As growth curves go, they don’t get much more spectacular. Canadian company Tilray, headquartered in a city of fewer than 100,000 people on Vancouver Island, saw its share price rocket 1,000% and its market value hit $20bn in just 12 weeks following its initial public offering in July.
It has become the talk not just of the town but the whole country. Yet Tilray is not the latest tech start-up du jour. It owes its success to the growth of a very different sector, one that many experts believe could have a profound impact on the country’s property market in the coming months and years – the weed economy.
Companies have been piling into the sector in Canada in anticipation of the legalisation of recreational marijuana on 17 October. Aurora Cannabis is set to list on a major US exchange following fiscal year profit of around $55m; Aleafia Health debuted on the TSX-V and saw its stock grow 300% in its first month; and fellow listed company Canopy Growth launched a venture capital arm last month that is already valued at more than $1bn.
In such a nascent and volatile sector, what goes up tends to come down, however, as Tilray found to its cost when two days after its share price had peaked at more than $200, it nosedived by 48%. But looking beyond such ups and down, just how big an occupier could the legalised cannabis industry become?
On the face of it, the opportunity would seem to be huge. Aurora recently announced plans to develop a 1.2m sq ft industrial facility in Alberta, and JLL estimates the space needed for growing cannabis in Canada will exceed 8m sq ft by 2020 – far in excess of the amount of industrial space currently on the market, which is at a 15-year low.
The retail sector is also expected to get a major boost. Brodie Henrichsen, senior vice-president in JLL’s Vancouver retail team, predicts that as many as 1,500 cannabis retailers could open across the country in the coming years. “I can’t say I’ve ever seen something that’s a whole new category fill 1,500 stores,” he says.
This does not mean that the weed economy is suddenly poised for rampant, unchecked growth, however, as the sector’s evolution south of the border attests. Colorado was the first US state to legalise cannabis, in 2014, and has been at the cutting edge of the burgeoning sector ever since, says Paul Kluck, first vice-president at CBRE in Denver, Colorado. Between the legislation being passed in 2012 and coming into force in 2014, cannabis growers helped to kickstart the revival of an industrial market that was still feeling the effects of the 2008 crash, according to Kluck.
The landlord pool in Colorado for recreational cannabis operators was, and remains, limited. Its federal illegality rules out publicly traded companies and some municipalities in the state banned cannabis companies from operating. But strong occupier demand – Colorado supports a steady 4m sq ft of space for cannabis operators – inevitably attracted the attention of some landlords.
Most were ‘grow investors’, who bought industrial space specifically to lease it to cannabis companies. While some new stock was built, investors mostly relied on converting old space.
Cannabis growers have specific requirements. They need at least 20,000 sq ft, power and heating, ventilation and air conditioning (HVAC) systems. These can be expensive to install, so investors either bought buildings that closely matched these requirements or asked operators to pay for the conversions. Demand was so high around the time of legalisation that cannabis operators paid three times the normal industrial rate.
Five years down the line, those inflated prices are catching up with some growers. New growing techniques have reduced production costs, but also hit sale prices.
“If you were early in, your process needs to be upgraded for newer techniques. So you’re faced with reinvestment in a market where the price has dropped dramatically,” says Kluck.
“The stronger, more efficient growers are surviving, but the weaker ones are getting weeded out”
Paul Kluck, first vice-president at CBRE in Denver
Some growers have not been able to take the heat. “The stronger, more efficient growers are surviving, but the weaker ones are getting weeded out,”says Kluck — pun intended.
He says he is acting for one investor that has decided to get out of the industry entirely. The space the firm owns has gone up for sale but, says Kluck: “We’re not seeing any other growers interested in that building – it’s likely to be converted back to a traditional industrial building and sold to a traditional user.”
A new standard price for industrial space occupied by growers will not be decided until next year, when lots of five-year leases are up. “What’s going to be the new price for these growers? We’re not certain yet, but I think we’ll see some reduction in lease rates.”
While the mature Colorado market is stabilising, it is a different story in California, the largest cannabis market in the US. Next year, it is expected to hit a value of $5.1bn, which is more than the state’s beer market. Tim McGraw, chief executive of cannabis real estate specialist Canna-Hub, has decided to set up shop there.
As in Colorado, many parts of California have banned cannabis operators, leaving two thirds of the state off-limits. Even the cities and towns that are open to the idea have imposed heavy regulation, along with high taxes. Before an operator can get a state licence, they need to show they have the required zoning for the necessary real estate and, currently, there is not much real estate set aside for that purpose.
“Operators now have one of two choices,” McGraw says. “Take a couple of years rewriting ordinances, or pick a property that has already been zoned. But nearly all of [those properties] have revenue taxes in place, from 3% to 40%. The average revenue tax is 7.9% for having a cannabis operation.”
That is where McGraw comes in. He says that by negotiating with local politicians, he has been able to wipe off revenue taxes for businesses based in the properties he builds. He has 2m sq ft under development and that space will be spread across two hubs, specifically designed for cannabis operators. He calls the schemes “incubators”, with growers, testing labs and distributors all operating under one roof, creating “synergies and economies of scale”.
His first hub, just outside Fresno, will be 600,000 sq ft, the first phase of which is 100,000 sq ft. Tenants are already beginning buildouts and the space will be full by November, he says. Tenants are still paying a premium on the space – at $3/sq ft, up to double what a non-cannabis operator would pay for industrial space – but it is in line with other space leased to cannabis operators, and comes without the added burden of heavy local taxes.
