Appraising Marijuana Properties- Dispensary and Grow Facilities

Introduction

Appraising a property with a marijuana (MJ) use can be very challenging and often times takes considerable more work and time by the appraiser as compared to a traditional property.

This post is geared mainly towards appraisers but could be useful to other people seeking to understand the value of a grow facility or dispensary.

The article is written by Cody Gale, MAI, CCIM, President and Founder of Colorado Appraisal Consultants on 1/6/2017. He can be reached at 720-315-2530.

Legal Landscapes and Market Changes

The market for this property type changes very quickly. More than any other property type. What is on this post may not apply in a week, or to your area. This is only a tiny snapshot of time and geography. Keep an open mind and stay on top of changes in your market. Federal and local changes will significantly impact this property type.

Market Rate Summary

As of this post, here is a brief summary of market rates:

• Typical fully built-out industrial grow facility property sale prices in the Denver Metro area are mostly in the $120-$170 per square foot (psf) range with some higher/lower transactions. Similar, non-grow industrial sale prices are mostly in the $80-$100 psf range with some higher/lower transactions.
• In all “fully built-out grow facility” examples, the building has extensive building upgrades such as HVAC, plumbing, electrical and lighting. Most “typical” industrial building examples refer to older (1950’s-1980’s) industrial buildings with more or less “average” industrial building conditions and zoning capable of grow use.
• Typical fully built-out grow facility cap rates are mostly in the 12%-15% range while comparable non-grow industrial cap rates are mostly in the 7-8% range.
• Typical grow facility buildout costs are mostly in the $40-$70 psf range but costs can and will vary substantially depending on existing electrical, water and other building conditions. I have seen reported buildout costs as high as $160 psf. The average buildout cost used in this post is $55 psf which is simply the average of $40-$70 psf and not necessarily a market-wide average.
• Investors seem to be pricing in 7-8 year economic lives of the grow facility upgrades.
• Base industrial grow facility rental rates prior to substantial buildout seem to be in the $12-$15 psf range on a NNN basis (NNN referring to all expenses by the tenant). If buildout is included in the rental rate, the case could be made for a rate in the $18.50 to $23.25 psf NNN range, depending on cost.
• Dispensary rental rates and sale prices are generally most similar to a comparable retail property.

Value Drivers

The biggest drivers of value for this property type are physical building factors such as power, water, buildout/condition and legal factors such as zoning, distance requirements, municipal requirements, and state/federal laws.

When appraising or valuing this property type, try to consider what improvements have been made to the subject, and their cost. Of if it is a potential future use, how much time and cash will be required to achieve the use? Keeping in mind that cost is not always equivalent to value- value can easily be higher or lower than cost for these types of improvements. And the time to gain approvals and fund the buildout is more extensive than typical tenant finish.

Some buyers/sellers feel as though any property that is zoned for an MJ use instantly has a higher value, or, that value is as high as a property fully built-out as a grow facility or fully improved as a dispensary. Compared to what? If the comparable has the same zoning, maybe not. If a less favorable zoning, perhaps. Though there may be a premium for zoning, in my experience, the biggest premium is related to actual improvements made to the building.

In Denver, industrial properties zoned for MJ use probably did experience an initial value premium due to zoning only. But during the same time period, the industrial market started to expand. So there was a lot of competition between traditional industrial users and MJ users that drove up prices regardless. And not all properties experienced similar value effects- there were just as many buyers unwilling to pay a premium as there were sellers who were somewhat out of the loop. So the effects were not necessary uniform.

If you are unsure if zoning will result in a higher or lower value, look at comparable sales and/or rentals with a similar zoning. Did they notably sell higher or lower as a result? What did the buyer/seller think?

Like many other commercial property types, if a property requires work and capital improvements to obtain its highest and best use, or a higher value, much of the value-add is after these are complete. On the same token, a piece of land zoned for one story is typically less than what is zoned for 8 stories. An MJ property would typically be considered to have more available uses than a property not zoned for it.

Also consider the legal landscape- is there only one county in the area that allows for this use, or are there multiple? Are there moratoriums expiring or being put in-place? Are there a lot of properties available for this use or only a few? Are there significant changes in the pipeline? Would those be positive or negative for the subject?

