Green Space Is Not A Risk-Free Buck

Michael K. Goswami Commentary

Green Space Is Not A Risk-Free Buck

The cannabis industry continues to expand rapidly across the U.S., including in Arkansas since the passage of the Arkansas Medical Marijuana Amendment in 2016. 

As investors become more comfortable participating in this industry, cannabis-related real estate transactions are more frequent. Until an investor gets up to speed, he or she might want to seek professional guidance on certain cannabis-based real estate transactions.

This is an Opinion

We'd also like to hear yours. Leave a comment below, tweet to us at @ArkBusiness or
email us.

Location, location location: If a purchaser seeks to use a real estate asset for cannabis-related business purposes, location is paramount. Differing state and municipal regulations may limit the purchaser's ability to operate a cannabis-related business in particular locations. 

In Arkansas, there are regulations regarding distance of cannabis-related businesses from churches and schools, and additional zoning limitations exist in various municipalities across the state. It's critical to review the property before purchase for conformity with land-use regulations proprietary to cannabis operations. 

Conflicts with federal law: Purchasers must also consider obligations to secured lenders. Particularly, a purchaser with lender financing who leverages a real estate asset in connection with a cannabis operation is likely to jeopardize the purchaser's borrower covenants for failing to comply with federal law. Obtaining consent to cannabis-related use from standard commercial lenders rarely happens, so the general remedy is to obtain alternative hard-money financing or seller-finance the purchase.   

Real estate investors expecting to offset the capital cost of their investment through income tax deductions may be surprised by certain limitations. The 2017 Tax Cuts and Jobs Act limits the ability of real estate investors to deduct certain interest-related expenses. In addition, IRC 280E disallows the deduction of ordinary and necessary expenses incurred in the trafficking of an illegal controlled substance, which can also mitigate the ability of cannabis real estate investors to benefit from non-cash depreciation expenses. 

While this position may change under the new administration, these limitations presently remain a large hurdle requiring the planning of efficient cost segregation structures which allocate permissible deductions.  

Insurance: Title insurance is also non-standard when considered in connection with cannabis transactions. Large title insurance underwriters generally refuse to issue policies for cannabis-related properties, however, there are more localized underwriters that will offer such a policy. 

It is essential to fully disclose any cannabis-related intended use when obtaining a title commitment so the underwriter can document the intended use in the final policy. Failure to transparently communicate this intent from the outset will lead to delays late in the acquisition and could leave the purchaser later holding a voided title insurance policy if a claim is submitted.  

Forfeiture risk: An overview of cannabis-related real estate concerns is incomplete without discussion of asset forfeiture risk. Real estate investors should be aware of the possibility of criminal and civil asset forfeiture for positioning an asset in connection with the manufacturing, cultivation or distribution of cannabis. Forfeiture risk cannot be presently mitigated by a real estate investor whose activities trigger the Controlled Substances Act, but most rely upon informal non-prosecution guidance from the Department of Justice in order to sleep soundly at night.

Rental issues: The above-described purchaser-oriented concerns are also applicable to real estate investors who desire to lease property to third-party cannabis-related businesses, but landlords will also realize a host of other concerns in addition to whether the rent will arrive on the first of the month.  

A landlord-centric concern arises regarding access to the leased property for the purpose of inspection, repair or other landlord obligations pursuant to the lease. Cannabis facilities are generally controlled-access by virtue of regulation, regardless of the contractual agreement between the landlord and tenant. Accordingly, landlords must be cognizant of how their access might jeopardize the tenant's operating license as well as the landlord's expected investment, which is contingent on the tenant maintaining such license.

On the matter of operating licenses, those issued to cannabis businesses are a delicate creature. Landlords should account in the lease for cancellation, revocation or non-renewal of a tenant's operating license. In such event, the landlord will generally require the lease be terminated, but a naked termination fails to address removal of controlled inventory on the premises and any resulting damages or liability related to coordinating transfer to appropriate authorities. Thoughtful covenants and indemnifications are necessary to protect a landlord from these unique occurrences. 

At the end of the day, it is imperative that an investor understand the legal risks and mitigation practices regarding a proposed cannabis real estate investment. Seeking professional assistance with experienced and up-to-date advisors is always recommended as a best practice for proceeding in this space.

Michael K. Goswami is a member of the business section at Rose Law Firm. Since the passage of the 2016 Arkansas Medical Marijuana Amendment, he has become one of the state's top attorneys to advise participants in the state's medical marijuana industry.