Legal Insights

How Marijuana Shops Pose Unique Challenges for Commercial Landlords

By: May 4, 2016

For the first time in four years, the Arizona Department of Health Services is opening applications for medical marijuana dispensary licenses this summer. Commercial landlords will have a golden opportunity to lease space to marijuana businesses, which have plenty of capital and a high demand for their product. But these businesses pose unique challenges to a commercial landlord.

The federal government regulates drugs through the Controlled Substances Act, which does not recognize the difference between medical and recreational use of marijuana. Under the CSA, it is illegal to manufacture, distribute, or dispense, or possess with intent to manufacture, distribute, or dispense, a controlled substance. Marijuana is designated as a Class One Controlled Substance, just like heroin, and under federal law is not approved for sale or distribution in the State of Arizona. Marijuana production and distribution continue to be federal crimes even in Arizona, where in November of 2010, voters passed the Arizona Medical Marijuana Act (“AMMA”). This conflict between state and federal law has created significant amounts of litigation in practice areas ranging from real estate to bankruptcy. This is because an exemption from prosecution under state law does not obstruct the federal government’s ability to investigate and prosecute an individual for a violation of federal law.

Federal law has not been strictly enforced for several years. This has been due to temporary moratoriums on federal funding for enforcement as well as federal policies outlining conditions under which the federal government will not interfere with state marijuana legalization programs. Federal enforcement of what is otherwise the legal production, distribution and sale of marijuana at the state level has been a low priority. This qualified “hands off” approach may be comforting to those inclined to lease facilities to a marijuana business.

But there is a definite balancing act—does the landlord determine the risks of civil forfeiture of its property or other penalties are too great and choose not to engage in any cannabis related business, or does the landlord calculate that risk into the costs it charges to the marijuana entrepreneur? There are many factors that must go into this decision, with just a few discussed below.

First, most commercial mortgages prevent tenants from operating illegal businesses on a subject property. This can reduce the pool of potential lessors to the small minority of properties that carry no commercial bank loan. Also there are certain commercial landlords who for moral reasons will not consider leasing to a marijuana business. As a result, the industry’s demand is concentrated into a small percent of the otherwise available market. Some research shows that rents for a cannabis based business can be three to five times higher than market levels. In this regard, the commercial landlord can reap huge rewards. Another consideration is whether marijuana operations violate use restrictions in other leases, declarations or other recorded covenants that affect the property.

Because banks are federally regulated, and in spite of some recent easing of certain restrictions, most marijuana businesses still do not have access to financial services and tend to do business entirely in cash. A commercial landlord should expect to receive its rent and other charges in cash, and normal boilerplate lease language will need to be drafted to permit this mode of payment.
Also, water and energy bills will be large if a grow facility is involved. As a commercial landlord, the allocation of these costs must be considered as well as other costs unique to a marijuana business, such as security. Additionally, if there are common areas, issues such as ventilation, waste products and use of marijuana on-site must be addressed.

As a commercial landlord, it would be advisable that any lease relating to a cannabis related business contain clauses that specifying the selection of venue and applicable governing law. It is important to provide that interpretation of the lease and adjudication of the parties’ rights be limited to current state law, to avoid the argument that the lease should be considered void as against public policy or contrary to existing law.

To be fair, a landlord might expect a savvy tenant to address what would happen in the unlikely but potentially catastrophic event of federal intervention. It might indeed be fair to expect a negotiated provision for an early termination event permitting the tenant to cancel the lease without any further financial obligation, if the federal government attempted seizure or other intervention.

Suffice it to say that assuming a commercial landlord determines it wants to both assume the risks and enjoy a possible lucrative lease with a marijuana business, simple boilerplate leases are simply not sufficient. Both the tenant and landlord have to navigate carefully through this changing landscape.