The Herb Column: How Commercial Landlords Protect Their Assets in the Age of Legal Bud

For building owners out to make money in the cannabis space, it’s not all roses

Back Web Only Dec 27, 2018 By Steven Yoder

For landlords with the right commercial space, the green premium would seem to be cash-flow heaven. Properties rented to cannabis operators in Sacramento are going for two to three times the average, says Bob Shanahan of Colliers International’s Sacramento office. Spencer Bones, a broker at Colliers, just negotiated a lease involving a marijuana business that will generate $2 per square foot for a building that otherwise would have brought in $.45, he says.

Even so, there are lots of ways for landlords to get burned. To survive, they’ll need to deeply vet their tenants and ensure they and their tenants have the right insurance coverages, say area experts.

Related: Still Unbanked, Cannabis Enterprises Struggle

Related: Battling for Onsite Consumption

For landlords new to cannabis, backgrounding potential occupants involves more checks than they’re accustomed to. The most obvious question to ask is whether the tenant has the right license to run their operation, says Keith Dunnagan, managing attorney for BPE Law Group in Gold River. But even if they can prove the answer is yes, that’s not enough. Nearly all of the licenses that the state has issued to date are temporary (and localities must issue their own authorizations to get those), so landlords have to build in protection in case a permit expires. Dunnagan says owners should have tenants fill out a declaration to the effect that, under penalty of perjury, they affirm that they’re complying with the conditions of their permit.

It’s on the landlord to make sure their tenant has the right insurance, which at a minimum means building and general liability coverage, says Doug Esposito who handles energy, construction and cannabis at Sacramento-based Owen-Dunn Insurance Services. Landlords need to be named as an additional insured on those and other tenant policies — standard practice in other industries, too. Equally important, they need to actually read those policies to make sure they don’t contain exclusions for someone operating an illegal business, which cannabis is at the federal level. Because the industry is so new, “There’s no standard, there’s no normalcy in these policies when it comes to cannabis,” Esposito says.

Landlords also need their own insurance plan — normally a “lessor’s risk policy” — to protect themselves from liability in cases in which the tenant’s insurance won’t pay. That was tough until last May, when the the state insurance commissioner granted approval to California Mutual Insurance Company to issue the first such policy for commercial landlords renting to cannabis operators. Today, Esposito says there are only two or three other companies that  sell those policies. That lack of competition means a landlord will pay about 30 percent more in premiums than they would for a plan that doesn’t cover a cannabis tenant, he says.

Screening a potential tenant’s financials poses another challenge because the industry is so new, says Ryan George, CEO of Orangevale-based 420property.com, a web-based platform for commercial cannabis space that is for sale and rent. Even for prospective tenants who have a longer history in industry, asking for bank statements may not do much good since most banks aren’t working with cannabis operators. George advises landlords to steer clear of tenants just starting out unless they have a deep-pocketed outside backer who can provide a personal guarantee on the lease.

Collier’s Bones says the landlords he represents and negotiates with are demanding that personal guarantee and doing careful scrutiny of the guarantor’s financials. Most landlords, he says, are looking for five-year deals, and he’s been asking for three to six months’ security deposit for the landlords he represents.

For landlords with existing mortgages on their properties, there’s another pitfall: Renting to a cannabis operator might violate the terms of their mortgage. George has heard of cases in which a lender finds out that their mortgagee has applied for a marijuana business permit and demands immediate repayment.

Buyers currently shopping for suitable space for cannabis operators also need to be painstaking with their financial projections. George sees many lured in by ads claiming a building is pre-leased to a canna-business and bringing in 10-12 percent returns. But potential buyers better crunch numbers with their lender if they’re borrowing to make the purchase. Loans that involve renting to a cannabis operator will carry high interest — 6 or 7 percent — and with the high fees and points typical for these loans, 10-12 percent very well could be a money-loser, he says.

And there’s no protection against the nuclear scenario — federal authorities raiding a cannabis tenant, even if they have a state permit — and seizing the building. “That is a valid and true fear: the feds are omnipotent,” Esposito says. “If someone is really financially conservative, this isn’t the space to be in yet. That’s just how it is.” 

For all of the furor over traditional tenants being driven out of areas like Power Inn, the market for commercial cannabis space has cooled some, says Lu Ann Henderson, a real estate agent at The Vollman Company in Sacramento. Henderson, who does most of the company’s cannabis deals, says tenants in 2015 and 2016 were paying $2.50 per square foot for spaces that needed electrical upgrades, had no conditional use permits and needed complete build-outs. The tenants paid those costs, which often ran into the millions. Now those same spaces with the upgrades, permits and build-outs, all done by the landlord prior to leasing, are renting for $2.50 or less, she says.

As with everything in California cannabis, time will tell how these deals pay out long term. “It’s honestly kind of early in the game,” Bones says.

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