Holland & Knight
The cannabis industry in the United States has experienced rapid growth, with an increasing number of states legalizing the use of marijuana for medical and recreational purposes. As of 2023, nearly half of the U.S. population lives in states where recreational cannabis use is legal and almost three-quarters of the U.S. population live in states where medical cannabis use is legal. The revenue from cannabis products is expected to surpass $39 billion in sales by the end of 2024.1 However, despite its growing legitimacy at the state level, the fear of violating federal laws – particularly the 1970 Controlled Substances Act – has made many property owners hesitant to lease to cannabis-related businesses. This legal uncertainty, coupled with tax implications, zoning restrictions and other challenges, requires landlords to approach cannabis leasing with a clear understanding of the associated risks and rewards.
In addition to navigating the federal and state legal landscape, landlords should consider a variety of lease terms and operational details when leasing to cannabis tenants. This article explores key factors that landlords should evaluate when leasing to cannabis businesses, including the latest legal developments and the specific terms to include in lease agreements.
Key Legal and Market Developments
The legal framework for cannabis in the United States is evolving rapidly. As of 2023, 22 states (including Washington, D.C.) have legalized high-THC cannabis for adult use, while 39 states allow medical cannabis. Most recently, Nebraska voters passed Initiative Measures 437 and 438, which permit the use, possession and acquisition of up to 5 ounces of cannabis for medical purposes.2 Meanwhile, voters in Florida, North Dakota and South Dakota declined to expand permitted use for recreational purposes. However, cannabis remains classified as a Schedule I drug under federal law, meaning it is still considered illegal at the federal level. This creates a legal paradox for landlords, who could face potential penalties, including property forfeiture, for allowing their properties to be used for cannabis-related activities. Although federal law enforcement deprioritized cannabis prosecutions under the Obama-era Cole Memo, the rescinding of the Cole Memo in 2018 by the Trump Administration means landlords must remain vigilant.
The 2018 Farm Bill permits sales of CBD products from the hemp plant consisting of no more than 0.3 percent THC. Forty-three states permit some form of possession of CBD from hemp, even if they do not permit other cannabis recreational or medical use. However, some states still consider using or possessing any cannabis product illegal, so verifying current state and local laws remains important for these types of products.
In addition to the federal restrictions, cannabis businesses face substantial tax challenges. Under IRS Code Section 280(E), cannabis operators are prohibited from deducting business expenses from their federal tax returns, including lease payments. This significantly impacts the profitability of cannabis businesses, as they face a higher tax burden than other retail operators. These tax issues are compounded by the fact that many cannabis businesses are cash-only operations due to banking restrictions, which presents additional risks for landlords in terms of security, rent collection and financial management.
Critical Lease Terms for Cannabis Tenants
Due Diligence
When leasing to a cannabis tenant, landlords must account for a range of unique considerations. Due diligence is essential. Landlords should check any applicable loan documents and any other title documents that affect the premises to see if there are restrictions prohibiting cannabis use. Reviewing requirements of zoning laws and determining what local permits, licenses and variances are required for cannabis operations is also critical. All of the forgoing can have substantial impacts on what requirements apply to operate. As a result, leases to cannabis tenants often include strict clauses around the tenant’s permitted use of the space, with special attention given to whether recreational sales, smoking or consumption are allowed on the premises.
Odors and Utilities
For multi-tenant centers, landlords should address ventilation and odor control in the lease, as that may be a major concern for neighboring tenants. Many licensing and/or zoning laws require satisfaction of ventilation requirements, so often cannabis tenants are understanding of these requirements in the lease. Furthermore, the lease should specify that a tenant should pay for any excessive consumption of utilities, given the high energy demands of many cannabis businesses.
Security
Security is another critical issue in cannabis leasing. Due to the high value of cannabis products and the cash nature of the business, landlords should ensure that tenants provide their own adequate security measures, which may include installing advanced security systems or hiring insured security personnel. Practically speaking, some jurisdictions include compliance with security measures as part of licensing requirements, so many tenants will not resist these terms in the lease.
Insurance
There is often a conflict between a landlord’s expectations of coverage available for cannabis businesses and actual availability of coverage. Many cannabis businesses have to seek insurance coverage from specialty companies. That means that insurance coverage is costly and includes many exclusions. Landlords should carefully review coverage options when drafting leases for cannabis tenants, considering whether tenants can practically comply with lease requirements.
Default and Remedies
One of the most significant risks for landlords in cannabis leasing is the potential for federal enforcement actions, which could lead to property forfeiture or other legal consequences. Tenants should be required to report complaints or notices of violations of applicable law to their landlords promptly. Landlords should include clauses in their leases that allow for termination of the lease in the event of: 1) a federal investigation or other legal actions related to the tenant’s cannabis operations, 2) the tenant’s failure to maintain required licenses, permits or other approvals, or 3) the tenant’s violation of state and local laws.
Surrender
In addition to customary requirements to remove personal property, leases to cannabis tenants should include an express requirement that the tenant remove all cannabis products. Depending on how much the tenant was handling cannabis products, such tenants should also be required to sterilize all impermeable surfaces of the premises.
Future Outlook: SAFER Banking Act and Beyond
The legal landscape surrounding cannabis leasing could undergo significant changes with the passage of the SAFER Banking Act. Various versions of the SAFER Banking Act have circulated since 2019. If passed, the act would allow cannabis businesses to access traditional banking services by permitting banks to provide services to legitimate cannabis-related business without threat of violating anti-money laundering regulations or the threat of asset forfeiture. That would also alleviate many of the financial concerns that landlords face when dealing with cannabis tenants. However, as of November 2024, the bill has yet to be fully passed, leaving uncertainty for landlords in the interim.
Another factor that could change the dynamics of cannabis leasing is the potential for marijuana to be rescheduled from a Schedule I to a Schedule III drug under the Federal Controlled Substances Act. The U.S. Department of Justice is considering this change, based on growing scientific evidence supporting the medical benefits of cannabis. The U.S. Drug Enforcement Administration scheduled a public hearing on Dec. 2, 2024, to allow experts to weigh in. Such a shift could open up new opportunities for cannabis businesses and reduce some of the legal risks for landlords.
Cannabis leasing presents distinct challenges for landlords, particularly due to the complex legal surrounding the industry. Although the market for legal cannabis continues to grow, the federal prohibition on cannabis use and sales presents significant risks for landlords. To navigate these risks, landlords should carefully craft lease agreements that address the specific needs and challenges of cannabis tenants. To mitigate the risks and take advantage of the opportunities presented by leasing to cannabis businesses, please reach out to the authors of this publication or another attorney in Holland & Knight’s Real Estate Practice.
Notes
1 2023 U.S. Cannabis Report: Market Updates and Projections produced by New Frontier Data.
