Cannabis Real Estate Investing: Considerations for an Emerging Asset Class
A version of this article was originally published on November 12, 2019.
EquityMultiple provides investors access to high-quality commercial real estate investment opportunities at low minimums and diversified offerings with a range of risk/return profiles. We have observed strong demand for non-traditional property types that have the potential to generate outsized returns.
Long-term success in private real estate investing is a function of quality management, a diversified approach, and decisive action to take advantage of inefficiencies in private markets. Forward-looking investors keep watch for niche property types with idiosyncratic operational and financing requirements, where market imbalances can create opportunity. One such opportunity lies in the cannabis sector. EquityMultiple has now offered several cannabis industry-focused real estate investments which have been met with strong interest from our investor network.
With demand growing, and easing regulatory restrictions paving the way for supply to meet this demand, the industry is poised for growth. Worldwide cannabis sales are now projected to reach $146B by the year 2025—a compound annual growth rate of 21%. From a regulatory perspective, cannabis is now recreationally legal in 15 states, and medically legal in another 20. In December 2020, the House of Representatives approved a monumental bill that would federally decriminalize cannabis.
This robust pace of growth has generated strong interest from institutional real estate investors. Still, the freshness of the industry puts the first movers in a favorable position to capture much of this opportunity. Much of the focus remains on cannabis stocks and private equity investments in pre-IPO cannabis companies; however, real estate investment in Cannabis Facilities presents another means of participating in the industry’s growth, while benefiting from the additional security of real estate. This article further expands on the compelling aspects of this emerging CRE asset class.
What are Cannabis Facilities and why invest in them?
Like any industry that cultivates, processes, and distributes a perishable good, cannabis companies require facilities tailored to the specifics of their operations. Given the demands of harvesting cannabis, industrial facilities may require improvements for sufficient security, climate control, energy throughput, and lighting to process and quality control (QA) at scale. Many cannabis tenants will also utilize office or retail components for administrative and dispensary purposes.
Cannabis Facility developers and investors must address material legal, regulatory, and zoning considerations. Cannabis real estate is complex and significant barriers to entry remain, resulting in a demand/supply imbalance. As such, investing in Cannabis Facilities can be attractive from a risk-upside perspective. Investors must be able to identify and acquire properties leased to licensed operators. They must also understand the nuances of working with cannabis operator tenants.
It is important to note that real estate investing with cannabis operator tenants is not the same as investing in cannabis operators directly. First, there is nothing illegal in owning real estate. Second, if a cannabis operation becomes legally unfeasible per local or federal law, the asset can still function as a productive property for traditional warehouse, manufacturing, or retail uses.
Key Considerations for Cannabis Real Estate Investing
Like any real estate property type, Cannabis Facilities present their own opportunities, risks, and underwriting considerations. Here are a few key considerations:
Specialized Knowledge and Experience Matter
We always seek investments where a sponsor, operator, partner or lender possesses specific market, asset class, and investment strategy experience. This is particularly true for Cannabis Facilities, given the industry’s regulatory and operational complexities. Lenders, for example, can command a return premium via expeditious loan closing and funding, which is gained through experience and a structured origination process. Additionally, those with experience in a young industry are able to drive down risk across borrower selection. The “first movers,” therefore, often have a leg up in this industry.
A Regulatory Arbitrage Opportunity
The cannabis industry continues to expand rapidly, but cannabis remains federally illegal. This results in a “risk premium” for Cannabis Facilities in the form of premium rental rates and above-market financing costs compared to traditional real estate debt providers. This creates a window for regulatory arbitrage wherein investors can potentially benefit from improved returns and protections due to regulatory complexities.
Debt Funds as a Means to Mitigate Risk
One of the main draws of a fund investment is the built-in diversification, which allows investors to spread risk over numerous properties, rather than concentrating it in one. Additionally, the debt component allows investors to live at the top of the capital stack, providing investors with payment priority over common and preferred equity investors in the borrowers’ properties. Along with these inherent benefits, borrower selection remains a critical component to reducing risk in debt fund investments. Therefore, experienced lenders with the datasets, infrastructure, and processes to select high-quality borrowers in low-LTV properties are advantageous to such investments. Diversification, payment priority, and diligent borrower selection allow investors in debt funds to drive down risk in cannabis real estate investments while still capturing the premiums associated with these investments.
The Bottom Line: Investing in Cannabis Facilities
The market for Cannabis Facilities remains inefficient due to the specialized nature of cannabis production/sales and the existing legal and regulatory complexities specific to the industry. This creates material barriers to entry and results in higher financing costs, creating an opportunity for investors to benefit from potentially higher income and total returns.
Want to learn more about how EquityMultiple can facilitate your participation in cannabis real estate investment? Please don’t hesitate to contact our Investor Relations team via email at email@example.com or by scheduling a call today.
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