Owner Users vs Investors

In my experience, there can be a significant difference in value for an owner-user vs investor. Owner-users are generally willing to pay for the buildout plus a premium, investors, not so much. This is probably partly due to risk and financing- for an investor, if an above market space goes vacant, you can take a significant hit. You are unable to ‘leverage’ the purchase with favorable financing which drives up cap rates. It is considerably more risky to own a property with a federally illegal use. The feds can and will seize properties. Some properties in Denver have been seized because a tenant’s product showed up across state lines. Though it is not common, having a commercial property completely taken with no compensation is a pretty significant risk. There is less risk for an owner-user if you need the building as part of your business.

Fee Simple vs Leased Fee

Appraising any MJ property subject to an existing lease (leased fee estate) vs free and clear of a lease encumbrance (fee simple estate) can have drastic value differences. One can be purchased for owner-occupancy, the other only by an investor. One typically values the improvements more than the other (owner-user). Sometimes only the valuation of one interest is applicable. Sometimes both, or blended if the lease is somewhat short-term. Complicating matters are if a tenant is looking for the market value to purchase the property from the landlord. If any other purchaser besides them, the sale would be subject to the lease and could have a lower value. But if they purchase it, the lease would terminate. Should they pay a higher price because they will terminate the lease? Or is a ‘typical’ buyer in this case an investor?

Cost Approach Considerations

Cost is very important for this property type. As is the time to gain approvals, which can be handled with an ‘entrepreneurial premium’ on the buildout costs. I have seen the premium on buildout be as much as 60% of buildout cost, simply because it takes so long and is such a hassle. I have also seen the value of the buildout be less than cost, because the initial costs were too high, or another reason. As of this post, depending on the project, the value premium seems to be in-line with cost, more or less, with no entrepreneurial incentive.

The traditional cost approach is based on land value plus the depreciated value of the improvements. With these properties, specialized improvement value (grow/retail buildout) may also be added to cost and depreciated separately, when applicable. This could be one cross-check of value.

Though more used in the market and more applicable is likely the cost of obtaining a property available for this use plus the buildout cost and time to do so. If you have a sound basis on the depreciated value (cost minus depreciation) of the specialized improvements, and a sound basis for the underlying property value, you should be able to cross-reference your conclusions with similar properties that do not have a MJ use.

If your value conclusion is significantly higher or lower than the cost to acquire a similar property plus build it out plus an entrepreneurial incentive that takes into account time/funding, there could be a problem with your analysis. There could also be a good reason- perhaps the property is negatively affected by a lease or there is a lack of demand or another good reason.

Cap Rates

As of this post, Denver grow facility cap rates are mostly in the 12.0%-15.0% range. The more above market the lease rate, the higher the cap rate. If the lease rate is comparable or at market for a typical industrial space, the cap rate can be comparable to the overall market. As of this post, the overall Denver industrial market is at around a 7.50% cap rate.

In terms of value via the income approach, the higher rent charged for a MJ property tends to be off-set at least to some degree by a higher cap rate. It may not be uncommon for the value via the income approach to be very similar for a MJ use vs whatever the traditional use is on the property. Though not always the case and is heavily dependent on “market” vs “contract” rent.

Consider this- if a typical property would have NOI of $7.50 psf and a cap rate of 7.5% (typical Denver industrial rates), the value would be $100.00 psf. If an MJ property would have NOI of $15.00 psf and a cap rate of 15.0%, the value is $100.00 psf. This is an example of the off-setting cap rate/rental rate value to an investor.

Dispensary cap rates are also very dependent on the contract lease rate- if the property more or less has a market lease rate comparable to a typical retail store with the same location, quality and condition, cap rates can be comparable to the overall market. If the rate is very high, the cap rate will likely be higher. Conversely, if rent is very below market, the cap rate will be lower than average. I have seen dispensary cap rates in the 6.50%-8.50% range for properties more or less at market rates. There is one dispensary listed for sale currently at a sub 6% cap rate that has not sold.

Rental Rates

Rental rates are significantly driven by tenant improvement allowances (TIA’s) included in the rental rate. Market maturity also play a significant role- When Denver first legalized this use, rental rates skyrocketed to $20.00+ psf NNN but have since tapered off as the industry has matured.

As of this post, most Denver industrial grow facility rates are in the $12.00-$14.00 NNN range with no or minimal TIA’s in the rate. Rental rates can easily push $20.00 psf NNN with significant TIA’s in the rate.

