By MICHAEL AUSHENKER Staff Reporter Despite legalization, cannabis remains a touchy and controversial product for industrial real estate brokers. Take the case of Ron Kassan, a veteran broker who has worked out of the Encino office of Beitler Commercial Realty Services for more than 30 years. A little more than a year ago, he put together a team of himself and three other brokers, and before they could really get started, cannabis clients were calling them. “During the fourth quarter of 2017 and the first and second quarters of 2018, our phones were ringing off the hook with cannabis growers looking for industrial buildings,” Kassan recalled. “Unlicensed growers were desperate to find property and willing to pay up to 200 percent above then-market rental rates to lease or buy industrial property. The demand at those rates captured the interest of many of our building owners.” However, as Team Kassan learned the hard way, such deals can easily go sideways. “As brokers, we thought our local markets were forever changed and that cannabis businesses represented the new standard,” Kassan recalled. “Reality couldn’t have been further from the truth.” Senior Associate Arthur Minassian, a member of Kassan’s team, said that with the January 2018 commencement of California’s legalized commercial activity came two new taxes: a cultivation tax and a 15 percent excise tax on the purchase of cannabis and related products. “The laws and regulations change so frequently that it is impossible to keep up with mandates being issued by the Bureau of Cannabis Control and other agencies,” Kassan added, noting that, additionally, the industry’s state rules conflict with U.S. federal law, under which cannabis remains illegal. Kassan and Minassian relate one of the most extreme learning curves their brokerage team went through last year with a Sylmar industrial facility. “We received an unsolicited offer for a sales price that was so high, our owner was willing to sell the building and force out his current tenant who had an option to purchase the building and a term on the lease,” Minassian said. The offer was hard to resist as the cannabis supplier arrived strapped. “The guy is willing to pay us a gigantic amount for the building,” Minassian said. “(The building’s owner) kicks out (the existing tenant) by paying him off hundreds of thousands. The tenant goes bye-bye. We go into escrow and it’s an investment with a cannabis tenant in tow. Right before their due diligence (on escrow) was set to expire, they backed out of the deal.” Ultimately, Minassian explained, the prospective tenants “weren’t able to get their licensing. Because the tenant wouldn’t sign the lease, (the deal imploded).” That left the warehouse’s owner with an empty building. “When our seller kicked out his tenant, the tenant was paying rent and the owner had a mortgage to pay,” Minassian said. “He had 10 months of mortgage without a tenant.” What’s worse, the situation repeated itself. In total, the industrial site went into escrow six times before Kassan’s team could finalize a sale – although only the first few deals were cannabis-industry related. Had the warehouse’s owner not chased out his original tenant — who was also interested in buying the building — to court the seemingly wealthier cannabis tenant, Beitler would have represented both ends of the deal, Minassian said — likely for an identical price at which they ultimately sold the building. “The building eventually sold to (a traditional) industrial owner,” Minassian said. “We did a year’s worth of work and ended up with the same amount we would have.” Representatives of CBRE Group Inc., Colliers International and Cushman & Wakefield declined to have their brokers discuss the cannabis industry with the Business Journal. Colorado: California’s future? Colorado is five years ahead of the California in legalizing the cannabis industry as well as profiting from it. However, based on California’s first-year 2018 data, the question remains if and when the Golden State can fold the weed business into the mainstream as relatively seamlessly as in Colorado, and when it comes to commercial real estate, brokers have seen plenty of hiccups so far. Many believe the problem in California lies with the dual-license system mandating that cannabis businesses have a license with both state and city. “California decided to do everything different than any other state that legalized cannabis and create a very complex regulatory scheme,” Arcview Group Chief Executive Troy Dayton told Bisnow in a Jan. 7 report. “We are starting to see the effects of that. Every time you add complexity, you add things that can go wrong. And a lot of things have gone wrong in the implementation of the laws here and it has really slowed things down and put a lot of people out of business.” In January 2014, Colorado’s first dispensaries began legal recreational sales, and financial data released this month by Colorado’s Department of Criminal Justice, describes what might be a mixed bag at best, according to a Jan. 10 report by Yahoo! Finance. In 2014, combined recreational and medical sales totaled nearly $684 million; in 2018, they are expected to top $1.5 billion. The most recently published sales data shows combined 2018 sales through October of $1.27 billion. Socially, the legalization of marijuana has produced its share of mayhem in the Centennial State, with significant rises in DUI citations, cannabinoid-related fatal car accidents and marijuana-related hospitalizations. On the other hand, tax revenues have jumped 266 percent, from $67 million in 2014 to $247 million in 2017. Colorado’s pot tax revenues currently represent about 1 percent of the state’s 2018-2019 fiscal year budget. However, since the November 2016 passage of Proposition 64, California’s legal market has performed neither as well as Colorado nor as California state officials and the cannabis industry had hoped. State officials who had envisioned $1 