The Cold Storage Market Is Maturing Beyond A Niche Industry

The outbreak of the coronavirus has accelerated America's growing dependence on industrial real estate, and cold storage is among the fastest-growing parts of the sector.

Distribution centers have become a mature asset class backed by institutional capital, now becoming the brightest spot in commercial real estate since the pandemic took over the country this spring, panelists on Bisnow’s Philadelphia Regional Industrial Update webinar agreed.

The e-commerce industry’s need for speed has resulted in an arms race of efficiency at warehouses, an ever more expensive proposition with the safety precautions now required in most states. As a result, margins have shrunk in some cases because of the increased cost of tenant improvements.

“When you turn over a property, if you have to put in more tenant improvements every time, it’s clearly creeping up toward [the requirements of] an office asset,” Centersquare Investment Management Senior Vice President Chad Burkhardt said. “But so far, institutional backers are fine with it, and putting more money into your assets and charging more rent is what institutions want to do.”

Cold storage is still in the early stages of growth into an institutional-grade asset class. It is similar to where distribution centers were 10 to 15 years ago, with a large portion of the market occupied by family businesses with deep connections to users. In both eras, knowledge has been a barrier to entry for prospective investors.

“There’s been such a rush into the space recently, partly because it’s something new and people are trying to wrap their heads around it,” Burkhardt said. “People in general like areas where they can become an expert, where it’s not just a commodity product. It’s something that you can feel like you have an edge, and invest with folks who really know how to do this.”

The market is currently split between opposite poles of developers and owners: the family businesses that mainly operate on a regional basis, and the early consolidators that have gobbled up market share.

Lineage Logistics, the largest cold storage owner in the world, spent nearly $2B in 2019 between two major acquisitions, while Americold Realty Trust is the largest publicly traded REIT in the space, with 183 facilities spread across the U.S., Canada, Argentina, New Zealand and Australia.

As demand for online food and grocery delivery accelerated, the demand for cold storage also ramped up over the past six months. Before then, market dynamics gave developers confidence that even speculative projects will lease up. FCL Builders was tabbed two years ago to build a speculative cold storage facility in the Fort Worth area for Hunt Southwest, the first of its kind in Texas, FCL Vice President Jeff Bonfoey said.

“We delivered that building last year, and there were a lot of eyes on that project to see whether cold storage users would accept a building that they couldn't completely create or personalize,” Bonfoey said. “The building leased entirely, and in less time than the developer had underwritten.”

Now, FCL is building cold storage on spec in the Miami market, in Connecticut and in Philadelphia’s suburbs, Bonfoey said. 

“I think you’re seeing an emerging acceptance for speculative product,” Bonfoey said. “Certainly there will be some users that still want a custom project, but many will have room in their supply chains for a less specialized facility.”

When a real estate market shows the strength to support speculative construction, it signals to institutional investors that there is a measure of certainty that capital sources like pension funds require. Bonfoey pointed to the $150M joint venture formed last year between PGIM Real Estate and Bridge Development Partners, which focused on the acquisition and development of cold storage.

With more capital in the space, developers might be able to take on more ambitious projects, via speculative development or redevelopment of more traditional warehouses. “Repurposing is fairly frequent if a warehouse is in the right spot for a user, and there are no other options nearby for a cold storage facility,” Bonfoey said.

Though the process is more expensive than ground-up construction, Bonfoey said that the “box in a box” method of adding cold infrastructure within the shell of a warehouse allows for the building to possibly be converted back into a traditional warehouse, providing a possible hedge option for owners.

These developing conditions in cold storage — institutional capital, appetite for redevelopment and demand to be close to consumers — are suited to the Greater Philadelphia market, even within city limits. As with cold storage, the past couple of years have cemented the viability and profitability of new industrial construction in Philadelphia, and the biggest limiting factor is the scarcity of land, Philadelphia Industrial Development Corp. Director Troy Mandy said.

“In Philly, wherever land is available and some of the criteria that developers look for, like proximity to [Interstate] 95 and thus the Eastern Seaboard, there will be development,” Mandy said. “But I see that running out fairly soon.”