Here are some examples of how to use cap rates, economic life and cost to derive rental rates.

As of this post, I see most dispensary rental rates in the $20.00-$25.00 psf NNN range which is a typical retail rate. Though this can easily be higher or lower depending on the property. A lower quality, non-updated dispensary could be below $20.00 psf. Conversely, a very nice property and/or a property with a lot of land could be $35.00+ psf.

Changing legislation could easily and quickly change market rent.

Initially, when it is more difficult to find space and landlords willing to take on this use, rents are higher. When more municipalities open up to this use, as do building owners, rents become more competitive.

Grow Facility Buildout Cost

In my experience, grow facility buildout costs typically range from about $40.00 to $120.00 psf depending on the property and extent of what is needed, including power upgrades. Most typical properties are under $100 psf, in the $40-$80 psf range. Additional buildout required for this use generally includes power, plumbing, HVAC, lighting and fertilization systems.  On the high side, a full power upgrade could be as much as $30.00 psf.

Gaining zoning approval, planning the design and coming up with the capital required to pay for the hard and soft costs are extensive undertakings. As a result, many MJ owner-users are willing to pay a premium for turn-key space. I have seen entrepreneurial incentive of up to 60% of cost.

Below are some examples of costs for illustrative purposes only.

* 40% entrepreneurial incentive is not actual and is for illustrative purposes only.

Grow Facility Value & Depreciation

The ultimate appraisal question often becomes a matter of whether or not the market value of the buildout is higher, equal to or lower than the installation cost. There is no one answer and every appraisal will likely have a slightly varying conclusion.

Generally, if I have a detailed cost estimate of the buildout, I will depreciate each item or group of items separately. A good rule of thumb is to depreciate most quickly changing/short-term/technically heavy systems in the 3-10 year range. Lighting and similar items can have a shorter life of 1 to 3 years. I depreciate most power upgrades and/or more permanent building system upgrades in-line with the economic life of the building which in Denver is mostly in the 40-80 year range.

Some appraisers argue that lighting, fertilization and other specialty fixtures are equipment, not real estate. This may or may not be the case.

This helps make sense of the value of 3-year old buildout vs new buildout. It also puts in perspective that value can decrease rapidly for grow improvements. Technology changes quickly in this market and growers are constantly seeking the highest yield in the shortest time. This puts downward pressure on grow improvement values.

Having a least some cost basis support of the grow facility buildout is important to understanding how much value it adds to the property.

Here are some examples of how to depreciate the specialized buildout:

Grow Facility Size

It is imperative to calculate how much of the property or approximately how much has grow improvements. Is it most of the building, or just a few rooms? When I appraise grow facilities, I have a mathematical calculation that applies a grow facility premium, if any, to the comps, based on the subject’s percent grow buildout. For example, if the subject is almost entirely grow use vs only about 20%, the value of the property will be affected. Trying to determine how much of a comparable sales is built out for this use is also very important, though not always possible.

Grow Facility Value

I have one paired sale in my database of an industrial property in north Denver that sold in 2014 with no grow improvements for about $93.00 psf then sold 405 days later in 2015 for approximately $215.00 psf, at a 15% cap rate. Including a 10% market conditions adjustment, the indicated premium was approximately $110.00 psf of GBA or 105%.

I have come to find that for the most part this is on the high end of grow facility premiums, however, and is only one sale. Keep in mind that most if not all grow facility sales are unique in one form or another. Relying only on one sale or data point sometimes can provide an incomplete conclusion.

In other cases, I have seen premiums between $50.00 to $70.00 psf of grow area.

However, this is not always the case and is extremely property specific. As one example, if a property is under a long-term lease, say for 10 years or more, the property is most likely going to sell subject to the lease rate and lease terms (leased fee estate).

Here is an example of how to derive a potential grow facility value premium:

Selling a turn-key grow facility capable of owner occupancy is drastically different than selling the same property to investor. The age and specifics of the grow improvements are also very important.

For any one property, an investor could require a 12%-15% cap rate wherein the cost of occupancy or implied owner-user cap rate is more like 7.5%. This could potentially affect value by as much as 100%.

Most importantly, look to the market for the value of grow facility upgrades. It can and will change continually, and per owner-user or investor.

