Last year I wrote a post titled “Cannabis Leases: Eight Important Considerations For Tenants”. The post outlined eight of the top considerations for tenants entering into cannabis leases. Today I want to focus on some of the most important considerations for landlords when renting to cannabis tenants.
1. Compliance with mortgages
Landlords who do not own property will likely have a much harder time renting property to cannabis tenants. Generally, when landlords have mortgages on their property and the lender is a bank, this can be a major barrier to these leases. Mortgages generally allow lenders to cancel a loan if the property is being used for illegal activity. This includes cannabis activities as well, as cannabis is still illegal under federal law. This could have dramatic consequences for the landlord and his mortgaged property.
2. Who is the tenant?
We have received many calls over the years from landlords enthusiastic about renting out to cannabis tenants only to quickly find out that the property in question is in a city where cannabis activities are invariably prohibited. In these cases, the potential tenant would openly violate local law (and thus state law) if he were to start a cannabis business, which could endanger the landlord. Even if a tenant opens a business in a “legal” city but does not abide by the rules or does not receive all necessary permits or licenses, this can put the landlord at risk. For these reasons, cannabis leases often look very different from normal leases. These include, for example, explicit requirements to obtain a full license before operations begin, and immediate termination if the landlord detects foul play.
3. Profit-sharing rental structures can lead to regulatory problems
Landlords may be tempted to charge a percentage of a cannabis company’s profits or revenues in addition to the fixed rent. This poses two main problems. First, landlords who participate in the rent increase their risk of federal crime violations. Should the federal enforcement priority ever change (although it may not), landlords involved in the profits of a cannabis business could, in theory, be at higher risk because they are more closely related to the cannabis business than landlords who are only Passively repaired rent every month.
In addition, landlords who have a share in the profits will likely need to be reported to state and in some cases local authorities. In California, any form of profit-sharing makes a landlord a “financial interest holder” who must be disclosed to the state. When the profit sharing reaches certain thresholds, a landlord can be considered the “owner” and much more important information would be required. It is important to understand this second point from the start. It is much easier for a landlord who does not want to be disclosed to know how to deal with it from the start than it is to try 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 changes to the premises. This is key for landlords as almost all rental agreements dictate how changes and tenant improvements are made and what type of consent and supervision landlords have. Understanding that tenants are guaranteed to have to make improvements can determine exactly what those regulations mean.
In many (if not most) cases, potential cannabis tenants are start-ups with no operating history and initially no bank accounts. Even a larger cannabis company negotiating a commercial lease will often create a new entity for the rented space to avoid liabilities and for other legal and practical reasons. Landlords therefore often want guarantees either from affiliated companies of the tenant (e.g. the parent company with an actual operating history) or personal guarantees from the tenant’s owners. In some cases, landlords insist on both. Without this, landlords may have very limited options in the event a tenant defaults.
6. Talk to strangers
Landlords may not understand the complexities of obtaining a cannabis license for a tenant. The process is never guaranteed and can take a significant amount of time. Many tenants may receive conditional or other land use permits, then spent months or even years completing buildings, obtaining local government licenses or permits, and then obtaining state licenses. This means that many months can pass between the start of the rental and operation. In some cases, operations may never start. This is good to know for landlords who do not want their property to be vacant for an extended period of time and a good starting point for discussing early termination provisions in the event a tenant cannot obtain a license.
These are a number of issues that can affect potential cannabis landlords. The actual factors are likely to vary significantly from lease to lease and from jurisdiction to jurisdiction. It’s a good idea to work with an experienced cannabis real estate attorney to find out which lease terms are best for a particular tenant and jurisdiction.
The big upside here should be that cannabis leases are difficult to draft and negotiate, and cannabis tenants can make life difficult for their landlords if not verified. Please visit the law Law Blog for more developments on cannabis leasing law and in the meantime, check out the posts linked below.