Friends, I was listening this morning to one of my favorite podcasts, Odd Lots, which we’ve talked about before. Today’s drop considered the upcoming maturities of mortgage loans on commercial (non-residential) real estate in the U.S., and what that means for landlords, lenders, investors, and the U.S. economy. TL;DR – it’s almost certainly not going to be pretty.
This got me thinking again about upcoming debt maturities in the cannabis industry. We’ve talked here before about handling financial distress, but I thought it’d be worth considering in more depth some of the dynamics at play.
For background, The Dales Report recently summarized the maturity dates of loans to many of the largest MSOs – there are a number of loans coming due in 2024, while the vast majority come due in 2026. Three years is an eternity in cannabis, let alone financial markets, and it’s pointless to even try to make predictions for next year. However, the public MSOs are not the only borrowers out there, and there are plenty of other companies navigating creditor demands.
The podcast guest, Jim Costello, Chief Economist of the Real Estate assets team at MSCI, a financial analytics company, pointed out an interesting distinction between having a bank as your real estate lender and having a fund as your lender:
“…[I]f I'm a big bank, what do I know about running an apartment building? What do I know about managing an office building? I'd rather, you know, have the experts take care of that and I just collect a nice stable yield. So I want to underwrite to avoid that. ... So I make sure that I'm whole. …
The debt funds, they didn't do any of that because the debt funds, a lot of them started as equity shops that had their own investments and own management in place. And you know, they viewed it as an opportunity. It might be a situation where I have either a nice stable yield and I can help my investors that way. But if I had the tail situation where there's a foreclosure, I have this equity management shop on the side, I can just take the property at a lower basis than before and I know how to run a property and I could probably do it better than those people who were coming to me for a loan. So I'll put it into that shop and raise some capital to stabilize it and I'll be good.”
Translated, this means that banks don’t want to own the real estate, so they tend to be more conservative in their mortgage lending – the returns may be lower, but the likelihood of default (and therefore foreclosure) is also lower. On the other hand, non-bank lenders like debt funds (also sort-of-paradoxically referred to as “credit funds”) are typically less afraid of owning the real estate if they have to, so they’re usually more willing to lend money on aggressive terms such as a higher loan-to-value ratio (more proceeds relative to the actual appraised value of the property) and looser financial covenants (performance metrics that gauge the financial health of the borrower). Commercial real estate investments are very much driven by the leverage provided by mortgage loans, so why have kishke when you can eat halvah?
What’s interesting about cannabis is that there are virtually no banks making loans– nearly all of the lending (including sale-leasebacks, which is kinda like a loan) is done by non-bank lenders. Notably, recent exceptions are a $71.5mm mortgage loan arranged by Valley National Bank to Trulieve and FVCbank’s $20mm mortgage loan to Jushi, but those are very much not the norm. Most of the lending is done by debt (credit) funds, real estate investment trusts, and the like. This, of course, is not a surprise – if federally-chartered banks won’t provide regular banking services and free toasters to cannabis companies, they’re certainly not going to offer loans to them.
It’s an interesting contrast from the broader commercial real estate lending market described on the podcast, but, in my experience, Jim Costello’s view of debt funds in that market is very similar to my view of the lenders in the cannabis space – the ones I know are asset managers who are not necessarily afraid of default. They may not be pursuing a loan-to-own strategy, but they’re generally underwriting risk in a more aggressive manner than a traditional bank.
This creates a really interesting dynamic. On the one hand, you’ve got a lender that’s willing to call the bluff and take possession of its collateral, and the borrower can’t stop that by filing for bankruptcy protection. On the other hand, you’ve got a borrower that knows that the lender’s ability to actually take over the assets, and either get them sold or operate them itself, is costly, difficult, and extremely time-consuming. No state allows for a lender to actually take possession of cannabis assets or licenses without state permission, and only a handful of states have laws outlining a process for an orderly court-directed sale of foreclosed cannabis assets (and even those are cumbersome). When things are in distress, time is not a luxury, and the borrower (likely) knows this can work to its advantage.
In the end, you’ve got a (metaphorical) battle between a honey badger and a lion – the typical fears (of the other side’s leverage and tools) aren’t really at play. When neither side has outsized leverage, then neither side really has any leverage.
I suspect this ultimately leads to more stalemates in the form of maturity extensions, which I’m already seeing happen in the market. Why fight now when credit markets may loosen and more lenders may come into the industry, allowing for a refinance; financial prospects may finally turn around; and we may someday have federal legalization (a leben ahf dir!)? In a way, everyone wins and no one wins – kind of a metaphor for the current state of the industry, no?
Be seeing you!
Hauser Advisory provides advice and strategy on business lifecycle events and cannabis industry navigation, tapping into a deep, national network
and twenty-five years of dealmaking and capital markets experience.
© 2023 Marc Hauser and Hauser Advisory. None of the foregoing is legal, investment, or any other sort of advice, and it may not be relied upon in any manner, shape, or form. Subscribe to Cannabis Musings at hauseradvisory.com.