In what observers say is a sign that California’s struggling legal cannabis industry is slouching toward a long-predicted “extinction event,” a major Southern California brand in the middle of ambitious expansion plans was recently sued by its landlord after falling behind on millions of dollars in lease payments.

In July, privately held Kings Garden – headquartered in Palm Springs and a holder of cultivation, manufacturing and distribution licenses – defaulted on $2.3 million in rent and related fees owed to Innovative Industrial Properties (IIP), a San Diego-based real estate investment trust (REIT) that’s a major player in cannabis, regulatory filings first cited by a Twitter user reveal.

A subsequent lawsuit filed by IIP – which leases more than 8.5 million square feet of commercial real estate to some of the nation’s biggest cannabis companies – against Kings Garden was settled out of court on Sept. 11 “to the mutual satisfaction of both parties,” according to more recent filings.

Reached via phone on Sept. 21, both Kings Garden CEO Michael King and IIP CEO Paul Smithers declined to comment, citing the confidential nature of the settlement.

“For confidentiality reasons, I’m not permitted to comment further,” King said.

King also declined to say whether the company’s now-interrupted expansion plans would resume.

However, several observers said the situation reflects an overall negative trend in California marijuana that highlights the difficulties Kings Garden and other licensed companies are facing.

‘You Scaled Your Debt’

Many legal-market operators have claimed over the past year to be falling further and further into debt as costs rise, prices plummet and stalled federal and state reform keep taxes high and the illicit market competitive.

Last winter, coalitions of large producers and small craft growers declaring themselves to be on the brink of failure unsuccessfully lobbied California Gov. Gavin Newsom to cut the state’s 15% excise tax and relax licensing fees and other burdens.

Some even threatened to withhold taxes if their demands weren’t met.

The governor eventually agreed to cut the state’s regressive cultivation tax, but he also changed where on the supply chain the state collects excise tax – a move that advocates say merely moves the pain elsewhere down the line at a time of historically low wholesale prices.

“Applicants and our permit holders, they’re like, ‘I’m broker than I’ve ever been because of the economic situation in the market,’” said Kristin Nevedal, a former grower and consultant in California who now works as a regulator in Mendocino County, told MJBizDaily in July.

The situation is so bearish that Chicago-based Choice Consolidation Corp. – a special purpose acquisition company (SPAC) managed by former Cresco Labs executive Joe Caltabiano – decided to fold and return investors’ money rather than try to acquire a company.

The value of major California cultivator Glass House Brands has dropped nearly 80% since it went public via a SPAC transaction in July 2021.

Kings Garden is just another once-high-flying company to run into predicted trouble, observers said.

“The problem with cannabis is that if you scaled your business, you scaled your debt,” said Jerred Kiloh, the owner of Los Angeles-area marijuana retailer The Higher Path and president of the United Cannabis Business Association (UCBA).

Kiloh has repeatedly sounded the alarm over the past two years that the legal industry is in serious trouble, only to be greeted by what he says are the deaf ears of lawmakers and regulators.

“I wish ‘I told you so’ meant something to them. I really do,” he added. “But this is where we’re going. This is where the metrics are.”

“It sounds like Kings Garden had too many employees, too much overhead, and then the price of cannabis dropped 50% overnight, basically,” said Ken Seligson, a cannabis business attorney with clients in California and New York who is also a co-founder of Padre Mu, an Oakland-based delivery service and distributor.

“Is it a harbinger of other things? Probably,” he added. “All my clients are fighting extinction.”

Short seller’s prediction

It’s also the fulfillment of an April prophecy from a short seller that predicted rocky times ahead for IIP.

IIP was rated a short in April by Blue Orca Capital, short sellers that called the company “a marijuana bank masquerading as a landlord.”

Blue Orca went on to say IIP’s business model was one of purchasing properties at above-market rates “so as to loan tenants money to build their businesses.”

The company did not respond to a request for comment.

But since Blue Orca published its 24-page brief in April, other publicly traded cannabis companies – many of which are IIP tenants – have reported more than $550 million in combined losses over the first two quarters of 2022, according to Politico.

And shares in Innovative Industrial Properties, traded on the New York Stock Exchange as IIPR, have plummeted along with other cannabis stocks, falling 52% from $183.44 on April 13 to below $88.50 on Friday.

The decline is in line with an exchange-traded fund that tracks U.S. multistate operators – AdvisorShares Pure US Cannabis ETF.

Asked for comment, IIP’s Smithers directed MJBizDaily to a company news release from April that called the Blue Orca report so “flawed” that it “does not warrant a response.”

The short seller’s report “demonstrates a basic lack of understanding of commercial real estate generally, the regulated cannabis industry and IIP’s straightforward, simple business model,” the company said at the time.

Smithers did not respond to further MJBizDaily messages seeking comment on Blue Orca’s vision.

Legalization hopes fall short

For Kings Garden, the default represents what outwardly appears to be a remarkable comedown, at least partially a result of bad bets by both investors and entrepreneurs who believed Congress would have legalized a national marijuana market by now.

In February 2020, Kings Garden claimed to be a profitable company, “with no debt,” that already had “begun paying dividends to its investors,” CEO King told New Cannabis Ventures.

At the time, King claimed the company had raised $55 million “from friends and families” and was cultivating more than 20,000 pounds of cannabis a year across 215,000 square feet of licensed space that Kings Garden “owns and operates.”

King appeared to back away from that statement in his Sept. 21 interview with MJBizDaily, claiming instead that the company had never owned its real estate.

Since that time, California companies have steadily added more and more cultivation capacity.

Kings Garden was no exception.

In early 2021, the company announced ambitious plans to expand to an eye-popping 665,000 square feet of “indoor operations” that would produce 140,000 pounds of cannabis and generate “over $300 million in revenue” by 2023.

That kind of optimistic arithmetic was typical thinking at that time – after President Joe Biden’s inauguration – when investors opened their checkbooks and poured cash into ambitious expansion projects.

“A lot of this industry believed that federal legalization was around the corner,” said Anthony Coniglio, CEO of competing cannabis REIT NewLake Capital Partners.

Since the easiest way to expand in California – where many localities ban or heavily restrict retail marijuana sales – was to add more cultivation space, this sanguine capital only further fueled the overproduction that in turn crashed prices and put businesses in their current delicate positions, Coniglio said.

Instead, in California and in other legacy states, taxable sales in the legal marijuana market have actually declined from a mid-2021 peak, a rebuttal of the conventional wisdom that predicts only increased sales and revenue throughout the decade.

According to the UCBA’s Kiloh, sales among his members dropped 40% from February to August.

“I think you will continue to see operators struggle financially, and I think we’ll see failures occur in California to an increasing degree over the next six to 12 months,” Coniglio said.

“We’ve had cycles like this before, but there’s always been a bucket of capital” available to rescue struggling operators, he added.

“That’s not there this time.”

Source: https://mjbizdaily.com/california-cannabis-company-default-highlights-debt-woes-facing-states-businesses/