Growth and Stability of the Cannabis Industry Investing in Cannabis CRE 2021

Last week U.S.NEWS cited a source that valued the U.S. cannabis industry as already being a $50 billion industry – that is expected to triple by the end of the decade.

While COVID-19 shuttered many traditional businesses, more cannabis than ever before was consumed in the U.S. in 2020 – a record $17.5B in legal sales – a 46% increase from 2019, according to a recent report cited in Forbes published by BDSA, a cannabis sales data platform.  This was aided by the unprecedented step taken by 28 of the legal cannabis states where dispensary operations were classified as “essential businesses.” Investing in Cannabis CRE 2021

Marijuana Business Daily tracks/projects the growth of the industry in this manner…

While Pitchbook is seeing dramatically rising median post valuations and deal sizes as we progress into this very active year…

What’s Driving This Accelerating Market Growth?

Overall in 2020, capital flowing into the cannabis industry dropped to $4.2 billion from $11.6 billion in 2019, and the even higher level of $14.2 billon in 2018, as reported by Viridian Research.  Yet, just in the first two weeks of January cannabis companies in North America raised over $619 million.  All indicators point toward a record year in capital flowing into the industry. Investing in Cannabis CRE 2021

Rapidly Increased State-by-State Adult Use Legalization

Indeed, the industry is living up to these promising foundational developments as we progress into 2021.  The passage of Adult Use in New Jersey sent a strong message to all neighboring states.  The slow-to-adopt states of Maryland, Connecticut, Delaware, New York and Rhode Island are all primed to quickly address Adult Use legalization now.

Accelerated Actions on the Federal Level

There are many predicting that historic reforms of Federal cannabis laws will happen quickly on the heels of the election results – anticipating decisive action by a Democrat Congress and Administration before the November 2022 mid-term elections. Others, though, believe that a drastic step like removal of the filibuster would be needed in order for such legislation to be brought to a vote, and Mitch McConnell and the Republicans are not likely to go along with such action. Also, with all that President Biden has on his most pressing agenda, cannabis may not be an issue he wants to tackle immediately, leaving full legalization to remain several years away. Investing in Cannabis CRE 2021

As a minimum, though, analysts are expecting some version of the act entitled Strengthening the Tenth Amendment Through Entrusting States (STATES) Act to be passed in relatively short order.  While this Act does not legalize interstate commerce in cannabis it does officially sanction the legitimacy of state cannabis legislation.

Regarding the rapid pace of the current growth legalization on the state-by-state basis, WealthManagement reports that it usually takes a much as two years for a cannabis market to start gaining traction in newly legalized states. Due to the enormous need for increased revenue that every state faces coming out of the Pandemic, more states are streamlining the sanctioning process, even down to the municipality level, to expedite the flow of new tax revenue.

Smart Money Flowing into Cannabis CRE

The booming marketplace in 2021 is generating renewed interest in cannabis commercial (CRE) investments.  Not only are more debt funding options becoming available to cannabis operators, but also how well the cannabis industry performed during the COVID-19 crisis has shown traditional financing sources and formerly reluctant landlords that the cannabis industry exhibits recession-proof qualities. As neglected store fronts in formerly derelict areas and industrial warehouses continue to escalate in value brought on by industry expansion, particularly into areas dedicated as Green Zones within municipalities.

A Green Zone is an area designated where legal cannabis/cannabis-related businesses are allowed/encouraged to set up cultivation, manufacturing and retailing facilities.  One funding resource, Canna-Hemp Debt Fund, estimates that industrial warehouses they are underwriting that are “green zoned” show at least a 20 to 30% in increase value.  For debt loans the company feels comfortable with LTVs of 60-65% in their green zoned properties.  For investor security, and to be able to offer lower than market rates, personal guarantees and cross corporate guarantees, wherever possible, are required from their borrowers.

Green Zones designated within Qualified Opportunity Zones (QOZs) offer investors the additional benefit of the potential of deferred and reduced taxes on capital gains while building equity in property purchased within the zone.  This provides the benefits of economic improvement and job creation to the surrounding low-income, distressed neighborhood.  While cannabis businesses are still subject to tax code 280E, which eliminates operational business expense deductions for income tax purposes, the current IRS ruling gives the owner of a QOZ property a hold in capital gains taxes if the property is held for a minimum of 10 years.

Because of the vagaries of the federal regulations and the laws in each municipality, and those that pertain to each individual property, the first step in any cannabis CRE investment is to always seek advice from professionals experienced in the nuances of the cannabis industry. Investing in Cannabis CRE 2021

What to Look for in Cannabis CRE Properties?

When advising our clients who are considering cannabis CRE investments, here is the guidance we provide: 

• Yes, it is about “Location, Location, Location.” In the case of cannabis CRE, though, location due diligence is crucial. Not only do the laws on the books relative to the property need scrutiny, but also a clear understanding of the support of community leaders for the cannabis enterprise is essential.
• Legal and CPA advice is vital in order to make sure risk and liability is reduced and all the potential tax savings are to be realized from the property.
  • In certain cases ownership of the property as a separate entity from the cannabis business is a consideration in order to realize the greatest value from the investment.
• Local ordinances must be thoroughly comprehended in the operations plan for the property.
  • Tax requirements vary from municipality to municipality and other ordinances may apply, even including those that may require a prescribed number of employees to be residents of the area in which the cannabis business is located.
• Effective planning and budgeting are crucial to achieving the ROI potential of the property.
• Typically, real estate agents aren’t attuned to stringent cannabis regulations. Advice from experts who are successfully transacting in the cannabis industry is imperative.

