Last year, I wrote a post entitled “Cannabis Leases: Eight Important Tenant Considerations“. The post outlined eight of the more important considerations for tenants entering into cannabis leases. Today, I want to focus on some of the top considerations for landlords in leasing to cannabis tenants.
1. Compliance with Mortgages
Landlords that do not outright own property will probably have a much harder time leasing property to cannabis tenants. If landlords have mortgages on their property and the lender is a bank, that can generally be a huge roadblock to these leases. Mortgages generally allow lenders to call a loan if the property is being used for illegal activity, which necessary includes cannabis activity given the fact that cannabis is still illegal under federal law. This could lead to dramatic consequences from the landlord and its mortgaged property.
2. Who is the Tenant?
We’ve received a lot of calls over the years from landlords excited to lease to cannabis tenants, only to find out quickly into the call that the property at issue is in a city that completely bans cannabis activities with no exception. In these cases, the would-be tenant would openly violate local law (and thereby state law) if it opened a cannabis business, which could lead to exposure for the landlord. Even if a tenant opens up shop in a “legal” city but does not follow the rules or get all required permits or licenses, that could lead to exposure for the landlord. For these reasons, cannabis leases often look a lot different from run of the mill leases. They include things like express requirements to get fully licensed before commencing operations, and allowing for immediate termination if the landlord discovers foul play.
3. Profit-Sharing Rent Structures Can Lead to Regulatory Issues
Landlords may be tempted to ask for a percentage of a cannabis business’ profits or revenues in addition to fixed rent. This raises two key issues. First, landlords who share in rent increase their exposure for federal criminal violations. If there is ever a change in federal enforcement priorities (though there may not be), landlords who share in the profits of a cannabis business could theoretically face more exposure as they are more intimately connected with the cannabis business than landlords who just passively get fixed rent each month.
Additionally, landlords sharing in the profits will probably need to be disclosed to state, and in some cases, local authorities. In California, any form of profit-sharing renders a landlord a “financial interest holder” requiring disclosure to the state. If profit-sharing hits certain thresholds, a landlord can be considered an “owner”, and much more significant disclosures would be required. It is critical to understand this second point at the outset. It’s much easier for a landlord who doesn’t want to be disclosed to know how to handle this from the outset rather than trying to reform a lease later.
4. Tenant Improvements
I don’t think I’ve ever seen a situation where a cannabis tenant applies for a license and is not required to make at least some modifications to the premises. This is key for landlords because almost all leases dictate how alterations and tenant improvements are made and what kind of consent and oversight landlords have. Understanding that tenants are basically guaranteed to need to make improvements can dictate just what those provisions say.
In many (if not most) cases, would-be cannabis tenants are newly formed entities with no operating history and no bank accounts at first. Even a larger cannabis company that negotiates a commercial lease will often form a new entity for the leased premises, in order to avoid liabilities and for other legal and practical reasons. Landlords often therefore want guarantees either by corporate affiliates of the tenant (e.g., the parent company with an actual operating history) or personal guarantees from owners of the tenant. In some cases landlords insist on both. Without this, landlords might end up with very limited options in the event a tenant defaults.
6. Addressing Unknowns
Landlords may not understand the complexities of obtaining a cannabis license for a tenant. The process is never guaranteed and can take a significant time. Many tenants may get some form of conditional use permit or other land-use entitlement, then spent months or even years completing buildouts, getting local regulatory licenses or permits, and then getting state licenses. This means many months may pass between lease commencement and operations. And in some cases, operations may never commence. This is good to know for landlords who don’t want their property sitting vacant for a protracted period of time, and is a good starting point for talks about early termination provisions in the event a tenant can’t get a license.
These are a number of issues that may impact potential cannabis landlords. The actual factors will likely change significantly from lease to lease and jurisdiction to jurisdiction. It’s a good idea to work with a seasoned cannabis real estate lawyer to determine what lease provisions are best in for a specific tenant and jurisdiction.
The big takeaway here should be that drafting and negotiating cannabis leases is tough and that left unchecked, cannabis tenants can end up making life difficult for their landlords. Please stay tuned to the Canna Law Blog for more developments on cannabis leasing law, and in the meantime check out the posts linked below.