The Cannabis Real Estate Investment Trusts (REITs) industry has been witnessing tremendous growth in the past few years. With the legalisation of marijuana in over 30 states for its recreational and pharmaceutical usage, institutional and individual investors are now eyeing the flourishing Cannabis REIT sector. Investors invested billions of dollars in the Cannabis REITs over the past few years. As a result, Cannabis REITs became the best-performing property sector for the second year in a row in 2020.
The industry holds a collosal potential for growth and fantastic yields on invested capital. This makes the relatively new industry an attractive one for investors. According to Leafly, an online marijuana marketplace, legal U.S. cannabis sales for medicinal and recreational purposes increased by 71% in 2020. This amounts to a total of $18.3 billion.
Just as more states begin to legalize the adult use of marijuana, New Frontier Data reports, overall sales in the legal marijuana industry will triple from $10.3 billion of sales in 2018 to $30 billion by 2025.
In this article, we discuss how investors can utilize the investment vehicle of REITs to unlock profits.
What are Cannabis REITs?
A Cannabis REIT is a public or private corporation that pools money from a base of investors. The REIT then uses the money to acquire, develop, or finance real estate used in the cannabis industry. This includes various property types like greenhouses, dispensaries, and industrial processing plants among other facilities.
A Real Estate Investment Trust (REIT) is a passive investment operation that uses the combined pool of capital by several investors to:
- Directly or indirectly own and lease an income-producing real estate (Equity REITs)
- Invest in real estate via debt by lending mortgage loans to landlords or operators (Debt or Mortgage REITs)
- Combine the investment strategies of both Equity and Debt Mortgages (Hybrid REITs)
- Invest in specific property types like cannabis production and processing facilities (Sector REITs)
The REITs generate their revenue from the income-producing properties. They derive their revenue from rents, sale proceeds or interest on mortgages. The REITs are required to distribute most of their income to their shareholders annually.
Cannabis REITs- a flourishing market for investments
Cannabis is popularly known as Marijuana. Its psychoactive components calms anxiety and produces a sense of mild ecstasy. Studies have shown that Cannabis has medicinal properties and is particularly effective in the treatment of AIDS, Cancer, seizures, Parkinson’s and other ailments. Hence, in 2018, 32 states legalized the use of marijuana for some purposes. Washington D.C, Arizona, New York, Minnesota, Florida were among the 32 states to decriminalize Marijuana usage.
Furthermore, in 2018 itself, the Bank of Montreal became the first financial institution to offer financing to Marijuana stocks. However, in 2020, the House of Representatives voted on the Marijuana Opportunity Reinvestment and Expungement (MORE). This ensured the legalization of Cannabis at a federal level.
The Bank of America predicts the marijuana industry can reach $166 billion in annual sales globally. The US, it predicts, will account for 34% of the cannabis market.
During the pandemic, the Cannabis REITs outperformed the other REIT sectors. Hoya Capital Cannabis Index measures that the industry grew by over 160% in 2020.
However, federal prohibition in several other states and little access to bank loans has left marijuana companies to starve for cash. As a result, Cannabis REITs are an extremely useful source for an alternate source of capital. As a result, the Cannabis REIT industry is flourishing and investors are eyeing the sector for high dividends and returns.
Subversive Real Estate estimates that the property value of the US Cannabis Real Estate will be $30 billion by 2030.
How do Cannabis REITs work?
Cannabis REITs have multiple functions. But principally, they acquire properties through sale-leaseback deals with cultivators. The majority of cannabis cultivators or companies often face a capital crisis. In such cases, marijuana companies or cultivators sell their property to the REITs. Then, they lease back the properties from the REITs at a rate previously agreed on. The REITs generally enter into a triple-net lease agreement of about 15 years on average. As a result, the marijuana cultivators get immediate and a healthy flow of funding. Such transactions have recently started gaining huge tractions.
In 2019, the cannabis company Curaleaf Holdings Inc., a major multi-state operator, sold six of their properties in Florida, New Jersey, and Massachusetts for about $28.3 million. Cresco Labs and Columbia Care are also among others to adopt the sale-leaseback model.
Cannabis REITs also provide real estate expansion loans. Mortgage or Hybrid REITs generally pursue such transactions. Here, the REIT lends money to the cultivator or company who wants to construct a facility or expand their existing one. This settlement creates a win-win situation for both the REITs and the Cannabis companies- the previous benefiting from the interest on the loans, and the latter getting easy funding for its real estate development.
A game-changer for cultivators
American cannabis producers often face monetary setbacks. This is mainly because many states and local bodies still prohibit the production, distribution and consumption of weed (cannabis). Hence, cannabis landlords are stigmatized. This results in significant challenges including the risk of incarceration, costly insurance, risk of property forfeitures and evictions, and discrimination by banks for loans. Therefore, cannabis production companies and institutions suffer bankruptcy as they cannot avail bankruptcy protection.
With Cannabis REITs, marijuana landlords, producers and companies have a definite advantage as the cost of capital by the REITs are much higher than the public or private equity markets. In addition to this, a REIT facilitates the management of the marijuana companies’ large portfolio of real estate assets. In the absence of REIT, the tedious tasks of real estate management were the burden of the companies. Moreover, unique zoning and land zone issues encumber the operations. Cultivators can leverage the core competency of the REITs to manage their portfolio of assets and take care of such regulatory issues.
A gold mine for investors
As the adult-use medical and recreational cannabis trend grows, Cannabis REITs will continue to be a viable capital source for cultivators and companies.
Real estate investors can access several advantages from a cannabis REIT. This is due to their potential to grow fast and offer high yields on invested capital. Public filings from Subversive Real Estate Acquisition REIT LP studies that cannabis REIT transactions generate yields on invested capital in the range of 11-18%. In addition to high yields, REITs are required to distribute at least 90% of their taxable income among their shareholders. Annual dividends from the cannabis REITs are sometimes 8% or more. Furthermore, the current tax law imposes a 20% deduction on ordinary REIT dividends. It taxes the remainder at the filer’s marginal rate. Hence, REITs become an attractive opportunity for investors who receive higher dividends and income.
In the 2020 election cycle, electors in Arizona, South Dakota, Montana and New Jersey approved the legalization of cannabis for adult use. The voters in Mississippi approved the legalization of marijuana for its medical uses, while in 2021, the legislatures of New York, New Mexico and Virginia legalized marijuana.
This wave of the massive expansion of the cannabis industry will require REITs to acquire and manage specialized properties for leased to adult-use cannabis production or processing. As commercial banks remain on the sidelines, cannabis REITs will continue to operate as the chief financing source for such companies and institutions. Hence, profits and high yields are unlikely to go any time soon for cannabis REIT investors.
The future of Cannabis REITs
Rest assured, the Cannabis REIT market holds tremendous potential for ‘high’ growth and offers multiple lucrative opportunities for investors. As more states legalize cannabis or marijuana and the federal regulations are modified, more new players will enter the market. As a result, cannabis REITs will not only be the most profitable source for loans for the businesses, they will also enable REIT investors to leverage the evolving trends of the industry to secure great returns and diversify their portfolio.