McGraw expects Canna-Hub’s portfolio to reach 5m sq ft in the next few years and says he is looking for existing industrial facilities that he can retrofit, both in California and out of state, as well as sale-and-leaseback deals with cannabis operators.
Growth will, in part, be fuelled by cities seeing the benefits of a “business-friendly environment” for cannabis operators, he believes. And while other landlords will get in on the act, he hopes to have a first-mover advantage.
What is happening in Canada has had a big impact on his plans, he says. He is looking to take Canada-Hub north of the border, and is currently in negotiations for his first Canadian scheme. American investors are keen to get into the sector having seen the huge valuations of some Canadian cannabis firms, but some are not willing to gamble on what they perceive to be a volatile market. Investing in cannabis-related real estate, therefore, is seen as a more attractive option.
“Instead of investing in one operator, you’re spreading your risk among dozens,” McGraw says. “We’ve seen a huge change over the past few months, especially with what’s happening in Canada, where American investors want to get into cannabis but don’t necessarily want to invest in anybody touching the plant.”
Canada sparks up
While the outlook for cannabis occupiers in the US is mixed, the mood in Canada is more bullish, given the government’s plan to legalise its use throughout the country. JLL predicts that, in Alberta alone, demand for industrial space will exceed 4m sq ft in 2019-20 – the province currently has less than 100,000 sq ft available.
Nationwide, industrial vacancy rates are already the lowest since the early 2000s, causing prices to rise, and the cannabis boom could push them even higher, JLL predicts.
But the impact will also be keenly felt in retail markets. In most Canadian provinces, private retailers as well as government-backed stores will be able to sell recreational cannabis. Growers are setting up their own shops to sell direct to the public or partnering with existing retailers.
Aurora, for example, has agreed to let Edmonton-based liquor retailer Alcanna set up Aurora-branded shops. It is planning to open 37 in Alberta – the maximum allowed for a single retailer.
Other firms are forming partnerships with existing medicinal marijuana clinics to get a foot in the door. Second Cup, a popular coffee chain with nearly 300 stores nationwide, will open cannabis shops in collaboration with medicinal marijuana company National Access Cannabis Corp, while Colorado cannabis retailer Starbuds is partnering with Canadian-based Compass Cannabis Clinic.
JLL’s Henrichsen says that there are six to eight “medium- to large-scale companies” that want to open 200 or more stores across the country, along with numerous independents. Conceivably, he says, 1,500 stores could pop up. Western Canada, mostly Alberta and British Columbia, has been leading the charge because the provinces set out their rules early, whereas Ontario is still deciding how many licences to issue, he says.
In Alberta, if a retail store is up for let, there is a good chance a cannabis retailer will be bidding for it. “We’ve been very busy, predominantly in Alberta, and it’s had a major impact on the retail market. It’s absorbed a lot of vacancy and it could be upwards of 1% to 2% of the total retail pool that has been absorbed in Alberta,” he says.
As in the US, the number of sites retailers can sign up for is limited. Certain cities, such as Markham in Ontario, are banning cannabis stores. Others have strict regulations about how close they can be to public parks, daycare centres and schools. Combining that with demand, retailers are able to charge a premium to cannabis retailers of around 10% to 20% above normal market value.
It has not, however, had a meaningful impact on rents for other retailers, Henrichsen says. “I think a lot of landlords have used this as an opportunity to fill challenging space where they’ve had a chronic vacancy. It will have some impact on vacancy and rates going forward, but for most other retailers it will be limited.”
He predicts a “big rush” for space over the next 18 months, followed by a period of consolidation, echoing what has happened on the growing side, where companies such as Tilray, Aurora and Canopy are starting to stand out.
But while there is a lot of excitement, there is also concern, particularly in Ontario, home of Canada’s largest city, Toronto. Michael Calderone, vice-president, retail, in JLL’s Toronto office, says that pension-fund-based landlords and large, family-run real estate companies are being “cautious” about who they let space to. “They’re still trying to understand what these stores will look like and who they will attract,” he says.
Where they may have been happy letting space to retailers in Western Canada, they are more wary of doing it in their own “backyard”.
The same was initially true in Alberta, says Henrichsen, but landlords came around after seeing the quality of the stores being set up. “Initially, everyone was cautious and none of the big REITs were willing to entertain it. Over the past nine months, it’s totally changed. Everyone has come to the realisation this is a legitimate business. They’re not just pot shops selling paraphernalia and tie-dye T-shirts. Some of the stores and their designs are first class.”
Some analysts have raised concerns about a cannabis “bubble” in Canada, fuelled by inflated market valuations – and the truth is, nobody really knows what the demand for recreational cannabis will be from the public. So is there a danger the retail market is needlessly overheating?
“That’s always a concern,” says Henrichsen. “The trouble with this industry now is that there are so many unknowns. The margins are unclear and the customer data is unclear. There’s going to be consolidation. I think that’s inevitable.”
Despite that, both he and Calderone remain upbeat. While the market in the US has been relatively disjointed, nationwide legalisation could make Canada the ‘poster child’ for cannabis retail. In turn, the Canadian boom is likely to fuel optimism in the US. Canna-Hub’s McGraw says this year feels like a “tipping point, politically and socially”, for the industry. “The next 12 to 18 months will be historic times, both here and in Canada,” he says.
How much longer than that the high lasts, only time will tell.