As California prepares to open its recreational cannabis market, savvy entrepreneurs and investors are studying the blueprint laid out in previous states to understand the potential for investment opportunities.
In 2000, Colorado allowed marijuana use for debilitating medical conditions. Over the next decade, the law expanded, eventually allowing legal dispensaries in 2009. Colorado’s Amendment 64, passed by voters in 2012, approved the use and sale of recreational marijuana in the state. The law left it up to counties and municipalities to determine if, where and how the production and sales of cannabis may occur.
Some cities and counties have determined not to limit the number of licenses for retail or medical sales; others set a maximum number of licenses that will be issued. As of mid-2016, 228 of 321 jurisdictions (71%) still banned all marijuana sales. However, jurisdictions that allow cannabis businesses have experienced massive changes to their industrial real estate markets, which affect the state as a whole.
Capital investments supporting cannabis-related real estate revved up in Colorado when the U.S. Department of Justice announced in 2013 that it would grant some limited protection to the marijuana industry. Out-of-market investors, their capital and their employees flocked to Colorado to cash in.
The state initially required cannabis businesses to be vertically integrated, with at least 70% of each retailer’s inventory produced in-house. Adult-use retailers were also initially required to have been medical purveyors licensed prior to Oct. 1, 2013. These restrictions were intended to restrain the expansion of retailers and curb an explosion of unlicensed grows.
Even with these limitations, marijuana-friendly districts experienced a land grab, particularly for warehouse space. The timing of cannabis legalization in Colorado happened in tandem with a rise in overall economic activity after the Great Recession, resulting in radical absorption rates and a rise in the rental rates of Colorado warehouses.
In any state that has legalized marijuana, roughly 80% of available industrial real estate is not available for cannabis industry use due to loan constraints and other ramifications of the federal classification of marijuana as an illegal substance. The remaining 20% of real estate is subject to jurisdictional restraints and the willingness of owners to risk seizure by federal statute, which affects its availability to the industry. The inventory left in Colorado, primarily in heavy industrial areas with 40- to 60-year-old buildings, became home to 4.2 million square feet of businesses growing, manufacturing, storing and distributing marijuana by the end of 2016, according to a story by The Denver Post. That number represented a 14% increase since the second quarter of 2015, when 3.7 million square feet of warehouse space was being occupied by marijuana businesses.
Between 2009 and 2014, 35% of all industrial leasing in Denver was related to the expanded legality of marijuana. Class C industrial warehouse vacancies plummeted from 8% to 2% in this period. Class C industrial rents jumped 56% from their 2009 recession lows to their 2014 levels, following recreational legalization.
Functionally obsolete factory and warehouse properties were rehabilitated at as much as $200 per square foot for installation of upgraded electrical capacity and delivery — mostly to control the climate for grow operations — and for manufacturing.
This capital investment not only recapitalized individual properties, but also revitalized warehouse districts, which are now thriving and supporting multiple levels of employment.
As the supply for cannabis meets the demand, retail prices are declining. Weaker players are being consolidated into dominant operators and the demand for space is leveling off, even as the overall economy is vibrant and demand for all warehouse space is strong. The absorption rate of industrial space by cannabis businesses is finally slowing.
Many investors are now setting their sights on — and deploying their capital in — markets like California that are earlier in the cycle of legalization and rapidly expanding the chain of supply and distribution.
California cities with functionally obsolete warehouse space are poised to take advantage of Proposition 64’s wealth-generating potential. In appropriately zoned areas, employment will get a nice boost and land values and rents will rise dramatically. Warehouses will get expensive renovations.
Early in the legalization cycle, landlords will be able to charge inflated rents in exchange for their risk of federal forfeiture, absence of debt constraint and simply having a location in jurisdictions that allow marijuana. Expensive upgrades to old warehouses and huge electricity costs will be justified by the anticipation of California’s multibillion-dollar market.
Federal, state and intrastate jurisdictional differences will concentrate marijuana-related wealth creation. Limitations on legalized marijuana amplify the opportunity in the concentrated areas. If — or when — restrictions are eliminated, economic activity will diffuse and marijuana will become just another crop, like lettuce or broccoli (or more like tobacco).
The race to build and deliver a legal marijuana supply chain will create huge winners — and some losers who are late to the game. Some players will be absorbed, as dominant operators push out the second-tier competition.
Marijuana will cost less in the future, as the supply meets the demand. If federal law is loosened and interstate transportation is legalized, production facilities will be located where land is very cheap and will not be required in each state, which will lessen the demand for warehouse space.
There is already speculation about the marijuana real estate boom and bust. If a marijuana real estate investment requires the price of cannabis to stay the same forever, don’t make the deal.
Remember, at one point in history, warehousing inventories of typewriters made sense — until it didn’t.
A new industry will come along, and the real estate will be retrofitted again. But with change comes opportunity.
Carol Ann Flint is an investment sales broker at First California Realty in Marin County, California. She relocated to the Bay Area from New York City in 2015. A version of this article was originally published in The VIEW, a quarterly publication dedicated to real estate in the Bay Area.