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Cannabis leasing activities slows a bit North Bay

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As California and North Coast regulations for cannabis-related companies settle out, the frenzy of commercial property acquisitions in the Santa Rosa area has cooled a bit. Yet the newly legal industry has left a mark on property pricing and contract structure.

Several properties gained a lot of Santa Rosa commercial real estate market attention in the past two years as they sold for higher-than-typical prices with designs on attracting cannabis tenants.

Now they’re back on the market, like buildings at 2835 Duke Court, 2049 W. Steele Lane, 3320 Industrial Drive, 2150 Bluebell Drive and 3023 Santa Rosa Ave.

“The frequency of people reaching out for leases has slowed down a bit,” said Steve Skinner, an agent for commercial real estate brokerage Keegan & Coppin Co. Inc./Oncor International. He is marketing some of those facilities for sale. “The reason those properties are back on the market is the laws, the business and business relationships have changed.”

Some properties with lease pricing at $3–$6 a square foot monthly are sitting empty, or get deals that fizzle out with the tenant’s business within six months, Skinner said. That’s compared to longtime rates of as much as $1 a square foot a few years ago.

And sale prices for cannabis-positioned industrial buildings have soaring to $225 a square foot, and a construction company working on Santa Rosa home rebuilds outbid cannabis contenders to get a building for $223 a square foot in February, according to Skinner.

“Noncannabis users are climbing to meet the market,” he said.

While location is a key factor in real estate value, it’s even more so for prospective cannabis tenants, as certain uses like manufacturing and distribution are only allowed in specific zoning areas such as “business park” and outside a 600-foot radius from a school. Cultivation operations are another matter.

KNOW YOUR UNKNOWNS

In Mendocino County, buyers of property do not usually disclose they’re in the cannabis industry, according to Dick Selzer, broker-owner of Realty World Selzer Realty, based in Ukiah.

“Sometimes, there is reluctance to disclose that to an agent because of the reluctance of notifying neighbors,” he said. Unless a lender in involved with the property or the seller is financing the deal, the topic may not come up.

But leasing space is another matter. A cannabis licensee needs a lease to start the application process for a local permit, which will require authorization from the landlord as well as disclosure to permitting authorities the contact information for the property owner, said Dan Beck, whose Santa Rosa-based firm Canna Legal focuses on certain North Coast areas.

“In this area, more or less, the consensus among landlords is they want rent from day one, regardless if they have a permit,” Beck said.

Property owners have obligations to investors, lenders and insurers about what happens at and to their facilities. Common concerns from owners that Selzer’s agents work with are its current illegal status under federal law and the financial stability of players in the industry.

Credit worthiness is a key issue. But the illegal status at the federal level has nearly shut out the industry from access to capital sources overseen by federal regulators. And funding sources for property owners can be under the same constraints, which is not typically a problem for traditional tenants, according to Beck.

“We have crafted (in lease documents) the basis for what happens if there is a foreclosure,” he said. “Do you get another type of loan because the lender might not like the use at some point?”

Alternatively, Beck said real estate developers and “flipper” speculators often use a hard money” loan, also called a bridge loan. Because they’re typically not from a federally regulated institution, the current issue with illegality under federal law becomes less of a concern, he said.

In practice, traditional lenders have been less worried with the federal question as they are uninterrupted loan payments, Beck said.

There has been action in Congress in the past few years to ease the minds of lenders and property owners in the emerging legal marijuana areas of the country by reining in civil asset forfeiture, a method of drug and organized-crime law enforcement that seizes assets rather than arresting individuals. Those reforms stalled this year in Congress, and the U.S. Justice Department has signaled a reversal of Obama administration policy to exclude locally licensed marijuana operations from federal forfeiture.

LEASES BEFORE PERMITS

Landlords also have the challenge of tenant improvements, or TIs, for a cannabis tenant, Selzer said. A common carrot commercial property owners dangle in lease negotiations is a per-square-foot allowance for improvements, and that’s amortized over the term of the lease. Stability of the newly legal cannabis industry in California and of startups trying to navigate the ever-evolving state and local regulatory waters gives property owners pause when considering such offers, Selzer said.

Selzer said a property owner might be wary of amortizing the cost of TIs over five to 10 years and then the cannabis tenant is gone after two or three years.

