Illegal Businesses, Perceived Risks Still Causing Headaches In LA Cannabis Industry

Five years into legalized cannabis sales in the city of Los Angeles, getting licensed is still a complex and incredibly expensive process, and retail operators are still wrangling with landlords that charge rents far above what they would charge a noncannabis tenant and spending years trying to get their approvals to operate. 

For would-be cannabis landlords and lenders, there are plenty of opportunities to make money in the long term, but those seeking to make outsized profits in the short term run a huge risk of getting burned, speakers at Bisnow’s California Cannabis CRE Conference said. 

One major risk for landlords is renting to an illegal cannabis operator. Many of these companies seem legitimate but do not have all the licenses to operate in the city of LA, according to panelists.

Landlords and management companies that rent to unlicensed cannabis businesses face a $20K-a-day fine, LA Department of Cannabis Regulation interim Executive Director Michelle Garakian told the audience at the Omni Los Angeles Hotel. 

A location where this infraction has occurred is also prohibited from being rented out to a legal business for up to five years, Garakian said.

“What I recommend is, don’t do it,” Garakian said. “We’re trying to curb illegal activity as much as possible.” 

Speakers across multiple panels recommended that owners go above and beyond with their research into potential cannabis tenants, making sure that they know who they are renting to. Garakian said that landlords can always reach out to the city’s Department of Cannabis Regulation to see if a potential tenant is properly licensed. 

The illegal cannabis market is a widespread problem in LA and in the state, taking a huge bite out of business for those who went through the arduous and costly process of obtaining proper permits. Several speakers said that part of the reason the illegal market flourishes is that the legal one is prohibitively expensive and subject to so many cumbersome regulations. 

In addition to those regulations, speakers who are operators of cannabis retail businesses said they are still regularly charged three to five times the rent a traditional retail business would be charged to occupy the same space. They are often asked to foot the bill for added security or give much larger security deposits for their spaces in anticipation of the storefront being robbed or being a target for violence.

“There are these ways that we are stereotypically looking at the possibility of what this business might be, when in reality, we know that it's not,” Biko CEO and founder Timeka Drew said.

Drew said she has spent “thousands and thousands and thousands” of dollars over three years to get the approvals to open her business. She is still in that process. 

These so-called cannabis rents are ostensibly put in place to make a landlord feel like they are being compensated for taking on a business that is risky, but they can become a self-fulfilling prophecy that makes it hard for those tenants to be successful, panelists said. 

“We've seen every single lease get renegotiated after about the first three or four years in our market because it wasn't sustainable for the operator to function — they were going to go out of business paying these types of leases,” American Cannabis Co. CEO and founder Ellis Smith said. 

As interest rates rise and inflation pushes up costs, operators are feeling the crunch. And while the cannabis industry is, in the eyes of some of the speakers, “too big to fail,” they agreed that individual businesses within the industry — tenants of these retail and cultivation spaces — aren't impervious. 

“Particularly [for] folks that did sale-leasebacks that were basically credit-driven plays for operators who have gone out and raised a bunch of other people's money, when that spigot turned off, I think that's going to be tough times,” Oak Funds and Oak Impact Group Chairman and Managing Partner Erik Murray said.

The sale-leaseback model — employed often in the cannabis industry because cannabis is still federally illegal, which limits loan options for these businesses — only works when the tenants pay their rents. Some highly visible owners that engage in this have already felt the crunch.

Earlier this year, the cannabis REIT Innovative Industrial Properties found itself looking at $2.2M in unpaid rent and insurance payments for one of its sale-leaseback tenants.