Five Major Concerns When Leasing to Cannabis Businesses (Part 1)

Recently, I’ve been asked to negotiate several commercial leases for cannabis cultivation centers (MJ Tenants) and registered marijuana dispensaries (RMDs) around Massachusetts. Competition is fierce, and parties are scrambling to scoop up real estate in qualifying zoned areas. As a result, the market value of these properties is increasing rapidly.

While high costs pose an entry challenge for new businesses, many commercial landlords are benefitting from the sudden increases in value. But despite their expanding profit margins, there remains a host of issues for commercial property owners to consider when leasing to operators of RMDs and MJ Tenants, which sometimes contribute to the increased rents/costs that many of the latter are experiencing.

1. Differences between state and federal laws regarding the growth and cultivation of cannabis
State and federal laws are vastly different concerning the cultivation and sale of cannabis, regardless whether for medicinal or recreational use. The Controlled Substances Act (CSA) classifies cannabis as a controlled substance; as such, cultivating and dispensing marijuana remains illegal at the federal level.

Property owners that derive income from tenants who use a space to cultivate or sell cannabis may expose themselves to prosecution under federal laws. It is a violation of Sec. 856 of the CSA to:

(1) knowingly open, lease, rent, use, or maintain any place, whether permanently or temporarily, for the purpose of manufacturing, distributing, or using any controlled substance;

(2) manage or control any place, whether permanently or temporarily, either as an owner, lessee, agent, employee, occupant, or mortgagee, and knowingly and intentionally rent, lease, profit from, or make available for use, with or without compensation, the place for the purpose of unlawfully manufacturing, storing, distributing, or using a controlled substance.

Landlords’ properties and MJ Tenants’ inventories are subject to forfeiture as a result of any such violation (although, to date, federal agencies have chosen not to prosecute such claims where the “violators” are otherwise in compliance with all state laws.) This risk puts an extra burden on landlords, who must ensure that their MJ Tenants comply with all requisite state laws and regulations, including, for example, not having cannabis-related imagery or paraphernalia displayed in any signage.

Property owners and MJ Tenants need to consider building “escape clauses” into their leases, whereby, in the event that federal agencies choose to act on any federal law violations, the landlord may evict the MJ Tenant. Although this would allow the landlord to quickly terminate the lease, and thus reduce the landlord’s potential liability for federal violations, they would also be left with a vacant building or space, and a lost rental stream.

2. Zoning and local restrictions
Location, location, location…in real estate, location is everything. Well, in this industry, location is really about being in the correctly zoned area, with a site that can fit, or that has a structure that works for, the intended use. While RMDs are expected to quickly become destinations, particularly in jurisdictions that have legalized marijuana use, they are still retail operators, and visibility and accessibility can make a difference in their success.

State and local municipal laws restrict where a cannabis business can operate. Accordingly, owning property in a properly zoned area can be hugely advantageous – in each community, the areas zoned for RMDs and/or MJ Tenants are relatively limited, so landlords are quickly realizing their value. Rents are at a premium, as potential MJ Tenants and RMDs are rushing to gain control over the precious commodity of permitted space.

Importantly, when drafting leases, landlords should incorporate strict non-assignment clauses, to prohibit potential MJ Tenants or RMDs from tying up a property, then assigning their lease or subletting to other MJ Tenants or RMDs for a substantial gain. Many property owners already incorporate non-assignment clauses, and if they do allow for assignment, or even sub-leasing, the landlord will take all, or a minimum of 50%, of the increased profit.

Another option for landlords to consider is having a lease that provides for percentage rents. These would award property owners a percentage of the tenant’s revenues, which could be potentially large payoff in the near future, as this “budding” industry comes into its own.

Next week, in the second part of this entry, I’ll examine the financing costs, security concerns, and types of insurance protection associated with operating a cannabis business.