29 states. 283,000 new jobs. $50 billion in annual revenue. What will it take for the mortgage industry to capitalize on this opportunity?
There is an emerging industry that employs as many as 230,000 workers and is expected to create over 283,000 new jobs in the next three years. Its businesses have a net worth of $7.2 billion, with a projected compound annual growth rate of 17%. Those kinds of numbers would usually prompt nancial institutions to go out of their way to establish a market foothold, both to extend credit to companies and establish consumer relationships with employees — particularly when the Bureau of Labor Statistics expects traditional sectors like utilities, agriculture, manufacturing and even the federal government to shed jobs through 2024.
But this budding business is the highly controversial legal cannabis industry that, so far, mortgage lenders and other nancial institutions have been reluctant to work with.
Marijuana is legal for recreational use in eight states and the District of Columbia, and for medicinal use in an additional 21 states. But the federal government regulates it as a Schedule I substance (one with a high potential for abuse and no currently accepted medical use), and there is no guarantee that the Department of Justice won’t seek to prosecute recreational or medical use providers operating legally under state law.
For mortgage underwriting purposes income legally derived from cannabis businesses cannot be used to qualify a borrower for an FHA-guaranteed loan. Fannie Mae and Freddie Mac, currently under federal conservatorship, have similar policies in their seller guides.
But even lenders that o er less restrictive loans outside of the federal Quali ed Mortgage guidelines can’t, or won’t, serve these borrowers.
Many cannabis business workers come into the industry knowing it’s “a lifestyle that is nontraditional. They’re not likely going to be able to get a mortgage; I think they just accept that,” said Lori Glauser, chief operating o cer of Signal Bay Inc., whose EVO Labs subsidiary tests cannabis for safety and e cacy.
It appears that no lender is willing to be the rst to try it, out of risk of being made an example by regulators. But as higher interest rates, plummeting re nance volume and housing inventory shortages continue to constrict originations — and the cannabis industry continues to grow in size and legitimacy — taking on this new strain of risk may soon become a more lucrative proposition.
The legal cannabis industry has two sectors: hemp, which has a number of industrial applications like rope and textiles, and marijuana, whose businesses are largely focused on consumable uses. Each sector has cultivation and manufacturing segments, while the marijuana sector also has a retail segment.
Each dollar spent on retail marijuana resulted in $ 2.40 in economic output in Colorado, according to an analysis of the state’s legalization law conducted by the Marijuana Policy Group, a Denver- based consulting irm. For the general retail business, including alcohol, the report found that economic output was $1.88 for each dollar spent.
Marijuana legalization created 18,005 full- time equivalent jobs in Colorado in 2015, of which 12,591 were directly involved with the marijuana business, the report also found.
“Additional employment is also generated when marijuana employees and proprietors spend their income on local housing, food and entertainment,” according to the report. “This is called an ‘induced employment e ect.’”
That category was responsible for 2,518 jobs in 2015.
What’s more, these jobs cover “everything from minimum wage ranging up to six gures a year,” Glauser said. “The industry hires high-level chemists and technical personnel that can operate sophisticated equipment such as extraction equipment to process certain materials, and they are very highly paid. And, yes, in some cases they are likely getting paid in cash.”
As more states are expected to legalize cannabis for recreational and/or medical use and industrial uses for hemp products expand, “the potential opportunities for job creation in cannabis-related sectors remains very strong and will signi - cantly dwarf the numbers that we have here,” said John Kagia, execu- tive vice president of New Frontier Data, a data and analytics rm in Washington, D.C., that specializes in the cannabis industry.
The irm analyzed the national job and economic impact of the cannabis industry by extrapolating from the Marijuana Policy Group’s Colorado study. In addition to the projections of 283,000 new jobs and the industry’s $ 7.2 billion net worth, New Frontier found legal marijuana sales will generate an estimated $ 745 million in state tax revenue in 2017.
By 2020, it could grow as high as $ 2.3 billion.
HOUSING’S CONTACT HIGH
Colorado and Washington were the rst states to legalize the recreational use of cannabis.
Denver is one of the nation’s hot housing markets. Home prices in the metro area increased 8.3% in July over the same month last year, ranking eight nationwide according to CoreLogic. Seattle was the leading city with growth of 14.55%.
On a statewide level, Colorado recorded an 8.3% increase; the state with the largest increase was Washington at 12.9%.
Such growth can’t be strictly attributed to legalized canna- bis; Utah, where it is not legal, had 10.8% year- over-year price growth, making it second, while Idaho was third at 9%.
Denver’s economy was doing well prior to legalization, said Kagia. But “cannabis has been just one of the contributing factors to the very strong state economic performance over the past few years. It has created very high rents, higher mortgages.”
So housing in general “has become a challenge for lower income earners, both in the cannabis industry and outside,” said Kagia.
