Industrial properties going to pot

Marijuana growers are pushing up the price of industrial properties in some areas as more states legalize cannabis consumption for recreational and medical use.

Rents on warehouses used by marijuana farmers also are higher than average warehouse leases in the same area.

So far, 29 states and Washington, D.C., have legalized marijuana for medical use and eight of those states also approved it for recreational use. While some institutional investors are not specifically aiming to invest in marijuana-related real estate because cannabis remains illegal under federal law, it still is affecting their real estate portfolios.

Higher industrial prices are good for warehouses that investors already own. But those higher prices also could make new warehouse purchases more expensive when they are competing with cannabis growers for the properties.

Institutional investors' total exposure to the industrial sector is inching up. According to Pensions & Investments' 2017 real estate manager survey, 13.6% of the total assets ​ managed by the top 50 U.S. institutional real estate managers was invested in industrial property as of June 30 vs. 12.8% a year earlier and 12.2% as of June 30, 2015.

Sales prices and rents on industrial properties in many states, including cannabis-friendly states California, Colorado and Maryland, are rising.

"Prices of small-to-medium-sized warehouses in the Sacramento region have increased between 30% to 40%" year over year, said Mike Zimmerman, Sacramento, Calif.-based senior vice president with commercial real estate manager and broker Jones Lang LaSalle Inc. who focuses on the industrial sector. "The driver is marijuana."

And Mr. Zimmerman expects prices to continue to increase. There's "no reason to suspect the trend will taper off anytime soon given that (marijuana use) was just legalized in California Jan. 1 and the market (statewide) is expected to grow throughout 2018," he said.

Sacramento also is benefiting from the cannabis-fueled warehouse prices because some neighboring communities including Calaveras, El Dorado and Placer counties have barred marijuana growers.

In Colorado, marijuana has been legal since 2012. Marijuana-occupied properties in Denver sold for an average premium of 20% in 2016 and a 25% premium over lower quality — Class B and C — warehouses in the same year, according to CBRE Group Inc. data.

Industrial properties in areas where marijuana cultivation is legal also are renting for higher prices. In Denver, for example, a sample of 25 leases signed between 2014 and 2016 revealed an average effective warehouse lease rate two to three times higher than the average warehouse lease rate, according to CBRE.

Warehouses continue to be the most popular place to grow marijuana, the report noted. Some 63.4% of the space used by marijuana growers is in warehouse space, 25.5% is in manufacturing space and 8.5% is in flexible or research and development space, the report stated.

Pushing up prices

Some real estate investors are getting into the business with the expectation that they will make money by charging premium rents to marijuana growers, and this sentiment is pushing up prices, said Christopher Mayo, a San Francisco-based investor with Casimir Partners, which makes real estate investments for high-net-worth individuals. Casimir has been investing in warehouses for marijuana growers for five years, he said.

Most of the marijuana growers are looking for 5,000 square feet to 10,000 square feet for their operations, Mr. Mayo said. "Some buyers are desperate to get in."

However, marijuana growers put a lot of requirements on properties they rent and municipalities also place myriad restrictions, which can affect lease rates and pricing, Mr. Mayo said.

Demand for warehouse space also has been affected in states in which marijuana is legal for medical use only. Since the Maryland Medical Cannabis Commission in 2016 approved 15 firms to grow medical marijuana, the industry has taken nearly 1 million square feet of industrial space across the state, according to an August report by JLL. Marijuana businesses accounted for 16% of the total square footage leased by industrial tenants in Baltimore and suburban Maryland over the past year.

Whether prices and rents will continue to increase will depend on how well the new marijuana businesses fare, Mr. Mayo said. "Legally, (growing and selling marijuana is) a gray activity," he said. "Banks won't lend and they (marijuana growers) generally pay 50% to 100% higher rent because they do not have the benefit of leverage."

What's more, Class C and D industrial buildings are being put on the market for sale at a premium "pretty much anywhere" because there is a shortage of those industrial properties, Mr. Mayo said.

At a certain point, if the businesses are not making as much money as expected, they will not be able to pay as much rent, Mr. Mayo said.

Premiums decreasing

In the past 12 to 18 months, premiums paid to lease or buy properties for marijuana-related businesses have come down a bit because there are more investors willing to invest in marijuana-related real estate. Even so, returns are still higher than for warehouses or retail locations not being used for marijuana sale or farming, said Hadley Ford, New York-based CEO and co-founder of iAnthus Capital Management, a U.S. cannabis operator. The premium varies depending on the laws and growing conditions in the state or area, he added.

Properties for the cannabis business are "still more expensive than baseline retail or warehouse," said Mr. Ford, "Until it's (marijuana) legal on a federal basis, there will always be a premium, but that is under pressure."

In Canada, the federal government is expected to legalize medical and recreational marijuana with some limitations by late 2018.

Warehouse prices might be pushed up by the demands of the marijuana industry in smaller Canadian markets, said Chris Langstaff, Toronto-based senior vice president, head of research and strategy for Canada at Jones Lang LaSalle in an email.

"But overall I don't think major market rents will move much, unless the demand is significantly higher than we expect," Mr. Langstaff said.

JLL Canada estimated the marijuana industry will account for about 8 million square feet of new demand, in addition to the estimated 1.1 million square feet of growing space already in place, Mr. Langstaff noted. Altogether this would amount to only 0.5% of Canada's industrial stock, he said.

"Yes, the sector is getting a lot of headlines, but I don't think this represents a huge demand spike that will necessarily move rents" in Canada, Mr. Langstaff said.

Legalization of marijuana could bump up demand for retail properties. In Canada, it will be left to the provinces to deal with distribution, which could translate into a minor demand spike for retail properties depending on how each province handles its program, Mr. Langstaff said.

For example, in Ontario, the provincial government decided it will be solely responsible for retail distribution of recreational cannabis in government-run stores, he said. Medical cannabis will be more widely available at existing pharmacies.

"So we expect to see a slight boost in store demand for plazas, strip and power centers," Mr. Langstaff said. "These units ... will be highly coveted government credit tenancies."

In the U.S., some marijuana retailers have done quite well, which is good for property owners. In Seattle, where marijuana has been legal for medical and recreational use since 2012, recreational retailers reported $149.5 million in total sales, with average sales per square foot of $1,513 in the year ended Oct. 31, according to a separate JLL report. This placed Seattle's marijuana retailers well above the national average across all U.S. retailers at $325 per square foot, the report noted.