Opinion: What marijuana real estate lenders look for in potential borrowers

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Rob Sechrist (Courtesy photo)

Securing capital to fund marijuana-related properties can be a complex and challenging endeavor – especially given the current state of the industry.

Equity markets are still getting pummeled, margins are being squeezed and pervasive, onerous regulatory hurdles continue to limit banking.

Understanding the factors that real estate-based lenders consider when evaluating borrowers can significantly improve a company’s chances of obtaining funds to strengthen the business, expand operations and solidify its position in the market.

By aligning with these expectations and implementing effective strategies, borrowers can position themselves as attractive candidates for capital and maximize their chances of success.

In-depth project understanding and preparedness

One of the first things that lenders seek in borrowers is a comprehensive understanding of their real estate project.

Borrowers should be well-versed in the intricacies of their ventures, demonstrating a clear vision and goals.

When approaching lenders, they need to be able to articulate the purpose of the loan, whether it is for property acquisition, expansion, refinancing or strengthening their cash position.

They must provide specific project details, including the property’s address, purchase price, budget allocation and intended use.

And they need to be prepared to handle unforeseen costs and project delays and have strong mitigation strategies in place.

Also, they need to keep in mind dynamics that are unique to cannabis.

For example, tenant-improvement costs and equipment costs are much higher than they are for non-cannabis tenants.

In addition to understanding their own project’s cost and timeline, borrowers need to have a  good understanding of the competitive landscape and what the market looks like as well as local and state regulations.

In some cases, there are zoning restrictions that could prevent build-out, so borrowers should know these conditions before approaching a lender.

In a capital-constrained environment, lenders don’t have time to ask repeatedly for basic information.

This is why it’s imperative for borrowers to conduct their own research and develop a plan that outlines the project’s timeline, milestones and potential risks – along with mitigation strategies.

By showcasing their preparedness and professionalism, borrowers instill confidence in lenders and demonstrate their ability to execute the project successfully.

Financial stability and feasibility

In the early days of marijuana, operators and analysts placed a strong emphasis on dominating market share, scaling quickly and first-mover advantage.

Now that the industry has matured and many companies have gone out of business, people are waking up to the dangers of unbridled growth and the uncertainty of stock valuations.

Instead, investors are focusing on business fundamentals and cash flow.

Lenders need assurance that borrowers have the means to pay their debts without delay.

A major component to this is having a strong sponsor as the guarantor and ensuring all parties involved are aligned on the business plan – all while factoring in equipment, tenant-improvement costs and potential delays.

If the operating company is financing a build-out, it might need to show steady cash flow coming in from other assets before the build-out is complete and revenue-generating.

Regardless of what the financing is for, borrowers must demonstrate an accurate and realistic business plan based on fundamentals with contingencies in place.

Don’t believe that lenders will be satisfied by one or two quarters of financials – reputable lenders dig beneath the surface.

In this nascent industry, things can change rapidly, and companies need to be able to illustrate that they have experienced, adaptable management as well as a diverse portfolio of assets, strong partners and a solid balance sheet – plus feasible revenue streams and cash-flow projections.

Additionally, to help gain the confidence of lenders, it’s important for principals to prove they have a significant stake in the property and are willing to invest their own funds.

A higher down payment or equity stake demonstrates the borrower’s commitment and reduces the lender’s risk.

Borrowers also need collateral and should have a low debt-to-income ratio to signal that they can make debt payments on time.

Industry experience and expertise

With the marijuana industry being so nuanced, complex and new – coupled with the overall lack of robust historical data – industry experience is crucial.

A lender needs to feel confident that the borrower understands the dynamics and regulations of the markets in which it operates.

The operator should have strong standard operating procedures in place, be able to demonstrate a history of compliance and have lawyers on retainer and/or use regtech to remain in compliance.

During due diligence, a lender will find any skeletons a company might have in the closet.

Lenders will pay special attention to credit history and the borrower’s track record of property management.

Beyond that, the operating company must demonstrate that it has a proven track record and strong management team with people who have been in the cannabis industry long enough to successfully navigate its peaks and valleys.

Lenders will look at the borrower’s partners, infrastructure, operational efficiency, production costs and viability of their short- and long-term strategies while taking market saturation and competitive landscape into account.

Regardless of the size of their company, borrowers must clearly illustrate their value propositions and competitive advantages:

  • Do they excel in terms of operational efficiency and producing solid margins?
  • Do they offer comparable quality at lower price points in relation to their competition or is their quality superior?
  • Have they developed brand affinity?
  • Are they offering unique products that others in their market aren’t?

Companies must prove to a lender that they consistently produce quality products, their ongoing operations are feasible and can withstand price compression and, when problems do arise, they can remediate swiftly and effectively.

Also, they need to show they are agile, as dynamics evolve rapidly in the cannabis space.

Viable long-term strategy regardless of reform

One of the major pitfalls we’ve seen with operators in the marijuana space is when they bank on reform and bake that into their core strategy.

If a company goes all-in on a new market opening and major delays occur, such as those we’ve seen in New York, the business might be dead in the water.

That’s why having a diversified strategy is key.

Of course, borrowers should not spread themselves thin and establish operations in several states without adequate footing or market presence.

There’s been a ton of media hype around when the SAFE Banking Act will pass, and market valuations have largely fluctuated based on public perception of regulatory momentum.

Many companies focused on expansion at the expense of fundamentals when they thought SAFE would pass, believing they’d be able to raise money from institutional investors.

While SAFE is gaining momentum again, nobody knows for sure if or when it will pass. Veteran lenders are more aware of this than anyone.

So, as a borrower, don’t approach a lender with a strategy that relies on federal legalization.

You need a strong strategy that stands up – regardless of when widespread federal reform happens.

Rob Sechrist is the co-founder and president of California-based Pelorus Capital Group. You can reach him at info@peloruscg.com.

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