Is Cannabis The Future Of San Diego Industrial?

The start of this year brought the end of recreational marijuana prohibition in California, which means ripple effects in a variety of industries, including commercial real estate.

Innovative Industrial Properties Chief Financial Officer Catherine Hastings said she feels like a bit of a circus act, referring to the spectacle surrounding legalization.

“I don't know how many people know what my company does, but we are the first public company dedicated to providing real estate to medicinal marijuana cultivators,” Hastings said in her opening remarks at Bisnow’s San Diego Industrial 2018 event at The Hyatt Regency La Jolla at Aventine. 

Her goal was to explain the cannabis industry and its place in the commercial real estate market. She joked that she did not have any snacks or handouts, but made sure the legitimacy of this business was well understood.

“We are on the New York Stock Exchange. We went public December of 2016. We have currently five properties, none of them in California. And it's been a wild ride,” she said of Innovative Industrial Properties.

Explaining the growth of the legal cannabis market, Hastings said the North American market has grown from $6.9B in 2016 to $9.2B in 2017. It is expected to grow to a $47B market by 2020.

California has had legal medical marijuana since 1996, she said. But the recent legalization of recreational use meant a new look at regulation.

“At the beginning of 2018, it's a much different environment," she said. "The California market is estimated to be $3.7B in 2018 and over $5B in 2019.”

So, what does this mean for CRE?

“It's really kind of hard to find industrial statistics on how much square footage is really part of the cannabis space,” she said. “I guarantee a lot of industrial space may be being used for cannabis purposes and nobody really knows about it. So ... there's a lot of companies who are flying under the radar [that] are doing portions of it, servicing the industry and are really very hesitant to tell their landlords and maybe some landlords are even kind of not wanting to publicize the fact either.”

Hastings used Denver as an example of how cannabis has impacted the CRE market.

“In Denver, the marijuana industrial footprint is almost 3% of the total warehouse inventory, so [that is] over 4M SF of warehouse inventory in Denver alone,” she said.

Hastings is sanguine about growing support and acceptance for medical and recreational cannabis use in the United States, saying it receives bipartisan support in government though cautioning about the tricky situation regarding federal law, which discourages many companies from entering into the space.

“It is illegal to grow, possess and consume cannabis,” she said.

So even for those in states where it is legal, they are breaking federal law. She said there are specific protections for medical cannabis cultivation and processing that prevents the U.S. Department of Justice specifically from using federal money to go after businesses that are in compliance with state laws.

Explaining why a developer might even want to wade into the cannabis legal minefield, Hastings said there are a number of risk factors that Innovative Industrial Properties has taken on, including an extreme dearth of available capital. She said most entrepreneurs in the space raise money from family and friends, along with a limited number of private equity groups in California interested in the cause.

“Most of those groups are requesting a percentage of the profits of that business,” she said.

“And so our tenants like our capital. We have no debt. We have raised equity in the New York Stock Exchange. We go in and are simply just a landlord relationship, so they tend to like our capital. The returns, which are all public information since we file our financial statements with the SEC, we're seeing between 14% [and] 15% initial yield on our investments. We have regular annual bumps in rent. Between 3.25% and 4%. And these are long-term leases [of] 15, 16 years,” Hastings said.

She outlined the typical life cycle for cannabis tenants: they hunt for capital, build a facility, then become operational.

“Because it's illegal to transport product across state lines, lot of these high-quality growers want to be in multiple states. So, will they have to build another facility in every state that they want to be in? A lot of them are seeing the opportunity to sell that real estate, take that capital out, go to another state and build a new facility and so that's where our business model will come in — after they have built their facility and do a simple sale-leaseback with them,” she said.

Drawbacks include difficulty finding reputable auditors who will touch cannabis, impediments to using the federal banking system, operating with cash-only tenants and other issues relating to stigma and legal problems.

But Hastings thinks the future is bright.

“If you can manage through these complexities — read our [SEC Form] 10-K —there has been great reward for us, so far, and it’s a fascinating industry."