By Dennis H. Doss
Cannabis Mortgage Lending
Marijuana Loans for the Hard Money Broker
Cannabis (marijuana) is listed by federal law as a Schedule I drug under the Controlled Substances Act, the most tightly restricted category reserved for drugs that have “no currently accepted medical use.” On August 29, 2013 and again on February 14, 2014, James M. Cole, United States Deputy Attorney General, issued memos to other attorneys general indicating that the federal government would not enforce federal law the Controlled Substances Act as to marijuana that is sold in accordance with state and local laws.
Marijuana use has proliferated. 22.2 million people had used it in the past month according to the 2015 National Survey on Drug Use and Health. 29 currently permit the sale of marijuana for medical use. 7 states have approved the recreational use. On November 8, 2016, California voters approved Proposition 64, which decriminalizes the cultivation, possession, and use of cannabis for nonmedical purposes. Licensing of sellers by the Bureau of Marijuana Control will begin in January of 2018.
Cannabis Industry Faces Financial Challenges
The cannabis industry faces significant financial challenges. Traditional mortgage sources will not finance them or even allow them to open bank accounts. When federally regulated mortgage lenders learn that their borrowers are growing or selling marijuana on secured properties, they are likely to call their mortgage loans.
Because of the scarcity of traditional financing sources, the cannabis industry is forced to turn to the more expensive hard money or private money mortgage market. Savvy mortgage brokers are seizing on this opportunity. However, those who do so blindly, are likely to get hurt. The following is a list of considerations a smart mortgage broker will consider:
Valuation. Cannabis operations throw off a lot of cash so it is tempting to put a premium on the value of marijuana buildings based upon that cash flow. However, if cannabis is legalized by the federal government during the term of a loan, cannabis will become like alcohol, still regulated but legitimate enough for big business to come in and squeeze out the smaller players. Mortgage financing will be abundant. A building housing a marijuana operation will no longer carry a premium value. The loan-to-value ratio of a loan will suffer. The businesses’ margins will be compressed by competition, thus increasing the risk of default.
Federal Policy Risk. I think a majority of Americans would agree that President Trump is a bit of a wild card. His Attorney General, Jeff Sessions, is no fan of marijuana. With a stroke of his pen, the President could reverse the federal policy of restraint and require the AG’s office to enforce federal law. Because the federal government has the right to seize (without compensation) real estate used for illegal purposes, a smart lender will want to make sure his or her loan documents have provisions to shut down cannabis operations on the property very quickly. Those documents should also contain covenants that the borrower is and remain in compliance with all state and local laws.
Investor Risk. If a broker is using private investor money to make a cannabis loan, that broker should be selective about who the loan is sold to and make sure the investor is aware of the risks associated with marijuana lending. If federal law changes and your borrower happens to be one of the first to feel the pain of seizure, you don’t want an investor suing you because of an undisclosed risk.
Local Compliance Risk. You can’t just stick marijuana seeds in the ground then sell the product. The entire business is subject to local regulation and zoning and a comprehensive scheme of regulation by the State of California. You will want to hire a local cannabis lawyer to vet the borrower’s compliance with the laws not only when the loan is made but periodically. Remember, even today the federal government can seize a marijuana operation that is not in compliance with state and local laws.
Environmental Risk. Outdoor marijuana farms have the potential to disturb local plants and water through runoff and chemical leakage. Pesticides and rat poison can also kill animals around outdoor grows. Solvent use and waste water are common issues in businesses that make derivatives of marijuana. These issues need to be considered.
The Cash Issue. Many marijuana businesses operate and pay their bills with cash. Cash deposits at a bank must be reported and could result in the closure of a broker’s servicing trust account. The broker needs to discuss this with the borrower and be comfortable with the result.
Your Exit Strategy. More likely than not, federal law will not change and traditional financing will not be an exit strategy for the marijuana business. Be prepared to make a long-term loan than you ordinarily would and consider amortizing your loan as your exit strategy.
Find Out Who You Are Dealing With. Bad people have a tendency to continue doing bad things. You should consider doing research on your borrower. If the borrower has an existing business, call the local district attorney’s office to see if there have been any complaints. Contact the California Bureau of Marijuana too. Run a civil and criminal background check on each of the owners of the business. A broker doesn’t want to discover after the loan is on the books that his borrower is a felony drug dealer.
Marijuana lending can be lucrative for a mortgage broker and his or her investors. A good broker will take to heart each of the suggestions in this article.
This article is intended as educational material, not legal advice. Consult a knowledgeable lawyer before implementing any of the ideas in this publication.