Connecticut’s CRE sector not rushing into cannabiz

“Start low and go slow.”

That’s the warning label attached to most recreational marijuana products. It could also serve as counsel to real estate investors with high hopes for business opportunities stemming from Connecticut’s potential embrace of recreational cannabis.

In early May, the Constitution State’s House of Representatives unanimously voted in favor of a bill for the production and sale of industrial hemp. That was only a few days after the legislature’s finance committee voted on another bill seeking to outline taxes for legal weed, which came after thumbs-up votes earlier this year establishing a legal framework and licensing process for the controlled substance.

At press time, 10 votes were reportedly all that stood in the way from Connecticut joining 10 other states and the District of Columbia in legalizing recreational marijuana use. Gov. Ned Lamont openly supports pot for pleasure, and many in Fairfield County’s real estate sector are considering the implications of the budding market on retail and industrial space, as well as rents for both types of properties. Those hopes could also go up in smoke.

Multiple bills need to be tied into one that will be debated and voted upon in what looks to be a contentious political process, leaving some proponents taking a wait-and-see approach. They say it could be summer before the march toward recreational marijuana gets any actual momentum.

“It has had minimal impact so far,” says Thomas LaPerch, head of Houlihan Lawrence’s commercial real estate group in Rye Brook, New York, which shares a border with Greenwich.

LaPerch said his group received a few inquiries about warehouse space earlier this year when the recreational marijuana bill was first approved in committee, but since then, the Fairfield market has been quiet.

“Connecticut has been tossing this around for close to three years,” said Brian Staffa, chief strategy officer of New Jersey-based cannabis industry consultant BSC Group. “Until… we can really start seeing some traction and movement, we don’t pay much attention to every little bill and announcement that comes out.”

Activity on the rise

The Connecticut Senate legalized medical marijuana in May 2012. There are currently four production facilities and nine dispensaries operating in the state. They serve approximately 33,243 patients in the medical cannabis program as of mid-May, up from roughly 2,000 individuals in 2014, when Connecticut’s first dispensaries opened, according to the state’s Department of Consumer Protection. To handle the additional volume, the DCP approved nine new dispensaries in December, including Fairfield locales in Stamford and Westport, which have yet to open.

Advocates claim that legalization will help solve inequalities in the criminal justice system that have unjustly hurt minorities and that regulations and controls will protect consumers. On the financial side, legal weed could become a $75 billion industry worldwide by 2030, according to analysis last year from Cowen Inc., one of the first major U.S. investment banks to branch into the cannabis sector.

While Connecticut expects to reap less than $50 million a year in taxes from medicinal weed, the local chapter of the National Organization for the Reform of Marijuana Laws estimates that legalized recreational pot could bring that total to $180 million a year in tax revenue for the state. Connecticut, like other states, has restricted the number of cannabis licenses it grants, thereby artificially capping the potential impact legalization could have on the state’s real estate sector.

There are only four companies in Connecticut that have licenses to grow and process cannabis, two of which were bought by outside entities within the past year. In August, New York-based private equity firm Tuatara Capital picked up Connecticut Pharmaceutical Solutions, a leading medical cannabis provider in the state. Green Thumb Industries, which is based in Chicago and Vancouver, paid $80 million in January to acquire Advanced Grow Labs, which operates a 41,000-square-foot manufacturing facility in West Haven.

“We are now solidly positioned in the tri-state area with this entry into Connecticut,” said Green Thumb CEO Ben Kovler, heir to the Jim Beam spirits empire, in a statement announcing the deal. Green Thumb and Advanced Grow declined to comment on their union, while Tuatara and CPS did not return phone calls.

Some experts believe that more Connecticut marijuana deals are in the offing as legalization looms on the horizon.

“There will be more merger and acquisition activity,” said cannabis industry expert Olga Usvyatsky, vice president of research at Sutton, Massachusetts-based Audit Analytics. She cited beverage giant Constellation Brands’ $4 billion investment last year in Canopy Growth, the largest pot producer in Canada, where cannabis is legal, as an example of where marijuana markets can go amid widespread legalization.

In the U.S., of course, Usvyatsky noted that there are still plenty of constraints on those hoping to buy their way into the market. One major complication is the ongoing disconnect between federal and state regulations, especially when it comes to financing. Usvyatsky said new players risk running afoul of federal law, which can lead cannabis tenants to pay premiums to lease space or buy properties entirely in cash.

Provisional pot players

Companies entering the marijuana market use three basic models depending on their strategy: They buy a business outright; buy a business and lease it back to its original owner; or they lease a property, a tactic more common with retail outlets.

An early May investment analysis from British banking giant Barclays found that if marijuana were legalized throughout the U.S. this year, the country’s cannabis industry could be worth $28 billion. The analysis noted that in Colorado, Nevada and Washington, all of which have legalized marijuana for recreational use, tax revenue from the substance has surpassed tax revenue on alcohol in those states.

Among the legal weed investors moving into the region around Connecticut is San Diego-based Innovative Industrial Properties, one of the nation’s top-performing real estate investment trusts last year and one that specializes in marijuana farms. During a conference call with analysts in March, Innovative Industrial executives noted how it had positioned itself in New York with two properties leased to multi-state cannabis operators PharmaCann and Vireo, as well as in Massachusetts, where it leases to PharmaCann and Holistic Industries.

Innovative Industrial’s business model of buying up warehouse space and renting it to cannabis cultivating tenants has so far been a success. Asset management giants BlackRock and the Vanguard Group are the largest investors in the REIT, which as of April had an average capitalization rate of 15.3 percent, according to analyst reports that follow Innovative Industrial.

In Connecticut, however, the lingering legislative uncertainty about legalized weed has not yet created a groundswell of industrial or retail demand. And property owners in the state are not exactly holding their breath waiting for state legislators to make a decision.

“A landlord is not going to hold out on a potential situation that hasn’t been approved yet,” said LaPerch of Houlihan Lawrence. “We’ve got to call a timeout to figure out what the rules of engagement are here. It’s kind of premature.”