By Stacey C. Tyler, Esq. and Stephen Tanico, Esq.

Finding a suitable location and obtaining site control for your cannabis operation is a daunting prospect: local restrictions and zoning laws drastically limit the permissible locations, and as a result, owners of suitable properties are seeking incredibly aggressive deal terms.  Knowing how your cannabis use will complicate your negotiations will help you end up with the best lease terms possible.

License Considerations

Depending on your licensing strategy, you may want to structure your deal as an option to lease or a contingent lease which only takes effect if you become licensed.  You can ask for an extended entitlement period to lock down the space while you seek your license in exchange for making payments to the landlord (these can be upfront, monthly, or along another negotiated timeline).  Under this structure, until you get your license you do not actually move in or perform any possessory obligations such as insuring and maintaining the premises, saving you a lot of money during the most uncertain period of this process. Require the landlord to cooperate with you during the licensing process, including by providing information to regulators and, if need be, amending the lease as they may require. Ask for a right to terminate the lease in the event the license application fails or if the license is revoked without any fault of the tenant.

Landlord Underwriting

Your landlord may want more security from you than they might with any other non-cannabis tenant because they consider your use riskier, more susceptible to crime, and generally more hassle due to the regulatory issues discussed below. Be strategic about how you present your creditworthiness, and if your entity is newly formed, be prepared to show proof of funds of one or more principals. Think about how much security deposit is realistically doable for you, but wait for the landlord to make the first ask (typically 3-6 months of rent, more if there’s an extensive build out).  See if the landlord will allow you to postpone paying the security deposit until you move in, and ask for the right to reduce the amount once you are operating and turning a profit (at which time the landlord’s risk will be much lower).

Your landlord will likely ask for a full guaranty of payment and performance for the entirety of the lease term and all of the tenant’s obligations from either a principal or a deep-pockets affiliate. Push to limit the term of the guaranty and/or the guarantor’s financial obligations, such as via a maximum dollar amount or by a “good guy” clause which will let the guarantor off the hook a certain amount of months after it has caused the tenant to vacate the premises. Ask for the guarantor to be swapped out for another creditworthy entity in the event certain transactions take place like a lease assignment.

Consider Your Long Term Business Plan

Think about the potential future trajectory of your business and how this lease will impact your decisions down the road.  It may make sense for you to structure your lease with a shorter initial term plus several rights to renew rather than one longer term so that you will have more opportunities to pivot if need be. Flexibility is also key with respect to assignment and subletting rights; get express rights to have microbusiness subtenants if that is part of your business plan and limit as much as possible any restrictions on subleases, lease assignments, and changes in control. Your state’s cannabis governmental authority would likely have oversight over many of these transactions, and you can argue that since regulators will prevent adverse changes to your licensed entity your landlord does not need to add additional red tape in the lease.

Initial Build Out

Engage an architect or other building professional during the term sheet negotiations to help you inspect the premises and identify any potential issues that will need to be addressed prior to your move in such as compliance deficiencies, hazardous materials (e.g., mold, asbestos, etc.), or building systems that may be approaching failure or needing costly maintenance.  Knowing these things upfront will allow you to either ask the landlord to address them now, provide a credit so you can do so, or limit the repair and maintenance provisions of your lease to make clear they are landlord’s responsibility.

Based on the initial inspection you can also put together a rough plan for your initial build out for landlord’s approval as part of the lease (including that you have no obligation to undo the work when you move out). If you anticipate doing any utility upgrades as part of your build out (for instance, additional electrical and water capacity), get landlord’s express approval and factor that often lengthy process into your overall project timeline. Consider whether the premises may need security enhancements in connection with the cannabis use (for instance, camera systems, a safe, driveway gates, etc.). If possible, negotiate for a free rent period equivalent to your total estimated build out time.

Operational Issues

Many landlords will attempt to impose stringent rules and regulations on cannabis businesses, such as dictating hours of operation or requiring landlord approval over branding and marketing materials.  Try to limit your obligations to compliance with applicable laws and keep your obligations as close to market as possible in your asset class and in line with the other non-cannabis users at the property.  Many landlords will want to require you to prevent any odors from emanating from the premises, which is unrealistic. Instead, limit your obligations to compliance with local municipal ordinances related to odors and agree to take commercially reasonable steps to minimize smells (such as installing an odor mitigation system).

Effects of Federal Prohibition

The cannabis industry is fraught with issues arising from the conflict between federal prohibition and state legalization. Both the landlord and tenant may struggle to obtain financing from federally-chartered institutions (state banks and credit unions are more willing to finance cannabis transactions). If there is existing mortgage financing on the premises you will want to get ahead of any issues by requiring your landlord to disclose your cannabis use to its lender, and ideally deliver a subordination, non-disturbance, and attornment agreement (an “SNDA”) which will allow you to stay in the premises in the event of a foreclosure. Your landlord’s insurance costs may go up because of your cannabis use, and they will likely want you to pay for that increase; push to get firm pricing before lease signing so you can have informed negotiations on this point. Finally, you and your attorney will need to ensure that the lease is carefully drafted to carve out from the tenant’s general obligations to comply with law any laws that are in conflict with the cannabis use (for instance, the Controlled Substances Act). The lease should also require that any disputes be taken to state and not federal court, or be resolved via arbitration.

Conclusion

While having a savvy broker or consultant and an experienced attorney on your team is important in any lease deal, the cannabis use adds complications that make having strong representation and thoughtful negotiation even more important.

About the Authors

Stacey C. Tyler, Counsel, Real Estate, handles a broad array of real estate transactions including acquisitions, dispositions, development, leasing, financing, hospitality, joint ventures, and public-private partnership arrangements. Her clients range from institutional landlords and lenders to tech startups. Stacey also has extensive experience in real estate issues arising in connection with cannabis enterprises and heads up Lowenstein Sandler’s Cannabis Working Group, which comprises seasoned practitioners providing a full range of services to cannabis companies, including regulatory, intellectual property, tax, and finance.

Stacey can be reached at: [email protected] | 973.597.6208

Stephen Tanico, Associate, Real Estate, advises clients in the pursuit of a wide range of transactional real estate matters, including acquisitions and dispositions, financing, joint ventures, and leasing. He provides counsel at all stages of the transaction process: drafting and negotiating operative documents, analyzing due diligence, collaborating on strategy, and liaising with third-party service providers (e.g., brokers, title companies, surveyors, zoning analysts, and environmental consultants).

Stephen can be reached at: [email protected] | 973.422.6704