The legal cannabis industry has seen explosive growth in the U.S., but the debt-funding options for marijuana growers, distributors and retailers remains spotty. Generally speaking, banks won’t make real estate loans or even indirectly do business with cannabis operators.
Direct private lenders, however, are partnering with commercial mortgage brokers who work with cannabis dispensaries and grow houses. In fact, in an industry where the expectation is for red tape, the direct lending process is comparatively smooth and seamless. For mortgage brokers, legal cannabis can be a highly lucrative niche with lots of growth potential.
Rapid expansion
Although cannabis remains illegal at the federal level as a Schedule 1 drug, marijuana laws in the U.S. have loosened dramatically in the past 25 years. In 1996, California was the first state to legalize medical cannabis. Medical use is now legal in 33 states and Washington, D.C.
In 2012, Colorado and Washington became the first states to legalize cannabis for recreational use. Today, there are 11 states that allow such use. In addition, five more states have ballot initiatives about marijuana legalization in November 2020.
New Jersey, Arizona and Montana are voting on legalized recreational use. Mississippi is voting on medical marijuana, while South Dakota has both medical- and recreational-focused cannabis measures on its ballot. Interestingly enough, the spread of COVID-19 has made legalization attractive to legislators who want to boost tax revenues after months of chronic unemployment and temporary business shutdowns.
According to Marijuana Business Daily, U.S. medical and recreational cannabis sales are on track to exceed $15 billion in 2020 — up 40% from last year — and could reach as high as $37 billion by 2024. Beyond the booming business itself, however, the banking and financing aspects of the cannabis industry have represented ongoing challenges for entrepreneurs. Because of the legal issues, federally regulated banks are unable to lend money to cannabis enterprises to purchase properties or fund operating expenses. Many of these companies are left to operate as cash-only businesses.
Direct private lenders, however, are funding these types of loans. In many respects, the direct private lender will treat the borrower as it would any other business.
Underwriting marijuana
A direct lender will want to verify with the state in question that an enterprise has the required license to grow cannabis or operate a dispensary. From the lender’s perspective, however, there is no difference between states with legalized recreational cannabis and those with legalized medical use.
As is the case with all commercial mortgages made by a direct lender, the focus is purely on the value of the real estate. There is no requirement to show revenues or tax returns, or to prove the crop value. That said, it is a good idea for a mortgage broker to be prepared to show key documents, such as the property appraisal, Realtor-generated comparative sales and a basic business plan. This will facilitate the lending process.
A cannabis enterprise can expect to pay a premium on a private money loan, with rates generally in the low teens. This is a direct result of our old friend, supply and demand. As more states have loosened their regulations, there has been a significant influx of people wanting to get into the cannabis business, yet only a handful of lenders are willing to offer financing on a national level.
The loan-to-value (LTV) ratio is customarily capped at 60% with terms between one to three years. At the end of the term, many borrowers will likely need to refinance, although the most successful businesses may have generated enough cash to pay off the loan in full.
The expertise of an experienced broker who understands the intricacies of the deal adds significant value when it comes to making a pitch.
Broker’s role
For mortgage brokers, representing cannabis operations can be an opportunity to diversify their portfolio and to get ahead of a fast-growing trend. The fact remains that the industry is still in its relative infancy. Many of these borrowers are unsophisticated when it comes to purchasing commercial real estate. For a significant percentage, it is their first time even operating a business. In some cases, they are cannabis hobbyists who accidentally lucked into a license.
The broker should take all of these factors into account. The aspiring cannabis entrepreneur may have unrealistic expectations about the loan process. The expertise of an experienced broker who understands the intricacies of the deal adds significant value when it comes to making a pitch, especially if they can come to the table with the appropriate property documentation and business plan. Adding the representation of a seasoned lawyer can help smooth out the financing process as well.
It’s important to note that there are differences between funding for grow houses and dispensaries. For example, take a 15,000-square-foot grow house on 17 acres that has been built to feature all of the latest technology, such as a metal greenhouse with lights and watering systems.
The valuation will include what the owner paid for the property as well as the amount they spent on construction. If a grow house costs $2 million to build and is appraised for $1.5 million, a direct lender might be willing to loan $700,000 to maintain an appropriate LTV. The challenge here, however, is that this is a property built for a single purpose. In the event that the current operator fails, how difficult will it be to bring in a similar business?
By contrast, a dispensary is a much more vanilla loan. Other than an upgraded security system, nothing out of the ordinary needs to be done to convert an existing commercial property into a dispensary. Unlike the example of the grow house, it would be comparatively easy for the lender to find a new buyer in the case that the borrower was unable to perform.
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As cannabis continues to gain acceptance across the country, growers and dispensary operators will need to be strategic about how they gain financing in order to foster growth. With the U.S. government showing little inclination to loosen federal laws in the foreseeable future, direct private lending will continue to be a vital resource for businesses that are not bankable through federally regulated institutions — and an opportunity for mortgage brokers who want to expand and diversify their offerings. ●
