Debra Borchardt, Editor-in-Chief, Green Market Report:
Rob Sechrist is the president of Pelorus Equity Group, a company that you may not be familiar with, but you will soon. This company is a little unique. It’s a mortgage REIT (real estate investment trust), not a traditional REIT. And Rob, why don’t you explain to our audience a little bit about that difference? Because most people are really familiar with their traditional REIT that buys buildings and then takes the lease money and gives that back to the shareholders. This is a little bit different. Can you go into that?
Rob Sechrist, President, and Co-founder of Pelorus Equity Group:
Sure. Debra, thanks for having me. I’m happy to explain the difference. Most people are unfamiliar that there’s more than one type of REIT that traditional REIT owns properties, like IIPR. A mortgage REIT simply means that that is a lender that’s able to get the same tax advantages of a traditional REIT. Those tax advantages, just to re-clarify are 20% savings on your federal taxes. You only pay state taxes in the state that you’re domiciled.
GMR:
Your company specifically focuses on the cannabis industry and what you guys do is help cannabis companies that need money to build out their facilities, which can be a really expensive endeavor for a cannabis company. How are you approaching these cannabis companies with this help?
Sechrist:
Our background is what we call value-added lending. In our world “value add” means that we are improving the property with a portion of our loan is going back into the property with a pre-approved budget. Typically, it’s going to be tenant improvements. It could be ground-up construction, but this is the largest newly created asset class in the country. We’ve extrapolated the data that it’s about $50 billion real estate asset class that just magically appeared. When that asset class was created by the legislature, in each of these states, those properties actually in order for them to be legal the real estate needs to be approved and that side is one element of it. It has to be built out. It has to be a purpose for cannabis use tenant, and then the tenant, the cannabis use operator must also be approved by the state. Those two elements, once they’re plugged together, that is a legalized property and now you’re on your way and it’s one of the 50 billion.
GMR:
To your point with cannabis, it isn’t so easy to just go to a bank and get a construction loan. So you’ve put up all this money to buy this building. You’ve spent all this money to get these licenses and these applications approved. A lot of these companies have spent millions just to get to basically square one. That’s really just the first inning of the ball game. They still have to build out these facilities, which is even more money. A lot of times, they’re kind of starting to get tapped out at that point and they can’t just go to a typical bank and say, “Hey, we got to build out this building. We’re a legit company. We’re not doing things that are illegal.” But the banks are just like, “No way.” The major banks want nothing to do with this, right?
Sechrist:
The major federal banks are not in the sector. The state banks and credit unions, there are 684 that are doing deposit relations for tier-one plant-touching operators and businesses. And of those banks, there’s probably a few dozen that are actually lending, but the banks are difficult to get loans in general. They certainly are not in the value add lending space at this time. And more importantly is that when you go to build a cannabis facility, typically these properties, the tenants are doing 10 to 15 times more revenue per month than a non-cannabis use tenant. And why I’m giving that and focusing on that is that to be focusing purely on your rate and points for the loan, as opposed to the speed of getting that property up and stabilized is very shortsighted. You want to get your property built as quickly as possible.
Our average borrower takes about 12 months to build and stabilize their property. And we’re typically processing 50 to 100 draws for the borrower to be reimbursed for the expenses that they’ve put out for the pre-approved budget. So for example, if your facility is doing one to $2 million a month or has the ability to do that, and you want to save a couple of percent, and even if it was a 10% difference between our rate and a bank rate, that premium might be a million dollars or $2 million in a year. But if you’re doing one to 2 million a month, that premium is absorbed, if we save them one month. Typically, we’re going to save at least 20% compared to other private lenders best in class and probably six months with a bank. And so it’s a no-brainer once you analyze it.
Unfortunately, the cannabis use borrowers are so focused on brands. They have so many things going on, compliance, inventory, genetics, all the stuff that they’re trying to deal with. A lot of them haven’t worked with a construction loan before, and they have only done their own home mortgage. The only thing they ever knew at that time was the rate and the points. So they’re not aware that you need a high-performance loan and they might get into a loan and realize, “This isn’t even going anywhere. I have to advance the money. I’m not getting reimbursed fast enough.” Usually the project comes to a stop. That is not the situation you want to be in. Plus Pelorus is the first dedicated holistic lender for the cannabis sector back in 2016. And we look at the cannabis use properties as a holistic approach. A bank does not do that.
