Experts are predicting CRE defaults, yet cannabis CRE could avoid the next round of busts
When you think of a 'bust' in cannabis, you normally envision helicopters, shouts of 'hands up,' and criminal defense attorneys, not real estate. Yet, there may be a different kind of bust affecting cannabis property owners. Over the last 12-24 months, cannabis operators have seen many distressed assets sold or placed in receivership. Property owners, business owners, and investors have had to accept losses. But is this latest round of forecasted commercial real estate (CRE) disaster real, and will it affect cannabis properties if and when it arrives?
First off, several unique factors set cannabis commercial properties apart:
- Licenses and Location: Cannabis licenses are intrinsically linked to the property, typically anchored to a specific address. This fixed nature means that relocating licenses is often restricted by local governments. For those municipalities that do permit moves, the process may involve a duplicate review, including community feedback, adherence to the California Environmental Quality Act (CEQA), and compliance with proximity restrictions related to schools, daycares, etc.
- Market Entry and Competition: The fierce competition for cannabis licenses, coupled with high costs, establishes significant entry barriers for new competitors. This competitive landscape ensures that obtaining a license is both a valuable and challenging endeavor.
- Barriers to Exit and Market Protection: These properties also present a considerable barrier to exit for tenants, benefiting property owners and their mortgagees by offering a layer of security against the broader commercial real estate (CRE) market's fluctuations. However, it's important to note the double-edged sword of this arrangement - if external factors or operational missteps lead a cannabis tenant to fail, the resulting unpaid leases escalate the risk of default.
What are the experts saying about the overall CRE market? From Bloomberg:
"We don’t see anything systemic - famous last words - in (the CRE) sector; there could be a confluence of things that sort of starts a fire," said Bernie Mensah, who leads (Bank of America's) international operations. "The US real estate sector is actually pretty sophisticated; it’s had its booms and its busts."
Cannabis enthusiasts usually seek a different kind of 'fire,' yet the looming maturity of over $1 trillion in commercial mortgages over the next two years poses a risk of igniting various economic challenges within traditional commercial real estate (CRE) debt. Particularly at risk are office spaces, especially Class B and C buildings, which are grappling with declining lease rates and increasing vacancies. Experts suggest that buildings with less than 50-60% loan-to-value (LTV) financing are more resilient in scenarios of market devaluation. This resilience is pertinent as the cannabis CRE sector has already experienced a market correction, with leases adjusting downward from previously unsustainable levels over the last two years.
Should defaults escalate, the impact could ripple through the entire US economy, potentially leading consumers to curtail their spending at licensed dispensaries. This shift not only has the potential to affect upstream suppliers but also their landlords, especially those focused on premium indoor products which have a higher production cost. Conversely, as budget-conscious smokers seek out more affordable options, value brands and the gray market might experience a surge in demand.
In response to these market dynamics, Pac Garden remains committed to moving forward, a stance that licensed cannabis entrepreneurs would do well to emulate. For landlords concerned about the impact on their cannabis properties or business owners seeking a free valuation, Pac Garden is here to support your needs. Don't hesitate to reach out to us or complete the future exit form. Thank you for your trust in us during these fluctuating times.
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