A hot time for those seeking the cold

Real estate money manager interest in cold storage warehouses is heating up.

Amazon.com Inc.'s announcement in October that it is now delivering groceries for free for Amazon Prime members in certain areas is a boon for cold storage investors and will further cement the trend of online grocery shopping, industry insiders say.

Already growing demand for cold storage space is expected to boom from Amazon as well as other food retailers and drug manufacturers moving to make delivery easier. But there is a hitch. Demand for the warehouses outstrip supply, making it more difficult for managers to invest in the growing subsector.

"There is still a lot of speculation on what the impact of Amazon's acquisition of Whole Foods would be within the cold storage space," said Graydon Bouchillon, Dallas-based managing director and head of U.S. industrial sector at Nuveen Real Estate.

Amazon Prime's offer of free groceries "is a validation of a secular trend in our minds," Mr. Bouchillon said. "Amazon making free grocery delivery available to its existing customer base bodes well for cold storage, particularly in urban locations."

Among the managers that are investing or seeking to invest in cold storage to take advantage of the move to sell food online as well as increasing home deliveries of medications include Blackstone Group Inc., PGIM Real Estate, Nuveen LLC, LaSalle Investment Management and CBRE Global Investors.

The U.S. industrial cold storage business is likely to add up to 100 million square feet of additional space over the next five years, a 47% increase, to keep up with the growth of anticipated online grocery sales, according to a report by commercial real estate firm CBRE Group Inc., parent of CBRE Global Investors. The growth of online grocery sales will cause grocers and other fresh food purveyors to move their cold storage operations to industrial cold storage facilities from stores to make delivery easier, the report said.

CBRE's projection is based on a Food Marketing Institute and The Nielsen Co. (US) LLC forecast that groceries ordered online will make up 13% of total grocery sales by 2022, up from 3% in 2018, the report said.

Investors expect industrial to continue to be a strong sector as a substitute for retail in their portfolios, said Matt Evans, chief investment officer of Los Angeles-based industrial operating firm Dedeaux Properties LLC. Dedeaux invests in industrial properties in joint ventures with institutional investors across three sectors including cold storage, he said. Malls and other retail have been suffering since consumers switched to online shopping, which is increasing the need for warehouses overall.

"For the last two years, we have continued to see an increase in the market for these types of requirements due to the e-commerce effect on food delivery, meal service and other related trends," said Nicholas Ilagan, Newport Beach, Calif.-based senior vice president, asset management at real estate developer and manager CapRock Partners.

As consumers continue to buy goods online, producers are forced to move discreet items from place to place, intensifying the demand for cold storage over the past 12 to 18 months, Dedeaux's Mr. Evans said.

"You want cleanser at your house tomorrow. How do I get (food) from farm to table quicker? How do I get the produce I need and do it quickly," Mr. Evans said. "It changed the requirements of (industrial) buildings."

Many managers are trying to figure out how to get exposure to cold storage because there is a need to support the population base that is demanding groceries and other perishables be delivered to their doors, he said.

"It's becoming an interesting subasset class because it has not been as penetrated by institutional capital" as other types of real estate, Mr. Evans said.

"We're at the leading edge," he said.

There is very little new construction of cold storage facilities in the U.S., amounting to 4.5 million square feet or 1.5% of all industrial real estate construction as of June 30, another CBRE report said.

Cold storage facilities differ from traditional warehouses in that they cost on average two-to-three times as much as a traditional industrial warehouse, known in the industry as a "dry" warehouse, and take four to five months longer to build. This is due to additional requirements for cold storage such as insulated metal paneling and refrigeration equipment.

There is huge demand for cold storage warehouses that can accommodate quick delivery, said Dwight Y. Angelini, Boston-based managing partner of Longpoint Realty Partners LP. Although rent for cold storage is higher than traditional warehouses, cold storage rents need to be even higher to accommodate the cost of building the facilities, Mr. Angelini said.

The greater building requirements for cold storage facilities also limits supply of cold storage warehouses compared with demand. This supply-demand imbalance makes it difficult for institutional investors, especially those with large real estate portfolios, to increase their allocations to the sector, said Robert Bellinger, president and CEO of real estate money manager ASB Real Estate Investments, Bethesda, Md.

Currently, ASB executives are considering new types of industrial investments including in cold storage, but they have not yet made an acquisition, Mr. Bellinger said.

"I think that for multibillion-dollar portfolios it is hard to increase allocations because of limited supply of product," he said. ASB manages $8 billion in assets.

Portfolios in the subsector are attractive acquisition targets. For example, Blackstone Group in May sold Cloverleaf Cold Storage to Americold Realty Trust, the largest cold storage real estate investment trust with 178 temperature-controlled warehouses, for $1.25 billion after owning the cold storage owner and operator for just two years. The company had been owned by two families, the Feiges and Kaplan families, since its founding in 1952.

North American real estate institutional investors had 13.1% in industrial properties in 2018, up from 12% in 2014, according to data provided by the Pension Real Estate Association.

Even so, traditional warehouses and cold storage are among the industrial and logistics assets that are at the top of everyone's buying list, industry experts say.

"Most investors wish they had more of it (industrial and logistics)," in their portfolios, said Jacques Gordon, Chicago-based global head of research and strategy at LaSalle Investment Management. "It's hard to do."

Warehouse lot sizes are smaller, especially those catering to last-mile locations close to population centers, and a lot of the best product has already been purchased, he said.

"More and more food-oriented users really want to be close in," to population centers, Mr. Gordon said.

Some of the demand is e-commerce driven and some is urban renewal driven, he said. There is a double-digit rate of demand for temperature-controlled food facilities. Nuveen's focus on the subsector is on more flexible warehouse facility design where cold storage is built inside of a traditional industrial building shell, Mr. Bouchillon said. "More of a box within a box, if you will," he said. Should demand stabilize, these warehouses can pivot away from cold and into dry distribution uses, he said.