Debt Financing Options for Cannabis CRE

The upward trend began in 2018 and advanced well into 2019 when about 30% of all capital raised in the cannabis industry was through debt financing, compared to only 19% in the boom year of 2018.  We are seeing more groups already in 2021 starting both dedicated debt funds and allocating a portion of funds for cannabis debt deals. 

Why Cannabis Turns to Debt Financing

While the industry has been capital-constrained, borrowing against assets has been a key source available for many cannabis companies to pursue. Vertically integrated cannabis companies often have significant real estate and other assets that can be leveraged. What has changed now, though, is that more debt providers have come online over the past couple of years addressing a range of needs.  This means that cannabis companies now can refinance at more attractive rates.

• In 2020, large multistate operators (MSOs) Curaleaf and Cresco announced their debt raises of approximately $300M and $200M, respectively, illustrating the capital available at the high-end of the market at that time. Then, on January 11 this year, Curaleaf has again secured a new round of financing – a $50 million secured revolving credit facility with a three-year term.  Curaleaf will be paying a 10.25% interest rate for funds when needed.  This is significantly lower than the interest rates cannabis companies paid for loans in previous years when the likelihood of progress on easing Federal regulations did not look as promising.
• Likewise, one of the largest MSOs, Green Thumb Industries, is reportedly seeking refinancing of its current $100M debt, currently carrying a 12% interest rate. Because of the capital markets now opening up, they feel they can obtain as significantly lower rate.
• When its stock was floundering in 2020, Acreage Holdings was able to raise debt with the credit arm of an unidentified institutional investor, for up to $100M; as opposed to further diluting equity at their weak stock prices at the time.
• Toward the end of 2020, Holistic Industries, a U.S. privately held, vertically-integrated cannabis company, closed an oversubscribed round of $35M in debt for expansion and the potential of acquiring distressed assets.

Debt Financing in Cannabis, What are the Options?

Sale and Leaseback Transactions

• While Sale-Leaseback (SLB) transactions aren’t technically debt they do allow companies to free up liquidity from their balance sheets without dilution. An SLB is the sale of real-estate assets to a buyer who then leases them back through a long-term lease.

Asset-Based Lending

• Based on the valuation of real estate and equipment assets, a cannabis company can typically borrow from within the range of 40% to 75% of asset value. In the case of development projects, the loan is usually based on project costs. While less typical, there are some working capital debt options in the market as well; though the availability of this option is much less than for real estate and equipment financing.

Convertible Options

• Up to this point, most debt financing by cannabis companies was found in convertible note options with low conversion premiums – which essentially delay issuance/dilution of equity. The company creates a note that converts to equity at a future date based on a future valuation method. These notes have given investors security that they are repaid before equity holders if something goes wrong. For both the investor and the company this note structure allows the valuation question to be answered in the future while providing needed capital to the company and a more secure instrument to investors.

MTN – Short-Term Solution to Minimize Dilution with Funding at Single Digit Rates

• True, that the three alternatives listed above are considered the standard. Now, however, a new alternative is emerging, the Medium Term Note (MTN) for companies with relatively strong balance sheets.  An MTN is an alternative to traditional long-term and expensive short-term financing – to aid a company with such objectives as accelerating a growth strategy, facilitating a roll-up M&A strategy.

Investor Takeaway

Key segments of the cannabis industry are, indeed, living up to promising foundational developments predicted for 2021.  As a result of the November election, 36 states have now legalized cannabis with Adult Use now legal in 15 of those states. Federal legalization measures continue their slow progress through the U.S. Congress. The industry has matured to the point where major players are now focused on strategic acquisitions, efficient operations and EBITDA.  And, MSOs are estimated to have $1B in dry powder, along with an estimated $2B worth of M&A deals in the works as this formerly cash-restrained industry advances toward its $35B potential as early as 2025.

All of this intensifies the interest and value in profitable cannabis CRE investments. To make those investments productive requires a resource that completely understands the national, state and municipality laws, the local ordinances, and the attitude of the community in which a property is located in order to expedite the process of a CRE investment destined to achieve a well-planned ROI. Investing in Cannabis CRE 2021

How We Can Help

Next Step – Category Expertise Needed

After six long years processing millions of dollars in successful sell-side and buy-side transactions, we know the cannabis industry. We excel at structuring deals to meet client investment strategies in opportunities with our core expertise in Cannabis.  And, we transact in other highly regulated markets in the fields of Pharma, Biotech, Healthcare, Agtech, Clean/ClimateTech, and CBD/hemp companies. We specialize in thoroughly vetted companies looking to drive growth and enterprise valuations through M&A, non-dilutive debt financing and/or capital investments.

Let’s talk about putting the power of this expertise to work for you as a Sell or Buy-side client.