It would stand to reason that, as more states open their portals to cannabis growth and sales–for both recreation and medicinal uses–an emerging asset class is also presenting itself to investors.
And that’s true, but with certain asterisks. The market sector is fraught with risks as we await regulatory issues to get ironed out and the market becomes more of a familiar investment commodity. For now, it takes a strong stomach and careful due diligence to hit a homerun here. Let’s weigh some of the pros and cons on the retail side of the industry.
First, it should come as no surprise that the number of states turning their backs on pot sales is shrinking. Reportedly, there are currently only 11 holdout states. So, the writing is clearly on the wall. Can a federal sanction of sales be far behind? As the number of states increases, sales naturally follow. In fact, last year outpaced 2021 activity by roughly a third. Both of these data points reflect the popular sentiment as revealed in national polls, which indicate that most Americans are in favor not only of medicinal use, but recreational legalization as well.
On the downside, those holdout states make for tricky interstate business protocols as well as banking risks since most lending institutions are governed at the federal level. If a lender chooses to transact a pot loan, they’re likely to do so at a higher interest rate. You may also have to turn to private sources and a hard money loan.
Also among the cons is some indication that, almost unbelievably, the market might be softening. The strong activity quoted above is giving way to a 2022 sales slowdown, possibly due to growth beyond market need. In some cases, rental negotiations in favor of the tenant and even shutdowns have been recorded, though these seem to be rare.
The question then for potential investors is if this downward track represents an ongoing pattern or if we’ll discover that marijuana is simply subject to the same cyclicality of more traditional, verticals. Another “con” consideration is the fact, again like more traditional markets, creditworthiness is always an issue.
Here we should mention that, despite flagging numbers, we’ve found the street reality quite different. For instance, we are about to close on two standalone asset sales–both with triple net leases signed by creditworthy tenants. I’m happy to report that interest from around the nation has been intense. The same was true with a third transaction we closed in the past few days. All three, coincidentally located in Florida, belie the numbers put forth by the data folks predicting a market slowdown.
Given the lending situation specific to cannabis deals, most of the investors we’ve talked with are focused on cash buyers. Given the risks, they’re also focused on higher rents and longer-term upside.
We mentioned above some of the pros and cons of cannabis-retail investment. There’s one other “pro” reason that this still-emerging market brings, and this is equally true of retail acquisitions in well-placed locations with healthy traffic and proper access–no matter the tenant.
Specifically, this isn’t about marijuana. This is about real estate, and successful retail checks off all of those boxes, no matter the market conditions of the particular store brand. In fact, investors weighing the benefits of cultivation plants versus dispensaries should consider that these retail locations provide cap rates that can be as much as 10% lower than their cultivation-facility counterparts.
The cannabis business might call for investors with a little more risk tolerance. The underlying real estate promises long-term gains for whatever tenant will stay on for the long haul.
Jonathan Hipp is Principal, U.S. Capital Markets and Head of U.S. Net Lease Group for Avison Young.