpose and update underutilized or derelict industrial properties to get the space they need within compliant zones.
This flurry of cannabis real estate investment and development has had a positive community impact in multiple ways. Adult-use markets have benefited from generous cannabis tax revenues, allowing state governments to better provide for their communities through improved public services and infrastructure.
Green Thumb Industries, one of the nation’s largest cannabis companies, agreed last year to build a large cultivation and processing facility in Warwick, New York, in return for receiving tax abatements and other incentives worth up to $30 million. This is an example of “big cannabis” spending its own money when traditional capital is not an option. This is considered a large-scale project.
The cost of cultivation and manufacturing projects varies greatly around the country, with small operations going for less than $1 million. Retail projects typically have a price tag of $500,000 to $3 million to develop. When traditional financing becomes available, commercial mortgage originators will need to seek cannabis real estate experts to improve the underwriting process in a unique and challenging industry.
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Although cannabis real estate poses risks and uncertainty, it is undoubtedly one of the top property sectors to watch in 2022 as the U.S. moves closer to potential federal legalization. The States Reform Act, a Republican-led initiative to legalize cannabis at the federal level that was proposed by U.S. Rep. Nancy Mace of South Carolina, is paving the way for bipartisan marijuana reform.
The act creates a federal regulatory structure that is molded to state systems already in place. It would treat cannabis much like other traditional industries under federal regulatory oversight, such as agricultural, retail and pharmaceutical businesses.
Only time will tell if these benefits and trends will continue, but for the moment, Arizona offers a window into what is possible. The state has differentiated itself from other contemporary legal-cannabis markets with its swift adoption and implementation, boosting its industry reputation and positioning itself alongside well-established, powerhouse markets such as Colorado and California. ●


  • Bryan McLaren

    Bryan McLaren is chairman and chief executive officer of Zoned Properties, a strategic real estate development firm for emerging and highly regulated industries. McLaren has accrued over a decade of experience in social, economic, and environmental development of complex business organizations. As a certified and licensed Realtor, Green Roof Professional, LEED Green Associate, and former city sustainability commissioner, McLaren provides compliant real estate, zoning, permitting, and operational expertise to Zoned Properties and its clients.

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