Real Estate Investment Trusts (REITs) are companies that own or finance income-producing real estate. The Pelorus Fund, managed by Pelorus Equity Group, is a private mortgage REIT specializing in value-add commercial real estate lending in the cannabis space, value-add meaning that a portion of their loans are pre-approved budgeted improvements increasing the value of the property. These improvements can be for ground-up construction, tenant improvements, and entitlement work for land development for cannabis-use properties.
Ganjapreneur spoke with Pelorus President Rob Sechrist about the company’s operations in the cannabis industry. “Our specialty has been in value-add lending and we’re one of the most experienced in the country prior to entering the cannabis lending sector,” he said. “Previously in the non-cannabis bridge lending space where we came from originally, we were able to get our investors low, double-digit returns on their investment, which is exceptional for a senior secured real estate debt transaction.”
Value-add is specialty lending, which requires accurately appraising the fully stabilized value of the property for how much a project will eventually be worth once completed, thus lenders must have accurate insights into commercial real estate construction. The nuances of the developing cannabis industry make this task even more complex: the lender must underwrite based on the property value in the future with a dynamic view of many moving parts within the construction process and apply that to the cannabis industry, which has a proven higher rate of return than the traditional non-cannabis market comps.
The Pelorus Fund is primarily comprised of retail investors but the Fund recently received an investment-grade rating from Egan Jones which allowed for institutions like large banks, credit unions, and insurance companies to participate in a $50M unsecured bond offering, clearing a path for institutional investors and bringing their total asset under management to $265M. The bond reduces the Fund’s cost of capital which allows the firm to offer fully stabilized, lower-cost loans to cannabis borrowers in addition to the value-add portfolio of loans on the balance sheet.
The Firm elected for the bonds to be unsecured, which means as long as the bond holders are paid, they can’t call the bonds due. This is true regardless of any change in the value of the real estate portfolio (as was the case in 2009). Bond holders receive a 7% coupon, which is accretive to the Fund’s equity investors. These complex structures are the foundation of the unique REIT that Pelorus has built. Rob credits the company’s success to his partners’, co-founder Dan Leimel and Managing Director Travis Goad, combined 65 years of hard-earned experience in the real estate and lending sectors.
Before writing a loan, Pelorus gathers property insights like location, purchase price, tenant information, and property improvements. Then they will order a third-party feasibility review to verify every line item requested from the borrower to the standard market price. Their proprietary data analytics, collected internally from tracking some 2,000 projects, is also applied to projections. This data fluctuates but provides a foundational baseline view of market trends. They also pull third-party data for insight into labor markets. Finally, they assess the saturation of cannabis businesses in the region to understand whether another facility is needed, revealing the value of building industrial cannabis-use facilities in that area. Pelorus was the first to create such a database. They are also the first value-add lender to use a cannabis industry valuation.
“Most borrowers in this sector have never had value-add lending, they’ve never done the types of development that requires a construction type of loan,” Rob said. “So we had to explain to them that, one, we’re using the cannabis valuation and the other ones aren’t. But more importantly, we’re the only value-add lender in the sector processing an unlimited number of budgeted construction draws and we lend on the fully completed, stabilized value.”
Once there is a clear understanding of the scope of the project, Pelorus can underwrite transactions much faster than traditional lenders. That speed is one benefit of borrowing from the Fund — the other is their deep understanding of value-add lending combined with their knowledge of the cannabis industry. The origination rates might be higher than traditional lenders but Rob believes they more than makeup for that in the speed in funding approved budgeted draws, getting the project completed and keeping the cash flowing. Many lenders don’t understand the actual value of a cannabis business in specific markets, therefore they don’t grant large enough loans. Pelorus writes loans that match the value, decreasing any possibility of a halt to construction which can gouge budgets. Providing loans that cover the entirety of a project removes the need to do any more fundraising. Private equity fundraising often forces business owners to relinquish stake in their company, which Rob asserts is a much higher cost than Pelorus’ fees.
Of course, there are multiple catches to ensure that projects run smoothly and spend funds efficiently. Pelorus writes covenants into contracts that solidify milestones and serve as a way to track the project. In addition to covenants, Pelorus will review the paperwork, look for canceled checks, and match up each line item in the invoice before releasing funds to a borrower. In addition, they send an inspector to the project site to take pictures for a report listing the percentage of completion on each line item. Each step in this protocol protects the investors and their assets.
A project’s scope can sometimes change so significantly that the borrower will need to raise more capital. If the necessary funds exceed the project’s contingency budget, there is a stipulation in the contract that the borrower must add the additional capital to the budget themselves. If the borrower is unable to do so, Pelorus will look at possible alternatives but may be forced to stop advancing draws for the loan. In a worst-case scenario, they may need to legally file for foreclosure, which begins the process of selling the property at auction. But if the borrower isn’t a bad actor, the Pelorus team tries to help solve issues creating a crux in the project before cutting off the loan and filing for foreclosure.
In one case, they had funded the construction of a licensed cannabis facility on unincorporated county land, but the company ran into issues when anti-cannabis civil servants used their power to block the permitting process. The issues halted groundbreaking and greatly increased the cost of the project. In this case, the team suggested ways to subdivide the land and change building plans to make the best of the permitting debacle and possibly even increase projected profits once the facility is in operation. The team utilizes quick-thinking alongside valuable multi-sector experience to serve the borrower and the investor.
Pelorus Equity Group is one of the first value-add lenders in commercial cannabis real estate and they continue to restructure and evolve alongside the developing cannabis industry. Rob teased that in 2022, they plan to continue building unique tax structures that are advantageous for their portfolio.
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