Musings from a Cannabis Lending Insider
Chapter List
The Importance for banks to get involved in Cannabis Real Estate Lending
Injecting Much Needed Liquidity
The entrance of banks in the Cannabis-related real estate market would inject much needed liquidity into the industry. Currently, the vast majority of banks will not lend to Cannabis-related entities due to the risk of asset seizure from the entity due to its federal illegality and the applicable anti-money laundering laws. This presents an issue for potential licensees with respect to real estate. As it stands now, applicants must own their real estate outright, purchase it with cash or seek private investment debt or equity. Overall, approximately 90% of the financing going towards the Cannabis industry comes from private firms or family offices.
In the event that the licensee isn’t already a commercial real estate owner, using such a large amount of cash to acquire a piece of commercial real estate destroys the applicant’s liquidity. The real estate acquisition is just one of many expenses each applicant will experience throughout the licensing process. If too much cash is tied up in the real estate purchase, it handicaps the applicant with the subsequent expenses, including taxes, licensing fees, build-out costs, legal expenses, payroll and more. Infusing bank debt via established commercial lending practices would loosen the liquidity and allow each licensee to put their capital to better use, benefitting the industry overall and improving the experience and quality of each resulting entity. The extra liquidity would also allow businesses to hire more employees, which would benefit the state and federal unemployment rate.
Bank lending is not limited to purchase property mortgages. Another way to increase liquidity would be allowing banks to participate in line of credit and installment lending. Currently, most of these Cannabis-related entities are in the formation stage and require a substantial build out prior to the operational stage. Asking applicants to be able to fund these items, which can be in the millions of dollars, after making such a substantial investment in the real estate itself is extremely limiting financially. Infusing bank funds into this pre-operating stage would also increase liquidity and allow these businesses to have more flexibility and leverage as they move towards operating.
Cannabis Friendly Real Estate
Allowing banks to lend in the Cannabis industry would also increase the supply of Cannabis-friendly real estate. Landlords that own their commercial real estate outright need not worry about this, but most, if not all landlords that do not are subject to a commercial mortgage held by a bank. Chances are, that bank is not Cannabis-friendly (there are only handful of Cannabis-friendly banks in the state). Should the landlord have an interest in securing a Cannabis-related tenant, the bank that holds the mortgage on the property would likely call the loan due to the nature of the proposed tenant. In layman terms, the bank would force the landlord to pay off the mortgage in full, or not do business with the Cannabis-related entity. This is a standard provision in both commercial and residential mortgages and it is within the bank’s right to make this demand. This pitfall prevents many landlords from entertaining Cannabis-related tenants, inhibiting the growth of the Cannabis industry in Massachusetts.
Worse yet, some landlords are unaware of the bank’s ability to do this and make the realization after they’ve already started negotiations with potential tenants. This forces them to back out of negotiations already in process, which is damaging to the potential tenant and serves to further delegitimize the industry. The participation of banks in this untapped commercial real estate market would allow landlords to freely rent their commercial real estate to legitimate businesses who need space. It would increase the number of opportunities for a developing industry, and it would increase profitability for landlords.
3. Banks Helping to Promote Diversity, Equity, and Inclusion
Bank participation in Cannabis-related real estate lending would also help promote diversity within the Cannabis industry statewide. As discussed, licensees must own a piece of commercial real estate, have an abundance of cash to make a real estate acquisition, engage a private investment group for high interest rate debt to finance the acquisition or seek out equity partners resulting in dilution of entity ownership. Overall, this limitation greatly decreases the number of individuals who are able to participate in the industry even in light of the economic empowerment or social equity programs.
Real estate is a requirement to achieve final licensure as a Cannabis operator. Very few individuals have enough capital on hand to fund a multimillion-dollar commercial real estate acquisition . That, combined with the number of individuals who own a suitable piece of commercial real estate outright, makes for a small pool of groups that can avoid the private investment funding route.
Should the owner go down the investor debt route, the monthly interest rate on those funds can reach almost 20%, which is prohibitively expensive and very limiting for most. Most commercial mortgage rates, alternatively, are regulated and capped in the mid-single digits with the opportunity for the bank to charge a slight premium based on extra due diligence and compliance requirements.
The alternative, unfortunately, is raising equity from those same investors. While this seems like a workable alternative, raising equity dilutes the true owners share in the business. Dilution of ownership means dilution of control. The result of all of this is that control of the industry, outside of those who have exorbitant capital or own commercial real estate free and clear, rests with those private investment houses who are willing to enter the space. In addition to the obvious negative drawbacks associated with that, most of those groups are out of state entities, so a lot of the real estate interest income is being piped out of Massachusetts.
