LOS ANGELES - The parking lot outside a stark-looking dispensary on a busy Los Angeles street is almost full on a weekday afternoon. Inside, jars of weed line the shelves behind a counter and colorful signs show prices. But if everything looks normal, it isn't.
The dispensary is part of a booming black market.
"The black market is a huge problem," said Patricia Heer, an attorney and founder of Cannabis Law Digest. "In some states, it's between 70% and 80% of sales."
Many saw legalization of marijuana as a huge economic opportunity, but the reality is its potential isn't fully realized. An underground economy is cutting into the profits of legal businesses. New Frontier Data, a Denver-based company that studies cannabis trends, estimates there are $70 billion in illegal sales nationally — seven times the size of the legal market. This means the legal market is "capturing only a fraction of total demand," the company said in a summary of U.S. cannabis demand trends released this month.
In California, early projections anticipated annual cannabis tax receipts of more than $1 billion by 2018. But those predictions were far off, with $345 million actually collected last year, according to the state's legislative analyst's office and tax records. The black market is widely cited as a major reason for the lower numbers.
It's not hard to see why.
A team of CNBC producers carrying hidden cameras visited 10 illegal cannabis dispensaries across LA. Some allow open consumption of weed. Others offer free cannabis for a positive review on Weedmaps, an online listing of legal and illegal cannabis businesses around the country. Others are open past 10 p.m. None of this is allowed under state regulations.
And despite a legal limit on the daily amount of cannabis stores are allowed to sell, there's no limit in many of the illegal stores.
CNBC did not purchase any products from the illegal dispensaries. None of the 10 visited by producers responded to repeated requests for comment.
"There are so many unlicensed locations that the cannabis locations that are playing by the rules are deeply concerned," Los Angeles City Attorney Mike Feuer said. He said he was not surprised when shown a compilation of videos from the illegal dispensaries.
Feuer recently said his office has shut down 151 illegal dispensaries, with more criminal prosecutions underway. At the same time, more than 1,000 defendants connected to illegal dispensaries and delivery services have been prosecuted, he said.
His office also has used civil litigation to go after illegal stores, with a recent lawsuit against one dispensary, which he said was selling cannabis laced with a type of pesticide used on golf courses. The case is pending.
"I do not think your viewers who buy marijuana are aware of the grave risks associated with buying marijuana at a location that does not test its product," he said.
In another tactic aimed at illegal dispensaries, the Los Angeles Police Department has accompanied city officials on operations in which they shut off utilities at illegal stores. Nevertheless, about 55% of the stores reopen within a week, said Detective Vito Ceccia.
"When we go out and conduct any type of enforcement effort, when we leave that location it is shut down," Ceccia said. "It doesn't mean it's going to be shut down the next day. It doesn't mean it's going to be shut down in a week."
So far in 2019, the LAPD has arrested 277 people in connection with raids at unlicensed cannabis businesses with a total of 562 arrests last year.
A review of Weedmaps listings in mid-June found 229 illegal dispensaries in LA. The Los Angeles Police Department estimates the number is closer to 259, but no one knows exactly how many are in business. There are 186 licensed dispensaries in LA.
Cat Packer, executive director of the city's department of cannabis regulation, declined repeated requests for an interview. Her office would not offer a reason for turning down the request.
California voters approved Proposition 64 in 2016. A total of 11 states have legalized recreational cannabis usage.
California's Bureau of Cannabis Control last year issued a cease-and-desist order to Weedmaps for "engaging in activity that violates state cannabis law" by listing illegal businesses. The company responded that it's a "technology company and an interactive computer service" that is protected by free speech exemptions under the Communications Decency Act.
In a statement, company spokesman Carl Fillichio said it "provides patients and consumers with valuable information about all things cannabis. We also advocate for them and the cannabis industry."
He said targeting online platforms that advertise cannabis "is not going to solve the unlicensed dispensary problem."
"Weedmaps is an agnostic information platform where businesses, consumers and patients can search and discover cannabis products," Fillichio said. "Businesses can self-report their listing in the same manner as on other digital platforms."
California's Bureau of Cannabis Control recently launched a $1.7 million public awareness campaign called "Get #weedwise" to educate consumers about buying from licensed businesses, which are listed on state and city websites.
In addition, the bureau has issued 3,915 cease-and-desist letters in 2018 and 2019 to illegal dispensaries and received 8,584 complaints from consumers, as of late June.
Cannabis industry attorney David Welch said he doubts these efforts will have much impact.
"What you find are dispensaries not being enforced against," Welch said. "Even when they're enforced against, they simply go and open up the next day because the penalties are so low it doesn't dissuade them from violating the law because the profit they're making is so much more."
The penalties are largely misdemeanors so if a store is shut down, there is an incentive to reopen since it's likely there will only be a fine, he said.
Cameron Wald, executive vice president of Project Cannabis, which owns four stores in LA, said the illegal dispensaries can sell the same product for nearly 40% less than a legal store.
"We have outrageous price compression that we have to see at our stores to compete with people that are not paying their taxes," he said. "They're not paying their permitting fees. They're not paying the city."
However, he doesn't expect increasing the number of available legal licenses in the city would solve the problem. The city is expected to issue 250 more licenses in the fall.
"We have (186) licensed stores right now and they're not even doing a good job of monitoring the illegal activity that's happening around them," Wald said. "Now they're going to fold in another 250 that they're going to regulate? I just think that enforcement against illegal operators just goes to the wayside."
A 2019 study conducted by Applied Development Economics estimated that California has about $6.2 billion in cannabis demand from "presumably illegal sales."
"I think that the black market is going to be a threat until we actually have it at the legal level," said attorney Susan Ameel, a partner at Global Regulatory Risk Advisors. "Only interstate commerce is going to prevent the diversion of marijuana from a legal state to a state where it is still illegal."
"Unlicensed shops outnumber licensed stores," said Virgil Grant, the operator of three licensed dispensaries and the co-founder of the California Minority Alliance, a cannabis trade group.
South LA, a historically minority community, has been one area with a large number of unlicensed shops, the California Minority Alliance said.
"Unlicensed shops have been a public nuisance and pose a critical public safety issue to the residents of South Los Angeles. The lack of enforcement has turned safe communities into havens for illicit activity encouraging the proliferation of unlawful cannabis operations," the advocacy group said in a letter to the city attorney and city council.
One way to solve the problem may be more licenses, especially for minorities. "Giving out more licenses is probably a good thing. The more licenses you give out, the more you can compete with the unlicensed shops. Begin to drown out unlicensed shops," said Grant, who owns one dispensary in South LA.
However, Grant warned that along with more licenses, the city needs more enforcement.
"Lower taxes or suspend taxes to allow us to charge the same rates everybody else charges," he said.
Wald said legal operators like himself need to see more assurance from city and state officials that they are going to solve the problem.
"This is the most influential market in cannabis in the world," Wald said. "So if we can't get it right, that's going to be embarrassing."
—CNBC's Yasmin Khorram, Louise Connelly, Caroline Skinner and Waverly Colville contributed to this report.