billion in annual tax revenue from legal cannabis have instead seen collective disappointment. During the first three quarters of 2018, California collected $228 million in revenue from legal cannabis, a shortfall from the $630 million annual total projected by the state. Although the Colorado market is years ahead of California, when the Beitler team attended a real estate industry conference last summer called the Commercial Network, they were warned by their Colorado counterparts not to deal with the cannabis sector. From a real estate perspective, those brokers described the market in Colorado as a shamble. “They all told us about how much of a time-suck it is,” Minassian said “They experienced the same frustration,” Kassan added. “It’s one in many deals (that is legitimate) and it’s a waste of time.” For Kassan, dealing with the marijuana industry has left a bitter taste in his mouth, but he hasn’t given up quite yet. At one point the Beitler team represented a 12,000-square-foot building in Hollywood that experienced a high volume of back-out from interested cannabis companies. “We have shown that property 60 times,” Kassan said. “In short order, we became educated about the cannabis industry, and started recommending to our clients that they not accept cannabis use in their properties unless the company could show us a valid cannabis license, an already established business and adequate financial information.” After about the 30th time showing that property, the team devised a “cannabis questionnaire” to separate the wheat from the chaff. “Half of the people don’t fill it out, so they’re not legitimate,” Kassan noted. “Or we’ve had brokers who fill it out (for their cannabis client) and they have no idea if they’re licensed or not.” Kassan estimates that one out of every 100 cannabis-related calls his office receives fits the brokerage’s criteria and likens finding a legitimate cannabis industry company to “finding the needle in a haystack.” But he stopped short of saying that he will not entertain prospective buyers or tenants from the marijuana industry. “We’re not officially out of it because some of our owners are still demanding we bring cannabis prospects,” Kassan said. “They say walk and we have to run.” “We’re not going to tell the client what to do,” Minassian added. “Our job is to help educate them.” ‘Fool’s Gold’ Another broker who is cautious about the cannabis industry is Jeff Abraham. Abraham, a member of ‘Team DeGrinis,’ which just opened a Woodland Hills office under the new brokerage they just aligned with, Newmark Knight Frank, told the Business Journal that last year’s incoming marijuana laws “led to learning a lot more of how that industry works.” In 2018, Team DeGrinis, at the time still affiliated with Colliers International, closed the deal with the owner of a Chatsworth warehouse who wanted to lease to a cannabis operation. In that particular case, all of the stars aligned: the tenant was legitimate and a cannabis industry leader; the owner knew both the tenant and the industry very well; the building (air-conditioned, on a gated property) and location were both great for a cannabis company. Also, the owner owned the building free and clear so there was no bank associated with the property. This is crucial as cannabis cultivation remains a federal offense and notable banks and lenders cannot be involved in that industry as of now. “It was a calculated risk,” Abraham told the Business Journal, about taking on this deal. However, Abraham was quick to add that this transaction was something of a unicorn and that most cannabis-related businesses in the current California atmosphere could not be counted on. “You had a private owner of the building who wanted to do a transaction,” Abraham said. “Institutional owners won’t touch it. The profile of your typical Valley owner is still private individuals, but the strong post-Recession economic run has led to many high-profile REITS acquiring industrial properties throughout the San Fernando Valley.” If leasing was not an option, many owners envisioned reaping above-the-market prices for their Valley warehouses by selling to a cannabis group at $300 to $400 per square foot. However, it “quickly became fool’s gold because these groups could not obtain financing,” Abraham said. “Some groups had private investors working with them; however, paying all-cash well above market value with no assurance they would be approved for cultivation proved to be too great of a risk for most. It’s simply not nearly as glamorous as it seemed.” In addition to a business sector laden with wanton actors and state of California bureaucracy, Abraham said the cannabis industry, in general, is not worth the headaches because “typically, they’re smaller transactions,” he said — the buildings that work best for marijuana growers ten to be only 5,000 to 15,000 square feet. Growing pains Given this industry’s instability, it creates much more work for the broker than a traditional tenant would. “I must’ve toured 25 groups through the Chatsworth property,” Abraham said. The reliable and legitimate marijuana player, “that’s very, very difficult to find,” Abraham said. While some may have cash up front, they may not have good credit or stable long-term funding, especially since a bank will not provide financing. Ultimately, Abraham and his colleagues reached a conclusion to not focus their time and energy on this industry. Abraham believes that a big part of the problem has been state bureaucracy in that industry. “It should’ve been something that was figured out a decade ago but government agencies in California, they want things a certain way,” Abraham said. “It’s taken longer than it should of. California should’ve been the leader, ahead of Colorado.” Today however, he believes the cannabis industry is still going through growing pains. “What that industry looks like today is not what it will look like in five years or 10 years from now,” he said.