One of the most important business decisions cannabis businesses need to make is whether to lease or buy real estate. I have worked on too many cannabis real estate transactions to count. And in my experience, the vast majority are leases. Today I want to look the top three reasons why that’s the case.
#1 – Deferring costs for a later day
Even long before the cannabis recession, cannabis businesses were cash strapped. The process between incorporation and operation costs hundreds of thousands, if not millions of dollars. At the same time, cannabis real estate (whether for lease or sale) tends to run at a much higher cost than for non-cannabis businesses. At the same time, cannabis business owners often bet on the ability to get licensed and succeed in an industry that’s basically designed to make them spend money in inefficient ways and where there is never-ending illegal market competition. Success is by no means guaranteed. Quite the opposite.
The prospect of an already cash-strapped business putting down millions of dollars to buy real estate is just… out of the question. I’m not saying that leasing cannabis real estate is cheap. It definitely is not, and in the long run, the rents paid under a lease can greatly exceed a would-be purchase price. But paying five or six figures (instead of seven or eight) per month now is a lot more doable for many cannabis businesses.
#2 – Good luck getting real estate financing
You might ask “why don’t these businesses just get financing?” Well, the answer is that it’s probably not available. I’ve written extensively on general financing issues for cannabis businesses (see here, for example). So I won’t re-hash all the details here. But the gist is that federal illegality and skittishness of bigger banks takes bank loans off the table for many cannabis businesses. And for the rest, loans tend to be much more expensive and even more predatory. Expect lots of guarantees and security interests.
#3 – Lots of red tape
Buying commercial real estate tends to be much more complicated than leasing it. I’ve gotten leases signed before with as little as a few emails. This kind of thing is basically unheard of for acquisitions, which involve much more diligence and red tape in general than leasing.
With cannabis, things are even more complex. Cannabis businesses (especially in newer markets) will have a hard time finding escrow and title companies that service cannabis businesses. This is a huge impediment to closing a real estate acquisition. Working with a small potatoes escrow company, in my experience, can be a huge pain, huge cost, and slow things down significantly. As cannabis markets open up, title and escrow companies become more open too, and this problem starts to solve itself. But it can take years, and cannabis companies don’t even have minutes.
These are the three biggest reasons why I’ve seen cannabis companies steer towards leases in the last five years of California’s cannabis licensing. This has been so much the case that many cannabis businesses I’ve seen start out buying have later done sale-leaseback transactions.
Does this mean leases are always perfect or even a better option? No. There are plenty of ways to botch a landlord-tenant relationship (you can read about some of them here). And real estate lessees have one less asset to collateralize when seeking financing later on down the road. But at the end of the day, a cash-strapped cannabis company that wants to get up and running quickly can generally get a lot more up-front value out of a good lease agreement.