Marijuana and Real Estate
By: Gerard C.S. Mildner, Ph. D., associate professor of real estate finance at Portland State University and a NAIOP Distinguished Fellow
Indoor marijuana growing facilities like this one in the metro Denver area require ample power, water and ventilation, as well as lighting and air conditioning to moderate the heat generated by lights.
Many issues, including the lack of access to banking facilities for marijuana retailers and growers, create complications for landlords.
IN NOVEMBER 2012, 56 percent of Colorado voters passed Amendment 64, which legalized the use and sale of marijuana for recreational purposes. In the past three years, Colorado has been joined by the states of Washington, Oregon and Alaska as well as the District of Columbia. By 2016, six states, including California, are expected to consider initiative referenda to legalize recreational marijuana use and legislative action is expected in others.
While 18 U.S. states have medical marijuana programs, the federal government recognizes no legitimate medical use of cannabis. At the same time, following the Colorado referendum, the U.S. Department of Justice issued the so-called “Cole Memo,” which outlined conditions by which the federal government would not interfere with state marijuana legalization programs.
The Cole Memo did not change federal banking laws that prevent banks from lending or accepting deposits from illegal businesses. Moreover, most commercial mortgages prevent tenants from operating illegal businesses on the subject property. As a result, marijuana growers and retailers have been limited to the small minority of properties that carry no commercial bank loan.
Denver’s real estate market has the most experience with marijuana-based businesses. According to Paul Kluck of CBRE in Denver, marijuana growers occupy approximately 3 percent of the industrial space there today. Growers tend to seek low-profile space that is relatively small (25,000 to 50,000 square feet) and has ample power and water capacity, along with good ventilation to prevent mold. According to Chad Brue of Denver-based Brue Capital, growers are paying up to $15 per square foot per year for electricity consumption and over $100 per square foot for tenant improvements.
Marijuana growing has increased industrial rents in the Denver market. According to Brue, 85 percent of the industrial space is encumbered by a commercial loan and another 5 to 10 percent of owners have legal or moral concerns about renting space to marijuana growers. As a result, the 3 percent of demand is concentrated in 5 to 10 percent of the market, leading to rents three to five times higher than market levels. Brue cited one building in the Denver industrial market that is receiving $20 per square foot triple-net rent.
Other elements of the recreational marijuana market don’t appear to impact the real estate market as much as growing operations. Retail operations, also known as dispensaries, seek locations away from schools and other stores, but occupy small amounts of space compared to other retailers. Manufacturers of cannabis oils or cannabis edible products consume much smaller amounts of industrial space, often less than 5,000 square feet.
Cash, Risk and Taxes
Because federal law does not allow the use of credit cards for marijuana sales, all retail marijuana sales are cash transactions. As a result, employees at dispensaries and grow warehouses typically convert cash into money orders, which can then be deposited, transferred or cashed. One Denver area landlord reports that he accepts 90 to 95 percent of his rental income in checks or money orders, and only 5 to 10 percent in cash.
Owners of industrial properties leased to marijuana businesses will need to command higher rents to compensate for the risk of hosting a business that is illegal according to federal law. However, according to Brue, 1,700 properties in Colorado are currently leased to marijuana businesses. They have experienced 15 raids for violations of state law, and in no case has a property owner been found liable.
The legalization of marijuana has generated significant revenue for the state of Colorado. The state imposes a 25 percent tax on recreational marijuana sales, generating an estimated $134 million in revenue in 2013-2014. Additional local taxes also add money to city budgets. Much of that revenue comes from out-of-state customers or “marijuana tourists,” who comprise 44 percent of sales. Officials believe the relatively low tax rate in Colorado has squeezed the black market sale of marijuana to only 5 percent of sales.
At the same time, the medical marijuana market in Colorado remains active. Medical marijuana is taxed at a rate of just 2.9 percent. As a result, the number of medical marijuana card holders actually increased after the creation of the recreational market.
In contrast, the state of Washington’s 2012 initiative required that growers sell to retailers, rather than being integrated in the same company, and taxed both wholesale and retail sales. The resulting effective tax rate of 45 percent has meant that the legal market in Washington hasn’t driven out the black market. In fact, the best retail locations for black market dealers have proven to be the parking lots of legal dispensaries.
The year 2016 will be a watershed year for the marijuana market. A recent poll by the Public Policy Institute of California found that 55 percent of likely California voters were in favor of legalizing recreational marijuana and only 43 percent opposed it. And while the U.S. will have a new president following the 2016 election, it seems unlikely that either a Republican or a Democrat would completely shut down the recreational and medical marijuana markets. In that sense, the marijuana issue has become like the issue of illegal immigration. Federal law hasn’t been strictly enforced for several years, and it’s hard to imagine the federal government arresting thousands of retailers and growers, much less seizing thousands of properties. At the same time, concentrated opposition to legal marijuana suggests that interstate sale of marijuana is decades away.
Whether marijuana production will consume 3 percent of the market for industrial space in other metropolitan areas where recreational use becomes legal — as it did in Denver — depends upon several factors.
First, it is clear that marijuana use in the U.S. is widespread. While the states that have legalized recreational marijuana had the highest rates of consumption prior to legalization, other states — including New York, California, Florida and Texas — are only a few percentage points behind. The true size of the market will become clear only after legalization occurs in more states.
Second, Colorado saw an explosion of grow operations because 44 percent of its demand came from out of state, and outdoor growing in Colorado is quite difficult, given its climate. By comparison, in Oregon, which is just a few months away from having a legal structure for marijuana sales, indoor grow operations will be competing with traditional outdoor growing in southern Oregon.
Finally, as marijuana becomes legal in more states, demand will be limited to the size of each local market.