Ontario’s esoteric electricity pricing scheme is well matched to a burgeoning, but niche alternative real estate asset class. Cold storage facilities are flagged to deliver robust returns to investors due to the evolution of food retailing, demand for vaccines and other pharmaceuticals, and the thriving outlook for the warehouse/distribution and logistics sector in general. However, those prospects come with complicated and costly development and operating considerations.
“Cold storage facilities are very capital-intensive. The number I’ve heard is roughly two to as much as three times the cost of a generic warehouse,” observes Bill Argeropoulos, principal and research practice leader with Avison Young Canada. “It’s usually design-build to meet a user’s specifications for their products; ceiling heights generally exceed the 40-to-60-foot heights in a typical warehouse/distribution facility; and power consumption can be double or triple that of a generic warehouse.”
The latter factor could make Ontario more attractive for investors and developers still prepared to get into the market. Cold storage operators are deemed to have a strategic advantage in the provincial electricity pricing program for large consumers, which ties their allocation of global adjustment costs to their energy demand during the five hours of the year when highest system-wide demand is registered. Electricity customers with the foresight and flexibility to cut energy loads during those hours can lock in a favourable billing factor for the subsequent 12-month period from July 1 to June 30.
“Cold storage (in Ontario) has the cheapest electricity price in North America,” Scott Rouse, managing partner with the consulting firm, Energy@Work, noted during a recent webinar sponsored by the Building Owners and Managers Association (BOMA) of Greater Toronto. “They’ve got it figured out. They’ve got the monitoring in place to get an indication of when there’s going to be a potential peak. Then they shut off their compressors, don’t open their freezer doors and everything’s great.”
Online grocery shopping escalates in-progress trend
Even before the COVID-19 pandemic, analysts identified urban population growth, consumer appetite for convenient-to-prepare healthy food and the rise of e-commerce as trends that would flow through to demand for cold storage. Those trends have simply synergized during the past 15 months as public health concerns and controls upended food retailing — significantly undermining grocery stores’ competition from restaurants and moving an increased share of sales to online platforms.
CBRE Canada’s newly released spring 2021 retail report cites a 12.4 per cent year-over-year gain in sales volume for food and beverage retailers. That’s compared to the category’s long-term average of 3.8 per cent annual sales growth, and juxtaposed with the 32.7 per cent drop in clothing and accessories retail sales during the same period. The report projects continued elevated sales growth, at least in the short term, and permanent integration of online services that were introduced or upgraded as pandemic contingencies.
“Recent studies from J.C. Williams Group show that the majority of consumers who have converted to online shopping will continue to as such in the future. Convenience is a driving force behind this, and stores will need to strike the right balance of serving walk-in traffic and fulfilling digital orders in-store in order to capture customers,” the CBRE report states.
“Online grocery shopping, which is still in its infancy stage compared to other retail categories, will be a key driver in the demand for cold storage space in the future, especially among younger consumers,” Argeropoulos submits. “As e-commerce expands within the grocery arena, I consider cold storage/freezer facilities, along with self-storage and data centres, as an emerging alternative investment class within the broader industrial sector.”
Nevertheless, he characterizes cold storage as something of a hidden element — sometimes literally incorporated into even larger warehouse/distribution complexes — in a flashier backdrop.
“It’s difficult to quantify and categorize the cold storage market because of its unique premises and uses within a warehouse, but it represents a small portion of the GTA’s 890-million-square-foot industrial inventory and Canada’s overall industrial stock of almost 2 billion square feet. Because of its unique classification, it’s also challenging to single out cold storage facilities to gauge investment capital flowing into the sector,” Argeropoulos says.
Developer partnerships with facility operators an industry norm
Cold storage facilities are defined and marketed in terms of storage space per cubic foot rather than on a square foot basis — generating far greater rent income than similarly sized warehouses. Because they are typically built to suit a specific tenant, lease terms tend to be lengthy, and tenants themselves may be cold storage facility providers, which, in turn, sub-lease the space to various smaller users.
Looking to the U.S. market, circa-2018 analysis from JLL lists that country’s 25 largest cold storage operators, which, at that time, ranged from nearly 900 million cubic feet to 16.5 million cubic feet of business capacity.
“Most companies in need of refrigerated storage services outsource these functions to industry operators to avoid the substantial costs associated with operating these facilities. While privately operated facilities can provide companies a greater deal of control and flexibility over their product, the substantial start-up costs deter many smaller companies from entering the space,” JLL analysts advise. “As a result, this form of vertical integration has generally been limited to large-scale food producers like Nestle and Kraft controlling their storage facilities.”
Meanwhile, some investors are moving from a strictly landlord role to holding a stake in facility operations. Notably, last September, Canada’s Oxford Properties Group made a CAD $475 million investment in Lineage Logistics, which owns and operates more than 320 facilities worldwide, comprising 1.9 billion cubic feet of cold storage capacity.
“The cold storage industry is a sector that is poised for growth and demonstrates great resilience and defensive attributes in this current climate. Our investment will provide access to the sector’s market leader and supports its management team to execute its growth strategy,” Kevin Egan, Oxford’s head of investments in North America, said at the time.
Argeropoulos tallies three significant cold storage transactions in Canada over the past six months: Tricor Pacific Capital acquired a three-building portfolio from Confederation Freezers for a total of $168 million; U.S.-based Americold Realty Trust acquired three buildings from Brookfield Asset Management/Nova Cold Logistics for $337 million; and the consortium of Investment Management Corporation of Ontario (IMCO), TorQuest Partners and OPTrust acquired VersaCold Logistics from KingSett Capital and Ivanhoé Cambridge.
“VersaCold is one of Canada’s largest cold storage warehousing and food logistics firms,” he adds. “The sale price was not disclosed.”
Particularly for institutional players with deep pockets and long-term horizons for holding investments, the fundamentals also appear to support new development. JLL pegged those costs in the range of USD $250 to $350 (CAD $324 to $453) per square foot in 2018, but, given construction complications, Argeropoulos is skeptical that other approaches deliver discernible savings.
“Although converting an existing generic warehouse to a cold storage use might seem like an attractive option, it can be no more cost-effective to convert a building than to build one from the ground up,” he concludes.
Barbara Carss is editor-in-chief of Canadian Property Management.