Housing shortage, legal cannabis businesses test Sonoma County's commercial property market

Sonoma County’s commercial real estate sector will mark 2018 as the year the cannabis “green rush” cooled, after the historic wildfires singed the local property market.

Eight months after recreational marijuana use became legal, many potential cannabis businesses in Santa Rosa still are awaiting permits and only a fraction actually have begun operations. An initial frenzy of speculation receded as entrepreneurs recalibrated building values. The long-term import of the county’s legal cannabis trade remains debatable.

In the aftermath of the fires last year, real estate experts acknowledged the county’s commercial properties suffered far less than the 5,300 homes destroyed in the October blazes. Nonetheless, the ongoing home rebuilding effort has boosted costs for commercial construction, including tenant improvements.

Moreover, the loss of so many houses and apartments in an already tight housing market is having a negative effect on the overall commercial market, real estate brokers and business park owners said. The housing shortage has outside business owners questioning the wisdom of relocating operations here, where workers would have trouble finding a place to live.

“It’ll be a huge impact going forward,” Al Coppin, president of Santa Rosa brokerage Keegan & Coppin/Oncor International, said of the wildfires’ blow to real estate.

Commercial brokerages used to have “a great story” to tell about financial and cultural advantages of placing a business in Wine Country, Coppin said. With the lack of housing, “now we’ve got one hand tied behind our back,” he said.

The county has made considerable progress eliminating a glut of empty commercial buildings from the recession a decade ago. Nonetheless, it took considerable time to land tenants for many offices, warehouses and manufacturing spaces.

Office vacancies stood at 12.7 percent for the year’s second quarter ending June 30, according to Keegan & Coppin. Five years ago, it hovered at 22.3 percent.

Industrial space in the second quarter of 2013 had a vacancy rate of 11.5 percent. Today, the rate has fallen to 4 percent countywide, with part of that decline due to leases and sales for cannabis cultivation and manufacturing.

Retail vacancies, meanwhile, declined to 3.7 percent this spring from 5.1 percent five years earlier.

For those seeking a business location, the county remains “a very desirable place to live, work and play,” said Blake Riva, president of Basin Street Properties, the county’s largest landlord.

With 5 million square feet of commercial space in its portfolio, the Reno-based company got its start in Petaluma. More than 90 percent of Basin Street’s properties here are leased, Riva said.

“That’s a pretty strong indicator of the strength of the commercial office space in Sonoma County today,” he said.

Sweeteners to lure tenants fade

After the economic downturn, landlords gave away months of free rent and made other concessions in order to sign tenants. Such benefits are less common today, due to fewer vacancies and higher costs of renovating space for tenants, brokers said.

Since the fires last year, “costs have increased significantly, making it more difficult for owners to make the improvement modifications necessary, while rental rates remain relatively flat,” Paul Schwartz, a senior associate in the commercial division of Santa Rosa-based Terra Firma Global Partners, wrote in an email.

For example, construction costs rose 10 percent between January and April on a new 57,000-square-foot industrial building in Windsor, said Larry Wasem, managing general partner of the Airport Business Center.

Along with increased costs, the county’s housing shortage is weakening demand for commercial space, Wasem said. Prospective tenants wonder “Where are my employees going to live?”

Higher construction costs and a lack of housing make the county less appealing than lower-priced regions outside the Bay Area, he said. When businesses call to inquire, Wasem asks whether they’re considering cities and states farther away. If they say “yes” and mention places like Reno or even Alabama, he discourages them from further talk about locating here.

“We’re just wasting each other’s time,” Wasem said.

While commercial construction has been limited this year, an industrial park is rising east of the Charles M. Schulz-Sonoma County Airport. Billa Landing is slated to house 370,000 square feet in five buildings near North Laughlin Road and Copperhill Parkway. The first two buildings are under construction and already one is leased, said Danny Jones, a partner with Keegan & Coppin.

The park’s developer, former Telecom Valley entrepreneur Ajaib Bhadare, plans to start a building each time he gains a lease for one under construction. Commercial building on speculation has proven more successful than waiting to first find a tenant, Jones said, but it requires a developer willing to make a major investment and “trust the demand will be there.”

