Will Your Tenant Go Up in Smoke? The Risks of Leasing to a Medical Marijuana Dispensary in Los Angeles

March 31, 2011Article
AIR Waves Newsletter and Daily Journal

I recently received a call from a client who owns a small commercial building that has been vacant for over a year despite his broker's best efforts. A medical marijuana collective had offered to pay above-market rent to lease the building as a dispensary. Naturally, he was intrigued by the prospect of filling the vacancy at rent amounts envy of his neighbors; however, he was equally concerned with the risks of leasing to a tenant whose use, while permitted in California, remains illegal under federal law. If he leased to a medical marijuana dispensary, would his tenant, like the product it sells, eventually go up in smoke?

In 1996, California voters passed Proposition 215 legalizing marijuana prescribed for medical use. However, under the federal Controlled Substance Act of 1970, the manufacture, distribution and possession of marijuana, whether for medical use or otherwise, is strictly prohibited. Both criminal and civil penalties, including forfeiture of assets, can result from federal prosecution for violations of the Controlled Substance Act.

California, like a handful of other states that have legalized medical marijuana, has argued that the Controlled Substance Act does not trump the state legislatures' right to exempt medical marijuana from criminal prohibition. This situation has created a challenge for landlords of medical marijuana dispensaries who are caught in the battle between the state and the federal government over the legality of medical marijuana.

In 2007, the federal Drug Enforcement Administration notified 150 landlords of medical marijuana dispensaries that their tenants' activities were illegal and could subject the landlords to the risk of arrest and forfeiture of property. Under the Civil Asset Forfeiture Reform Act of 2000, if a landlord has provable knowledge of illegal drug activities occurring at the premises and does not take reasonable measures to prevent them, the federal government may seize assets and property deemed to be the proceeds or instrumentalities of a criminal act. Even though there are few, if any, examples of actual asset forfeiture actions by the federal government, the prospect of losing assets and property understandably frightens away all but the most determined or desperate landlords.

Even landlords who are willing to lease to medical marijuana dispensaries may have difficulty navigating the city of Los Angeles' medical marijuana ordinance, especially in light of a recent Los Angeles County Superior Court decision that found key provisions to be unconstitutional.

The medical marijuana ordinance came about in response to a proliferation of medical marijuana dispensaries that at one time numbered over 1,000 within the city limits. It regulates the establishment, location and operation of medical marijuana dispensaries and collectives within the city. Under the ordinance, all dispensaries must be registered and approved by the city. Dispensaries cannot be located within a 

1,000-foot radius of a school, public park, public library, religious institution, licensed child care facility, youth center, substance abuse rehabilitation center, or another dispensary. They also must be proportionately distributed across the city's neighborhoods (e.g., each of Westchester-Playa Del Rey and West Los Angeles has a maximum of one permitted dispensary). Registration with the city must be renewed every two years and any violations of the ordinance conditions can result in a dispensary being shut down.

Even if a dispensary is currently operating in compliance with all city regulations, this is no guaranty that it may continue to operate. In light of a recent court decision finding portions of the medical marijuana ordinance unconstitutional, Los Angeles recently amended the ordinance to provide for a cap of 100 dispensaries citywide, which will be chosen by lottery from among those dispensaries that can prove they were lawfully in existence prior to the city's Sept. 14, 2007 moratorium.

Confirming the current legal status of a dispensary is imperative. The city is currently sending cease and desist letters to any medical marijuana dispensaries that were not lawfully in existence prior to Sept. 14, 2007 or lawfully in existence prior to Sept. 14, 2007, but failed to register with the city clerk by Feb. 18, 2011 for the upcoming lottery. The lottery leaves current Los Angeles landlords of medical marijuana dispensaries rightfully concerned whether their tenants may continue to operate.

Faced with this conflux of federal, state and local regulation, what is a landlord to do when considering an offer from a marijuana collective to lease a vacant premises in the city of Los Angeles for use as a dispensary?

First, although the DEA under the Obama administration has dialed back the raids and rhetoric on medical marijuana dispensaries, the risk of criminal prosecution and asset forfeiture under the Controlled Substance Act cannot be disregarded. However, a landlord with minimal or no equity in the property would be less concerned, as would a landlord having trouble meeting the property's debt service coverage without a rent-paying tenant. In these circumstances, leasing to a medical marijuana dispensary at a market or above-market rent may be worth the risk.

Second, before entering into a lease with any dispensary, the landlord must confirm with the city's Department of Building and Safety and the Los Angeles Police Department that the location of the property is permissible for a dispensary and the prospective tenant is properly licensed and registered with the city under the medical marijuana ordinance. With the recent amendment of the ordinance, the tenant must be one of the lucky 100 lottery winners permitted to continue its registered dispensary; otherwise, the landlord will likely be the unfortunate recipient of a cease and desist order from the city.

Third, the landlord should work with a qualified real estate broker or attorney who can appropriately value the fair market rental based on the inherent risks involved, and draft a lease with sufficient security, indemnifications and releases to protect the landlord to the full extent allowable under law. Brokers and attorneys do not need to shy away from medical marijuana dispensary leasing because it is extremely unlikely that asset forfeiture or criminal prosecution by the federal government under the Controlled Substance Act would ever extend to a landlord's brokers or legal counsel.

Even with these precautions, there is a measurable risk that the tenant's dispensary may be raided by the DEA, closed for violations of the medical marijuana ordinance, or shut down under federal law as administrations change enforcement tactics. Like evaluating the creditworthiness of any prospective tenant, it is ultimately a cost-benefit analysis. A landlord may make money and look like the smartest kid on the block - or be left holding the bag when the tenant goes up in smoke.