Now that cannabis has been legal in Colorado for several years, “we can see that it has absolutely a ected our market,” said Kelly Moye, a real estate broker at Remax Alliance in Bloom eld, Colo. It started on the commercial side, where cannabis businesses increased the demand for warehouse and retail space.
Now, “tons of di erent companies who want to take up that space and are willing to pay a premium for that,” said Moye, who is also the spokeswoman for the Colorado Association of Realtors.
The dynamic between commercial and residential demand does not operate in a vacuum. When space got rented or purchased by legal cannabis businesses, it created many new jobs with people moving to Colorado who needed places to live.
“Our supply and demand has really taken a crazy turn in the last ive years for lots of reasons, legal marijuana being one of them,” Moye said.
In addition to legal cannabis creating new jobs, Amazon and Google have also added employees in the state and increased competition for housing. Colorado’s quality of life is particularly appealing to a lot of people looking to ll those positions.
Some of her clients are between 25 and 35 years old are looking to buy a condominium or rst home and they might not have been in a position to buy if they didn’t have a job in the cannabis business.
“There are a lot of people who are moving here to work in that industry who may not have moved here otherwise. And all of a sudden, we have a signi cant low supply and high demand issue, which pushes prices up,” Moye said.
And even if they can’t get credit or lack the cash to purchase a home, they are competing for rental properties. So rents are rising and people working in more
traditional businesses are making the calculation that it is cheaper to buy.
“So those people who are renting and working in the marijuana industry cause the people who are not to go out and buy, which then fuels our housing market,” Moye said.
UNDERWRITING HEAT SCORE
Medical marijuana use was approved in New York State in 2014. Soon after, Michael Barone, the managing partner of Abrams Garfinkel Margolis Bergson’s mortgage compliance practice, began receiving client inquiries about what is permissible when it comes to lending to that industry’s workers.
“Now you have employees — the growers, the retailers, the bookkeeper that works there, the packager — who are getting W-2s that show [they work in the] marijuana field and some of them are having trouble” obtaining credit, Barone said.
The industry’s hyper-sensitivity toward compliance has lenders concerned that trying to qualify cannabis workers for mortgages would amount to an underwriting “heat score” — activity that draws unwanted attention from regulators.
“These banks are not taking chances; they’re not taking risk on a compliance level,” he said, adding there is not enough business in making loans to these workers to take on the additional risk.
The reluctance to lend means “these people are really getting hurt. They need that income to qualify for a loan or to refinance,” Barone said.
Cannabis employers have problems with access to banking services because of the federal prohibition. Approximately 70% of businesses that touch the plant cannot establish a bank account, according to a December 2015 survey from Marijuana Business Daily, a trade publication for the cannabis industry. Without bank accounts, employers are forced to pay their workers, along with their business expenses such as rent and taxes, in cash.
But that doesn’t mean employees are getting paid under the table. Most of the businesses, even if they are operating in cash, have a payroll management system or use an outsourcer. So the employees are getting paystubs with tax- es withheld, along with a W- 2 at the end of the year, that lenders could use to document income, said Taylor West, the deputy director of the National Cannabis Industry Association.
But while being paid in cash is not an automatic disqualifier for getting a mortgage, it can be a red flag for underwriters.
Large sums of cash passing through a bank account worry lenders who have to be mindful of anti- money- laundering laws, including compliance with the Bank Secrecy Act. Any cash deposit or multiple deposits over $10,000 trigger a reporting requirement for banks.
A number of professions involve people who receive much of their income in cash, usually from tips, and they don’t have a problem qualifying for a mortgage. For a cannabis worker who still receives a W- 2, “in its essence, how is it any different than other industries where people get paid cash,” said Ann Fulmer, a mortgage fraud expect and chief strategy and industry relations officer at FormFree Holdings, an asset data verification company.
If the applicant is receiving a W-2, that should be good enough for AML and BSA compliance, she continued, because the income is being reported.
On the other hand, “If I was an underwriter and I saw a $25,000 cash deposit, my antenna would go way up,” Fulmer said. But just because it’s a red flag doesn’t mean an underwriter should automatically deny an applicant. If the income is reported on a W-2 and taxes are being paid, that could be enough to assuage concerns, she said.
Yet, “it’s still illegal on a federal level. They can’t [use] income for underwriting purposes which is derived from what is considered an illegal activity on the federal level,” said Barone.
Two federal guarantee programs have no specific bar on the use of income from cannabis businesses.
The regulations for the Veterans Affairs loan guarantee program require lenders to ensure that a borrower has a stable and reliable source of income, said agency spokesman Randal Noller. The U. S. Department of Agriculture Rural Development program does not have a policy regarding loans to people working in the legal cannabis business.
