As online grocery sales surged during the past two years, so did demand for cold storage properties, which prior to the pandemic occupied a niche space in the U.S. commercial real estate market. Now, with COVID-19 turning from a pandemic to an endemic illness, is the demand for cold storage holding up?
After peaking in the fourth quarter of 2020, overall e-commerce sales have tapered off as the pandemic receded, according to Orange County, Calif.-based Greg Healy, executive vice president and head of the industrial services group in North America with real estate services firm Savills. He attributes the decline to pent-up demand by consumers to get out of their homes and physically go to stores. “Still, e-commerce sales are far above pre-pandemic levels, and in some Asian countries, more than 50 percent of retail sales are performed online,” he adds.
In fact, online grocery sales have increased slightly from where they were last year, to $7.1 billion in May 2022, Healy says. Online sales penetration is reaching almost 13 percent of the total grocery market, up 2 percent from 2020 and 10 percent from its pre-COVID share. Mercatus/Incisiv, a group that tracks the evolution of technology in the grocery space, projects that by 2025, e-commerce will capture 21.5 percent of total grocery sales.
However, there have been some changes in consumer preferences when it comes to online grocery sales recently. According to Healy, direct deliveries to consumer homes have declined, while in-store pick-ups have increased. This might be due to both people wanting more time outside of their homes and inflation leading cost-conscious consumers to try to save on delivery costs, which typically tack an additional 25 percent onto a grocery bill.
At the same time, an increase in online grocery sales doesn’t necessarily translate into outsized growth in cold storage infrastructure, says New Jersey-based Marc Duval, managing director with JLL Capital Markets. Temperature-controlled products purchased online for home delivery are mostly serviced out of individual grocery stores and therefore do not add to additional demand for cold storage, he says.
Grocery stores typically work with locations within three to five miles of their targeted shopper population, creating a situation where the cost of logistics, the availability of sites for development and construction expenses make it difficult to build cold storage fulfillment centers close to consumers, Duval notes. That’s pushing grocers to invest in automated solutions in the backroom of their stores instead. “The best play for last-mile grocery distribution is the grocery store itself,” Duval says.
Some grocers are also focusing on adding large fulfillment centers (of 300,000 sq. ft. or more) in proximity to customers for direct-to-consumer delivery, according to Chicago-based Matthew Walaszek, director of research at JLL who specializes in industrial and logistics, also notes that grocers are leveraging their stores for distribution, particularly pick-ups. “We’re still in the ‘early innings,’ and time will tell whether this model works given high construction, operational and delivery costs,” he notes.
Noting that cold storage facilities typically cost twice as much money to build as dry warehouses, Healy says that alternately, grocers are also creating smaller, mobile, last-mile, temperature-controlled distribution facilities in locations where they are needed, often within an existing facility. Since the turnover of goods is fast, the required amount of temperature-controlled space tends to be limited, he adds.
Fundamentals hold up
Overall, there is still high demand for cold storage facilities amid end-users, leading to low vacancy and continued rent growth. The average vacancy for cold storage is around 3.5 percent today, according to Duval—that’s below the 4.2 percent average vacancy for traditional warehouse space, and in some markets, cold storage vacancy is close to zero. Core markets in the cold storage sector are those that typically have a high population, significant agricultural receipts, proximity to large ports and a limited amount of new cold storage space, Duval notes. That includes Jacksonville, Fla, Detroit and Southern New Jersey.
Extremely low cold storage vacancy reflects very healthy demand. And similar to the overall industrial market, Duval notes that this sector is also experiencing a flight to quality. Demand for new, state-of-the-art facilities is extremely high, as more than 50 percent of the existing infrastructure was built 30 years ago, he says. JLL is currently tracking 40 (proposed) cold storage projects nationally, but only 30 percent of them are under construction. “Due to high construction costs, complexities of building on speculation and challenging zoning ordinances—particularly building height, projects actually beginning construction will always be a fraction of what is proposed,” adds Duval.
Over the past two years, cold storage rents have grown by 27 percent, according to Healy. And cold storage lease terms tend to be longer than those for dry warehouses, given the highly specialized nature of these facilities, he adds.
In markets where land costs are higher and make up 50 or more percent of the total cost of the cold storage development project, rents can be north of $30 per sq. ft., says Duval.
Still in demand
As a result of these dynamics, cold storage continues to be in demand among commercial real estate investors.
Historically, the refrigerated warehouse sector has been dominated by a small group of cold storage REITs, including Americold Realty Trust, and third-party, publicly-traded refrigeration warehouse (PRW) logistics providers, like 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 an ownership stake in East Coast Warehouse, which operates 72 million cubic feet of temperature-controlled warehouse space.
In fact, the CBRE 2022 Investor Intention Survey reported that 39 percent of the firm’s survey participants indicated an interest in cold storage investment, 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 warehouses, says Walaszek.
“The most attractive thing about cold storage is that investors are buying stable, non-commoditized, crucial infrastructure,” notes Duval.
Strong demand, however, has driven the cap rate spread between dry warehouses and cold storage facilities to as low as 50 basis points in 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 at commercial real estate services firm Transwestern who specializing in industrial services and tenant advisory, rising interest rates should intensify investor interest in alternative product type. “As interest rates rise, investors will look to place a higher percentage of capital into more stable asset classes,” he says. “The projected rent increases in the industrial market overall, including cold storage and refrigerated space, make for an attractive investment.”
What investors are looking for
Modern cold storage facilities, with higher ceiling heights and better efficiency, are more attractive to users and, therefore, more in demand among investors, notes Duval. “Purpose-built cold storage development is more complicated to design and develop than traditional warehouses, which limits speculative development and keeps supply low.”
Cold storage is still a niche subsector of the larger industrial market, representing just 1.0 to 1.5 percent of overall industrial inventory, according to Walaszek. Therefore, the development landscape is driven by build-to-suits.
“Cold storage is hot as an industry vertical, but it is not easy to develop,” adds Healy, noting that due to this product’s high capital expenditure, it’s rarely built on spec. ‘What we have seen is the major national players expanding their networks organically, as well as through acquisition of mom-and-pop regional players.”
In addition, while many of these older cold storage properties are less efficient than new class-A projects, they are often located close to core markets, making then valuable due to location, Healy says.
Meanwhile, the preference for modern cold storage is more about energy efficiency than the quality of the buildings themselves, notes Walaszek. Some of the older facilities are perfectly fine depending on how they’re used, he says.
