The recent announcement by MedMen that it is selling its real estate to an affiliated REIT focuses attention on a developing trend in the cannabis sector. There is already a publicly-traded cannabis REIT (Innovative Industrial Properties) that has been successfully raising capital to assemble a portfolio of cannabis-related real estate, and other cannabis companies are considering forming REITs in connection with their real estate acquisitions.
What is a REIT?
REIT stands for Real Estate Investment Trust – it’s a corporation that has made an election to be treated as a REIT. REITs are not true pass-through entities like partnerships or LLCs, but they are close – a REIT is required to distribute at least 90% of its taxable income to its shareholders as dividends, and those dividends are deductible from the REIT’s taxable income. Many REITs choose to distribute 100% of their taxable income so they have no tax liability.
REITs are essentially passive investment vehicles that invest in real estate. A REIT has to meet tests with respect to its assets (at least 75% of its assets must be real estate-related) and income (at least 75% of its income must be from real estate assets), and there are other requirements about how widely held the stock must be and how passive the investments must be (the REIT can’t actively manage the real estate).
How can REITs be useful?
A REIT can benefit a cannabis company by freeing up capital to use in a company’s core business that would otherwise be tied up in real estate. The REIT raises funds from outside sources (for example, Innovative Industrial Properties has a number of individual retail investors) and uses those funds to purchase the real property from the cannabis company – it then leases the property back to the cannabis company. There are a number of variations on this theme, of course, and there are many different types of REITs that are funded in other ways. It helps that most REIT dividends qualify for a 20% deduction under the new tax law, so REIT shareholders in the highest 37% tax bracket will be taxed at a 29.6% rate on qualified REIT dividends – making REITs a more attractive investment class for many people.
While the rules to qualify for REIT status can be complicated, and complying with those rules needs to be taken seriously, there are clear reasons that cannabis companies are turning to REITs as an efficient source of capital.
REITs can also be used as part of an opportunity zone structure to create an incredibly tax-advantaged (and thus less costly) source of capital – see previous blog post on cannabis opportunity zones.