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Cold Storage Yet to Tap Full Potential

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Cold storage properties, such as this 500,000-square-foot facility in Los Angeles that is leased to Preferred Freezer Services, represent a subcategory of industrial real estate for which there is tremendous runway for growth.

Across the country, natural population growth is triggering demand for more space for the manufacturing, processing, storing and distributing of food. Cold storage facilities cater to this demand by offering numerous types of warehousing solutions, from chilled spaces for dairy products and dry fruits and vegetables to freezer facilities for meat and seafood.

Most major grocers are slowing their paces of new store openings while also developing their online delivery platforms, the latter of which is a key demand generator for cold storage facilities. A 2018 study by Food Marketing Institute and global market research firm Nielsen found that the online grocery shopping market will ensnare 70 percent of consumers to some degree by 2024.

The report also projected that the percentage of online grocery shopping relative to total grocery sales would grow significantly in the coming years from its mark of 3 percent in 2017. Total online grocery sales are eventually expected to exceed $100 billion. According to some industry experts, that growth translates to a need for an additional 40-some million square feet of cold storage product — just to meet demand for online groceries.

The advent of meal kits — online platforms that provide ingredients and recipes for home-cooked meals — also has implications for the asset class. Numerous concepts have entered this space, and it remains to be seen which ones will prevail. But there is unquestionably a market for meal kits, as evidenced by Amazon’s move to enter the space through AmazonFresh.

As both online grocery shopping and meal kits grow and mature, wholesale food providers for these industries will need to invest in and lease more cold storage space. They will also need to consider partnering with third-party logistics providers to save on storage and distribution costs while maximizing the amount of product they deliver to food retailers.

Sales of food and the performances of industrial facilities that house food uses tend to hold steady during broader economic downturns, but with the aforementioned trends fueling demand, more cold storage projects should come on line over the next decade in major cities across the country.

According to data from CoStar Group, the cold storage market in Texas currently spans approximately 18 million square feet. With the vacancy rate at 6.1 percent — down by 360 basis points from a year ago — and rent growth of 4.1 percent over the last 12 months, the fundamentals suggest Texas is ready for more cold storage facilities. Add in the fact that the state’s population has grown by approximately 4 million people over the last decade, and that need becomes even more pronounced.

New Development Needed

According to research from CoStar and HFF, there are more than 2,000 cold storage facilities totaling approximately 193 million square feet in the Unites States. Roughly 50 percent of that inventory was built prior to 1980 and therefore is or is becoming functionally obsolete — another catalyst for development of new supply.

Texas ranks toward the bottom in terms of the ratio between population and supply of cold storage product, according to data from the United States Department of Agriculture (USDA). The state’s population growth, along with its supply of available land and affordable power, are all appealing factors to cold storage developers.

Yet the Lone Star State has yet to see a building boom in the space in recent years. Inventory levels are relatively unchanged from a year ago and 12-month construction starts amounted to just 63,400 square feet of new projects, according to CoStar.

As the need for more facilities has become clear, developers have turned to new technologies to maximize efficiency of the cubic space — cascade refrigeration systems, energy-efficient walls, higher clear heights, automated retrieval systems that maximize vertical storage space. But relative to regular warehouses of the same size, cold storage facilities are considerably more complicated and expensive to build.

Preston Herold, Hunt Southwest

“With cold storage, you’re building an insulated box and preparing for temperatures as low as minus 10 degrees,” says Preston Herold, senior vice president at Dallas-based development firm Hunt Southwest. “You have to have an insulated slab with heating to protect the subgrade from freezing, insulated metal panel walls and an insulated roof. You have to consider how the refrigeration equipment affects the roof load, implement a dry sprinkler system and deliver clear heights that are much higher than comparable warehouses.”

Hunt Southwest is developing DFW ColdSpot, a 300,000-square-foot facility within Carter Industrial Park in Fort Worth. The project, the first cold storage facility of this size to be built on spec in the metroplex, is being marketed to food companies that need cooler, freezer and/or processing space.

