Pot declines over 30% what does this mean for real estate?

In a recent study, marijuana prices dropped from 2106 last January to 1402 in June, an astonishing 33% decline in prices (MJbizdaily) and they likely will continue to tumble even further.   Marijuana now occupies over 3.7m square feet of space (1 in 11 buildings are pot related) throughout the metro area and is one of the largest drivers of the run up in industrial space.  With prices dropping precipitously what does this mean for rents and building prices?

First, let’s discuss what is driving the large price decline?  For a long time, most in the industry for some reason thought that basic economic principles of supply and demand didn’t apply to marijuana.  Many thought that there was so much pent up demand after the prohibition of marijuana that supply would not catch up with demand any time soon.  Unfortunately, as predicted, supply not only caught up with demand but also has surpassed demand leading to the price compression.  As I predicted years ago, marijuana is ultimately a commodity that can be easily grown and therefore over time supply will continue to rise since the barriers to entry are low.

With so much supply now, it is inevitable that prices will continue to fall.    Currently Colorado is supplying many neighboring states with marijuana (see Kansas/Nebraska sue Colorado) and therefore demand is not only from Colorado but the surrounding states.  For example Trinidad has become a hotbed for marijuana retail operations since many from New Mexico drive across the border to buy marijuana.  The same thing happens with other products, for example certain fireworks were legal in North Carolina but illegal in Georgia.  So around the 4^th of July hundreds of stores would pop up on the GA, NC border selling fireworks.  Why am I mentioning this?

With the elections on Tuesday, Marijuana is poised to become legal in California (see Bloomberg poll) which will inevitably bring on considerably more supply.  Along with California three other states would legalize recreational marijuana and many more could legalize medical marijuana.  This increase in supply will no doubt further reduce pricing for marijuana in Colorado and throughout the country.

Along with supply, efficiency is also driving down prices. The three largest expenses in growing are rent/mortgage, property improvements (hvac, electrical,etc..), and electricity.  All of these costs are being challenged by newer more nimble and efficient growers.  For example, many of the newer marijuana growers are migrating to lower cost areas (think pueblo) which exponentially reduces their costs.  Instead of paying $100+/ ft for a building in Denver, they can pay $10-20/ft.  Along with reduction in building costs many growers are migrating to more efficient growing.  There was a grower in Northern Colorado that built greenhouses for 15-20 a foot and also decreased their electricity costs by almost 80%.  They built modified greenhouses that can open and close panels to let in natural air and light. This strategy exponentially decreased their costs and also increased the quality of their product.

According to Marijuana Business Daily, “Industry insiders said it will be more difficult for indoor growers with inefficient, old-school lighting setups that gobble electricity and result in higher costs.”  With comparable quality, why would a marijuana retailer pay more for marijuana grown in a warehouse in Denver vs a greenhouse in Northern or Southern Colorado?  The short answer is they will not which leads to the impact on real estate.

Why is the pricing of marijuana so important to real estate?  Almost 10 % (1 in 11) of all industrial buildings in the metro area are utilized somehow related to marijuana.  Each of these marijuana properties are paying above market rents (and typically bought well above market) that is driving up the entire industrial sector.  According to a Wall Street Journal Article: “ Mark Bowen, vice president in the Denver office of DCT Industrial Trust Inc., a real-estate investment trust that owns warehouses, said demand from marijuana growers has driven up the cost of warehouse space for users from the natural gas and tech industries by 60% or more, and increased lease renewal rates by 25% for DCT’s clients worried that if they don’t re-sign they will lose their space to the pot industry”

Basic economic principles will dictate the markets reactions.   As prices of marijuana decrease, growers will no longer be able to afford above market rents and prices for space.  What does this mean?  If 10% of the occupants of industrial space are driving the market up, they will inevitably drive the market down as well.  Over the long term I don’t believe indoor grows in Denver in 5 to 10 years will be viable at all (manufacturing of infused product is a different story) leading to a glut of class B-D space that is functionally obsolete.  I like to think of this as a game of musical chairs except you don’t want to be the last one at the end of the game “high” chilling out in a chair.

References:

1. Marijuana Ballot Initiatives: Bloomberg: http://www.bloomberg.com/graphics/2016-ballot-initiatives/
2. Why Marijuana Prices at Colorado Dispensaries have been falling: Westword: http://www.westword.com/news/why-marijuana-prices-at-colorado-dispensaries-have-been-falling-7866624
3. Wholesale Recreational Cannabis prices tumbling: Marijuana Biz Daily: http://mjbizdaily.com/colorado-wholesale-recreational-cannabis-prices-tumbling/
4. Marijuana Producers Gobble up Warehouse space in Denver: The Wall Street Journal: http://www.wsj.com/articles/marijuana-producers-gobble-up-warehouse-space-in-denver-area-1440495000
5. Marijuana industry drives Denver metro areas real estate recovery: The Denver Post: http://www.denverpost.com/2015/10/19/marijuana-industry-drives-denver-metro-areas-real-estate-recovery/
6. Kansas Sheriffs sue Colorado over Marijuana: http://www.kmbc.com/article/kansas-sheriffs-sue-colorado-for-legalizing-marijuana/3687217

Written by Glen Weinberg, COO/ VP Fairview Commercial Lending.  Glen has been published as an expert in hard money lending, real estate valuation, financing, and various other real estate topics in the Colorado Real Estate Journal, the CO Biz Magazine, The Denver Post, The Scotsman mortgage broker guide, Mortgage Professional America and various other national publications.

Fairview is the recognized leader in Colorado Hard Money and Colorado private lending focusing on residential investment properties and commercial properties  both in Denver and throughout the state. We are the Colorado experts having closed thousands of loans throughout the state.

When you call you will speak directly to the decision makers and get an honest answer quickly.  They are recognized in the industry as the leader in hard money lending with no upfront fees or any other games. Learn more about Hard Money Lending through our free Hard Money Guide.  To get started on a loan all they need is their simple one page application (no upfront fees or other games).