Pot of Gold?
The $1.4 billion legal cannabis industry packs promise for commercial real estate pros.
On January 1, Illinois became the 11th state, along with the District of Columbia, to legalize marijuana for adult recreational use.
There's interest across the country as well, with voters in as many as 10 states finding the question of legalized recreational marijuana on their ballots later this year. A look at tax revenues in states where legalization has occurred explains some of the interest; Washington took in $319 million in 2018, followed by $300 million in California and $266.6 million in Colorado. Overall in 2018, legal marijuana was a $1.4 billion industry in the U.S.
There is “tremendous opportunity” in cannabis retail, says Wendy Berger, principal of WBS Equities, LLC, in Chicago. “This industry is exploding. We describe this often as Prohibition 2.0, and the question is: How does the real estate industry play a role in this tidal wave of demand?”
Cannabis, notes Berger, “is one of the very few areas of brick-and-mortar that's growing at a rapid pace, so that alone has attracted attention. If you're a developer and own a building with a vacant storefront or a broker and you have focused on retail, you have to ask: What's the next growth industry?”
For cannabis consumers, she says, “my feeling is that they want to do this legally. They want a safe, consistent experience; they want laboratory testing; they want a regulated product. They want to be able to go into a retail store and get educated, so the retail environment matters. These are not the head shops of our youth. These are beautiful, well-lit open spaces. They're places where you can get comfortable with a product that maybe you're unfamiliar with at some level.”
But it's also a new industry, with every segment learning the ropes as they go and with complicated laws and guidelines that vary and can change continuously. Additionally, cannabis is still illegal on the federal level, which can affect a variety of factors, particularly financing. “I tell brokers this is a totally different commercial real estate industry - there is no historical data that you can use,” says Kerry Mann, CCIM, principal at Pacifica Commercial Realty in Santa Barbara, Calif., who's worked with cannabis clients for about seven years.
Real estate professionals who have worked in the cannabis field agree on one strong point: It's essential to be well-versed in both state and municipal laws and ordinances governing the business, because they are the primary tools for regulating where and how businesses can operate. Issues in licensing, zoning, taxes, and even safety can delay or derail deals. It's also advisable to seek out advice from professionals who have experience with retail cannabis. Mann, for example, works with attorneys who are members of the International Cannabis Bar Association, based in San Francisco.
One of the first challenges a cannabis retail business faces is site selection. “From a developer or broker perspective, when we're focusing on picking a location, the first thing you need to do is understand local zoning and local sentiment,” says Berger. States can provide an overall framework and licensure regulations for the businesses, only to then leave it up to local governments - either county or municipal - to decide if cannabis can be sold in their jurisdictions and, if so, how and where.
Some communities have been quick to embrace the promise of additional tax revenues from cannabis businesses, but others have rejected cannabis sales in the face of opposition from local residents and businesses.
Modern cannabis retail outlets are well-lit and
open, aiming for a more comfortable, inviting environment.
Brokers may also encounter resistance from potential landlords. Some may simply be dead set against renting to a cannabis business; others may be concerned with issues such as an increase in insurance costs. Ryan Brandt, director of commercial acquisitions for BW Strategies in Charleston, S.C., has worked with MedMen, a cannabis multistate operator, to locate dispensary space. “In 2018, there was a lot of resistance to us,” he says. “I'd say seven out of 10 properties that we'd call would say they weren't interested. They just didn't know what cannabis was yet. But today, I'd say that's more like four to five. There's still some resistance, but there's an awareness coming to the market.”
Building requirements can be limiting as well. “In most retail stores, 99 percent of your inventory is going to be on the store's floor, so you don't need much backroom space,” says Berger. “But if you're a marijuana dispensary, very little of your inventory is allowed on the floor - and every state requires, in different and slightly nuanced language, that every bit of product be placed in a secure vault every single night. You need a vault for money, you need a vault for product, you need employee welfare space, and then you need your selling floor - so you end up with a lot more back office space than a traditional retailer that has tiny amounts of back office space.” And, she adds, states have different requirements for the thickness and types of materials used in the vaults, as well.
“It's essential to be well-versed in both state and municipal laws and ordinances governing the business, because they are the primary tools for regulating where and how the businesses can operate."
The next complicating issue for those who are leasing is whether the landlord holds a mortgage on the property, because most mortgages bar federally illegal activity on the property, which would encompass cannabis sales. And then there are the neighbors. In any building, says Brandt, it's necessary to examine what lease controls co-tenants have. If the property is part of a shopping center, it's necessary to check the covenants, conditions, and restrictions document to make sure a dispensary isn't expressly prohibited. He adds that even if cannabis isn't mentioned specifically, businesses may run into resistance from anchor tenants in the center.
“Once you apply all those filters to properties, it's challenging to find a compliant piece of real estate,” Brandt says. Berger says that she owns a building in Silver Spring, Md., that's leased to a dispensary; when she initially started looking at locations there more than three years ago, “there were three choices in the entire town.” This can lead to competition for available locations, and Berger says she's seen many examples of bidding wars and escalated asking prices for rents.
Because of the changing nature of cannabis laws, standard commercial lease agreements may not be adequate to address specific risks related to cannabis business. Lease provisions that may need to be added include permitted use and compliance with local and state laws, specific financial issues, and even physical aspects of the business such as signage and ventilation. It's an area where Mann strongly urges working with an attorney experienced in the cannabis industry.
Because FDIC-insured institutions can't lend to cannabis-related businesses, financing tends to be through private sources and can come at premium rates - possibly 8 to 12 percent or more, says Brandt. This could change, though, with the passage of the Secure and Fair Enforcement (SAFE) Banking Act, a bill that would protect banks and financial institutions that deal with legal cannabis businesses while also allowing deposits from the businesses. (Cannabis advocates also argue that it will improve the safety and convenience for what now functions as an all-cash business.) The bill passed the House in September and is awaiting consideration in the Senate.
“If that gets passed, a lot of these institutions can decide legally to step into the space, although it doesn't mean they're going to,” Brandt says. “I think they have to make a strategic decision at the corporate level, and for large banks, it could take a while. But a lot of smaller, mid-tier banks may see this as an opportunity to increase market share and revenue. So I would expect them to step in, but even that process could take three to six months before that impact is felt in the marketplace.”
As the industry continues to change and move forward, commercial real estate professionals who get experience within it can play a role in sharing their knowledge. “We are all learning,” says Mann. “If you have education in this field, the best way to help municipalities is to share that education. If we want to make this industry strong and good, we help with the education.”
“This is a business where there are great opportunities for changing the landscape and conversation, and destigmatizing something that has long been stigmatized,” says Berger. “And whether you are a consumer or a supporter, it's here. We now have the opportunity to tax and regulate something that has been untaxed and unregulated. A lot of people say this is terrible - but it's already happening, so let's create a safe environment for companies who hold licenses that are responsible and are offering responsible adult use.”