Last month we talked about green energy and ways to keep some “green” in your pocket. This month, there is a different kind of “green.” One that is transforming our real estate world, and one that you should be aware of.
First, let me state that marijuana is not my thing. I’d consider myself more neutral on the topic. It’s just business. If I had to pick a side then I’d be prejudiced against it. No particular reason. While I have no experience in that market, I am told that the marijuana today is very different than the marijuana previously on the market. I guess it got fancier and more specialized.
Regardless of your opinion about this drug, there are some facts that might be helpful to know surrounding how it is impacting our state and our real estate market.
AN INFANT INDUSTRY.
The Northwest marijuana industry appears to be flourishing, but is still operating in a gray area. Our laws are not yet fully developed, and changing on a regular basis at that. In some instances the states are developing regulations to implement laws, while at the same the legislature is simultaneously changing the laws! Landlords and tenants find themselves in uncharted waters. With a good team and plan in place, both landlords and tenants can account for future changes in their leases and contracts.
Before we go into some basic guidelines from a landlord perspective, let’s take a brief look at the limited history of the industry and the impacts it has had in our state so far.
In 2012, Washington State passed legislation I-502, which legalized marijuana for adults over 21. In the commercial real estate world, we just refer to these sites as “I-502.” Not all cities embrace I-502, and the impact that it has had in Washington on commercial properties has really forced me to pay a lot more attention to this part of the market and what is going on.
The first stores opened up in Washington on July 8, 2014… so just over a year ago. What you may not know is that.
- Washington had over $250 million in marijuana sales in the first year.
- Initially, the state forecast $36 million in marijuana excise tax. Actual number is closer to $62 million the first year.
- For comparison, Colorado’s recreational sales began January 1, 2014 and brought in $44 million their first year.
- When other state and local taxes are included for Washington, the total payday is $70 million in total tax money to the state and local municipalities. Not bad.
Now, I look at this from a tax payer standpoint and think “great, maybe my property taxes will go up a little less than they would have.” I know it’s a drop in the bucket compared to the state’s $38 billion two-year budget… but, a girl can dream, right?
THE FLIP SIDE.
Sounds like business is booming. As with all stories, there is another side.
When you talk with the guys who are actually in the business, they complain about the burden of the taxes. Surprise.
As a general statement, 40% or more of the money from pot sales goes to taxes.
I guess it’s not as lucrative of a business as you would initially think.
James Lathrop owns Seattle’s first legal marijuana shop. In an interview with Gene Johnson, Associated Press published July 2015, he said that through the end of 2014, his estimated federal tax liability was $510,000. This was in addition to the $778,000 that he owed Washington on $3.1 million in sales. Lathrop said “Nobody’s gone out of business, but I’m not driving a new truck either.”
So… how does I-502 come into play with the real estate market? Let me tell you.
For one, it’s driven vacancy rates down substantially in the industrial markets. Take South King County. Vacancy is currently estimated at 4.14%, down from 6.93% when the law passed. Snohomish County is estimated at 6.03%, down from 8.55%. Seattle core 1.93% down from 3.26%.
Let’s face facts though. There are definitely other factors that tie into the improvements in vacancy rates. We have an improving market in general. This is partially from recovering from a recession; zoning changes in our region that have shifted some of the local markets around; and rebounding and expanding businesses.
From the street level, marijuana still seems to be having an impact. A number of our warehouses and flex space (meaning warehouses with large offices) are now I-502 instead of light industrial manufacturing. It’s popping up in downtown retail locations and rural agricultural settings. In the southern part of our state, based on signage and billboards it looks like the only businesses in town are cannabis related. I know that’s not true. This part of our state will need to be cautious, as Oregon will be selling for recreational uses later this year which may impact the sales in Washington.
There don’t seem to be any complaints from landlords. With this improvement in vacancy, our rental rates are climbing. Historically, we could expect approximately 1% annual increases, but lately it’s been closer to 3-4% annual increases.
Lower vacancy and higher rental rates are good. (You can feel the “but” coming, right?)
Where I think investors need to be cautious is in leasing a building to cannabis tenants. For starters, seek a higher return. To say it bluntly. Ask for more money.
REWARD VERSUS RISK. Think about it for a minute first. These tenants (meaning businesses here, NOT the individuals involved) are not superior credit tenants with major companies behind them. Their businesses haven’t existed long enough for them to establish a long history of credit lines. In many cases, they still have issues getting a bank account! Due to these challenges, they tend to pay more as a way to compensate. Ask for higher lease rates on the building and get a large, non-refundable fee to lease the space that may off-set your clean-up costs later.
FLEXIBILY. Build flexibility into your leases. The laws are changing, so keep your contracts flexible. You could specify in the lease if the tenant is using the premises for medical vs. recreational uses. Are they manufacturing, distributing, using for wholesale or retail sales? Do you want copies of licenses or permits each year? Spell it out. Protect yourself. Include escape clauses that allow a landlord to terminate without penalty if there is a change in government policy or complaints from neighbors.
BANKING AND INSURANCE. Many larger banks and insurance companies get nervous about marijuana uses. The good news is that some local banks, credit unions, and private money will still lend. Insurance might be a challenge. Make sure you can terminate the lease if your mortgage or insurance creates an issue for you as a landlord.
THE COLE MEMO. Marijuana is still a federal offense. While probably not likely, a property housing marijuana activities is subject to seizure by federal agents. The “Cole Memo” was issued by Deputy Attorney General James M. Cole on August 29, 2013. This is an internal memo in response to Washington’s legalization and essentially states that prosecution of individuals and companies who are complying with state law are not “enforcement priorities.” (If you own an I-502 site, don’t give federal agents a reason to prosecute you. Follow rules and pay your taxes.) Industry experts think it will be legal federally around 2020.
WHAT IS MY POINT?
The cannabis industry has had a much larger impact than I ever would have thought on real estate. Some property owners may not want to work with the industry on moral grounds or because they have a low risk tolerance. Others will see the opportunities as lucrative.
As an investor in a building, can you find a little extra profit? Yeah. Should you? That is up to you. Just like all investments.. it’s risk versus reward.
Also, like all investments, having the right team involved to help you understand the risks and protect both you and your property will pay off. Invest accordingly and have a strategy.
Looking for an investment that will show you positive returns? I’ll do my best to find what you’re looking for (I prefer not I-502 sites, but do know my market for most properties here locally. Of course, I’ll always tell you when something it out of my area of expertise.)
Give me a call at (206) 293-1005 or email: Jen@HudsonCREG.com.