With the surge in online sales of groceries, meal delivery services, perishable specialty foods and vaccine distribution over the past two years, so has demand for cold storage, which occupied a niche in the US commercial real estate market before the pandemic. Will cold storage demand continue now that COVID-19 precautions and mitigation strategies are becoming a thing of the past?
Overall, there is still a high demand for cold stores among end users, which leads to low vacancy rates and sustained rent growth. Today, the average vacancy rate for cold storage is about 3.5 percent, according to New Jersey-based executive director of JLL Capital Markets, Marc Duval. That’s below the average vacancy rate of 4.2 percent for traditional warehouse space, and in some markets cold store vacancies are close to zero. Core markets in the cold storage sector are those that typically have high populations, significant agricultural revenues, proximity to major ports and a limited amount of new cold storage space, notes Duval. These include Jacksonville, Fla, Detroit and southern New Jersey.
The extremely low vacancy rate in the cold store reflects very good demand. And like the entire industrial market, Duval notes that this sector too is experiencing a flight to quality. Demand for new, state-of-the-art facilities is extremely high given that more than 50 percent of the existing infrastructure was built 30 years ago, he says. JLL is currently pursuing 40 (proposed) cold storage projects across the country, but only 30 percent of these are under construction. “Because of the high cost of construction, the complexity of building on speculation, and challenging zoning ordinances — particularly building height — projects that actually begin construction will always be a fraction of what is proposed,” adds Duval.
According to Healy, rents for refrigerated warehouses have risen by 27 percent in the past two years. And given the highly specialized nature of these facilities, lease terms for cold storage are typically longer than those for dry storage, he adds.
In markets where land costs are higher and account for 50 percent or more of the total cost of the cold storage development project, rents can exceed $30 per square foot, Duval says.
Due to this dynamic, cold stores are still in demand among commercial real estate investors.
Historically, the cold storage sector has been dominated by a small group of cold storage REITs, including Americold Realty Trust, and outside publicly traded cold storage (PRW) logistics providers such as Lineage Logistics, Agile Cold Storage and NewCold. But cold storage is now attracting both private equity and institutional capital. Sam Zell’s investment firm Equity Group Investments, for example, last year acquired a stake in East Coast Warehouse, which operates 72 million cubic feet of temperature-controlled warehouse space.
Actually the CBRE 2022 Investor Intent Survey reported that 39 percent of the company’s survey respondents expressed an interest in investing in cold storage, up from 22 percent in 2021 and 7 percent in 2019.
Investors continue to be attracted to the cold storage sector due to its growth prospects and higher yields compared to traditional storage, says Matthew Walaszek, research director at JLL, who specializes in industry and logistics.
“The most attractive thing about cold storage is that investors are buying stable, non-standard, critical infrastructure,” notes Duval.
However, strong demand has driven the cap rate spread between dry storage and cold storage to as much as 50 basis points in the core markets. (Walaszek notes that this trend has been in flux lately due to the rising interest rate environment.)
According to Chicago-based Steve Kozarits, senior vice president of commercial real estate services firm Transwestern, which specializes in industrial services and tenant advisory services, rising interest rates should increase investor interest in alternative product types. “As interest rates rise, investors will look to allocate a higher percentage of their capital to more stable asset classes,” he says. “The projected rent increases in the industrial market as a whole, including cold storage and cold storage, represent an attractive investment.”
What investors are looking for
Modern cold stores with higher ceiling heights and better efficiency are more attractive for users and therefore more in demand with investors, notes Duval. “The development of purpose built cold storage is more complicated to design and develop than traditional warehouses, limiting speculative development and keeping supply low.”
According to Walaszek, cold storage is still a niche subsector of the larger industrial market, accounting for only 1.0 to 1.5 percent of the total industrial inventory. Therefore, the development landscape is being driven by build-to-suits.
“Cold storage is a hot industry vertical, but it’s not easy to design,” adds Healy, noting that it’s rarely built to specification due to the high capital expenditure for this product. “What we’ve seen is that the big national players are expanding their networks organically as well as through acquisitions of large regional companies.”
Additionally, while many of these older cold storage properties are less efficient than new Grade A projects, they are often located near core markets, making them valuable because of their location, Healy says.
Walaszek notes that the preference for modern cold stores now depends more on energy efficiency than on the quality of the buildings themselves. Some of the older facilities are perfectly fine depending on usage, he says.
After peaking in the fourth quarter of 2020, overall e-commerce sales have declined as the pandemic subsides, according to Greg Healy of Orange County, Calif., executive vice president and head of industrial services group in North America with real estate services company Savills. He attributes the drop to pent-up demand from consumers to leave their homes and physically go to stores. “Even so, e-commerce sales are well above pre-pandemic levels, and in some Asian countries more than 50 percent of retail sales are online,” he adds.
In fact, online grocery sales are up slightly year over year to $7.1 billion as of May 2022, Healy says. Penetration of online sales reaches nearly 13 percent of the total grocery market, up 2 percent from 2020 and 10 percent from pre-COVID share. Mercatus/Incisiv, a group that follows the development of technology in the food sector, projects that e-commerce will account for 21.5 percent of all grocery sales by 2025.
Recently, however, consumer preferences have changed when it comes to online grocery shopping. According to Healy, direct shipments to consumer homes have declined while in-store pickup has increased. This could be due to both people wanting more time away from home and inflation-conscious consumers looking to save on delivery costs, which typically add 25 percent to a grocery bill.
At the same time, a surge in online grocery sales doesn’t necessarily translate into outsized growth in cold storage infrastructure, says Duval. Temperature-controlled products bought online for home delivery are mostly served by individual grocery stores and therefore don’t contribute to the additional demand for cold storage, he says.
Grocery stores typically work with locations within three to five miles of their target audience, which creates a situation where the logistics costs, availability of sites for development, and construction costs necessitate the construction of cold storage fulfillment centers closer to consumers complicate, notes Duval. This is forcing grocers to instead invest in automated solutions in the backroom of their stores. “The best play for last-mile grocery distribution is the grocery store itself,” says Duval.
Some grocers are also focusing on setting up large fulfillment centers (300,000 square feet or more) close to customers for direct-to-consumer delivery, according to Walaszek, research director at JLL, who also notes grocers are leveraging their stores for distribution traffic, especially pick-ups. “We’re still in the ‘early innings’ and time will tell if this model works given the high cost of construction, operation and delivery,” he says.
Noting that cold storage typically costs twice as much money to build as dry storage, Healy says grocers are alternatively creating smaller, mobile, temperature-controlled last-mile distribution systems at locations where they’re needed, often within one existing facility. Because goods turnover is rapid, the amount of temperature-controlled space needed tends to be limited, he adds.