To accommodate this wide range of uses, DFW ColdSpot will feature 45-foot clear heights and the ability to handle temperatures anywhere from ambient to freezing. Developing such a project on spec that can be marketed to a wide range of users is challenging in terms of construction, not to mention securing financing, says Herold.

Carter-Cold-Storage-Fort-Worth

DFW Coldspot, Hunt Southwest’s 300,000-square-foot cold storage facility within Carter Industrial Park, aims to capitalize on growing demand for this sub-type of industrial real estate. Much of Fort Worth’s existing cold storage product is outdated.

“Underwriting a spec cold storage facility is hard because there aren’t many sales or lease comps,” he says. “It’s not yet a commodity business like warehousing and distribution, though it’s undoubtedly headed in that direction. But these are very capital-intensive buildings that can only be marketed to a small subset of industrial tenants, so you really have to be smart about how you approach the development.”

Because construction costs are even higher in the cold storage space, there is still considerable value in rehabilitation projects. In many cases with older facilities, the refrigeration systems are expired and the clear heights can’t support the necessary equipment. But users — many of which own their facilities — would still rather spend on rehabbing their properties, in part because there’s limited new space available for lease in their desired locations.

“There’s definitely a place for older, Class B and C product because not every food company has the credit or scale of operations of public refrigerated warehousers, grocers or suppliers,” says Herold. “Companies with smaller requirement (under 100,000 square feet) must settle for the lack of efficiency because there simply aren’t any other options.”

Several rehab projects have been executed in Texas during this cycle to meet demand for cold storage space without breaking the bank. A number of years ago, New York City-based KTR Capital acquired an 800,000-square-foot facility from Minyard Food Stores Inc. in the metroplex city of Coppell and upgraded it. More recently, California-based Provender Partners purchased a 1.2 million-square-foot facility in Fort Worth and leased it to Texas-based food wholesaler McLane Co.

Investors Warming

The cold storage space has recently seen a flurry of new investment as buyers continue to deploy capital into industrial real estate to either satisfy mandates and/or chase additional yield. Due to their heftier development costs, pricing is generally higher for cold storage facilities than it is for comparably sized dry warehouses.

For the past year, the average sales price for cold storage properties in Texas was $65 per square foot, while the average cap rate was 6.5 percent. To put those numbers into context, the average cap rate has compressed by roughly 200 basis points over the past decade, while the average sales price in 2009 was approximately $35 per square foot, per CoStar.

Much like other niche sectors of commercial real estate — self-storage, medical office, seniors housing — successful investment in cold storage is largely driven by partnering with the right operator, says Alec Haley, a director in HFF’s San Francisco office who specializes in cold storage and other food-related facilities.

“Because much of the inventory is old or obsolete, we see investors that want to get into cold storage providing development equity to build facilities for third-party operators on a build-to-suit basis,” says Haley. “This not only gives investors extra yield; it helps them save on costs for facilities that are very tricky and capital-intensive to operate. As a result, most landlords will require these operators to sign absolute or triple-net leases.”

Alec Haley, HFF

Haley adds that some cold storage investors are taking it a step further and outright buying operators with significant real estate holdings. The most recent example of such a deal came earlier this year when Atlanta-based Americold, a cold storage owner-operator with 155 facilities around the world, acquired Cloverleaf Cold Storage for $1.24 billion.

That deal was announced in April and is expected to close some time during the second quarter. The acquisition came on the heels of Lineage Logistics buying Preferred Freezer Services (operating company only) for roughly $1 billion, combining the No. 2 and 3 operators in the space, overtaking Americold as the largest operator in the space.

Haley notes that simple ecological events can create major damage to cold storage properties with inexperienced operators, resulting in major headache and capital expenditures. For example, freezer facilities must include systems under the building for heating the earth; without that, ice can grow under the slab and crack the floor, which can result in a staggering repair bill. To that end, capital sources see tremendous value in aligning their funds with operators that know the cold storage business literally from top to bottom.

