Legalizing recreational marijuana in California is creating a gold rush for a decidedly less intoxicating sector: warehouses in which to grow the plants.
Investors have few options to cash in directly on the state's recent decision to legalize the drug, as there are no publicly traded cannabis producing companies and marijuana remains illegal under federal law. However, they are anticipating a lift in demand for warehouses as legal pot companies search for space to grow their supply.
Shares of industrial warehouse companies such as Prologis Inc, Rexford Industrial Realty Inc and Terreno Realty Corp that have significant exposure to the California market should benefit even if they do not lease to marijuana companies directly, fund managers and analysts say.
This is because cannabis companies are expected to pay above-market rates for older, outmoded facilities that are more suitable for growing plants indoors and storing products containing marijuana, taking out some of the vacancy in an already-tight market and pushing overall rents higher, said Michael Underhill, a portfolio manager at RidgeWorth Capital.
"Cannabis companies are going to find some distressed properties and get them up and running, and in many cases they will have the capital to pay whatever it takes to get space," said Underhill, adding that this allows companies with more modern facilities to charger higher rents.
Underhill said he finds real estate investment trusts for California-based warehouses attractive but did not comment on whether he owns any.
A spokesman for Rexford said the company would not lease space to such users, "but this new demand is expected to be a benefit, overall."
Prologis and Terreno declined to comment.
BALLOT BOX VICTORIES
California last month became the most populous U.S. state to make recreational marijuana legal for adults, in a major victory for supporters of liberalized drug laws.
Recreational marijuana was first approved in 2012 by the states of Washington and Colorado, and later by voters in Oregon, Alaska and the District of Columbia. In addition to California, Massachusetts and Nevada also approved recreational use last month.
The increasing need for warehouse space in California on the part of marijuana-related companies comes as consumers are doing more of their shopping online through Amazon.com Inc and other retailers, adding another demand driver for distribution centers.
Warehouse rents jumped 10 percent in Colorado after legal marijuana sales began in 2014, according to CBRE Inc, a real-estate data firm. Shares of First Industrial Realty Trust Inc - which, at 5 percent of assets, has the biggest slice of its portfolio in the Denver market - jumped 25 percent the same year, a figure double that of the broad S&P 500 Index.
Pot grown indoors is typically more consistent and has higher concentrations of tetrahydrocannabinol (THC), the psychoactive agent in marijuana.
FUND OWNERSHIP RISING IN FALLING MARKET
The number of funds owning shares of California-focused warehouse companies is rising while the broad real estate sector slips. The number of funds owning Prologis - the largest warehouse REIT overall, which has about 20 percent of its portfolio in California - increased 11 percent over the last quarter, according to Morningstar data. Fund ownership of Rexford and Terreno, smaller companies that have 20 percent or more of their portfolios in the state, grew by about 2 percent.
Overall, the MSCI U.S. REIT index is down 4 percent over the last three months as investors move away from dividend-focused companies in anticipation of higher interest rates. Shares of Terreno and Rexford are both up approximately 9 percent and shares of Prologis are up 4 percent over the same time, even as they offer lower yields than the average 3.6 percent of the S&P Real Estate sector.
Increased pricing power from a tighter market should help California-focused warehouse companies counter rising interest rates, said Jonathan Petersen, an analyst at Jefferies.
"Rent growth is very strong and they have some occupancy to lease up at higher rates," he said.
Approximately 90 percent of Rexford's inventory is leased, compared with about 96 percent of all warehouses in Southern California, which should give the company stronger rent and occupancy growth than its peers, he said.
RISKS OF INVESTING IN POT COMPANIES
Investors have shied away from most companies that have direct ties to the marijuana industry because the drug remains illegal under federal law. Innovative Industrial Properties Inc, the first REIT that focuses on warehouses for regulated medical-use marijuana production, began trading on Dec. 1 at an IPO price of $20 per share. Shares had eased to $17.50 as of Tuesday afternoon.
Eric Frankel, an analyst at Green Street Advisors, said the lack of institutional ownership will put the lid on the pace of the marijuana industry's expansion overall. Yet he added that recreational marijuana will likely help warehouse companies in any state in which it is legal.
"Someone is going to be willing to lease to these guys, and the whole industry is going to see a catalyst from that," he said.
(Reporting by David Randall in New York; Editing by Dan Burns and Matthew Lewis)