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Cannabis Reclassification Would Likely Boost Cash Flow, Opening Doors For CRE Moves

This week’s announcement that the Department of Justice recommended cannabis be reclassified as a lower-risk substance is a long-awaited move toward legitimacy coveted by thousands of marijuana businesses in states where recreational use is legal.

The decision could bring big changes for cannabis-related real estate as a result of loosened lending restrictions, a lower regulatory bar and more available money to spend on facilities and growth.

Cannabis cultivators usually take up residence in industrial spaces.

“The increased cash flow from the reduced tax burden will provide financing for expansion of all different types of licenses,” Charlie Alovisetti, partner at cannabis law firm Vicente LLP and chair of the firm’s corporate group, told Bisnow in an email. “And the momentum from the rescheduling will hopefully lead to improvements in banking access, payment processing, and ability to obtain bank debt, all of which will also spur growth and the need for new and larger facilities.”

The Drug Enforcement Agency is expected to follow a recommendation from the federal Health and Human Services Department to reclassify marijuana from its Schedule 1 status under the Controlled Substance Act to Schedule 3.

Nearly half of states have legalized the recreational use of marijuana for adults, but even in those states, cannabis businesses have been stymied by the substance’s classification as a Schedule 1 drug, which places it among the likes of LSD and heroin. Other Schedule 3 drugs include ketamine and Tylenol with codeine.

The revenue potential for legal marijuana, meanwhile, is nothing to sniff at. States collected nearly $3B in marijuana revenues in 2022, according to a December Tax Foundation report. It also projected that national cannabis legalization could generate $8.5B annually for all states.

The cannabis industry’s lack of access to banking is perhaps its largest issue. Congress is considering the SAFER Banking Act, which would allow state-legal cannabis businesses access to banks and other financial institutions. 

The cannabis sector’s access to commercial property remains dependent on banks, said Robert DiPisa, a New Jersey-based member of the real estate department at law firm Cole Schotz and chair of its cannabis law group.

“Don’t forget, the banks drive the issues down onto the landlords, who are then forced to draft for and solve these issues in the leases with these tenant operators,” he said. “The banks are the ones dictating the language that they need in the agreements.”

And many of those banks still view the cannabis industry from a pre-legalization perspective, DiPisa said, pointing out there hasn't been a civil asset forfeiture action against cannabis companies in over a decade. 

“Yet the banks still want to see language that provides that, in the event the Department of Justice, which hasn’t done this in over 10 years, commences such an action, they want the landlord to have the ability to terminate the lease immediately to preserve the collateral that’s being used for that loan,” he said.

While such regulations might work for a retailer with a small storefront and minimal build-out, “that type of requirement and language is much more difficult to swallow for a cultivator or a manufacturer who is pouring millions or tens of millions of dollars into a property,” he said. 

It is difficult to quantify the amount of real estate in the U.S. where cannabis is grown, sold or distilled into edible products. Industrial and retail spaces are most commonly used for cannabis businesses, although other property types can make appearances, like marijuana-friendly hotels or a church in Denver that houses the International Church of Cannabis.

In Denver, the American vanguard of legal marijuana use, cannabis growers contributed to the post-Global Financial Crisis recovery of the local industrial market, taking up lower-class warehouse space and pushing other users into newer, pricier product. At the height of cannabis business creation in 2015, 1 in 11 Denver warehouses were filled with weed.

A marijuana grow operation

But DiPisa is skeptical the potential rescheduling will have a direct impact on commercial real estate in the near term.

“If anything, maybe it somewhat removes another layer of taboo from the cannabis space and shows some movement on the federal level,” he said. “But I really don’t anticipate a lot of banks, especially the big banks, to change their position on cannabis.”

Removing that taboo, though, could go a long way toward helping cannabis companies access new and different real estate.

Stigmas around marijuana have contributed to the way municipalities zone for cannabis businesses. 

The result of these zoning disparities “has been forcing the cannabis business into the worst properties in any market, and often with predatory landlords with the highest possible rents,” said Steve Fuhr, director of sales and business development at SciPhy Systems, a Portland, Oregon-based cannabis company. 

Local governments regulate marijuana zoning laws, which often create a “buffer zone,” usually 1,000 feet or more, between cannabis businesses and schools, churches, daycare centers, parks and places where children congregate. That zoning can severely restrict the number of properties marijuana companies can consider, Fuhr said. 

Another issue is acquiring insurance, which Fuhr described for marijuana companies as “more akin to betting parlors than true insurers, with rates five to 10 times higher than regular insurance.”  

Then there is the problem of manufacturing facilities that meet federal standards under the Food and Drug Administration’s Good Manufacturing Process regulations.

“When the FDA starts to enforce GMP clean room standards, these low-grade properties will not meet the requirements,” he said. “These businesses will then have to move, retrofit a dilapidated building at great expense or close. And if they do move, the grade of a property will have to be higher to meet these regulations.”

Finally, rescheduling cannabis would ease the burden companies face under the U.S. tax code's obscure Section 280E. This rule prohibits federally illegal businesses such as marijuana from deducting “the normal overhead expenses” available to mainstream businesses, such as advertising and travel expenses, as well as wages and salaries.

In an email to Bisnow, Aaron Smith, CEO and co-founder of the National Cannabis Industry Association, said rescheduling marijuana “would lift the unfair tax burden of Section 280E from thousands of legal businesses.”

The reclassification to Schedule 3 “will be a lifeline to many who are paying effective tax rates of upwards of 80%,” he said.

“This change will allow legal cannabis businesses to take the deductions [available to] all other small businesses, reducing their effective tax rate to closer to 20%.”