Cold storage: a real estate perspective
The appetite for yield in the industrial sector is driving the investor demand for cold storage assets, from both the equity and lending community.
Industrial real estate has emerged as one of the most sought-after property types by institutional investors due to historically strong market fundamentals and the boom in e-commerce. According to the National Council of Real Estate Investment Fiduciaries (NCREIF), the industrial sector delivered total returns of 13.07 percent in 2017, more than twice the returns of any other asset class. Additionally, according to Real Capital Analytics (RCA), the industrial property sector was the only real estate asset class with an increase in deal volume in 2017, a year-over-year increase of 20 percent.
Increased investor demand has led to a historically low cap rate environment, leaving many investors feeling priced out of the primary coastal markets. As such, investors are expanding to secondary markets and looking at non-traditional industrial assets in an effort to deploy capital into the space. Queue Public Refrigerated Warehouses (PRW), commonly known as cold storage facilities. The appetite for yield in the industrial sector is driving the investor demand for cold storage assets, from both the equity and lending community.
The consumer is becoming more conscious about what and how they eat. As demand for healthy, fresh food increases, the requirement for storage of fish, poultry, meat and produce increases. Couple that with the demographic shift to more urban locations and the ever-increasing population, the need for more PRW’s or cold storage buildings is a natural evolution. Historically, JLL’s cold storage experts have seen a 150 to 200 basis point spread in cap rate between dry warehouse and cold storage. With the recent rise in investor demand, that spread compress to 100 to 150 basis points, and, in certain cases, 75 basis points for Class A product located in gateway markets like Los Angeles, New Jersey or the East Bay. This as evidence that institutional capital is warming up to the cold storage asset class and anticipate further compression of cap rates.
In May 2018, Blackstone, one of the most prolific investors in commercial real estate, purchased a 2.3-million-square-foot portfolio of nine industrial properties that were primarily cold storage facilities for $255 million at a 6.25 percent cap rate. The properties are in Maryland, Georgia, Texas and Northern California, which are some of the leading markets for cold storage warehouses.
Cold Storage Real Estate Perspective
The value metric of cold storage warehouses is based primarily on the number of pallet positions per cubic feet. This is evidenced by the newest cold storage buildings being constructed with clear heights far exceeding dry warehouse buildings (as high as 110 feet). However, rents are cited on the basis of square footage and can be nearly double the cost of dry warehouses (see below for rent comps). Operators like Preferred Freezer will enter into a full-building lease for up to 30 years and lease out pallet positions to smaller users. Due to the higher cost of rent and the steep cost of construction ($250 to $350 per square foot), investors have to pay a high price per square foot to acquire newer, Class A buildings. As such, investors look for opportunities with approximately 15 or more years of lease term to mitigate risk and provide a steady cash flow stream to buy down their basis.
Facilities located in primary coastal markets with access to ports and proximate to large population centers are the most sought after by investors. Emerging secondary markets with strong population growth and/or a robust agricultural economy are also gaining the attention of investors.
Cold Storage Industry Overview
Refrigerated storage has become an integral part of the supply chain when it comes to transporting and storing temperature-sensitive products. Proximity to population centers, population growth, changing consumer preferences and consumer spending are the primary drivers for cold storage facilities. The frozen food industry benefits from being rather inelastic as the demand for food and pharmaceutical products remain relatively the same regardless of the country’s economic condition. During the 2008 recession, restaurant visits dropped dramatically while demand for frozen food products increased. The steady demand through various economic cycles mitigates the potential risks to owning and operating cold storage facilities.
Most companies in need of refrigerated storage services outsource these functions to industry operators to avoid the substantial costs associated with operating these facilities. While privately operated facilities can provide companies a greater deal of control and flexibility over their product, the substantial start-up costs deter many smaller companies from entering the space. As a result, this form of vertical integration has generally been limited to large-scale food producers like Nestle and Kraft controlling their storage facilities.
Due to the high cost and restrictive government food grade storage regulations, there is virtually no speculative development market in the cold storage industry. Instead, developers will partner up with cold storage operators to perform build-to-suit projects for them. Below is a list of the top 25 largest cold storage operators by cubic feet of storage in North America.
