A potential sign of the future for marijuana-related real estate may be found in a decision by two real estate investment trusts focused on cannabis, Inception and Subversive, planning a merger.

The $15.5 million transaction, which involves 15 properties across seven states including California, is intended to help the two companies in what’s becoming a competitive industry as states legalize recreational cannabis sales and communities restrict where it can be sold, Subversive REIT CEO Richard Acosta said.

The merged portfolios and pending acquisitions represent just a small portion of a much larger special purpose acquisition company formed earlier by the firms to invest up to $225 million in cannabis-related commercial properties nationwide, he said.

“The pandemic has been an incredible tailwind for the cannabis industry,” said Acosta, a former executive with Colony Capital in Los Angeles. “Especially if you see more legislative control by Democrats after these upcoming elections, there will probably be more momentum toward federal legalization.”

The deal could signal more potential consolidation ahead for an industry dealing with financial challenges partly stemming from federal and community-restrictions despite rising legalization.

The two firms are among a growing slate now pursuing property deals as sales have been rising during the coronavirus pandemic, with customers dealing with illness and anxieties tied to economic and political tensions.

Acosta said further pressure for federal legalization could come as U.S. cities, including many in California, seek to make up for major losses of sales and hotel tax revenue caused by pandemic-related business closures and lost tourism.

Both REITs were founded within the past two years, holding properties and mortgages tied to cannabis-related retail and industrial properties. Real estate demand has generally been rising in recent years, particularly since recreational marijuana sales have been legalized in 11 states including California, Colorado, Nevada, Washington and Illinois, with more considering legalization.

However, community-level regulations and restrictions on where cannabis can be sold or cultivated vary widely, with companies often competing for a limited number of operating permits. Cannabis also remains illegal under federal law, meaning retail transactions cannot be conducted through bank-connected payment methods such as checks or credit cards.

Acosta noted that cannabis-related companies also face challenges obtaining property and title insurance, as well as financing from many institutional investors. That means they must have stronger non-institutional investment and underwriting sources lined up to finance acquisitions and developments.

Options for Scale

Analysts who track cannabis retail have noted that operators have had success with delivery services and specialized artisanal product offerings, but the industry has also faced issues with management turnover, market saturation and competition from illegal black-market sales of marijuana.

In a recent research note on Chicago-based retailer Cresco Labs that was generally favorable, analysts at financial services firm Cowen still noted that California, the nation’s biggest cannabis market, poses challenges for sellers.

“California represents a key market for [Cresco] and a failure to issue more legal licenses, provide a better regulatory framework and crack down on a robust illicit market can limit the upside that the state has to offer,” Cowen analysts said.

Such warnings come as analytics firm BDSA projects that U.S. cannabis sales are on track to reach $34.5 billion by 2025, rising at an annual average rate of 18%. Global sales are projected to rise 22% annually over the next five years.

Inception co-founder Omar Mangalji said in a statement that the merger with Subversive is part of a strategy to offer potential investors “additional options for scale, liquidity and a public market premium” at a time of broad global uncertainties and limited avenues for high investment yield.

The Southern California properties and retail mortgages to be held by the merged Inception and Subversive REITs are in downtown Los Angeles, Desert Hot Springs and Coachella, with other properties in Arizona, Florida, Maryland, Michigan, Nevada and Washington.

The Nevada property is known to be a 455,000-square-foot industrial building at 3950 N. Bruce St. in North Las Vegas, where Subversive holds a $39 million loan and recently announced it has entered into an option agreement to purchase and lease back the property to current owner Flower One Holdings Inc. of Toronto.

Acosta said cannabis real estate is steadily moving toward more efficient raising and deployment of capital, similar to what’s happened in recent years with other specialty areas including self-storage and industrial cold storage. He said consolidations and joint ventures in the cannabis sector could become more common in coming years.

“There are still very few entities like ours in the U.S. who are out there investing in these portfolios, and we were just the second one to go public,” Acosta said, referring to the earlier formed cannabis REIT competitor Innovative Industrial Properties of San Diego.