It’s no secret that California’s legal cannabis industry has struggled to thrive since the commercial adult-use market launched in January 2018.
For Graham Farrar, co-founder and president of Glass House Brands, a Santa Barbara-based cannabis operator with more than half a million square feet of cultivation space, high taxes and a shortage of retail outlets are straining the world’s largest cannabis market.
“Right now in California, surviving is thriving, but I think the opportunity on the other end makes it more than worthwhile,” he says.
California’s two-tiered licensing system has, from the outset, created challenges for the market, Farrar says. The state has not set a cap on the number of cannabis licenses it will issue, but businesses cannot get a state license without first securing a municipal license—and more than 60% of California’s municipalities still ban cannabis operations in their jurisdictions.
Local bans on cannabis have created a shortage of dispensaries for the state’s cultivators to supply with product. Farrar says that before California voters passed Proposition 64 to legalize adult-use cannabis, there were 3,500 to 5,000 dispensaries operating under Proposition 215, the state’s medical cannabis law. Now, he says, there are roughly 1,000 retailers.
“Oklahoma has twice as many as the state of California does and has a tenth the number of people,” Farrar says.
The state has allowed cannabis businesses to operate with provisional licenses as they work to secure more permanent annual licenses, but operators now face a June 30, 2022, deadline to convert to annual licenses or lose out on licensure entirely.
The transition to annual licenses may cause a tightening in supply, which Farrar says could ultimately stabilize the market in the long run.
“From a supply and demand point of view, it should help stability in the market,” he says. “From an operator’s point of view, if you’re struggling through the red tape, your clock is going to expire and you’re going to be pretty upset.”
The state’s cannabis industry also continues to struggle with high taxes, Farrar adds, especially the cultivation tax, which is weight-based. The current tax rate is $10.08 per dry-weight ounce for flower and $3 per dry-weight ounce for leaves.
“As prices compress and the cost of cannabis comes down, the tax percentage actually goes up,” Farrar says. “For easy math, call it $150 a pound. If cannabis is $1,000 per pound, it’s a 15% tax. But if cannabis is $500 a pound, it’s now a 30% tax. That hits the smaller growers and the outdoor growers particularly hard because their product is usually worth less on the market, but the tax isn’t adjusted for that at all.”
In short, Farrar says California’s cannabis businesses need two things in order to thrive: less taxes and more retail.
Gov. Gavin Newsom seems to understand this, Farrar adds, as he included a proposal in his state budget to reform cannabis taxes and help increase the number of retailers.
In addition, State Sen. Mike McGuire has introduced Senate Bill 1074, legislation that would end the flat-rate cannabis cultivation tax on July 1.
That bill would also raise the cannabis excise tax from 2025 onward, however.
To increase the number of dispensaries in the state, California regulators implemented a social equity fee waiver program, where license fees are waived for social equity applicants who meet certain criteria.
Municipalities have also been reducing or waiving their local-level taxes to help operators launch their businesses and compete against California’s illicit market, Farrar adds.
“We follow all these rules and pay a 100% markup, effectively, in taxes, and then we’ve got the illicit guys who really aren’t facing any enforcement at present, who follow none of those rules and can sell product for half our cost because they’re not paying any taxes,” he says. “It’s really about these governments doing the smart thing, which is taking a smaller slice of a much bigger pie and [getting] everybody into the legal side of the market instead of trying to overly tax the few of us who are already here. … It’s anyone’s guess, but I’d say the illicit market is two to three times the size of the legal market today. So, you can see where you could take a tax slice that’s a third and still make more money if you have an entire market on the right side of the law.”
Declining cannabis prices have also impacted California’s cannabis businesses over the last year, Farrar says.
“We’ve had a tough pricing market in the last 12 months, big price declines [and] oversupply, I think from people keeping a 2020 harvest, which then got layered on top of a good-sized 2021 harvest,” he says. “You have folks growing hemp that was really cannabis in Oregon, and that was being imported into California. It’s been a struggle pricing-wise, but the bigger picture is that California is the single most exciting market on the planet.”
Despite the challenges, Farrar says opportunity abounds in the state’s cannabis industry. He predicts that in the future, eight out of the top 10 cannabis brands will come from California, and people will think of cannabis coming from California much like tequila comes from Mexico or Champagne comes from France.
Flower is Glass House’s best-selling product category and accounts for 50% of California’s market overall, Farrar says. Edibles have experienced a sales boost during the ongoing COVID-19 pandemic, he adds, and vape cartridges remain in the top three most popular products in the state.
The company’s biggest goals this year include integrating newly acquired edibles brand Plus and opening the four dispensaries it has under construction, Farrar says.
“We’re going through building permits on the retail side, and then I’m optimistic we’ll see the cultivation tax go away this year, which is the second largest expense for our entire company,” he says. “I think we’ll see a bunch more retail doors open, which will be great for our brand. Really, I think 2022 is the year of execution and optimization, doing what we do and making sure we’re efficient.”
It will be a challenging year for California’s cannabis industry as a whole, Farrar adds, but one that he hopes will drive consolidation in the market.
“We are going to keep going through this, as it makes us get tougher and leaner and more efficient, and when we come out the other side, we’ll be ready to take on the world,” he says. “Our belief is that cannabis makes the world a better place, and we’re going to provide more cannabis for more people, on a national scale, eventually, and do it efficiently enough that everybody can afford it. That’s our goal, and I think we’re making good progress."