And at least one lender has originated loans for cannabis industry workers and sold them to the government-sponsored enterprises. Evergreen Home Mortgage has sold loans to both Fannie and Freddie where the borrowers are W-2 employees and don’t have an ownership interest in the cannabis business where they work, said Tamra Rieger, executive vice president of loan fulfillment at the Bellevue, Wash., lender. She declined to specify whether these borrowers had additional income sources that were considered during underwriting or how many of these loans have been originated.
“Now that cannabis has been legal in Colorado for several years, we can see that it has absolutely affected our market.” — Kelly Moye, Real Estate Broker, Remax Alliance
When asked specifically about this, Freddie Mac spokeswoman Lisa Tibbitts said in a statement, “The Department of Justice has made it clear that selling marijuana and other related activities violates federal law regardless of state law.” Fannie Mae declined to comment.
If the traditional secondary market won’t consider these workers for loans, the non-qualified mortgage lenders would be a logical alternative. But even these companies are worried about lending to people getting paid in cash.
There is not one jumbo or non- qualified mortgage lender that allows Evergreen Home Loans to use income from a cannabis business to qualify a borrower, said Rieger. “That is where we had the worst trouble.”
She couldn’t find anybody in the scratch-and-dent market willing to work with these borrowers, either.
“Jumbo is the most restrictive out of all the types. What we found in Washington is the credit unions have been the only ones that have been able to help jumbo borrowers because of the way they are regulated by the NCUA.”
The National Credit Union Administration has taken a hands-off approach to working with cannabis businesses and their employees.
“The NCUA’s position is that the decision whether to work with a cannabis-related business is one for the credit union itself. We have advised credit unions of FinCEN’s guidance and that we examine for Bank Secrecy Act and anti-money laundering compliance. We also expect credit unions to analyze and mitigate risk, as we do with any financial service product they provide,” agency spokesman John Fairbanks said in a statement.
A number of credit unions known to work with the cannabis industry declined, or did not respond, to requests for comment.
Jumbo lenders are likely concerned about the risk of an expensive mortgaged property being seized by the Drug Enforcement Administration or the institution being subject to prosecution by the Justice Department, regardless of the laws in the state of Washington, Rieger said.
FHA and jumbo are “the two products we have no ability to provide [people who work in the legal cannabis industry] with a loan. We’d love to be able to help those borrowers,” she said.
Angel Oak Mortgage Services is another lender staying away from the cannabis industry. Despite taking additional risk for other types of borrowers in its non- Qualified Mortgage lending, it can’t ignore federal law.
“We still have to issue compliant loans based on federal laws, Consumer Financial Protection Bureau guidelines and DoddFrank; those still apply to non- QM loans,” said Tom Hutchens, senior vice president of Atlanta- based Angel Oak.
“The challenge is that there are just so many hurdles that don’t apply to other employees,” he added.
The problem is that federally chartered banks don’t allow deposits from cannabis businesses, and employees must have verifiable information about income and assets.
“If [ the information] is not verifiable because of the type of business they are in, then that’s not a loan we’re going to be able to transact,” Hutchens said. “We have to have a documentable ability to repay. Anyone in an all- cash business, do they have a documented ability to repay? Chances are the answer is no, but they could. It’s not an absolute.”
Easing the prohibitions is up to Congress, with at least 23 bills introduced in the current session that would affect the treatment of cannabis, according to The Cannabist website.
There is the Secure and Fair Enforcement (SAFE) Banking Act, introduced in the House by Rep. Ed Perlmutter, D-Colo., and the Senate by Sen. Jeff Merkley, D-Ore. The bills seek “to create protections for depository institutions that provide financial services to cannabis-related businesses.”
On Sept. 8, in the emergency aid package for Hurricane Harvey, Congress extended the Rohrabacher- Blumenauer amendment (first passed in budget legislation in 2014 and formerly known as Rohrabacher-Farr) through Dec. 8. It prohibits the Justice Department from spending funds to interfere with the implementation of state medical marijuana laws.
However, Attorney General Jeff Sessions opposes any attempts to legalize marijuana for any use. In May, Sessions sent a letter to congressional leaders asking them not to include the amendment in any appropriations legislation.
“I believe it would be unwise for Congress to restrict the discretion of the Department to fund particular prosecutions, particularly in the midst of an historic drug epidemic and potentially long-term uptick in violent crime,” the letter said. “The Department must be in a position to use all laws available to combat the transnational drug organizations and dangerous drug traffickers who threaten American lives.”
As long as federal and state policies — and executive branch and legislative branch objectives — remain at odds, there will be no change in the status quo. Lenders’ ability to serve those in the marijuana business remains limited.
“We still have to issue compliant loans based on federal laws, CFPB guidelines and DoddFrank; those still apply to non-QM loans.” — Tom Hutchens, Senior Vice President, Angel Oak