Also, what if there’s too much product on the market and it crashes wholesale prices? “An owner will be leery about building a warehouse for a cannabis tenant, because they are concerned they will be left with an empty warehouse in three years. But they would be willing to build for a (good) credit tenant, if they get a 10-year lease and it’s unrelated to the cannabis industry.”

CANNABIS BUBBLE?

The wholesale price of cannabis trim for products manufacturers was $60 a pound last year, but the dwindling supply of licensed cultivators plus adult-use legalization at the new year has pushed the price to $200 a pound, according to Tiffany Devitt, chief information officer for CannaCraft, a Santa Rosa-based large-scale product maker.

“We have not increased the price of end products, but at some point, we will have to do that,” she said. The Sonoma County cultivation tax is $44 a pound, which with additional city and county taxes brings the levy to 69 percent of the product cost, Devitt said. “What’s suffering is R&D and our compassionate-care program, where we used to give away 10 percent to people in need and make donations to the community.”

In Mendocino County, many cultivators remain outside permanent structures, largely in “hoophouses” — greenhouses created by translucent material stretched over half-circle frames.

As of July 25, the county had 623 temporary cultivation licenses issued since the beginning of this year with the California Department of Food and Agriculture, according to its online records. That includes 336 still active, 71 that expire by the end of August and 216 inactive.

These licenses are intended as a stop-gap measure until local government issues permits.

In Sonoma County, of the 5,000–7,000 growers estimated to be operating there, only 105 temporary license applications have been filed this year, with 53 active and 14 near expiration. Only five county permits have been issued.

“Cultivation is where we’re really seeing difficulties in leasing issues, not so much with leasing but with getting space and approvals,” said Devitt of CannaCraft. Cultivators are being “driven indoors” in urban areas by the strict Sonoma County regulations on outdoor grows, including restrictions on operations in unincorporated areas zoned rural residential, where many existing plots currently are located.

“Indoor grows have a much heavier environmental footprint than outdoors,” Devitt said. “We would like the regulations to be loosened and treated like other agricultural commodities in what is allowed.”

LEARNING HOW TO SHARE

One provision in the forthcoming state regulations that commercial property owners will want to pay attention to are shared-use spaces, said Beck of Canna Law. Type S licenses were added to the emergency state cannabis regulations by the California Department of Public Health in mid-April to allow smaller businesses to enter the market. Conditions for those licenses were clarified with the draft final regulations on July 13.

The facility owner or operator must have a type 7, 6 or N cannabis manufacturing license for the facility, which is registered as a shared facility. Other cannabis companies that plan to use the space then apply to state Public Health for a type S manufacturing license.

“The facilities must be cannabis specific and are expected to resemble community kitchens or be locations in which a larger manufacturer offers use of space and equipment to a smaller manufacturer,” according to an email statement from Public Health.

Another analog to type S cannabis licenses are alternating proprietorships that allow multiple vintners to work at one winery facility.

Until the type S license, only one cannabis permit was allowed per property, Beck noted.

“This means that landlords with a standard clause that a tenant cannot sublease without the consent of the landlord that is not reasonably withheld may take the additional step of prohibiting subleasing,” Beck said. “If there is a shared premise like a time-share arrangement that allows other to use the building, owners should have more control of who is going in and out.”

The draft regulations clarify that each type S license must have its own address or suite number, and only one user can be operating in a space at a time. The rules also would call for a lot more specificity on building security arrangements and specific layouts of tenant spaces, so lease documents will need to reflect these elements, Beck said.

Another standard lease contract element that may need adjustment is percentage-of-sales clauses, Beck said. That allows the property owners to share in the financial success of the tenant’s business, and it’s a common element of retail leases, particularly in shopping centers.

“It is allowed technically, but sometimes regulators or government officials are not happy with that, because they see it as a way around rules that if there is more than 20 percent ownership (not including liens and loans) of the operating tenant they have to be vetted,” he said.

Santa Rosa has become a focal point for cannabis business leasing, because its business taxes and regulations are among the most inviting in California, Beck said. But the nuances in local permitting vary so widely that attorneys well-versed in this emerging practice of law should be heavily involved in commercial property transactions, he added.

Interactive Editor Jeff Quackenbush covers construction, commercial real estate, wine and other industries. Reach him at jquackenbush@busjrnl.com or 707-521-4256.

Correction: Dan Beck's first name was misstated in the original version of the story.