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Ins and Outs Of Cannabis Real Estate Lease Negotiations

by Roger Tower on November 27, 2018
Ins and Outs Of Cannabis Real Estate Lease Negotiations

By, Jason Piazza

Negotiating cannabis real estate leases is a full-time gig which requires much more understanding and patience than most commercial real estate landlords realize or are willing to give. While the majority of cannabis real estate deals are negotiated on industrial real estate, the negotiation of cannabis real estate is more akin to a high-end retail negotiation because those businesses will require a lengthy licensing process, detailed & specialized planning, costly build-out, and high-level entitlement work.

Until 2017 I spent 10 years in commercial real estate as a generalist, and over the last (nearly) 2 years I have worked solely as a cannabis real estate specialist. I can tell you without uncertainty that cannabis real estate is the most challenging industry to serve from a real estate perspective. While there are several reasons for this, I want to be clear that although it’s a difficult row to hoe, it’s the best road to be on….so long as your knowledge of negotiating deals is of a wider breadth than any one commercial asset class. As a commercial real estate generalist, I have negotiated deals for many types of businesses across all asset classes: industrial, retail, office, medical, and land acquisition, and I’ve listed each asset class for sale and/or lease. As a result of my breadth of experience, I have a keen sense of the various needs and deal points that get negotiated on a wide array of deals, and this experience is tantamount in cannabis real estate.

One of the easiest deals to negotiate of course are industrial leases. Don’t get me wrong, there are hurdles that can arise in industrial lease deals, but they’re much less common and might have a licensing timeframe on a CUP that could slow an occupant down for up to 4 or 5 months, although usually, it’s just a 3-month process. The issue here, in my opinion, is that because cannabis real estate has largely been pushed into industrial zones, the deals aren’t getting negotiated in a fair enough manner from the tenant/buyer perspective. Why? Because the owners and their agents are used to a more simple, straightforward negotiation. Cannabis, however, requires a tenant or buyer to go through a licensing process that could take up to a year, and in some cases longer. There is no shortage of canna-businesses which have paid rent for over a year on a property without ever becoming operational. For the most part, these issues are not the fault of the operator but are in fact an issue with local municipalities taking too long to finalize licensing. Furthermore, these canna-businesses require lengthy, expensive build-outs, and are forced to pay premium prices due, largely, to supply and demand.

As an example, I’ve seen cannabis lease negotiations where a landlord is only willing to give a tenant 4 months of 1/2 rent to become operational while charging a deposit equal to 3 months of premium rent. That “premium rent” is generally double or triple non-cannabis market rent, meaning that the 1/2 rent they are paying is at or above market lease rates. If it takes the business a year to get the city to approve their plans and build-out, which has become common, then that tenant would be in an awful position to make a profit as a result of overpaying on rent prior to becoming operational. In contrast, a non-cannabis industrial tenant would get 1-3 months of free rent while they obtain necessary licenses, build-out, and move in. Once moved in, they would begin paying the agreed rent which is 1/2 to a 1/3 of what cannabis tenants pay. That’s a stark difference which is a recipe for disaster quite honestly. Industrial landlords need to understand that these licensing timeframes are not what they’re accustomed to.

The aforementioned timeframe of up to a year for cannabis licensing, while rare in industrial real estate, is common in retail leases. Just think about a restaurant, bar, or gym. They hire: top-notch architects to optimize their layouts, entitlement experts to process their difficult to obtain city permits, and they spend hundreds of thousands if not millions of dollars on their build-outs. These processes take time & money and retail property owners know this and structure their deals accordingly. Why? Because they want their tenants to succeed. There’s no point in starving a business of cash before it’s operational because that business will have a harder time making a profit and therefore getting through their lease term and potentially renewing their lease. In fact, retail landlords often offer several months of free rent, money towards tenant-specific improvements, and other concessions where necessary.

Another interesting similarity between retail leases and cannabis leases: the prevalence of the NNN (triple net) lease. Industrial real estate is, more often than not, done on a gross lease wherein the building’s operating expenses (property taxes, property insurance, water, sewer, trash, and maintenance) are generally included in the rental rate. In a NNN lease, those operating expenses are viewed as pass-throughs to the tenant and are either paid as an extra fee/SF or paid directly by the tenant. This is a change from standard industrial leases. It’s not to say that there aren’t instances where industrial real estate is leased NNN, but it’s certainly not the norm. With cannabis, however, landlords are largely moving to the NNN lease which is an extra expense for cannabis operators wishing to lease real estate.

In my view, cannabis real estate should be dealt with in a more thoughtful manner than we are currently experiencing. If a landlord or seller is comfortable with the tenant’s/buyer’s experience level, amount of capital, and if that prospect has hired a competent entitlement expert, then the chances are very strong that the deal will gain licensure and the tenant will begin paying a hefty premium in rent. As long as the tenant can verify that it is doing everything it can in a timely manner to gain licensure and build-out their space, then what’s the rush? They’re paying market rent and the landlord isn’t losing any money. It’s the local municipalities that have been the hold up in gaining licensure and tenants shouldn’t be punished for this lengthy, difficult, licensing process. Don’t get me wrong; I’m not saying that cannabis tenants shouldn’t pay hefty deposits, or shouldn’t pay rent during licensing. What I’m saying is that all too often these business operators are forced into negotiations where they would be agreeing to pay double and sometimes triple market rents well before they are operational, and that is just not acceptable in my view. After all, is the landlord looking to make a decent amount of money in one year, or a hefty amount over 5-10 years? I would think the latter and if cannabis landlords would take a more common sense approach, perhaps we wouldn’t see as many defaults as we’re bound to see in the coming years. I will say though that the most lop-sided deals are the ones where a property owner has decided not to hire a competent commercial real estate agent. In reality, they should be hiring cannabis specialists who fully understand the intricacies and needs of a canna-business, but at the very least they should have proper representation. After all, the goal here is the full enchilada; not just a couple bites of it.