We want to make sure that we provide all the money that is necessary or make sure that all that is encapsulated in our loan that gets the property acquired, built out with the tenant permits and the equipment to make sure that, that tenant can actually start operating. A bank would not provide all those features to that loan. And so you might have a situation where the tenant doesn’t have the money because the property is not cash flowing yet. And they’re not able to go raise that equity that’s necessary for the equipment to build it out. And this equipment is enormously expensive. Some of the equipment as a whole, for the project might be more than the purchase price of the building. And so if you are trying to go raise that money for equipment for a building you don’t even own, it’s a very difficult challenge. So you want to have a solution that is holistic in the approach. And we were the first to do that.
GMR:
One of the things that kind of differentiates Pelorus is your rates are quite high, but to your point, you’re getting the money to the client faster, correct?
Sechrist:
We offer high-performance loans to achieve what the borrowers looking to do. 100% closing ratio of all the transactions that we’ve ever done. I don’t know if any other lender can say that. More importantly, or just as important as closing is to make sure that the facility gets up and running and built as quickly as possible. And so you need to look at that ratio of what is the pricing savings that you would get with a lower pricing loan as opposed to what is the opportunity revenue that we lost by not penetrating the market and not getting this facility up and running as quickly as possible. So as today, most of the cannabis community knows who we are and knows that this is the place that they want to go to get a facility built.
GMR:
How much money have you guys raised today?
Sechrist:
We’ve deployed more than $185 billion. We’ve got about $60 million going out in the next 30 days or so. So we’ll be to $250 million here in the very near future.
GMR:
You’re working with some pretty big names. I saw you’re doing a deal with Acreage Holdings (OTC: ACRHF) for a fairly large amount.
Sechrist:
We did a deal with Acreage Holdings in the fourth quarter of last year. By the way, they are big enough that they could have gone to an institutional rate. So in that specific scenario, their board came to the realization that they needed to look at the entire cost of the capital, not just the pricing of the loan and they quickly determined in the end that was the direction to go after. Our pricing does shock people, but that’s because you’re buying a high-performance loan and there’s a lot to go into process, an unlimited amount of draws in one to three days. Nobody else can do that. That is so important. And that’s what you need to be focused on. If you want to go and take your time and have the lowest cost, and it really doesn’t matter how long it takes for that facility, then you probably want to start with another lender.
GMR:
That’s pretty interesting. Now, we’ve seen a lot of situations in Canada with regards to overbuilding. Some of the companies like Canopy Growth (NASDAQ: CGC) has shut down some of their indoor facilities. Do you feel that because the United States is so early on in its legalization, that we’re not going to be in that kind of situation, that we have companies that could get overbuilt with regards to facilities?
Sechrist:
So two comments there. In Canada, as far as we know, there’s nobody that had built a hundred thousand or a million square foot facilities that were at scale in the entire country and anywhere in the world. So you have people that are trying to scale from zero to a thousand or whatever on the first try and by the time that facility gets built, you realize we didn’t build this correctly, and you have to write that whole facility off. So, they didn’t have a learning curve and they made mistakes up in Canada that I don’t think that you’ll see duplicated. And certainly not to that same extent, that happened up there. One was, is that you really only had a gray market or illegal market operators that were mostly operating outdoors. Some of them might’ve had some indoor greenhouses, but they would have been tens of thousands of feet, not hundreds of thousands or millions of square feet.
When you go to that scale, you have different challenges that you’re trying to deal with. And if you get it wrong, you’ve already built the facility, before you realize we didn’t configure this properly. And it’s actually less expensive to sell this property and to go somewhere else. We started analyzing the sector because we realized that our skills in value add lending were immediately applicable to the sector. We analyzed it and we originated the first transaction in 2016. We only did small transactions to make sure that not only were we learning what the borrowers needed to do, but they were learning as well.
