Why the Legalization of Marijuana Will Have a Negative Impact on These REITs

Marijuana legalization is set to take place in Canada within the next year, and there are many legal issues that need to be sorted out before that happens. However, those issues largely relate to how marijuana will be sold, distributed, and advertised. Marijuana legalization will also impact other industries and companies as well, and I will specifically focus on how it could affect residential REITs.

Residential REITs, like Canadian Apartment Properties REIT  (TSX:CAR.UN) and Boardwalk REIT (TSX:BEI.UN), operate apartments and townhomes — the very types of properties, where people could legally grow marijuana themselves.

Any adult will be able to have a grow-op 

When marijuana becomes legal in Canada it can have serious impacts beyond just the ability of people to consume it for recreational purposes. The new legislation would allow any adult to grow up to four plants in a residence.

Insurance providers don’t want to insure the risk

There are many inherent risks with growing marijuana, and insurance companies are unwilling to cover the risks related to it — at least not yet. Marijuana grow-ops lead to lots of moisture, which can create mould that could result in potentially expensive repairs for the landlord. In addition, grow-ops can also be fire hazards and create poor air quality inside the residence.

There is no shortage of issues for landlords when tenants are allowed to grow marijuana. The law is clearly on the side of the tenants at this point and puts landlords in a precarious position.

Landlords might not know of a grow-op until well after damage has been done

Even if landlords were to try and restrict grow-ops by putting conditions in the rental agreement, those terms may not be enforceable. In fact, under existing legislation for those that are allowed to grow marijuana, landlords don’t have the right to even know about it.

The obvious concern here is that if a landlord doesn’t know of the grow-op going on, then there is no way to prepare or mitigate the related risks. This could result in costly expenses to repair any damages after the tenants have moved out.

What this means for investors

Long term, this could mean lots of problems for shareholders of these companies since it could mean added expenses that will erode the profitability of these stocks. It remains to be seen the scale of these potential issues and how widespread of a problem marijuana grow-ops will be for the industry. There is still time before legalization takes place, and some of these issues may be resolved by that time.

However, if landlords don’t even know about the grow-ops in the first place, it would be difficult to enforce any laws relating to the amount a tenant can grow, to what height, and whatever other restrictions (if any) are put into place.

Although the legalization of marijuana might be good news for stocks like Canopy Growth Corp. (TSX:WEED), companies operating residential properties are likely not looking forward to the day when grow-ops become legal.

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Fool contributor David Jagielski has no position in any stocks mentioned.

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