Rising demand from food producers and the adoption of cost-cutting technological advancements, such as radio frequency identification (RFID), have caused profit margins in the cold storage logistics industry to expand over the past five years. Increased profitability has encouraged new operators to enter the market. IBISWorld estimates there are a total of 1,638 enterprises in the cold storage industry. However, many of the industry’s largest players have started to acquire smaller competitors to increase market share. In 2014, for example, Lineage Logistics acquired three of its competitors: Millard Refrigerated Services, Loop Cold Storage and Oneida Cold Storage. Similarly, in 2016, United States Cold Storage acquired the former CFC Logistics enabling it to expand operations in the Northeast region.
Industry operators continue to develop innovative cost-reduction solutions by utilizing cutting-edge technology, such as voice recognition and the above-mentioned RFID in material handling activities. RIFD, for example, enables greater product control and automated inventory tracking. Many operators will also start investing heavily in energy efficiency solutions to lower operating costs. For example, United States Cold Storage recently invested in CO2/NH3 cascade refrigeration systems, which are easier to maintain than ammonia systems.
Due to rising construction and labor costs, coupled with the technology and infrastructure required to build new cold storage facilities, many service providers are renovating existing buildings with new equipment and technology. Additionally, operators are increasingly looking for innovative ways to automate their processes. Despite the high initial investments for automating warehouses, the reduced labor and operational costs, improved productivity and order accuracy assist in reducing overhead costs. Operators are also implementing energy management systems, solar panels, water reclamation systems and refrigeration plugins as part of their strategy when renovating existing buildings.
- Private and Semi-Private Warehouses: Warehouses that are constructed and/or owned by the same enterprise that owns the merchandise stored at the facility.
- Public Warehouses: Warehouses that are operated as an independent business that offers various services such as handling, storage and transportation for a fixed or variable fee and is charged by the pallet.
- Chilled: Warehouses that maintain their storage temperature in the range of 32 to 33°F and are used to store fresh fruits and vegetables, eggs, dry fruits, milk, dehydrated foods and others.
- Frozen: Warehouses that maintain their storage temperature in the range of -10 to -20°F and are used to store frozen vegetables, fruit, fish, meat, seafood and others.
United States Capacity of Cold Storage Warehouses
Gross refrigerated storage capacity in the United States totaled 3.60 billion cubic in 2017. The five states with the largest gross warehouse capacity (million cubic feet) were California (396), Washington (271), Florida (259), Texas (231) and Wisconsin (228).
Private and semi-private warehouse refrigerated capacity totaled 767 million gross cubic feet, or 21 percent of the refrigerated space.
Public warehouse refrigerated storage capacity totaled 2.83 billion gross cubic feet in 2017, accounting for 79 percent of the total storage.
Refrigerated warehouse numbers totaled 950 in 2017. The number of public warehouses at 601 and private and semiprivate warehouses at 349. Below is a breakdown of public and private refrigerated inventory in the top 10 states.
The Rise of E-Grocery
E-commerce is reshaping the customer experience and is impacting virtually every industry. E-grocery delivery has been on the rise over the last few years and is being led by companies like Amazon, Albertsons and Target. A survey conducted by Unata found that 36 percent of U.S. consumers plan to grocery shop online in 2018, up from 22 percent in 2017. Packaged Facts predicts online grocery sales gains will accelerate in the coming years, with annual growth increasing from 19.4 percent between 2013 and 2017 to 27.1 percent between 2017 and 2022. The firm predicts online grocery sales will be worth nearly $42 billion in 2022 – more than triple the market’s current value.
Primary Demand Drivers
Growth in the U.S. population means more mouths to feed and an increased need for cold storage facilities to store the food. According to the U.S. Census Bureau, the U.S. population is projected to increase by nearly 20 million people by 2026.
Growth in consumer spending translates to more spending on food, pharmaceuticals and other products stored in refrigerated warehouses.
Growing consumer demand for nutritious products such as organic flax, fish oils and organic vegetables is expected to drive demand for operators in specific regions throughout the U.S.
Total Trade Value
A significant share of products stored in refrigerated warehouses are imported from abroad and also destined for export to other countries. According to a 2016 study conducted by Capgemini Consulting, 73 percent of U.S. shipping and transportation companies expected to increase their use of outsourced logistics services in the coming years. Additionally, the World Trade Organization and the bilateral free trade agreement such as NAFTA has created opportunities for U.S. exporters and European importers. This has led to higher trade volume, bolstering demand for cold storage facilities in coastal markets with access to ports.