Is cold storage still a popular investment choice?

As online grocery sales have increased over the past two years, so too has demand for cold storage properties, which pre-pandemic occupied a niche in the U.S. commercial real estate market. Now that COVID-19 has gone from a pandemic to an endemic disease, is the demand for cold storage holding up?

After peaking in the fourth quarter of 2020, overall e-commerce sales have declined as the pandemic receded, according to Greg Healy, executive vice president and head of the Orange County-based North America Industrial Services Group. , California, with real estate. Savills service company. He attributes the decline to pent-up consumer demand to get out of their homes and physically go to stores. “Yet e-commerce sales are well above pre-pandemic levels, and in some Asian countries more than 50% of retail sales are done online,” he adds.

In fact, online grocery sales were up slightly from a year ago, reaching $7.1 billion in May 2022, Healy says. Online sales penetration is nearly 13% of the total grocery market, up 2% from 2020 and 10% from its pre-COVID share. Mercatus/Incisiv, a group that tracks the evolution of technology in the grocery space, predicts that by 2025, e-commerce will capture 21.5% of total grocery sales.

However, there have recently been changes in consumer preferences when it comes to online grocery sales. According to Healy, direct deliveries to consumers’ homes have declined, while in-store pickups have increased. This may be due to both people wanting to spend more time outside their homes and inflation pushing cost-conscious consumers to try and save on delivery costs, which are typically 25 % extra on a grocery bill.

At the same time, an increase in online grocery sales doesn’t necessarily translate to outsized growth in cold storage infrastructure, says Marc Duval, New Jersey-based managing director of JLL Capital Markets. Temperature-controlled products purchased online for home delivery are mostly served at individual grocery stores and therefore do not add to the additional demand for cold storage, he says.

Grocery stores typically work with locations within three to five miles of their target shopper population, creating a situation where the cost of logistics, availability of sites for development, and construction expenses make it difficult to build. cold storage processing centers close to consumers, notes Duval. . This is pushing grocers to invest in automated solutions in the backroom of their stores instead. “The best game for last-mile grocery distribution is the grocery store itself,” says Duval.

Some grocers are also focusing on adding large distribution centers (300,000 square feet or more) close to customers for direct-to-consumer delivery, according to Chicago-based Matthew Walaszek, director of research at JLL who specializes in industry and logistics, also notes that grocers are leveraging their stores for distribution, especially pickups. “We’re still in the ‘first rounds’ and time will tell if this model works given the high construction, operating and delivery costs,” he notes.

Noting that cold storages typically cost twice as much to build as dry warehouses, Healy says that, alternatively, grocers are also creating smaller, mobile, last-mile, temperature-controlled distribution facilities in places where they are. necessary, often in an existing environment. ease. Because goods turn around quickly, the required amount of temperature-controlled space tends to be limited, he adds.

The fundamentals hold up

Overall, demand for cold storage remains high among end users, resulting in low vacancy and continued rental growth. Average vacancy for cold storage is around 3.5% today, according to Duval, which is lower than the average vacancy of 4.2% for traditional warehouses, and in some markets, vacancy for cold stores is close to zero. The primary markets for the cold storage industry are those that typically have large populations, large farm receipts, proximity to major ports and a limited amount of new cold storage space, Duval notes. This includes Jacksonville, Fla, Detroit and southern New Jersey.

The extremely low vacancy rate for cold rooms reflects very healthy demand. And like the industrial market as a whole, Duval notes that this sector is also experiencing a flight to quality. The demand for new, state-of-the-art facilities is extremely high, as more than 50% of the existing infrastructure was built 30 years ago, he says. JLL is currently tracking 40 (proposed) cold storage projects nationwide, but only 30% of them are under construction. “Due to high construction costs, the complexity of building on speculation, and challenging zoning ordinances, especially building heights, projects that actually begin construction will always be a fraction of what is on offer,” Duval adds.

Over the past two years, cold store rents have increased 27%, according to Healy. And cold storage rental terms tend to be longer than dry storage, given the highly specialized nature of these facilities, he adds.

In markets where land costs are higher and represent 50% or more of the total cost of a cold storage development project, rents can be upwards of $30 per square foot, Duval says.

Always in demand

Due to this dynamic, cold storage continues to be in demand among commercial real estate investors.

Historically, the cold storage industry has been dominated by a small group of cold storage REITs, including Americold Realty Trust, and publicly traded third-party cold storage logistics (PRW) providers, such as Lineage Logistics, Agile Cold Storage and New Cold. But cold storage now attracts both private and institutional capital. Sam Zell’s investment company, Equity Group Investments, for example, last year acquired a stake at East Coast Warehouse, which operates 72 million cubic feet of temperature-controlled warehouse space.

In fact, the 2022 CBRE Investor Intentions Survey reported that 39% of company survey participants indicated an interest in investing in cold storage, up from 22% in 2021 and 7% in 2019.

Investors continue to be attracted to the cold storage sector because of its growth prospects and higher returns, compared to traditional warehouses, says Walaszek.

“The coolest thing about cold storage is that investors are buying stable, uncommoditized, mission-critical infrastructure,” Duval notes.

However, strong demand caused the cap rate differential between dry and cold storage to drop to 50 basis points in major markets. (Walaszek notes that this trend has been changing lately due to rising interest rates.)

According to Chicago-based Steve Kozarits, senior vice president of commercial real estate services company Transwestern, which specializes in industrial services and tenant advice, rising interest rates should intensify investor interest in the types of alternative products. “As interest rates rise, investors will seek to place a higher percentage of capital in more stable asset classes,” he says. “Projected rent increases in the industrial market as a whole, including cold stores and refrigerated spaces, make for an attractive investment.”

What investors are looking for

Modern cold stores, with higher ceiling heights and better efficiency, are more attractive to users and, therefore, more in demand by investors, notes Duval. “The development of purpose-built cold storages is more complicated to design and develop than traditional warehouses, which limits speculative development and keeps supply low.”

Cold storage is still a niche sub-sector of the broader industrial market, accounting for just 1.0-1.5% of overall industrial inventory, according to Walaszek. Therefore, the development landscape is driven by bespoke construction.

“Cold storage is a vertical industry activity, but it’s not easy to grow,” adds Healy, noting that due to the high capital expenditure of this product, it’s rarely built to spec. . “What we’ve seen are major national players expanding their networks organically, as well as through the acquisition of regional mom-and-pop players.”

Additionally, while many of these older cold storage properties are less efficient than newer Class A projects, they are often located near major markets, making them valuable due to their location, Healy says.

Meanwhile, the preference for modern cold stores has more to do with energy efficiency than the quality of the buildings themselves, Walaszek notes. Some of the older facilities are perfectly fine depending on how they’re used, he says.

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