Seeing Green: Cannabis Can Fill Vacancies, Boost Property Values, But Deals Are Hard To Do

When it comes to making it in the cannabis industry, the journey is not unlike a real-life Squid Game. The potential to win big leads players to take unimaginable risks, but one false move could mean their demise.

The cannabis industry touches almost every commercial real estate asset class, from industrial to retail to office and flex. Despite its many obstacles, a fervent desire by developers to capitalize on the emerging industry is translating to increased demand for space. A 2021 survey by the National Association of Retailers found that in states where recreational or medicinal marijuana is legal, 36% of members had seen increased demand for warehouses, 23% for storefronts and between 18% and 28% for land.

Wendy Berger, founder and CEO of WBS Equities, said CRE investors are bullish on the industry because of its high potential for growth as legalization unfolds. Legal marijuana sales are expected to reach $33B in 2022, a 32% increase over last year's total of $25B, according to MJBiz. The illegal cannabis industry, on the other hand, has an estimated value of more than $100B per year, according to Forbes.

“We have a brand-new industry that is growing faster than any other brand-new industry since cable television or mobile phones,” Berger said. “If you begin to move some of the demand from illegal to legal and pair that with new consumers coming in, you have massive growth.”

That can be easier said than done.

Greg Tannor, principal and executive managing director at Lee & Associates NYC and part-owner of a retail dispensary in Massachusetts, said investors are attracted to the higher rents commanded by cannabis operations. Some landlords also charge a “cannabis premium,” or an additional fee tacked onto a lease in areas where there is greater competition for properties.

“For the most part, there is not a lot of back and forth in terms of negotiating rents because of the need for space and the limitations surrounding buffer zones along with debt and financing on buildings,” he said. 

Because marijuana is still federally illegal, lenders willing to underwrite loans for new cannabis businesses are few and far between. Most landlords have loan stipulations that prevent them from working with cannabis tenants, which limits the pool of available rental properties, Berger said.

Lender-driven constraints, as well as issues of perception, are a massive problem, but Berger said the growing presence of high-quality cannabis dispensaries should begin to chip away at preconceived notions about the product. Berger owns six properties leased to cannabis cultivators or dispensaries, half of which have traditional mortgages.

“Some real estate professionals still have in their head this old-fashioned view of a dispensary as a head shop — as dirty [or] disgusting,” she said. “Thankfully in the last two years, there are now 10 or 12 good real estate debt choices, or you go into a property with all equity.” 

In absence of mainstream acceptance, many operators look to smaller, regional banks or seek out alternative financing mechanisms to fund their ventures. Jarrett Annenberg, director of acquisitions at NewLake Capital Partners, said his publicly traded REIT uses sale-leasebacks to fund cannabis operations. The group, which formed in 2019, has $425M worth of assets under management across 29 facilities in 11 states.

“Everyone thinks it’s easy because they’ve read a couple of articles and seen lines out the door at cannabis dispensaries,” he said. “If you have access to the capital and you're willing to grind it out for a decent amount of time, it’s fun — but it’s hard, much harder than people think.”

Underestimating the amount of money it takes to start out in the cannabis industry is perhaps the biggest rookie mistake, said Ryan George, whose companies include 420 Properties, Iron Fist Extractors, KannaXpress, Gold Country Growers Distribution and more. 

“Everywhere you turn, there is a delay or a roadblock just waiting to pop up,” he said. “I tell people all the time — if you’re considering getting into the cannabis business, don’t even think about it unless you have $1M liquid.”

Some jurisdictions require operators to have a facility locked in before they are issued a license, which can take anywhere from a few weeks to a year or longer. This was the case for George when he set out to open a new cannabis business in California.

“That’s an entire year of rent, an entire year of insurance, an entire year of electricity and operational costs without seeing a dime of revenue,” he said. “Even once we get the license in hand, that still doesn’t mean we are going to be operational tomorrow — that just means we have a license and we can continue down our local compliance.”