The final alternative to owning real estate is renting real estate. This has many limitations as discussed prior. First, the supply of Cannabis-friendly landlords is largely tied to those who own commercial real estate free and clear, which is limited. Second, the landlords that are willing to dive into Cannabis realize the unique supply and demand power dynamic and use it to charge an extreme rental premium. Either way, the real estate piece is extremely expensive and cost prohibitive for many applicants including people of color and other minority groups, whose interests are supposed to be protected and promoted.
4. Solution: SAFE Banking Act
The best path forward would be the passage of the SAFE Banking Act, which includes a lending provision that reads as follows: “A depository institution is not, under federal law, liable or subject to asset forfeiture for providing a loan or other financial services to legitimate cannabis-related businesses.” The historical fears of lending in the Cannabis industry are becoming irrelevant the further we trend towards federal legalization, and it has already received support from the Credit Union National Association, the American Bankers Association, the Independent Community Bankers of America, and the National Association of State Treasurers.
If passed, this Act would right the wrongs being experienced by the industry to date. It would provide more liquidity to the businesses and promote diversity of Cannabis-related entity ownership. It would increase access to real estate in the rental market. It would help business owners keep control of their businesses instead of farming it out to investors who are simply seeking to profit instead of experience success in the Cannabis industry in Massachusetts. It would further legitimize the industry help regulate the flow of funds, keeping Cannabis driven revenue in the state. It would help prepare both the state of Massachusetts and the United States for the day that Cannabis finally becomes federally legal and place both at the pinnacle of what figures to eventually be a globally significant industry by creating a lending program proactively instead of reactively after the floodgates have opened. Finally, adding another stream of interest income would be beneficial to the banks of Massachusetts, increasing their lending exposure and profitability in a new and exciting industry that’s poised for extreme future growth.
5. Opposition to SAFE Banking Act
Unfortunately, passage of the SAFE Banking Act is not imminent, as it was recently dropped from the National Defense Authorization Act for Fiscal Year 2022. There are still remedies that could positively impact the industry short of the Act’s passage, however. First, the idea of a monthly rental cap on pre-operating businesses should be explored. It shouldn’t be so low as to prevent landlords from engaging in the industry, but it should be set at an attainable level for businesses that have yet to start generating revenue.
Secondly and more importantly, it would be prudent for the banks to meet with their state and federal regulators regarding the pitfalls being experienced currently, especially with respect to state-chartered banks. A good first step for any individual bank would be to create the parameters of a program. Many of the businesses in need of lending are pre-operating, so the underwriting may be unorthodox. Perhaps a lower loan-to-value ratio on the real estate to mitigate the risk would be appropriate. Requiring these loans to be of the recourse nature might make it more palatable for the risk averse. Even if the businesses have yet to commence operations, there are ways to generate cash flow for underwriting purposes. Rental income can be considered if the building has other tenants. Requiring each group to set up a separate entity to own the real estate and executing a lease between the entities would generate some additional rental income to the property-holding entity to which the loan would be issued. At a minimum, allow banks to enter the market after the groups have reached an operational, cash flowing stage to eliminate the high interest debt or payoff the equity investors in the first couple years of the commitment.
Whatever form the program takes, it is paramount for each bank to establish standard Cannabis-lending procedures to present to their regulators, especially Massachusetts state-chartered banks. This will create pressure, whether it’s the Federal Reserve, the OCC, the FDIC or the Division of Banks, to make a decision. Considering the tax revenue and overall Cannabis-friendly nature of Massachusetts and the amount of unrealized revenue currently in the market, it would be difficult to outright reject the proposition. Perhaps it would lead to a counter proposal. Regardless, getting the conversation started would be a major step in the right direction.
6. Conclusion
Overall, allowing banks to lend to Cannabis related entities would further legitimize the industry. This would benefit the state, the nation, the banks and even the regulatory bodies with the increase in lending regulation that would inevitably result. Most importantly, however, it would benefit the business owners, specifically those of minority status, and allow more individuals to participate and retain control. Real estate in the Cannabis-industry is key, and so is making sure that as many people as possible have access to it. The Cannabis industry is here to stay and continues to grow exponentially. It’s time for banks to catch up and start lending.
For More Information See Consulted Sources
https://perlmutter.house.gov/safe-banking-act/
https://www.americanbanker.com/news/regional-banks-credit-unions-begin-lending-to-pot-firms
https://www.ft.com/content/28d8375a-3bd9-4fba-b1b7-a2e5e8b4fcdb
https://www.bankingdive.com/spons/what-federal-legalization-would-mean-for-cannabis-lending/601320/
https://www.bankingdive.com/spons/what-federal-legalization-would-mean-for-cannabis-lending/601320/
https://www.americanbar.org/groups/business_law/publications/blt/2020/02/cannabis-banking/