According to HFF’s data, in certain primary markets, investors can achieve spreads of 100 to 150 basis points on cap rates between cold storage facilities and comparable dry warehouses, down 50 basis points in the last 12 months. The limited amount of new, high-quality supply coming on line enables landlords to push rents and achieve more tenant stickiness, bolstering operating income and investor appeal.

Cold storage facilities require higher clear heights than dry warehouses to house more sophisticated, automated storage and retrieval equipment. This feature alone can make the asset class more costly to develop.

Among investment sales deals that HFF tracked in 2018 was the disposition of a 174,786-square-foot facility in Chicago operated by New Jersey-based Preferred Freezer Services. As a relatively new piece of construction in a top market and a proven operator/occupant, the asset sold for $54 million, or $309 per square foot. By comparison, the average sales price across all sales of all cold storage properties in 2018 was $202 per square feet.

“The market for investment is very competitive, with new capital emerging and strategies being formed around the space,” says Haley. “Cap rates are at historic lows in primary markets and are compressing in secondary markets with strong demand drivers. Demand is balanced in terms of the types of buyers, many of which are mandated to purchase industrial product and are drawn to cold storage as an alternative asset class that offers a discount to traditional dry warehouses.”

Haley adds that lenders are beginning to develop a better understanding of the product type. Some lenders are wary of how specialized the asset class is and of the binary exposure from having a single tenant. But now that investors have been circling the asset class and growing more educated on the space, lenders are beginning to warm to cold storage deals.

Leasing & Fundamentals

Leasing volume within the cold storage space has been modest compared to the tremendous amount of deal activity for regular industrial warehouses and distribution centers. But modest leasing velocity is undoubtedly a direct factor of the extreme scarcity of available space, particularly in the Class A segment of the cold storage market.

CoStar reports that the industry saw positive net absorption of 4.3 million square feet in 2018, dropping vacancy to 3.9 percent. This absorption occurred in a year in which only 1.5 million square feet of new product was delivered. Texas posted 12-month net absorption of 651,000 square feet, good for 15 percent of the national total.

Rents across the spectrum of cold storage assets in Texas rose by 4.1 percent in the last year and currently sit at an average of $6.96 per square foot, per CoStar. According to Kevin Kelly, senior vice president of CBRE’s National Food Facilities Group, rents are rising in most major markets, with rates for freezer space being the highest. There is a vast discrepancy between lease rates, depending on build-out configuration, temperatures and quality.

“Demand is higher for freezer or convertible space, which reflects a key trend in the market,” says Kelly. “Because there are so many types of specialized spaces in the broader industrial food category, it’s tough to pinpoint average rents for those facilities. But as we move toward more sophisticated food facilities and operations, we’re likely to see greater rents for those properties.”

Kevin Kelly, CBRE

Kelly notes that the fact that many facilities are user-owned can also make tracking precise rent growth numbers a somewhat tricky process. But that doesn’t mean the uptick in demand isn’t clearly visible. In addition to online grocery shopping and the rise of meal kits, Kelly points to general consumer behavior and the economic resiliency of food as important demand drivers within the cold storage market.

“Though it’s rarely an explosive sector, the food sector tends to chug along with consistent growth and not suffer as much during downturns,” says Kelly. “But there are a lot of smaller impacts too, from e-commerce to the fact that people are eating out more to the growing demand for more food in pre-prepared forms.”

Rising construction costs are also fueling rent growth. But notwithstanding the high costs of building and operating these facilities, the fact remains that more space is going to be needed, in Texas and across the country, in order to meet the demands of a hungry, growing population that is sourcing its food in more ways than ever before.

— By Taylor Williams. This article first appeared in the June 2019 issue of Texas Real Estate Business magazine. 

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