Cannabis land development is growing and gaining traction in Opportunity Zones (OZ). Not only has a large amount of stock wealth been created for cannabis entrepreneurs because of the tax advantage, but the returns of a cannabis project make the OZ vehicle a win-win. The cannabis industry is experiencing a number of trends, most notably diminishing prices and an increase in the size of the businesses. The industry is characterized by large initial capital outlays, with real estate being the primary cost component of most facilities.
This results in a trend of increasing capital investments. Let’s look at some attractive tax options that the more traditional investors can take advantage of in this emerging industry.
STATE VERSUS FEDERAL LAWS
The most important factor is the legality of the investment. Currently, federal law has taken a stance to allow states to decide their legal framework for cannabis through a budgeting amendment. But for now, the federal laws still have cannabis as a schedule 1 narcotic and prevent common business practices like banking and normal tax deductions. It is not expected that the cannabis regulation will stay in this federal grey zone and soon, larger hedge funds and corporate America will be investing. For now, individuals still have a great advantage by investing in states that are legal. Many cannabis companies add a layer of safety by dividing the land ownership and development from the management of growing cannabis or touching the leaf. The OZ opportunity exists in the land development for both deferring capital gains invested and capital gains on sale. The actual operation or management is taxed regardless on its income so separated structures works well from all perspectives.
WHICH KIND OF INVESTMENT IN CANNABIS
Cultivation can be done indoors, outdoors or in greenhouses. Let’s take a brief look at the defining characteristics of each:
Indoor was spawned from the underground starts of the industry and is typically done in industrial or warehouse buildings. Indoor is known to result in higher quality product. The model also lends itself well to year-round harvests, with increased yields. The predictability of indoors makes it well-adapted to industrial-grade operations. However, scalability is limited due to very high operating costs. Indeed, with buildings having to be erected or retrofitted, often in high-priced cities near their target markets, the initial and on-going real estate cost is often heavy, even prohibitive. Also, zoning regulations and other industry-specific restrictions greatly limit where the business can be located, resulting in additional costs for more distant facilities. Finally, and more importantly, high utility costs result from numerous lights and accompanying cooling needs, where heat and cold are in a constant fight looking for balance. As a result, costs per pound can often range between $500 and $1,000.
Outdoor quality is considered inferior for bud sales and most cost-effective for trim sales, and wholesale prices are commensurate, in the $500-$1,000 range at most, potentially lower. In addition, yields are subject to the elements, with a limited number of annual harvests (generally one per year). Finally, the low operating costs, sometimes as little as $50-100 per pound, are more than offset by all the unpredictability of growing outside, and unlike traditional farming, a range of options from sophisticated chemical pest and disease management to crop insurance are just not available to the industry.
Greenhouses can offer the best of both worlds. Using the sun, they only need supplemental artificial light, limiting electricity costs. In turn, the lesser temperatures sidestep the need for expensive air conditioning and excessive water use. The environmental footprint is thus diminished. But the positive impact on costs is also significant. As greenhouses are positioned in more extreme climates, high-tech is needed to complement the basic greenhouse layout. A best-of-breed approach uses cooling that is achieved by a combination of evaporative “wet-pads,” misting systems, and a network of horizontal and vertical fans. Multiple shade systems also provide a gradient of options. Water management and fertigation (irrigation and nutrient delivery systems) are also integrated. The entire system is automated by specialized hardware and software, configured and programmable at will, with diagnostics, data mining, and management reporting capabilities.This high-tech approach, combined with an experienced management team with solid corporate standards, focuses on modularity, scalability, and reliability, in an effort to provide a flexible model for industrial strength cannabis cultivation. Resulting costs can be lowered to $200-300 per pound.
KEY TRENDS IN THIS EMERGING MARKET
One of the key trends in the cannabis industry is that market prices have become more competitive in many of the early-adoption states as a result of increased competition. They are down to a range of $1,000 - $1,700 per pound in the Western states. This trend is likely to affect all the new states gradually entering the industry, especially with the recent pushes to relax some state border limits. As a result, indoor operations will gradually be unable to compete effectively. This basically leaves greenhouses and outdoor facilities as the most cost-effective ways to cultivate cannabis in the long run. Outdoor being limited to adequate climate zones.
Another industry trend has been an increase in size. This can happen either organically or more commonly through consolidation. As the Canadian public companies have clearly shown, size has been a key driver to achieve critical mass. Incentives for spending raised money quickly, which resulted in mega grows that will continue to drive prices lower as capacity comes online. This has not remained unnoticed: they have successfully attracted U.S. big tobacco, alcohol, pharma and retail corporations to take significant equity stakes. Given the current valuations, high based on present revenues and profits, this race to expand and realize the promised economies of scale is now in full force in the U.S.
The key cannabis industry trends of lower prices and larger players seems to favor a greenhouse cultivation method, ideally high-tech, in the context of a more sophisticated corporate approach.
Similarly, the refinement of the financial and capital structure aspects of the industry will have to increase in step. Agriculture has long been a capital-intensive industry. Cannabis in particular is heavy in real estate. Typically, investors have to purchase real estate on a state-by-state basis, often starting with raw land that needs to be custom-built for the specialized use in question. Then, investors have to find local license-holder partners that they can trust. This is a time-consuming process that is quite error-prone in this industry, often referred to as the Wild West. Once the land and license are acquired, the real estate needs to be built or an existing building outfitted. This is also a lengthy process, easily taking more than 2 years, with tough local building code hurdles. Once the real estate is ready, operations take 6 months from seed to first harvest, with another 6 months needed to tune operations and narrow down the strains and phenotypes desired.