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Understanding Impacts of the Cannabis Industry on Property Management

October 14, 2019 | Ted Thurn

“The cannabis industry is here to stay.” These were the words of Tony McDonald, CEO of Surna, an indoor cultivation and agriculture business located in Boulder, CO, who spoke at the National Real Estate and Cannabis (NREC) Summit earlier this month. McDonald supported his statement by noting that, “In the U.S., 55 million people use marijuana once a year, and 35 million use once a month.”

The NREC was hosted by IREM’s Greater Denver chapter and drew 150 real estate professionals wanting to learn more about how to protect their properties when leasing to those who cultivate, sell, or use cannabis.

McDonald went on to discuss how the marijuana industry is expected to continue growing. The industry generated $9 billion in sales in 2019, and experts forecast sales will exceed over $20 billion by 2023. Not only will sales increase, but the size of the workforce in the industry will also expand in the next few years, he said. Currently, there are 200,000 people who work in the cannabis industry. By 2023, the number of individuals working in the business will reach 500,000. 

Impact of Marijuana Legalization on Property Managers
Gustin Tubbs, Operations Consultant for MJ Freeway of Denver, CO, took the stage to provide attendees best practice recommendations for property management companies when they conduct due diligence vetting potential cannabis tenants. Because it’s such a new industry, “Right now there’s no limit to what a property owner can ask a cannabis business when assessing a potential partner,” stressed Tubbs.  He also offered a few of the risks and rewards of going into the cannabis business. He informed the audience that the property’s value will increase because of renovations made to the property, and because of product involved. However, property owners and managers need to understand that once the property has been converted into a cannabis facility, it will be harder to flip back to a traditional property.

In addition, if the property is being used as a growth/cultivation facility for cannabis, property owners and managers should realize that flooding and sanitary issues will be a concern as the property is basically an indoor farm. Tubbs noted that mold, decay, and other types of growth need to be carefully monitored as heat and humidity can create unsanitary conditions. Property owners should also understand the concept of perpetual harvest, when plants are in a constant state of flowering and vegetation. If the property owner does not understand the concept, then the owner/manager bears a greater liability risk, he said.

Tubbs also addressed financial and security matters when vetting a tenant. “A good applicant should have enough financial resources to devote funds to capital expenditures, and have liquidity to cover at least 2 years of operational expenses.” This means the applicant needs around $9 million in funds to develop and operate the property. Regarding security, he said, it’s imperative for real estate professionals to conduct a close review of security for the property, and possibly recruit a security partner for an analysis. The property owner and applicant should also have an understanding that any liability for security breaches will fall to the tenant, and not the property owner/manager.

Legal Concerns
A legal overview of what landlords should know about leases and cannabis was presented by Mark Tschetter, Senior Managing Partner of Tschetter, Hamrick, Sulzer Law Firm of Denver, CO. Tschetter started his presentation by stressing, “It’s imperative that landlords secure qualified counsel. There are no standard rules in the cannabis industry, and leases vary widely depending on the jurisdiction, parties involved, and the use of the property, whether it’s growing, manufacturing, or sales.”

Tschetter strongly recommended that landlords hire an attorney with a track record of working in the cannabis-related business (CRB). Landlords should also ask for references and to see the attorney’s work product. If a landlord already has a good attorney, they may want to ask them for help identifying a CRB attorney.

He then shifted his comments to address the risks of working with a tenant in the cannabis industry, suggesting that landlords need an intimate understanding of the tenants they’re working with. Tschetter recommends hiring a private investigator to run a “complete and full” background check. In addition, he believes that under no circumstances should a landlord go into business with a tenant, as this type of relationship is fraught with pitfalls, and has very little upside for the landlord. The landlord who does decide to partner with a CRB tenant should ask for a large deposit (for example, $100,000). He also recommends that contingencies be included in the lease agreement to make sure the applicant clears the necessary hurdles.

Another matter addressed during his presentation focused on lease termination. Tschetter informed the group that early termination rights are critical. Clauses in the lease should clearly state that if the tenant doesn’t meet certain expectations, the lease can be terminated. Examples include: not meeting timelines, losing a license, engaging in non-permitted use, and any law enforcement activity.

Marijuana and Multifamily Properties
Cannabis in multifamily properties was also addressed by Tschetter. Although Amendment 64 was passed in 2012 to legalize marijuana in Colorado, the law doesn’t prohibit landlords from banning its use. Since a landlord can prohibit cannabis, and it’s still illegal at the federal level, landlords probably don’t need to amend the lease to ban cannabis from the property, he said. Landlords who operate multifamily facilities have a few options when deciding if tenants can use marijuana: prohibit all and any use; only allow use for disabled tenants; no smoking, but allow use of edibles; allow full use of marijuana. 

A former Chief Deputy Attorney General for Colorado, David Blake, provided attendees with some of the challenges on being the first state to legalize marijuana. As the first state to pass legalization, Colorado had to deal with an increase in crime, a growing number of children and adults sickened by potent doses, and driving under the influence. Some of the issues the state addressed specific to the real estate industry included: public vs. private consumption, property rights; safety (fire, electrical, mold); contract enforcement; and asset forfeiture. Blake noted that states, and the industry, made a number of mistakes when marijuana legalization was rolled out in 2012, but the industry has learned from their mistakes better and faster than the state.

Marijuana Tax Revenue
Blake also shared that while marijuana has generated tax revenue, it still isn’t the panacea to resolve all of Colorado’s financial issues. “In 2018, marijuana generated $2 billion in sales, which generated $200 million in tax revenue,” stated Blake. “However, Colorado also had a $36 billion budget in 2018.”

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