Risky Business: Marijuana Real Estate Boom Or Bust?
Real estate investors should be careful not to overpay for cannabis properties based on the assumption that their lease market has “nowhere to go but up.”
The Denver Post recently did a story on how cannabis businesses are having to pay sky-high rents nationwide. In Portland, for instance, commercial real estate that typically rents for five dollars per square foot goes for three times that amount for cannabis businesses. Though rents for cannabis businesses in Washington and Colorado are stable, they are considerably higher than the lease rates for any other business, and real estate investors looking to lease to cannabis businesses are mostly betting this trend will continue.
Several things are pushing up cannabis rents, all of which decrease the available supply of cannabis real estate. The vast majority of commercial real estate mortgages contain a clause mandating that the property be used lawfully, but because marijuana remains federally illegal, a property with a cannabis business on it is not operating legally. This illegality entitles banks that hold the mortgage to deem their loan in default and to accelerate the principal so it’s all due immediately and to then foreclose if the borrower cannot find alternative financing to cover its outstanding loan balance. If federal cannabis laws stiffen under President Trump, many of the banks holding notes on cannabis properties likely will use these legal changes as an opportunity to call their notes in default. Because of this potential threat from banks, most cannabis businesses prefer to lease properties free of any bank notes and most landlords with financed property prefer to lend to federally legal businesses rather than risk their property being seized by a federal government asset forfeiture.
The diversity and the complexity of state and local cannabis regulations also helps drive up prices for marijuana business real estate. State laws that limit how close cannabis businesses can be to a school, a park, a church, or another cannabis business also limit the number of properties available to cannabis businesses. When you add in local zoning codes that often push cannabis businesses to heavy industrial areas and building codes that often require cannabis production facilities to have full fire suppression and air quality systems in place, the list of available properties for the marijuana industry plummets even further. With so many marijuana businesses fighting for so few spaces, it is no wonder cannabis real estate prices just keep rising upward.
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There is also still a ton of money being invested into cannabis real estate from out-of-state and foreign investors. Many marijuana licensees who lack sufficient capital to build out their growing facilities look for turn-key real estate opportunities, often with deferred rent, where they are expected to pay out the nose when they start making revenue. These higher-priced turn-key cannabis grow operations tend to increase the price ceiling even for landlords who only offer bare warehouse space. Hardly a day goes by where my law firm does not get a call from someone on the East Coast or from overseas (Spain, Israel, Germany, South Africa, and Eastern Europe, mostly) asking one of our cannabis business lawyers about cannabis real estate opportunities in Washington, Oregon, or California. Even public companies are involved in the turn-key cannabis real estate market, including Innovative Industrial Properties, Inc., a cannabis-related REIT that did an IPO on the NYSE earlier this month.
There are some punctures in the ever-rising cannabis real estate balloon, though. Innovative Industrial Properties, for instance, managed to raise only $67 million after making clear it expected more like $175 million. The media has tended to blame President-elect Trump’s choice of Jeff Sessions to run the Justice Department for casting a pall on the cannabis real estate market, and though that is a real concern, there are also other factors at work.
In Washington State, cannabis businesses renting warehouse space in heavily populated King and Pierce counties are facing fierce competition from outdoor growers in Eastern Washington who are rapidly developing techniques to increase the quality and consistency of their cannabis. The continued trend toward oils and other concentrates also puts downward pressure on the market price for crafted indoor product.
Outdoor spaces in rural Eastern Washington counties tend to be significantly cheaper than urban or suburban warehouse space, and if more growers see growing outdoors as a real alternative for them, we should expect cannabis real estate prices (especially warehouse prices) to fall. And even if the Trump-Sessions administration makes policy choices that decrease cannabis availability, the long-term trend among our country’s citizens still inexorably leans toward legality, with cannabis looking more like other businesses. As the cannabis industry “normalizes,” we lease rates for cannabis businesses should begin to fall more in line with lease rates for other businesses.
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Though the marijuana real estate bubble seems to be growing ever larger, it’s anyone’s best guess as to when it will actually burst. In the meantime, real estate investors should be careful not to overpay for cannabis properties based on the assumption that their lease market has “nowhere to go but up.”
Hilary Bricken is an attorney at Harris Bricken, PLLC in Seattle and she chairs the firm’s Canna Law Group. Her practice consists of representing marijuana businesses of all sizes in multiple states on matters relating to licensing, corporate formation and contracts, commercial litigation, and intellectual property. Named one of the 100 most influential people in the cannabis industry in 2014, Hilary is also lead editor of the Canna Law Blog. You can reach her by email at [email protected].
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