Dispensary Buildout and Value

Most dispensaries are not as customized as a grow facility and are more similar to a typical renovated retail space. Buildout costs are therefore generally similar to typical retail buildout plus a little more depending on the property. Added costs for this use can be related to planning and permitting and hard costs. In Denver, the planning and development office is generally more stringent on bringing these properties up to current ADA compliance and building code. A lot of dispensary spaces end up being gutted down to the studs and brought up to like-new condition.

Typically, the value of a fully renovated retail property with a ‘like-new’ condition is higher than a comparable retail property that is older. In this regard, a fully updated dispensary can have a higher value than an older retail property.

In terms of a premium specifically because it is a dispensary, by and large, I haven’t seen it. But that could change if it becomes harder to approve a location or if other legal requirements change.

Appraisal Complexity

These properties are very complex from an appraisal standpoint for a variety of reasons:

1.     Data- Finding good comparable rentals and sales takes a considerable amount longer than a traditional property. There are fewer transactions overall and when they occur, market participants are not eager to advertise all the details of the transaction. Even in mature markets, there are few transactions compared to traditional uses.

2.     Financing- As of this post, there is no true lender financing available for a property with this use. It is also not legal for most lenders to mortgage a property with this use. If a property requires an all-cash purchaser or an above average interest rate to be financed, the pool of buyers and sellers can be more limited. It also can create difficulties if a property is already financed with a loan. For instance, a retail property that has a mortgage by a lender may not be suitable for this use.

3.     Legal Classification of Buildout- Grow facilities have a lot of fixtures and equipment. Deciphering what is “real estate” vs “personal property” is very difficult and may be open to legal debate. One person may easily consider much of the buildout to be trade fixtures, or removable personal property. Another may consider these items as real estate.

4. Market Changes- Legal and/or other market changes occur rapidly.

5. Legality- What is legal today may not be tomorrow, and vice versa. The legality of the use is not always cut and dry.

6. License Value- Obtaining accurate information as to whether business licenses were included in a transaction or not can be difficult if not impossible.

7. Much more…

Comparable Sales and Rentals

When finding comparable sales for this property type, keep in mind what interest you are appraising in the subject. If fee simple (no lease), your best comparable sales will have sold with no lease in place. If leased fee (with a lease), your best comparable sales will have sold with a lease in place.

Like most other commercial properties, your end-user and market value can be very different if selling to an owner vs an investor.

Leases can and do drastically affect commercial real estate pricing, both for this property type and other commercial property types.

Most of the time, you will struggle to find perfect comparable sales for this property type. Seek to bracket the features of the property- find at least one sale with a similar location, one with a similar condition, one with a similar use, etc. If you can generally bracket the features of the property in the sales, it should generally bracket the value. But even if you can’t bracket the use, having a solid base value for the property if it were not available for this use, is an excellent basis. It may only be one or two more calcs for a premium or value loss associated with the specialized buildout/use.

In my experience, dispensaries are best compared to similar retail properties with a similar building size, similar land size/ratio, similar location and similar condition. I would prefer if there were 6 dispensary sales on the same block for an identical building, but that just isn’t reality.

Seldom if ever will you find enough good sales that are all dispensaries with the same overall retail characteristics of your property. In my opinion, it is better to use a similar retail property in the immediate area, with a similar condition, than a very dissimilar overall property that simply has the same use. It might be good to consider that as one sale, but ultimately value is most affected by the retail property itself not the temporary user.

If licensing is such that the dispensary cannot relocate and the subject will have a competitive advantage moving into the future, perhaps there is a premium for the property. Though in most cases, I have not seen a notable premium simply for an MJ use at the property, and sometimes it can even be negative because of financing difficulties or a lease.

The best grow facility sales are industrial properties with the same use. Barring the ability to find perfect grow use comps, looking at industrial sales with the same zoning and potential use can be good comps to understand the base value. Using industrial properties with additional buildout such as cold storage or manufacturing can help understand the value of a specialized property to a specialized user.

If there is a cost/value premium, one can easily come up with a “base value” of the property then add a specific value premium if applicable. All sales do not have to have the same use. If you think about the specifics of what most properties are used for, it is very rare that the use of the subject and the comps will be identical.

