With the current $6.7 billion legal cannabis market expected to grow at 27 percent compound annual growth rate over the next five years, the largest horticultural Green Rush since the Dutch went wild over tulips back in the 1630s, is now spawning an all-out land grab for American real estate.

  • In the four states with legalized recreational cannabis — California, Colorado, Oregon and Washington — an economic and employment boom has already lifted residential real estate prices, especially in smaller cities.

With the current $6.7 billion legal cannabis market expected to grow at 27 percent compound annual growth rate over the next five years, the largest horticultural Green Rush since the Dutch went wild over tulips back in the 1630s, is now spawning an all-out land grab for American real estate.

What’s driving the boom?

Coincidentally, it’s the federal prohibitions that keep most traditional players, lenders and investors, at bay — dampening competition and juicing prospective returns — that’s now fueling the current craze.

Investors, on the other hand, view real estate as a relatively safe vehicle to profit from the budding industry growth without getting involved in the production itself. It’s hard to argue with their logic: brick-and-mortar assets are far more tangible than bongs and munchies.

Many of these same investors are also lured by the once-in-a-lifetime opportunity to tap a large underground market ($46.4 billion) with a loyal consumer base (so loyal, in fact, that consumers have been breaking the law to get the product).

Fueling the excitement, many private equity funds have already reported staggering annual returns of over 50 percent — numbers not seen in real estate since the Florida Land Rush of the 1920s.

Cannabis has higher sales per-square-foot than Whole Foods 

Are these returns real?

Although historical returns provide no indication of future performance in this fast-moving industry, prices of those industrial spaces have doubled, and in certain cases, even tripled right after those cities legalized production, and cannabis industrial space has a current national cap rate (a proxy for cash on cash annual return) as high as 25 percent — three times higher than its non-cannabis comparable.

However, these investments are not without risks.

What are my risks?

Many industry outsiders lured into the fold by tall tales of outrageous profits tend to have a hard time separating fact from fiction in an industry that’s still opaque, mostly illicit and operates on a cash basis.

That being said, factors such as uncertainty and well-documented legal barriers to entry  have created a rare opportunity for big-money private equity funds eager to make abnormally high profits — especially for those willing to take the outsized risks and drag other industry partners in tow.

However variables that could swing the current boom in either directions are:

Government regulation: Because much of the industry is driven by regulations, even small changes in local taxation, zoning laws and easing of the required licensing caps could dramatically impact the profitability of most cannabis operations.

Illegal market:  How much of that  $46 billion-plus illegal market representing nearly 90 percent of consumption will come online depends on how strictly states start to crack down on illegal operations. Because illegal operations undercut the legal ones, many smaller players may not have the staying power to outlast falling prices and may default on their leases.

Falling prices: Wholesale marijuana prices have dropped precipitously over from up to $2,500 per pound in 2016 to just around $1,600  in July 2017.

Many insiders including iconic cannabis entrepreneur Steve DeAngelo believes the wholesale price-per-pound will have to fall below $800 before we see many tenants defaulting on rents.

Prohibitive taxes: Because federal tax laws don’t allow for any cannabis-related deductions, most operations pay an effective tax rate of about 40 percent and as high as 70 percent, leaving fully compliant operations with pittance for profits.

Overbuilding: As concentrate and edibles containing cannabis oil, which has been economically extracted from outdoor plants, become more popular, many industry insiders are seeing pockets of overbuilding in the more mature markets of California, Washington and Colorado.

Impact on residential real estate

As the cannabis industry grows faster than any other consumer industry in the past 50 years, not surprisingly, the industry is also set to surpass manufacturing in job creation by 2020, according to Forbes.

This economic and employment boom already lifted residential real estate prices in four states (California, Colorado, Oregon and Washington) that legalized recreational cannabis, especially in smaller cities in need of economic stimulus,  according to a report by National Association of Realtors (NAR).

The prospects of employment — as well as the ability to legally grow and buy — have led to more people to move to states with legalized marijuana, boosting home prices, according to the NAR report.

How long will the boom times last?

The answer depends on which market you are referring to. Newly legalized Nevada recently declared a state of emergency due to acute shortage, meanwhile, oversupply has hit more mature states like Washington and Colorado

Real estate markets traditionally go through four phases: first expansion, then  hyper-supply, followed by recession and recovery. California, for example, is still very much in “expansion phase,” one usually marked by a flurry of new construction and extremely low vacancy rates.

Compare this with certain districts in Colorado now experiencing a “hyper-supply phase,” where new construction continues to rip in spite of rising vacancy rates.

Most industry insiders continue to believe that more recreational markets coming online and more cities legalizing production means the profitable combination of new construction and low vacancy in California could stretch as far as 2020.

However, with the recreational cannabis market itself still a huge unknown, it’s hard to predict how long this expansion phase will last.

Others, meanwhile, are hopeful that an exemplary transition toward the recreational market in America’s largest and most trendsetting state will turn up the heat on competing state legislatures in similar budget binds, forcing them to embrace cannabis tax revenue and effectively blessing a bona fide cannabis real estate boom that will sweep across the nation.

Mir Haque is the CEO of  Aphaea Capital, a cannabis venture fund. Mir, a Wharton MBA and a serial entrepreneur, has previously worked for McKinsey & Company, Deutsche Bank, Google and Adobe, and has recently served as a VP of strategy for realtor.com.

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