High Returns in the Cannabis Space
By Dan Gorczycki May 8, 2019 12:30 pmreprints
“The grass ain’t greener, the wine ain’t sweeter, either side of the hill,” as Jerry Garcia sang.
If you would have told me when I started in the real estate capital markets industry that I would be financing a cannabis building, I would have asked you what you were smoking. But, here we are. There is a cloud over the industry because marijuana is still a Schedule I drug on the federal level—the same classification as heroin or cocaine—but it is approved for either recreational or medical use in 33 states. Due to the federal ban, federally chartered banks cannot even consider a loan in the industry. But, where there is a need, there is opportunity for lenders and investors alike. Last month, I financed a recently built 60,000-square-foot greenhouse and warehouse in Eastlake, Ohio, a state where cannabis is only licensed for medical use. The lender was able to achieve a 9.75 percent annual coupon (plus origination and exit fees) on a building that was well secured. It came with a corporate guarantee and the knowledge that the building would have only a 70 percent loan-to-value ratio as an alternate use (cold storage), even in the unlikely event that the cannabis laws got reversed and the drug became decisively illegal in every state. We also had several other lenders that were interested, albeit only at double-digit interest rates plus fees.
Years from now we will look back and be amazed that a lender could obtain a double-digit return on low leveraged loans to very a profitable business. But the federal ban did lead to some strange conversations during the closing process.
The lender wanted to open a bank account within Ohio (at a credit union), so as to not cross state lines with funds involving cannabis. In fact, fewer than 40 percent of all retail dispensaries even have bank accounts. Title companies were willing to issue owners policies, but were reluctant to write one to the lender. (We managed to find one).
For those that aren’t familiar, cannabis is considered a drug because of the level of the psychoactive ingredient THC—10 percent. Meanwhile, the often-confused related product, hemp, contains no more than 0.3 percent THC. That is the reason why hemp and hemp-derived CBD oil is found in food stores around the country: It’s federally legal. Hemp is said to have 25,000 uses, including in textiles, lotions, plastics and paper. Over 75,000 acres of it have been harvested across the country, thanks primarily to federal legislation that shapes agriculture policy. Hemp CBD oil is best known for its health benefits in relieving epilepsy and seizures.
New York and New Jersey are inching closer to legalization. New Jersey has support from the state’s governor, legislative leaders and 60 percent of residents (according to recent polls). New York will have a few additional obstacles because some lawmakers have said they will block any marijuana legalization bill that doesn’t help minority owners share in the industry’s profits. In all, 10 states are approved for recreational use, with Michigan being the most recent.
Closing our first cannabis deal has led me to dozens of other loan and joint-venture equity requests in both the cannabis and hemp spaces. On the loan side, I’m obtaining acquisition financing for the purchase of a large greenhouse currently used for flowers near Santa Barbara, Calif. On the equity side, I’m placing equity on a hemp deal in Nevada that, assuming the projections are achieved, will yield the equity investor 50 times his money. Optimistic? A bubble? Quite possibly, but we are in the early stages of the growth of the industry and there will be fortunes made before it’s over. If institutions and other conventional sources aren’t willing to lend or invest in the space due to the federal ban, private investors and high-net-worth family offices will gladly fill the void. According to a report by Grand View Research, the legal global cannabis market will be worth $146.5 billion by 2025. As a lender, you can achieve very high returns only because so many other lenders aren’t yet allowed in the space. The golden opportunity to lend or invest in the space at the current high returns only exists because institutions don’t want the headline risk or are waiting until the federal ban is lifted.
Dan Gorczycki is a senior director for Avison Young and provides debt and joint-venture equity across all product types.