In Bhadare’s favor, the vacancy rate for industrial space in the area between the airport and Healdsburg is less than 2 percent, according to Keegan & Coppin. Such a market favors landlords but a vacancy rate closer to 10 percent would be more balanced between tenants and building owners, Jones and Coppin said.

Cannabis space costs leveling

Cannabis entrepreneurs last year prepared to launch businesses once California legalized recreational marijuana effective Jan. 1. Some paid large sums for local properties on the theory that being first to market would more than make up for excessive land purchases.

What resulted were “speculators that got it right and speculators that got it wrong,” said Tim Ricard, who manages the county’s cannabis program and is part of the county Economic Development Board staff.

Building costs for marijuana-?related enterprises are “coming back to earth,” after the wave of speculation last year, Ricard said. This year so far more than 120 businesses have applied for permits to operate retail, cultivation, manufacturing and other operations within Santa Rosa. About 40 have received permits, with another 80 or so in the review process, according to a new city report.

The combined space of those proposed operations would cover in excess of 790,000 square feet, with more than half of it already approved. The city has about 10 million square feet of industrially zoned land, where the vast majority of cannabis operations would be situated.

The city report attributed the increase in lease prices for industrial space to $2 or more a square foot this year, up from 90 cents to ?$1.10 a year ago to cannabis firms. The price of industrial buildings, meanwhile, increased to as much as $250 a square foot this year, jumping from $80 a square foot in 2014.

City planning director David Guhin, whose department wrote the report, said in an email businesses granted permission for cannabis commerce in Santa Rosa have moved slowly to get building permits and begin operations.

Two high-profile buildings that were sold for cannabis businesses last year, the T&B sports site on West Steele Lane and the Cokas Dikos furniture outlet on Industrial Drive, have new operators still preparing to open their doors, Guhin said. And a third, formerly home of the Sonoma County Farm Bureau on Piner Road, is slated for city review this month of a proposal to split the lot into two separate parcels.

This year some cannabis-related buildings have been resold at lower prices, too, brokers and commercial real estate agents said. The market for such space could be in flux for the next few years as the legal pot industry gains traction.

Regarding the future value of such buildings, “my guess is it’s probably going to be lower, because it went up really, really high,” said Todd Schapmire, an agent who sells commercial and residential properties in Sonoma and Mendocino counties for Santa Rosa-based ?W Real Estate.

In Santa Rosa, the city has approved three permits for retail pot dispensaries and is reviewing another 38 applicants. Of those, almost two dozen will be reviewed and some likely turned down because of the potential for an overconcentration of dispensaries in certain neighborhoods, Santa Rosa attorney Dan Beck said.

Beck estimated “there could be seven or eight” retail outlets that actually receive a permit to operate from among the nearly two dozen under review.

Meanwhile, businesses that want to grow marijuana inside industrial buildings face a different challenge: securing the extra power needed for the “grow lights,” fans and other equipment.

The typical industrial building is equipped for 400 to 800 amps of power, said Stephen Skinner, an advisor with Keegan & Coppin. A typical cannabis cultivation operation can require 2,000 amps, he said. Making the required electrical improvements can cost tens of thousands of dollars.

Scarcity could hurt economy

Santa Rosa has succeeded in drawing many potential cannabis businesses because it enacted relatively low taxes and clear regulatory guidelines, Skinner said.

Skeptics continue to wonder, though, how much the fledgling sector will add to the county economy. Beck, the founder of Beck Law, predicted in three years the city will enjoy “a very, very productive cannabis industry.”

Looking ahead at the commercial property sector, Coppin said local officials must set aside more land for office and industrial business parks. Manufacturing can offer a much bigger boost to the local economy than tourism, he said, and a lack of growth in commercial space would stunt economic growth.

A report earlier this year by the county Economic Development Board said the demand for commercial space should be studied further and “cannot be forgotten,” despite the shortage of housing stock.

“Local businesses need modern, utility-served warehouse, office, and flex space to expand as they modernize and grow their operations,” according to the Strategic Sonoma report.

You can reach Staff Writer Robert Digitale at 707-521-5285 or robert.digitale@pressdemocrat.com. On Twitter @rdigit.