Marijuana is taking many industrial real estate markets by storm, including in California, where the drug’s recreational use became legal at the beginning of this year. So far, nine states and Washington, D.C. have legalized both recreational and medical marijuana, and 92% of states already have cannabis access laws.
The impact on industrial real estate in these states has been massive: marijuana tenants often pay as much as 100% in rent more than non-marijuana tenants, and we are seeing cultivation use in some of the most expensive industrial markets in already pricey California. This has caused a steep increase in the values of properties located in “Green Zones” due to expected high returns.
But does weed and it’s associated real estate opportunities actually represent an attractive venture, or even a viable one? I would advise investors not to stir the pot. In my opinion, the marijuana business’ investment premise is terribly flawed and basic economics suggest that the hype is, by definition, temporary.
Supply and Demand
Let’s start with an unavoidable fact: marijuana is nothing more than an annual, flowering plant in the family Cannabaceae. A green thing. Very hardy, it can be grown just about anywhere in the world.
Marijuana’s value, just like for any other product in the market, is driven by age-old laws of supply and demand. Unless supply is constrained, pricing will always fall to the average necessary to trade. As there are no real barriers to entry, an ample continuing supply must be assumed and this will impact pricing. A Forbes contributor recently wrote that “cannabis cultivation will be a race to the bottom.” In Colorado, which legalized marijuana as of the beginning of 2014, the market rate of cannabis dropped roughly 50% between 1/1/2015 and 4/1/2018. A quick Google search will teach you that even the cultivators themselves recognize that we are in a short-term “green rush” and that they must capitalize on it as quickly as they can.
As we near the end of this financial cycle, oversupply and inevitable economic slowing suggests many marijuana cultivators will not exist in a few short years, let alone pay tens of thousands of dollars of rent for their centrally located facilities.
Legal and Financing Risk
One other consideration for investors is legal risk. Selling pot, while legal in some parts of the U.S., is still illegal at a federal level. This means that as a landlord you are exposing yourself to the consequences of non-compliance with Federal law. Depositing marijuana money in a federally chartered bank (which is just about all of them) is money laundering, a serious charge that will sober anyone up!
When a property is occupied by a marijuana cultivator, an investor is generally precluded from placing debt on a property, no typical lender is interested. In fairness, we are starting to see REITs emerge with a focus on providing debt and equity to such deals, however the terms are likely to be inferior to traditional lending sources and true liquidity is probably still a few years away.
A Real Estate Enigma
California’s Central Valley is the world’s breadbasket, while in Northern California, the plant has been grown outside in Humboldt County for several decades.
So why does anyone bother growing marijuana in the country’s most expensive urban real estate markets? Why set up a “manufacturing” facility in Los Angeles or San Francisco when you could do so in Modesto or Stockton at less than half the cost? Short haul supply chain costs are hardly a factor.
Some insight into this real estate enigma was provided by a Los Angeles Times article in March, which explained that cannabis growers are usually willing to pay high rents to seek prime storefronts for opening upscale retail shops. On the surface, this seems like a tremendous investment opportunity for landlords. But it could be a disaster waiting to happen. As the LA Times report pointed out, in January, Attorney General Jeff Sessions ended an Obama-era policy that provided federal protection for weed sales in six states (including California) where recreational use is legalized, meaning all local marijuana businesses remain at risk of going extinct in the long run despite the fact that they’re legal on the state level.
The Bottom Line
As a real estate developer, imagine investing top dollar in a marijuana industry property with seemingly huge potential, only to see pot get banned nationally or to have the tenant fail because of collapsing weed prices.
As a broker, imagine the backlash that would ensue from facilitating such a deal. Real estate professionals gain reputations based on years of building trust and relationships. Looking at the marijuana business, it’s easy to see how hard-earned trust could erode in the blink of an eye.
As an investor, my recommendation is that if you have a marijuana cultivator as a tenant, or if you own a property in the “green zone,” capitalize on today’s low cap rates combined with the high (potential) rent, and invest your money someplace else. Find a tenant who isn’t doomed to cease operations within its lease term. Then, you can really party!