So we scaled with small facilities, 10,000 square feet, 20,000. Now, we do 100,000 square feet and larger, but we worked our way up to understanding the market. Secondly, we also built the first proprietary database where we analyze each of the cannabis operators that are licensed within each state. We identify who they are, what types of licenses they have and we associate what properties they’re in. We look at the average build cost, the average price per square foot of the universe of properties. For each of these types of licenses. So we know the size of the capacity of the market is existing. We also look at some other things with other technology we look at to understand, “Is this market reaching capacity from a production size? Is it oversupplied? Is it under-supplied?”
We’re monitoring all of that stuff. So we’re using data and facts to analyze this. Typically in most lending sectors of the country, there would be a hedge fund, or there would be a third party doing this and spending millions of dollars to analyze this. Well, we needed that data. So we had to make the investment ourselves and so today we have a very robust, what we call the big data project that we pull all that data and extrapolate it to help us make our decisions.
GMR:
I was wondering with regards to risks, so risks for your investors. In this situation, you’re lending money to these companies to build out their facilities. What is the risk that they potentially aren’t able to complete that facility, whether they’ve run into other problems elsewhere? Certainly, it’s the cannabis industry. We’ve seen lots of situations blow up pretty quickly. Are you, or have you seen anything like this, and have you seen other companies willing to then jump in and take over? What is your situation with that?
Sechrist:
We’ve originated more than 5,000 of these types of transactions. Whether you’re a cannabis company building a facility or somebody else building a facility, that’s an issue that we have to de-risk or look at. The way that we start is we first start with a feasibility review of the budget to make sure that, that budget is sufficient, regardless of who the contractor is. If we had to replace the contractor, that there’s sufficient capital, and it’s also reviewed to make sure the water’s there, the permits are in place, the electricity has ample to supply that for what we’re building, etc. We take that budget and we run it through our data to make sure that it’s sufficient, no matter who we use for the budget, that there’s enough capital. Then we build a contingency as well, just in case there are some overruns.
We start with that aspect and then as we are going through that project, actually the borrower has to advance the money first. Then we go and verify that the invoices have been paid. We get proof of payment. We get lien releases from the contractors to make sure that they can’t lien the project. Once all that’s been reviewed and completed, then we do a physical inspection to verify that those went into our property and you get a percentage of completion. So we’ve de-risked that and we’re prepared to fund that project and complete that project, whether it’s with our borrower, that contractor, or if we take it ourselves. So that’s on the property side. As far as the tenant or operator side, we also analyze to make sure that we’ve got a path through to replace that tenant ourselves, if necessary, if the borrower failed and if the tenant failed.
We have the ability to complete the building and we have the ability to replace the tenant. As far as our portfolio, we haven’t seen a situation where the tenant has not been able to be replaced. We don’t have any transactions that we’ve had to replace the tenant yet. We do have one of our borrowers that replaced another facility next door, not ours, but they did it in 90 days. We use that as a case study to make sure that what we’re thinking is as possible and what the timelines are. And once these facilities are built out, they have the power, the water, the infrastructure, the general configuration, isn’t going to change that much. Most of our facilities start with indoor cultivation, and then they might have some processing or some extraction, and some other things in there.
Once you’ve got kind of that layout, different operators reconfigure within those rooms, but the general gist of it, it’s going to be the same. Commercial properties are a lot easier to reposition walls and things than in residential houses where everything’s load-bearing. So it’s a different situation.
GMR:
Absolutely. So what are the plans for Pelorus for the rest of the year? Are you guys going to continue to raise money? I would assume keep lending.
Sechrist:
We’re scaling the company. We continue to add to our team. We just opened a New York office to get a presence on the East Coast. Our goal is to get to a billion dollars assets under management. Our investments in the company, from our team and our people that we work with are positioned on that on growth and to maintaining our position as the number one value add lender and the first and the most experienced in the sector.
GMR:
Well, there will certainly be a lot of activity happening in the Northeast, now that all the legalization is happening in New Jersey, in New York. Rob, thank you so much for taking time out of your very busy day to talk to Green Market Report.
Sechrist: Thank you so much.
Debra BorchardtMay 17, 2023
Staff
