The boom may be over.
Marijuana’s appetite for metro real estate, once a driver of the industrial-market recovery, is showing signs of stabilizing after Denver’s decision last year to cap the number of grow operations in the city.
But first, the industry gobbled up another big chunk of warehouse space.
Marijuana grows occupied 4.2 million square feet of industrial space in metro Denver at the end of 2016 — up 14 percent since the second quarter of 2015, when they accounted for 3.7 million square feet, according to a new report from CBRE Research.
“Most of that growth took place in the second half of 2015 and the first half of 2016. Nothing really has happened in the latter half of 2016,” said Matt Vance, economist and director of research and analysis for CBRE in Colorado. “Things have stabilized.”
Overall, the Denver market is home to 145.8 million square feet of warehouse space. The overwhelming majority of grow space in the metro area falls within Denver city limits.
The commercial real estate firm’s report, released this week, updates a 2015 study that was the first in-depth look at pot’s impact on Denver’s commercial real estate market since Coloradans voted to legalize recreational marijuana in 2012.
The Denver City Council approved a cap on retail dispensaries and grow houses in April 2016 following weeks of debate.
“There’s been a pretty significant dropoff in new properties being licensed,” said Jason Thomas, CEO and managing broker of Avalon Realty Advisors, a Denver real estate brokerage that specializes in the marijuana industry. “The changes to Denver’s setback and zoning and sensitive neighborhoods has restricted the industry from growing significantly.”
Those policy changes, crafted in hopes of protecting already saturated Denver neighborhoods, banned all new medical marijuana businesses and allowed for a permanent cap on the number of recreational grow and dispensary locations.
That cap has yet to be set, but it won’t be more than 467 total locations, said Dan Rowland, spokesman for Denver Excise & Licenses. The 467 number was reached last year, accounting for the number of existing locations plus applications pending at the time.
As of April 1, there were 450 active grow and store locations and 30 applications pending for new locations within Denver city limits. Once all those applications are processed, it is possible that there will be more than 467 approved locations, but the cap would still be set no higher than 467, Rowland said.
“There won’t be a lottery (for additional locations) any time soon — no matter where we end up with these 30 pending locations,” Rowland said. “It’s going to take some time before we have some attrition in the market happen or we have enough locations fall out that we’re under the cap.”
The new rules also include a ratcheting provision on cultivation locations. For every two grow locations that are given up, the city will only issue back one permit until a total of 15 grow locations have been eliminated from the city’s footprint, Rowland said.
All new locations must be at least 1,000 feet from schools and residential zones. In the first year of the lottery, new grows will also be banned from the five neighborhoods with the highest concentration of existing businesses.
In practical terms, the new rules mean the only way weed growers can expand in Denver is by adding square footage to a facility for which they already have a license, buying an already licensed location from another operator, or by transferring their own license to a new facility and surrendering the old one, CBRE’s Vance said.
“You’re not going to see a dramatic increase or an overcorrection in the market, with too much supply,” Vance said. “It’s a relatively high barrier to enter the market. To enter, you have to be pretty serious.”
The growth that did happen since 2015 was largely a factor of more cities deciding to allow marijuana cultivation within their limits, said Paul Kluck, first vice president with CBRE Industrial & Logistics Services.
Kluck said in 2015 that he believed the market to be “overgrown” at 3.7 million square feet and expected little additional demand for space.
“We felt like everyone was on the bus,” he said. “It was there that we realized, oh, it’s because of the new municipalities that jumped into the fray.”
Aurora, for one, saw its first permitted grow open in late 2014 and is now up to 11, according to a city spokeswoman. There is no cap on the number of locations, but zoning rules allow them only in industrial areas in a sliver of the city, mostly along I-70 and near Denver International Airport.
Marijuana Industry Group chief Kristi Kelly said growers aren’t worried. “What’s happening is that people are just looking for options outside of Denver.”
CBRE’s report shows the industry’s footprint continues to be heavily concentrated along major highways — I-70, Interstate 25 and South Santa Fe Drive among them.
Nearly 40 percent of all grow space can be found in just one submarket, the Airport area that runs north and south of Interstate 70 west of Colorado Boulevard east into Aurora.
That area alone is home to 1.57 million square feet of marijuana grows. Overall, more than 96 percent of the industry’s footprint is clustered within just four submarkets — Airport, Boulder and two central Denver districts that span Interstate 25 between Interstate 76 to the north and U.S. 285 to the south, according to CBRE.
All grows are located in aging Class B and C warehouses, but tenants still pay a premium over non-marijuana tenants. According to CBRE’s review of 25 leases signed between 2014 and 2016, the average lease rate for marijuana grows was $14.19 per square foot — two to three times higher than the overall average rate in the top four cultivation submarkets.
Finding a willing landlord continues to be a challenge, too. Publicly traded companies and those with traditional bank financing can’t lease to grows because of the conflict with federal law. Others won’t because of the costly electrical and HVAC upgrades required, Kluck said.
“If you want any prediction, these rental rates are going to go up when these leases start to roll,” he said. “If you think about some of these tenants, they were trying to get in to deliver product Jan. 1, 2014. If they signed their lease in 2013, they signed a four-year lease, those leases are coming up. In 2018, you’ll see these marijuana guys get hit with some pretty big rent increases.”
Kluck doesn’t expect to see marijuana’s real estate footprint to shrink, especially given Denver’s cap on additional locations.
“The less than efficient operators are going to get weeded out,” Kluck said. “Does that mean that it’s going to affect the real estate? Probably not. There’s still value in the license that’s attached to a piece of real estate. Once you’ve got a license associated with that space, you’re not going to change it, because you’ll never be able to go back.”
Thomas is currently working with a client who is looking to sell a half dozen dispensary/cultivation facilities with active licenses. A growing number of operators are interested in owning their own real estate, a sign of the increasing amount of capital in the industry, he said.
“I would like to see more cities open, even on a limited basis, along the Front Range,” Thomas said. “We do need new markets to open, in my opinion, to continue the growth in the industry.”