How Lenders Are Underwriting Cannabis Deals

There is huge demand to fund cannabis deals, but lenders are focused on protecting against the downside. Cannabis-use assets receive significant rental premiums, but a lot of the rent boost is because cannabis remains illegal at the federal level. To protect against the higher risk, lenders are underwriting cannabis real estate as standard-use and with standard market rents.

“Lenders are seeing that Cannabis deals are great cash-flowing assets when leased on the upside, but there is a lot of risk on the downside in the case that the government shuts down the use. Lenders are looking at the property’s real estate attributes and underwriting the property without the premium rents for cannabis use,” Gary Mozer a principal and co-founder at George Smith Partners, tells GlobeSt.com. “The lenders know that in the worst-case scenario, they have to kick the tenant out and lease it up to a non-cannabis user. So, lenders are stressing their underwriting to their downside scenario, not only for NOI but also for the cost to re-tenant, the carry costs and any capital expenditures. Excess cashflow can be used to amortize the loan or create reserves for re-tenanting.”

Despite the more stringent underwriting standards, investors are still very bullish on the market, and it is generating strong demand for financing. “Equity Investors love this business because there is a great return on investment,” says Mozer. “The more expensive cost of debt is still leverages the returns proving a higher cash flow. Most investors believe that everything is going to work out in the future with the governments, and on the downside, the investor still owns a good real estate. But, because the market is so inefficient, there is a lot more upside than downside.”

A lot of the upside, however, is because cannabis use is higher risk. Remove some of the downside risk—which would happen when cannabis is federally legalized—and the upside benefits would also decrease. “I don’t think you lose all of the premium rents, but you lose some of it. If cannabis were completely legalized.  With the lower rents, the values of these properties will likely decrease too.  says Mozer.

The challenge is also navigating the lending rules, or lack of rules. “This is a big business, but it is the Wild West,” says Mozer. “The rules are just being written right now. When you talk about the cannabis business, there is whole lifecycle from manufacturing to the distribution to the retail. So, you have to think about where a tenant is in that lifecycle. That is the first step.”

The firm has set up an internal process to better serve cannabis clients, as well as a roster of lenders—all private lenders—that are open to cannabis deals. “We are closing five of these deals per quarter .  Internally, we are sharing lessons learned,” says Mozer. “We are refining the database, and we are really understanding who has the ability to lend on these properties. That is largely non-federally insured lenders and non-regulated lenders.”