Tips for cannabis business owners facing sky-high real estate costs

Image depicting real estate

The “green tax” levied on many marijuana companies often sprouts like a weed in the real estate business.

That’s because some landlords charge a premium when leasing to marijuana businesses, according to cannabis industry officials.

Landlords, these officials note, often are under the impression that everyone in the marijuana industry is getting rich – and has money to burn.

“Landlords see cannabis executives coming from a mile away,” quipped Kevin Bush, chief financial officer for Denver-based Sweet Leaf Madison Capital, which provides funding to marijuana companies.

But getting rich in the cannabis industry is far from a sure bet – especially these days.

In mature markets such as Colorado, for example, real estate prices have skyrocketed in the past few years. Wholesale cannabis prices, meanwhile, have gone in the opposite direction.

That one-two punch is making it harder for marijuana companies to pay rent – much less purchase property.

“It has been well-documented that cannabis companies are struggling to pay their bills, including leases,” said Jason Vegotsky, CEO of Petalfast, a sales and marketing agency for the cannabis industry based in Irvine, California.

Tim Cullen, CEO and co-founder of Denver-based Colorado Harvest Co., leases all of his properties and has felt that crunch.

Moreover, landlords seem more than happy to to let marijuana business foot those tax hikes, as was the case for Cullen.

“Everyone’s taxes just went up because the value of their properties went up 30%,” Cullen noted.

“Our rents went up significantly because the landlords pass on the cost to us.”

But the situation isn’t hopeless.

Cannabis business owners looking to navigate soaring real estate costs amid tough market conditions have options at their disposal, including negotiating with landlords and linking business profitability to lease payments.

Tips to deal with landlords

As a possible recession looms in the United States, landlords overcharging cannabis companies for rent might be open to negotiations, said George Mancheril, CEO of Bespoke Financial, a Los Angeles commercial lender that works with cannabis companies.

“Do we play nice, or are you going to be looking for a new tenant in the middle of a recession?” Mancheril asked.

He added that landlords see marijuana businesses as both more lucrative and higher risk, which is why they tend to charge more. But larger macroeconomic factors also play a role.

“When it comes to a recession, more or less everything is up for renegotiation to some degree,” Mancheril said.

Those property owners need to understand that while cannabis is a “very idiosyncratic risk, in general, those premiums on the lease rates have to reset to the actual profitability of these businesses,” he said.

Marijuana businesses – especially those in mature markets such as Colorado, Oregon and Washington state – are not seeing margins as favorable as they once were.

To weather rising costs, Gary Cohen, CEO of Cova Software – a Denver provider of cannabis point-of-sale and tracking software – advises working out a deal with the landlord where the cost of rent is tied to business receipts, sales and profitability.

“Look at another way to skin the cat, because it’s not happening,” he said.

Another approach is negotiating with the property owner to make sure you’re paying the market rate, said Troy Datcher, CEO of The Parent Co., a vertically integrated cannabis company based in California.

By “market rate,” Datcher means the amount comparable mainstream businesses are paying to rent similar properties.

“For existing leases that are over market, I recommend you meet with your landlord and share your business challenges and be as transparent as possible and negotiate a lower rent,” he said.

“It is in everyone’s best interest to make sure your business is viable and you continue to pay at least market rent.”

For a new lease, Datcher recommends locking in a shorter team lease with two or three renewal options. For example, a three-year lease with an option for three, one-year renewals.

Business owners should also negotiate a reasonable termination clause should they need to exit early, he said.

A termination clause favorable to the tenant would be a fair penalty for breaking the contract, for example.

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Silver linings

One silver lining: The COVID-19 pandemic lockdowns and subsequent shift to work-from-home or hybrid models mean more commercial spaces are going unused.

As a result, some cannabis companies may be able to find savings, said Blake Schroeder, CEO of Medical Marijuana Inc., a San Diego-based holding company with subsidiaries that make and sell a range of hemp-based products.

Beyond finding cheaper commercial buildings, negotiating with landlords and tying rent payments to business performance, some companies are downsizing and putting more responsibility on their partners, said Vegotsky.

For example: If a business has partners with deep pockets or other ongoing interests, the cannabis company could rely on that partner to weather an economic downturn or unfavorable market conditions – such as the booming real estate market.

“This strategy should lessen the burden compared to taking full responsibility in any one, single business,” Vegotsky added.

“Companies that are lean and focused will have a higher rate of success in a stressful economic environment.”

That’s smart business strategy, said  Skip Motsenbocker, CEO of Pacific Stone, a cannabis cultivator based in Carpinteria, California.

He added that cannabis companies with leases should have their prices and cost of production adjusted accordingly so that real estate costs aren’t as much of a financial hit as a line item.

For example, a cannabis cultivation company ought to make sure it is growing marijuana as efficiently as possible to protect itself from rising real estate costs.

Moreover, growers in markets with favorable wholesale prices might try to raise prices as lease rates rise.

For companies that own their own properties, Motsenbocker added, rising real estate prices could provide potential benefits with the ability to leverage assets that have increasing values.

A property that has increased in value can be refinanced for more operating capital, for example, or used as collateral for another loan to expand the business.

“In either case, however, the line item has to be controlled,” he said.

“This stems from a solid business practice that maintains top line so the relative percentage cost doesn’t fluctuate out of the norms.”

Bart Schaneman can be reached at bart.schaneman@mjbizdaily.com.