Throughout 2018, we have discussed the implications of the legalization of marijuana on the real estate industry. In this final year-end edition, we provide a few important considerations and recommendations for property owners, landlords and tenants when purchasing or leasing green property.
1. Location, Location, Location
As with any type of real estate investment, location is key. Before the property hunt commences, it is important to first establish your business use and work backwards. Growers and cultivators will want to look for property located in more rural areas, while industrial locales are more ideal for processors and distributors. To foster high-volume sales, retailers will likely want property in commercial areas with dense populations. Another important consideration is the local work force and the unemployment rate. The ability to decrease the unemployment rate in a community will give you leverage in seeking the city’s approval for your project.
2. Do Your Due Diligence
Whether owning or leasing the property, conducting thorough due diligence is imperative. Cannabis comes with unique considerations in terms of easements, covenants, conditions and restrictions, and other title encumbrances, which may prohibit violations of laws, water use rights and zoning restrictions. Neighbors and surrounding areas should also be taken into consideration. Although the majority of Americans support the legalization of marijuana, they nonetheless do not want it in their backyard.
Due diligence should also consist of consulting third parties who have a stake in the property. If the property is subject to a loan, a landlord and tenant should review the loan’s security instruments, which may prohibit cannabis-related uses or require the borrower to comply with all state and federal regulations. (Remember, federal law still disfavors all aspects of cannabis development and distribution.)
3. Just Say “No” to Forms
With respect to cannabis commercial leases, a key for success is ensuring that your property is tailored for its intended use, yet is flexible enough to compensate for the turbulent legal environment.
Landlord and Tenant Recommendations. Leases should be custom-tailored to the specific type of cannabis business. Form leases, while seemingly convenient, will ultimately result in more time and money down the road.
4. Compliance with Law Provisions
Because cannabis is an illegal drug under federal law, boilerplate clauses that require a cannabis tenant to comply with all laws put the tenant in default from the outset.
Tenant Recommendation. The compliance with law provision in the lease should require compliance with all state and local laws, with a specific carve-out for inconsistent federal law.
5. Use Provisions
If the permitted use is not clearly defined under the lease, a tenant runs the risk of its cannabis-related activities resulting in a default under the lease. A landlord will also want to ensure that the tenant is limited to a defined scope of cannabis activity.
Landlord and Tenant Recommendations. Permitted use provisions should identify the specific activities that the tenant will be conducting on the premises. Will the premises be used for cultivating, processing, transporting or selling marijuana?
What type of marijuana—medicinal or recreational? Or will the property be producing a by-product of marijuana, such as oils, resins or hemp? These are all questions that both parties should consider in tailoring the use provisions of the lease.
6. To Share Profit or Not to Share Profit
In commercial leases, it is common to see rent arrangements that require the tenant to pay a percentage of its profits as part of the tenant’s monthly rent.
Landlord Recommendation. Because the tenant’s profits are linked to cannabis sales, by taking a portion of the tenant’s profit, the landlord can be exposed to liability for cannabis activity as a de facto owner.
7. Expect High Costs
Marijuana cultivation requires an extraordinary amount of water and electricity, and unique environmental control systems, which often means that such tenants will increase utility expenses and also engage in expensive build-outs and alterations.
Landlord Recommendation. In a multi-tenant building where a cannabis tenant’s utility expenses will disproportionately increase common operating expenses, a landlord must account for this and adjust the cannabis tenant’s proportionate share accordingly. The lease should also be clear as to which party is responsible for the costs of installing and removing tenant improvements. Landlords should also consider lease provisions that prevent any tenant improvements that might result in liens filed against their property.
8. Access and Inspections
Many states have strict rules governing when and who may enter onto a marijuana licensee’s premises, and as such, unfettered access by a landlord may raise problems in California and any other state with similar requirements.
Landlord Concerns. Landlords will want to protect their right to inspect a marijuana premises to ensure that tenants are complying with the applicable use provisions of their lease, are not damaging the premises, and are operating within the confines of state and local laws.
Tenant Concerns. Tenants, on the other hand, will want to ensure that the landlord’s inspection rights do not fun afoul of their applicable state’s regulations, or else cannabis tenants run the risk of losing their licenses.
Landlord and Tenant Recommendations. Inspection clauses should be drafted in such a way that balances a landlord’s right to inspect the property with the tenant’s right to operate in accordance with state law.
9. Anticipate Uncertainties and Have an Escape Route
The turbulent legal environment surrounding the marijuana industry creates a number of uncertainties for both landlords and tenants. For example, most cannabis tenants have secured leases without first obtaining their state license or permit to operate. An obvious risk exists that many cannabis tenants may never be granted a license. Without a license, a tenant cannot operate legally, and thus is unlikely to meet their expensive rental obligations.
Landlord and Tenant Recommendations. An early termination clause that specifically defines the events that will trigger a right to terminate should be considered. The lease should also provide for a period of rent abatement until the tenant is granted their license/permit and should also make it a termination event if the tenant is denied their license/permit.
As we have discussed often on this blog, the commercial cannabis industry provides lucrative, yet risky opportunities, as cannabis laws are complicated and constantly evolving. Landlords and tenants will need to work closely together in order for the fruits of this industry to be realized for both sides of the deal.