Cannabis REITs Face Challenges in Federal Law
NEW YORK ( MainStreet) Although the founders of Articulated Investors considered setting up a Real Estate Investment Trust (REIT), Jake Schrader and Bill Gottlieb settled on the more flexible structure of a Limited Liability Corporation (LLC) before acquiring a warehouse in Rifle, Colo. for $600,000, which the dispensary L.E.A.F. Aspen is now leasing.
"We may include non-real estate investments in the cannabis industry in our portfolio which is problematic within a REIT structure," Schrader told MainStreet. "The lack of flexibility in a REIT was concerning to us. We decided to sacrifice the REIT's tax advantage, because we didn't want to be bound by the prescriptions of being a REIT. We felt an LLC was a better structure for us for the flexibility it affords."
The fact that federal law prohibits the distribution and use of marijuana would likely pose investment and financing challenges, but it would not itself be a barrier to establishing a REIT structure.
"Even if a REIT were to focus its operations in Colorado, where state laws concerning cannabis have been relaxed, federal law is still applicable," said Andrew Maguire, an attorney with McCausland, Keen & Buckman. "An investor could be scared to put money in any investment that's illegal under federal law because the potential of a shut down by the Drug Enforcement Administration (DEA) is a likely deterrent to attracting investment into the REIT."
Because REITs are governed by federal tax law under the Internal Revenue Code, there are certain rules and structures that have to be complied with.
"You need 100 or more shareholders and you can't have five or fewer shareholders own 50% or more of the trust," McGuire told MainStreet.
Although Schrader and Gottlieb's investment firm includes money invested by others, both invested $500,000 of their own money into the company.
"We may elect to create other structures that reflect outside capital but at this time we are not open to outside investors," Schrader told MainStreet. "Currently, we have less than a dozen SEC accredited investors."
Another REIT requirement is that 75% of the revenue be generated from rent, which in the case of a cannabis REIT would come from a tenant in a green house, growing facility or dispensary.
"A REIT model is more complex than a basic acquisition using a limited partnership or a single member LLC to take title of a property," McGuire told MainStreet. "Under a basic non-REIT acquisition, you are free of all the regulations that govern REITs in development, structure and operation."
In addition to IRS rules and regulations, there are legal implications around borrowing money that pose a barrier for a REIT invested in pot growing facilities and dispensaries that don't apply to other industries.