by Andrew Robinson (with research and support from Brad Bachman)
At some point in the lifecycle of every cannabis business, owners/operators must make a decision on whether to purchase or lease the real estate necessary for their company’s operations. The decision to purchase or lease presents a host of strategic and financial issues, and there is no bright-line rule or one size fits all solution to this quandary. The acquisition of property often requires increased start-up costs for land and constructing facilities, but, in the end, results in a long-term marketable asset for the company. On the other hand, while leasing property may result in lower up front start-up costs, it typically requires giving up ownership of build-outs and improvements to the facility to the landlord upon the termination/expiration of the lease, and accepting many other use limitations and controls subject to the terms of the actual written lease. As such, it is important to model out both options to ascertain the costs and benefits of the two methods of acquiring real estate interests, and to become familiar with the laws and regulations that dictate sales and leases. This article will explore what businesses need to consider when real estate hunting, and especially when entering commercial leases.
An owner’s business plan must recognize that the nature and regulation of the cannabis industry results in limited site selection. Whether businesses work with a real estate broker or other real estate professionals to identify properties or do the research themselves, the market of available and suitable properties will often present challenges in the site selection process. Sellers and landlords can discriminate against medical and recreational cannabis businesses due to the Schedule I status of cannabis, as well as for concerns around insurance coverage, and forfeiture rights held by landlords and their lenders. For prospective owners/operators who live in jurisdictions which require evidence of site control as a condition of licensing approval, the rush to secure suitable properties complying with local zoning codes, etc., may result in a dramatic increase in the market price for such properties and increased competition. As such, many owners/operators often find themselves in a “seller’s market” in the pursuit of suitable locations.
Leasing owners, however, must understand how commercial lease agreements for cannabis businesses differ from the typical lease forms which most real estate professionals are familiar. General “permitted use” clauses and covenants requiring that the tenant’s trade or business comply with federal, state, and local laws, will need to be negotiated and revised to permit the cultivation, processing, and/or sale of cannabis products and related uses, as applicable. Such provisions must be altered to permit those uses authorized under the applicable programs controlled by state and/or local law, and it is imperative that every cannabis owner/operator understand what laws control and what the program requirements allow. Many landlords expect to be able to have unfettered access to leased premises within their properties during certain times and emergencies, which many state and local laws and programs simply do not allow in connection with cannabis operations. As such, cannabis owners/operators should ensure that any general “access” clauses contained in their leases are modified to establish procedures allowing landlords to appropriately enter their leased properties using means and methods which comply with the applicable state or local programs, such as having a designated staff member of the business accompany the landlord throughout the entry.
The structure and sources of financing available to owners/operators during the build-out phase of their respective businesses depends, in large part, on whether they have purchased the subject site or entered into a leasing arrangement. Within the cannabis industry, it is common for the tenant, not the landlord, to fund and perform needed improvements to the leased premises. While these investments may raise the value of the subject real estate for the landlord, tenants rarely see the long term benefits of such improvements as they typically become the landlord’s property upon the expiration or termination of the lease. This aspect of leasing can be a credit risk for owners and operators seeking investors, as these buildout funds represent the bulk of start-up costs and little, if anything, is available to be pledged as appropriate debt security. State and local laws can also require extra accommodations on the premises of cannabis businesses, such as extra security and surveillance systems. Tenants should be mindful of any general clauses in the lease regarding the costs of such extra improvements and the rights available to tenants upon the expiration or termination of the lease regarding the removal of such tenant improvements.
The negotiation phase of the commercial lease process presents the tenant’s singular opportunity to achieve compromises and concessions relating to these startup and buildout costs. For example, rent abatement can be given for an initial term to provide time for the build-out, which would allow the tenant to avoid paying full rent when they are not completely using the property. Landlords and tenants alike should discuss the issues relating to high levels of electric and water consumption by the tenant within the leased premises and the increased security costs related to cannabis operations.
An often overlooked cost and consideration of utmost importance to many cannabis operations (growers and processors especially) is the implementation of effective odor controls. Cannabis operations can be exposed to the nuisance claims under the Racketeer Influenced and Corrupt Organizations (RICO) Act, a federal law providing a civil cause of action for acts performed as part of an ongoing criminal organization. The 2017 decision in Safe Streets Alliance v. Alternative Holistic Healing set precedent for federal civil lawsuits to be filed against cannabis operations. As the court held in the Safe Streets Alliance decision, sights and smells emanating from cannabis operations can violate a plaintiff’s rights by subjecting them to the knowledge that the operation is illegal under federal law. Odor controls, such as charcoal and carbon filters and strong HVAC systems, combined with sight controls like setbacks from the property line and planting appropriate perimeter landscaping can be effective against sights and smells resulting from certain cannabis operations. Leases for cannabis operations should expressly address the potential liabilities arising from civil actions in this regard and the role of the parties to indemnify and/or defend the other in the event such actions are instituted.
Owners and operators of cannabis businesses should be aware that many aspects of standard commercial lease agreements which they may be used to will need to be revised to properly address the unique concerns and risks inherent in the cannabis field. Working with experienced legal experts in the creation and review of these documents will ensure that the interests of owners and operators of cannabis business are protected and the appropriate contingencies are in place prior to commencing operations. For business owners who lack the capital to purchase property at the time of startup, purchasing options can be included in the lease allowing for certain acquisition rights relating to the facility and land at particular milestones, price points, etc. The process of finding property and then setting up a commercial lease agreement or contract of sale can be onerous, but being thorough and proactive will ensure a smooth establishment of the cannabis business.
If you have any questions about zoning in the cannabis industry, please contact Andrew Robinson at firstname.lastname@example.org.
ABOUT ANDREW ROBINSON
Andrew Robinson is a Principal in the Real Estate Law And Transactions group. He focuses on land use cases as well as areas of administrative and construction law. Mr. Robinson has experience representing clients facing homeowner association, landlord-tenant or construction disputes. He has assisted clients in processing subdivision and condominium development as well as in planning and zoning matters. Additionally, clients turn to Mr. Robinson for complex real estate transactions, commercial leasing and general litigation
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