A LivWell Enlightened Health employee inspects marijuana plants at a facility in Denver. LivWell operates one of the largest cannabis cultivation centers in the country. (Denver Post file)

Marijuana industry drives Denver real estate recovery

Your nose isn’t lying: One in 11 industrial buildings in central Denver is full of marijuana.

The state’s cannabis industry occupies at least 3.7 million square feet of industrial space in Denver, clustered in areas of older warehouse stock, including the Interstate 25-Interstate 70 junction, Montbello, central Denver and along the Santa Fe Drive corridor in southwest Denver, according to commercial real estate firm CBRE.

CBRE’s research team conducted the first in-depth study of pot’s impact on the city’s commercial real estate market, looking at the early years of medical and retail marijuana in Denver.

Between 2009 and 2014, the industry’s appetite for real estate was voracious, with marijuana cultivation gobbling up more than a third — 35.8 percent — of all industrial space leased in Denver during that five-year period.

MOBILE: Map of Colorado marijuana grow facilities

“It really kick-started the recovery of the industrial market in Denver,” said Jessica Ostermick, director of research and analysis for CBRE in Denver.

That infusion has continued to impact the overall Denver market as traditional industrial demand has rebounded from the Great Recession, leading to near-record-high rents, low vacancy rates and tenants of all stripes struggling to find space.

Average industrial lease rates in the third quarter were $7.05 per square foot across the metro area, according to CBRE, up 5 percent year over year and approaching record highs not seen since 2004. For lower-quality warehouse space, known in the trade as Class B and C, lease rates jumped 56 percent in the past five years to $6.34 per square foot in key cultivation areas. Marijuana tenants often pay a premium of two to three times the average.

“Right now, we feel like the marijuana grow market, we call it overgrown,” said Paul Kluck, first vice president of CBRE Industrial Services in Denver. “That 3.7 million square feet, some of it’s still vacant and there are some growers who haven’t reached full capacity. We don’t feel like there’s additional demand for grow facilities other than the normal in-and-out in existing facilities.”

Industry experts said that dynamic could change if Denver lifts a moratorium that allows only medical marijuana businesses that existed prior to Oct. 1, 2013, to apply for recreational marijuana licenses in Denver.

“If that moratorium goes away, there might be a lot of people trying to open up grow facilities in Denver who had otherwise been locked out,” said Michael Elliott, executive director of the Marijuana Industry Group.

The moratorium is set to expire Jan. 1, although the City Council could extend or modify it, a Denver spokesman said.

Marijuana entered the real estate game in force just as “the industrial market and economy was coming out of the doldrums” of the recession, Kluck said.

Growers ended up in Class B and C space, where vacancy was high. In the past five years, vacancy in the aging warehouses has declined to 2 percent from 7.9 percent.

On average, grows leased 10,000 to 20,000 square feet, although operations range from 2,000 to 100,000 square feet, CBRE said. All told, marijuana occupies about 2.6 percent of all warehouse space in Denver.

Industrial space across the metro area posted a vacancy rate of just 4.6 percent in the third quarter, according to CBRE. Many areas popular with pot growers measured even lower, with the North Central market at 1.9 percent, Central at 2.3 percent and Southwest at 2.4 percent.

“We’re in strong economic times,” Kluck said. “The grow demand is just a small part of it.”

In Denver, marijuana cultivation is typically permitted only in areas zoned for light and heavy industrial uses — about 3,038 acres, or 3.1 percent of Denver’s land mass.

Most new commercial cultivation, however, gets pushed into heavy industrial areas, because grows are not allowed within 500 feet of residential areas and many light-industrial areas are too close to homes, according to a city spokeswoman.

Many property owners will not even consider leasing to marijuana growers because of loan constraints and the conflict with federal law, Kluck said. The cost of the often-extensive electrical and HVAC upgrades required for grows also can be a deterrent.

“It’s only the owners who own their property free and clear and don’t have issues with lenders or who are actual grow investors willing to take on the risk,” Kluck said. “That’s a small pool of owners.”

Assuming they do find a willing landlord, marijuana tenants also can expect to pay higher rent than mainstream businesses, often at two to three times the average, according to CBRE’s analysis.

It happens in “pretty much every transaction,” said Jason Thomas, principal of Avalon Realty Advisors, a firm that specializes in real estate for marijuana businesses.

In one recent deal, one of his marijuana clients was offered a $13.50-per-square-foot lease in the same building in which a mainstream tenant paid $5.50, he said.

“Tenants are at the mercy of whatever landlords and sellers want to achieve,” Thomas said. “It’s a dynamic that’s hard to swallow to pay two to three times the rent because you’re a marijuana company.”

Marijuana leasing could have some interesting consequences on Denver’s development cycle, as well, Thomas said.

“Of the 3.7 million (square feet), the vast majority are your C properties, most of them functionally obsolete and should be scraped and redeveloped in the next cycle or two,” he said.

But, now, many buildings are locked into leases for the next five to 20 years and “off the potential redevelopment list,” Thomas said.

“It’s a new and disruptive industry,” he said, “one that’s making a huge impact, some positive, some negative, to mainstream businesses.”

Emilie Rusch: 303-954-2457, erusch@denverpost.com or @emilierusch

This story was first published on DenverPost.com