The pandemic and the concurrent increase in demand for grocery deliveries have pushed up the need for cold storage. Now, this trend is changing the calculations surrounding the development of cold storage projects.
Cold storage facilities are expensive to build, costing from $250 to $350 per sq. ft. compared to $100 per sq. ft. for dry warehouse space. So historically this has not been a play that was attractive to a broad swath of investors and developers.
In fact, the vast majority of refrigerated warehouse space has historically been developed, owned and operated by a small group of cold storage REITs, like Americold Realty Trust, and third-party, publicly-traded refrigeration warehouse (PRW) logistics providers, like Lineage Logistics, Agile Cold Storage and NewCold.
But with the pandemic accelerating online grocery sales over the last 12 to 18 months and U.S. restaurants and bars re-opening, demand for cold storage space is at an all-time high, with the average national vacancy dropping from 4.7 percent to 3.8 percent over the past 12 months. As a result, this alternative property type is now attracting both private equity and institutional capital. For example, the most recent Investor Intentions Survey from commercial real estate services firm CBRE noted that the share of investors pursuing cold storage rose from 7.0 percent in 2019 to 22.0 percent in 2021.
“The cold storage sector has traditionally been dominated by owner-occupants, but that is changing as more investors are attracted to this niche property type,” says Mark Russo, director in the research department of real estate services firm Savills North America. Investors are attracted to this sector’s higher returns, he notes, as well as the opportunity to diversify a real estate portfolio beyond traditional property types. Russo expects that competition among investors will drive prices higher over the coming year.
Just 12 months ago, development yields for cold storage development averaged around 7.5 percent to 8.5 percent in yield on cost (YOC), while dry warehouse yields averages between 5.00 percent and 6.0 percent, according to Dallas-based Dustin Volz, senior managing director with JLL Capital Markets. “Now, for cold storage, the spread looks more like 6.0-7.5 percent YOC,” he says, but adds that increasing rents, which are double those charged for dry storage space, continue to show strength.
In the past, investors came to cold storage chasing development and acquisition yields, Volz says, given that cold storage used to trade at an over-sized spread to dry space. But he notes that this spread has continued to narrow, and the investor make-up in the sector is now similar to those focusing on traditional industrial properties. Investors in cold storage now include private equity, advisors, infrastructure funds and traditional commercial real estate investment managers.
Investment sales of cold storage facilities increased during the pandemic, but the supply of for-sale assets remains very limited, according to Matthew Walaszek, director of industrial and logistics research with CBRE. That may explain why sales of cold storage facilities accelerated in 2020, from $2.7 billion in 2019 to $3.5 billion, according to real estate data firm Real Capital Analytics (RCA), then dropped back to about $2.5 billion last year.
One newcomer to this sector is real estate mogul Sam Zell’s investment firm Equity Group Investments, which recently acquired an unspecified ownership stake in East Coast Warehouse, which operates 72 million cubic feet of temperature-controlled warehouse space.
The supply-demand imbalance in the cold storage sector has attracted new developers. Firms that have been building traditional industrial facilities have entered this space over the last 12 to 18 months and are now building speculative cold storage projects—a new phenomenon, according to Chicago-based Steve Kozarits, senior vice president of industrial services and tenant advisory with real estate services firm Transwestern.
He cites Atlanta-based industrial developer Realty Link, which has established a cold storage division, and New Jersey-based Saxum Real Estate, which recently launched a cold storage platform and is developing projects in partnership with other developers, such as Austin-based Yukon Ventures.
Noting that speculative cold storage development follows population growth, Volz notes that 18 to 24 months ago, speculative cold storage development didn’t exist outside of a 2019 project in Fort Worth by Dallas-based Southwest ColdSpot—the first U.S. spec cold storage project ever.
“Now you have 40-plus speculative projects announced, which is a bit inflated, as we believe some of the developers in this space that are launching press releases for new projects are fishing for prospective build-to-suit (BTS) tenants,” he says, adding that actual spec projects under construction are probably in the 15 to 20 range.
The explosion in cold storage development is not only due to a shortage of existing supply, but also tenant demand for modern facilities. Russo notes that U.S. cold storage inventory totals just 210 million sq. ft., and the majority of it is made up of obsolete assets that are 30 to 40 years old, with clear heights of no more than 30 feet.
Clear heights of 50 to 80 feet and above, state-of-the-art refrigeration technology and more efficient operating systems are the top features today’s tenants are seeking in cold storage facilities, according to Volz.
Kozarits says that high-tech facilities that improve efficiencies and reduce human labor requirements are becoming increasing popular among tenants due to current labor challenges. He notes that a new design system, where facilities are built up to 80 feet clear height around a structural rack skeleton from the inside out, along with automation and robotic technology, allows more pallets to be stacked in less space, reducing both storage and labor costs. He expects that over time the dry warehouse community will recognize the benefits of this design and adopt it too.
As grocers look for ways to expand their multi-channel sales and improve delivery times, operators including Whole Foods, HEB, Kroger and others are moving into the kinds of automated facilities described by Kozartis, Volz notes.
Kroger, for example, has partnered with Ocado, a high-tech, cold storage distribution provider with an automated racking system, to build 20 high-tech robotic warehouses nationally. Ocado-powered automated customer fulfillment centers fill digital orders for same-day and next-day delivery.
“We are likely still in the early innings of grocery e-commerce penetration,” says Russo. “This sector was jolted by the pandemic and will continue to take a larger share of the market, which will create even more demand for state-of-art cold storage facilities near major U.S. population centers.”
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