When it comes to borrowing money as a marijuana company, most roads lead to real estate.
“The industry has challenges accessing capital markets that other industries do not,” Travis Goad, managing partner at Pelorus Equity Group, said of plant-touching marijuana companies.
“In a fully developed market, there’s real estate as one lending source and then there are pure corporate loans as another lending source. In this space, the vast majority of financing is tied to your real estate,” added Goad, whose firm is a cannabis-focused real estate lender.
Applications for cannabis business licenses often require proof of real estate, leaving precious little capital for successful applicants to get their companies up and running.
For marijuana businesses that own property, there are three main ways to borrow, according to Goad, who runs Pelorus’ New York office:
Real estate lending: These loans require borrowers to contribute 25%-40% in equity. The other 60%-75% of the facility’s cost is returned to the borrower in the form of a mortgage, which can be used for construction and other business purposes.
Sale-leaseback agreements: Some finance companies offering sale-leaseback agreements will purchase a property for 100% of a site’s cost to complete, though financing costs are typically higher than with traditional real estate lending.
Business-development company: Lenders in this category might offer up to 180% of a property’s value. However, the higher proceeds come with stringent corporate covenants, higher costs and often require giving up board seats or other control to the lender.
Lenders are looking for hard assets to back their loans, and few options exist for no-asset lending in the cannabis industry.
Shopping around
Dana Arvidson, chief operating officer of Boston-based Tilt Holdings, said that when his company started looking for options to raise funds, the executive team met with the “main providers in the market.”
Tilt, which provides cannabis technology and hardware as well as cultivation and manufacturing, let the lenders know that its executives were meeting with other groups, the process was competitive and they were looking for the “most attractive rates and terms possible.”
Tilt ultimately chose Innovative Industrial Properties (IIPR), a San Diego-based real estate investment trust, to fund a $40 million sale-leaseback agreement on a 104,000-square-foot cultivation and manufacturing facility in Taunton, Massachusetts. The first deal closed in May 2022, and the multistate operator expects to close a second sale-leaseback on a cultivation-manufacturing property in White Haven, Pennsylvania, this quarter.
“We had done this calculus leading up to the transaction that we did in May of last year. One option that we explored pretty closely was to finance the property specifically with a mortgage, which can be pretty attractive in some ways, because you can get bank-level interest rates and retain ownership of the property,” Arvidson said.
“The challenge that we found with bank financing is that banks are somewhat limited in how they can value cannabis cultivation properties, given the federal status of cannabis. They don’t have the ability to value the property at quite the same level as a sale-leaseback.
“Given that, for us, the purpose of the (funding) was ultimately to retire long-term debt, it made the most sense for us to enter into a sale-leaseback,” he said.
The Massachusetts sale-leaseback agreement netted Tilt $27 million in proceeds. In exchange, Tilt will lease the facility back from IIPR for 20 years, with the possibility of two, five-year extensions.
Transactions slowing
In early January, Goad said Pelorus was offering construction loans with interest rates in the “mid-teens” and rates for “stabilized loans,” or facilities that are already operational, starting in the low teens.
Paul Smithers, CEO of IIPR, told MJBizMagazine via email that, “We continue to see 15-20-year lease terms and low- to mid- double-digit initial yields, with fixed-rate annual escalations.”
According to New York City-based Viridian Capital Advisors, cannabis capital raises were down 64% from the previous year as of Oct. 28, 2022, with debt financing accounting for more than 95% of all capital raised.
IIPR’s sale-leaseback deals, too, were down more than 75% from the previous year as of Sept. 30, 2022, according to an investor presentation by the REIT.
Smithers said that “all capital providers to the cannabis industry saw a slowdown in 2022 due to various headwinds experienced across the industry: lack of capital availability across the board and ever more stringent underwriting requirements.”
“This is not to say that the demand for capital—and specifically real estate capital—has waned in a material way from prior years, but sale-leaseback deal activity can mirror the broader capital raising/M&A ebbs and flows experienced by the industry in general.”
Al Brooks, head of commercial real estate for banking giant JPMorgan Chase & Co., said in a December 2022 report that he expects “challenges ahead” in 2023.
“Retail is at a crossroads, and the future of office space is unclear. Plus, supply chain issues persist, and inflation is near 40-year highs, prompting the (Federal Reserve) to steadily increase interest rates,” Brooks wrote.
Weighing the options
Boca Raton, Florida-based multistate operator Jushi Holdings took on a sale-leaseback deal when it acquired Pennsylvania Medical Solutions (PAMS), a grower-processor with operations in Scranton, Pennsylvania, from Vireo Health in 2020.
“When we inherited the business, we inherited the current lease with the current market cap rates and the dollars that have been put toward the building that we are moving into,” said Trent Woloveck, chief strategy director at Jushi.
Woloveck said that Jushi carefully considered the sale-leaseback deal when it was conducting due diligence on the PAMS acquisition, given that Jushi had been able to grow its own business using other funding tools and assuming minimal debt.
“Financing other large capex (capital expenditure) projects … off our own balance sheet … has allowed us flexibility as we continue to move forward and be in a better position to take cheaper debt,” Woloveck said. “The issue with the sale-leaseback is it’s forever.”
While traditional real estate loans often have a clause for early repayment, sale-leaseback agreements are typically for 15-20 years, and refinancing options are few.
Goad, the marijuana lender from Pelorus, posited that “when there’s a legalization event … you don’t get to benefit from that, because you’ve locked in today’s cost of capital, and it goes up every year.”
“When all your competitors may be able to go borrow at 7%, you are stuck paying 12% or 15%,” he said.
That said, the timing of legalization is anyone’s guess.
Smithers, meanwhile, said that the long-term nature of sale-leasebacks provide operators with “long-term control over their mission-critical facilities … without the added risk of near-term maturity dates.”
Doubling down
In the case of Jushi’s Pennsylvania facility, the previous owner entered a 15-year, $8.6 million sale-leaseback deal in 2018. The amount included $2.8 million worth of tenant improvements on the 89,000-square-foot industrial space.
In 2021, after acquiring the property, Jushi expanded its agreement with IIPR for an additional $30 million. At the time, the MSO announced it would use the extra cash to finish building out the facility and expand it by 40,000 square feet.
Vireo’s initial sale-leaseback agreement with IIPR—the largest provider of such deals to the marijuana industry—was for annualized aggregate base rent equal to 15% of the sum of the purchase price and tenant improvements. In addition, rent was subject to annual increases of 3.5% for the term of the lease.
Woloveck said that Jushi has “done subsequent borrows on the property in deals with IIPR, and we’ve been able to negotiate a lower cap rates based on our credit.
“Those have been at different rates than what the original deal was struck at,” he added.
In December, Jushi entered a $2 million sale-leaseback deal with Los Angeles-based XS Financial, a capital financing provider, for heavy equipment such as Auto Cure, which automates the cannabis drying and curing process.
“Things that IIPR wouldn’t give us credit for roll into the principal amount. XS is a backstop from that perspective,” Woloveck said.