Finding grow facility sales and rentals requires more general internet searching with keywords than a typical commercial appraisal. Use your comparable sales/rental database and make sure to scrub through the data, with no filters. Often times these sales occur with no mention. If it seems like an odd sale or higher than most others, take a look and find out why. But also do a lot of internet searching like “your city” + “grow facility for sale” or “marijuana for lease”, etc. In a lot of cases, you will find more and better data with general internet searches than your comps database. Though a lot of postings online include business licenses and plants.

Licenses & Business Value

The recreational or medical marijuana license itself, like a liquor license, can be very valuable. If you have some high sales prices, try to make sure the license was not included, if you are appraising the real estate only. If it is a ‘turn-key’ operation with existing plants, product and/or a business, most likely there was a lot of value included in the sale that was not real estate.

Build Your Database

Keep a file on your computer that is only MJ info. If you come across an MJ comp or article when you are doing another property, take time to put it in that file for when you need it later. Put a few notes in there about it as well. Perhaps it seems higher or lower than a typical property? How much higher or lower was that cap rate, rental rate or sales price compared to what you were working on? The more info you can say about it while you are in the midst of something, the better.

Superadequacies

A property has a superadequacy if it has an improvement in excess of what the market will pay for that improvement. In some cases, if a dispensary or grow user goes well beyond what is ‘typical’, they will not recoup that value. If a grow facility is extensively upgraded but the appraiser determines that the value of the upgrades is less than the cost, that is a superadequacy.

As an appraiser, don’t be afraid to call the grow improvements a superadequacy if you legitimately determine such. But if doing so, the burden of proof lies on you. In my opinion, until otherwise indicated, the value is generally equivalent with the typical cost. If the improvements have less value than cost, there needs to be some support for it besides simply that the appraiser doesn’t understand why people pay for certain things. You may not see the value, but someone running one of these businesses might.

Tips for Appraisers

If you are an appraiser, here are a few tips:

1.     Spend time researching general legal issues regarding zoning and use for your property type beyond what you would do for a typical appraisal.

2.     The time to appraise a MJ property is about double if not triple a standard commercial property. It could even be longer on your first one or two. Charge accordingly.

3.     We collect our appraisal fees up front for all appraisals.

4.     Be flexible until your final adjustment. Accept new data and calculations as they present themselves. Try not to conceive your value before it is truly supported. What you start off thinking can and will change when you get more data or analysis. Accept that you might be wrong and seek a variety of opinions, not just your own.

5.     Talk to brokers and users of this property type. Your best information and market support will come from picking up the phone and talking with people doing this stuff daily.

6.     Disclose: “The use of the subject is related to marijuana sales and/or cultivation and is federally illegal. The property can be taken at any time by the Federal government without compensation. Market participants are not currently paying lower prices for this fact.”

7.     Disclose: “The appraisal is based on the extraordinary assumption/hypothetical condition that all marijuana related fixtures such as xyz are real estate and not removable personal property. If any fixtures on or in the property are removed, or any other item that what present on the date of the inspection is no longer at the property, or is found to be personal property and not real estate, the results of this assignment may be affected.”

8.     Keep disclosing, the more the better.

9. Use the tools you have learned about and may seldom use. Try to really “extract” what the market is or is not paying for.

Closing Thoughts

What is stated in this article may or may not apply to your appraisal and/or situation. Even if you engage me to appraise your MJ property, I could appraise it entirely different than what is said in this article. Every property and point in time is different and simply because something is said here doesn’t mean it is right or applies to any specific property.

I have learned a fair bit appraising these properties and I’m sure will learn more every time I do one. I could be wrong, and everything on here could also be wrong. This post is not legal advice and is non-factual and opinion-based only.

Market strength will continue to transform the value of MJ properties. Like most other specialized properties, I would expect the contributory value of MJ uses/improvements to be less in a down market and more in an up market.

Like most new markets, pricing is initially high across the board then comes down with more competition. The price of marijuana in Denver has fallen since being legalized. So have rental rates, for the most part. The important thing is to value the property based on the market’s perception of it, not whether you see it as good or bad.

The industry needs people to be able to value these types of properties. To do so, people need to be able to discuss facts and opinions.

To appraisers considering appraising these property types- if MJ is legal or soon to be legal in your area, you will eventually have to understand MJ value even if you never appraise a single property with this use. In Denver, if you don’t at least have a working knowledge of these issues, you could very will miss-value standard properties. You will have to adapt in some shape or form, you may as well be the front-runner.

Thanks for reading.

If you have comments and/or data points please post below.