The cannabis industry also has unique construction challenges. The business must comply with that particular jurisdiction's rules and regulations, which vary from state to state and from city to city. Cannabis Facility Construction CEO Andy Poticha said the best way to avoid a costly mistake is to loop in a general contractor before site selection.

“We like to be involved as early as we can be,” he said. “We can be very helpful on the front end in helping them avoid potential errors and challenges, [rather than] if they choose a site and we have to fit a square peg into a round hole.”

When a state legalizes recreational cannabis, jurisdictions decide whether or not to allow retail storefronts, and Tannor said many initially choose to opt out. In New Jersey, for example, around 400 municipalities chose not to participate. That drove demand for properties in areas that opted in through the roof, Tannor said.

Some jurisdictions will opt back into a state’s program once they realize the industry’s tax revenue potential. As of December 2021, marijuana sales translated to about $10.4B in tax revenue for states where it is legal, according to a report by the Marijuana Policy Project. 

Cannabis businesses also have the potential to boost property values in dilapidated areas, George said. In some cases, cities designate underutilized areas as “green zones”; in other cases, cannabis operators seek out those parts of town for cheaper real estate.

“A lot of cannabis users will find a Class-C commercial space and gut it and make it a state-of-the-art cannabis facility,” George said. “If they’re revitalizing those areas, they’re usually doing it with a flair — you’re not going to see an auto-body shop go out of their way to put a $200K mural on the side of their building.” 

Despite boundless opportunities, high startup costs and regulatory hurdles prevent many newcomers from entering the cannabis space. Large companies dominate the industry, and that can leave small-business owners, particularly those in communities of color, sidelined by the process.

Whitney Beatty, CEO of Josephine & Billies, a Los Angeles dispensary, focused on the recreational and medicinal needs of women of color, said she had to pay rent on her property for two years before she could open her business in October.

“For people who are disproportionately disenfranchised and have the least [amount of] access to capital, that’s a huge issue,” Beatty said. “We’ve got so many people who are not able to open their businesses because they’ve wasted money holding onto property.”

Beatty’s startup costs were covered by social equity funding and angel investors, but that money was not easy to come by. These investors tend to be older white men, and because many people of color do not have those connections in their network, Beatty said it is especially difficult to land that capital.

“[Angel investors] usually invest in people that they know and people who remind them of themselves, and they don't necessarily think of themselves as a 43-year-old single mother who’s a Black woman,” she said. “It's very hard for us to raise that sort of funding, and that sort of funding is necessary in the cannabis space — you need a runway.”

Several states and jurisdictions have enacted social equity programs to try and ensure minorities have preferred access to the cannabis industry, but in many cases, those initiatives have been mired in controversy. In Illinois, for example, a lawsuit accused the state of failing to give priority to social equity applicants, instead allowing a few high-profile families to control the local industry.

Beatty said it is in the best interest of lawmakers to continue tweaking these programs until they find something that works. A 2022 report by nonprofit Supernova Women found that for every dollar invested in a successful social equity program, a jurisdiction gets $1.20-$4.50 back. Profit potential aside, states have a moral responsibility to ensure social equity.

“The cannabis industry was built on the backs of Black and Brown people,” she said. “We cannot have a situation where we’re allowing people to sell cannabis … while we have people languishing in jail for the same action. We can’t turn our noses up and forget the history that is there.”

Setting a gold standard for social equity is something Berger said the industry must commit to as it continues along a path of explosive growth for the next five to seven years. According to George, about 55% of Americans still live in states where recreational marijuana is outlawed, though roughly 28% live in states where medical marijuana is legal.

As more jurisdictions legalize marijuana for recreational use, the demand for commercial space will grow in tandem.

“By my estimates, we’ve only seen 20% of the capacity of what cannabis could do,” he said. “After federal legalization, we're going to see a lot more demand and a lot more cannabis businesses popping up across the nation.”