In the next five years, the legal cannabis industry is expected to have a steady compound growth rate of 27 percent. With a current estimated value of nearly $60 billion and rising, it is not surprising that there has been an upsurge in the acquisition of cannabis real estate.
What may have caused this recent increase?
It is quite simple: despite the fact that the risks are high, the returns on investment are also really high, which makes investors want to have a part of the industry. In addition, more than two-thirds of states now have laws that deem the cannabis business as legal and this has further opened up the market. However, the recent boom in cannabis real estate can be tied to the perspectives and activities of investors.
The current federal legislation concerning cannabis makes it very risky for the traditional modes of investment to thrive, hence the need for alternatives. Investors would more readily put their money into real estate than into the actual production of the product. This is quite logical because real estate is believed to be safer in terms of investment security in cannabis business than other items involved in the production and distribution of cannabis. In fact, multiple Real Estate Investment Trusts have been established for the purposes of buying cannabis real estate, one example is Innovative Industrial Properties.
In addition, the existence of an expansive network of loyal consumers further contributes to the appeal of the industry. Investors are aware of this and the potential effect it would have on the industry in the nearest future and so they want to tap into it in the safest way possible. In addition, there have been reports of some private equity fund recording returns on investments of over 50% per annum, thereby prompting more investors to join the feeding frenzy.
The truth about these high returns
The cannabis industry is a very fast-paced one, rife with risks but also with incredible returns which could be as high as 25% for cash on cash annual returns. In other cases, the prices of real estate doubled and even tripled in some cities where the production of cannabis was legalized.
The high returns are real but what about the associated risks?
It is quite easy to get drawn in by the possibilities of immense profit and incredibly impressive returns on investment. However, it is important to note that the cannabis industry is very complex, still evolving and has a lot of factors at play that could determine the direction of the market.
Firstly, the industry is regulated by so many regulations that even a slight change could affect the market outcomes. For instance, if more states and cities legalize the business, then the profits would keep increasing but if the regulations are made stricter, then it might impart the market negatively.
In the same vein, there are a lot of regulatory agencies and the authorities are constantly clamping down on illegal cannabis markets. The current estimated value of the illegal cannabis market is $46 billion (which is one of the reasons investors are so excited) but what happens if these illegal businesses are shut down by the authorities or they overshadow the budding legal businesses? It goes without saying that the small legal businesses will have more room for growth if illegal businesses are shut down.
Furthermore, the price of marijuana would also determine the market outcome. If the prices continue to fall, tenants would be unable to pay rent and the erstwhile high returns real estate may become a liability for a while.
Other factors that may impact the industry includes heavy taxations and overbuilding. These can affect the operations of small legal businesses and also result in oversupply of real estate which would now become a problem due to excess vacancies.
How long will these good times last?
The conditions of the real estate market vary from state to state depending on the phase of the market as well as the location itself. States like Colorado and Washington are currently experiencing an oversupply of real estate due to overbuilding while other places like Nevada actually have a shortage. A typical real estate market goes through four phases: expansion, hyper-supple, recession and recovery. California, with the recent legislation is in the expansion phase where the vacancy rates are low and more buildings are springing up. Colorado, on the other hand has high vacancy rates and is in the hyper-supply phase because construction hasn’t reduced.
With favorable legislations, it is expected that the expansion phase would stretch for a while, maintaining a steady increase in construction and low vacancies. However, it would be difficult to accurately predict when the expansion phase would end because the industry is quite unstable and has too many influencing factors.
It is important to mention that this boom is also expected to have an effect on residential real estate based on the fact that the expansion of the cannabis industry would result in an influx of people into cities where the business is legalized because jobs would be available and this would translate into a demand for residential real estate.
This “cannabis boom” sure holds a lot of promised but for how long?
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