The point has come in this series where we are finally getting into the meat and potatoes of what “Farm to Frozen” is all about. In the first two articles of the series, we established why cold storage is important and why it is hard to come by. Now we’ll begin exploring different methodologies for food manufacturers, processors and distributors (“occupiers”) to use in securing the much needed refrigerated and cold storage space their businesses need.
At the most basic level, occupiers can own or lease a building. From there, we can expand into further options. On the ownership side, an occupier can own an existing building or can finance and construct a new building through development. On the leasing side, occupiers can lease someone else’s existing building or lease a developer’s new building. One further step away from leasing is that an occupier has the added advantage of having the option to be a customer of a public refrigerated warehouse (PRW). That PRW can either be a tenant in a landlord’s building, or can be the landlord/owner themselves. Each option has its own set of advantages and challenges.
Buying a Warehouse
Purchasing a warehouse is a significant investment that requires substantial capital. However, it provides the occupier with complete control over the property. They can modify the building to suit their specific needs and won’t have to worry about rent increases or lease expirations.
However, buying isn’t always the best option for every business. The upfront costs can be prohibitive, and owning a warehouse means being responsible for all maintenance and repairs. For our audience, in the cold chain, the maintenance specifically for the refrigeration can be burdensome. Additionally, locking up that much equity in a building is often not the best use of capital as opposed to process optimization, R&D, labor, etc.
Lastly, if the business’s needs change, selling the property can be an unknown outcome. The potential buyer pool for these types of buildings is not very large.
Leasing a Warehouse
Leasing has typically been a more flexible and cost-effective option for businesses versus buying a building. Leasing allows the business to save their much-needed capital and deploy it in a growth manner rather than on real estate. This is particularly beneficial for businesses with changing needs or those looking to expand or contract quickly.
However, leasing also has its drawbacks. Primarily, the availability of such space is rather small. In recent years, this scarcity has increased asking rents for cold storage at a rapid clip, doubling, if not tripling, in many markets. Rents in Miami, New Jersey and other top-tier markets have crossed over $25 per square foot for existing buildings. These higher rents have also increased the values of these buildings. An occupier that only leases a building is certainly participating in this value creation, but unfortunately won't benefit in any way from a potential building sale.
Whether buying, leasing, developing, or engaging a real estate investor to partner with, the right choice depends on a variety of complex factors. Getty Images.
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Developing a Warehouse
Developing a warehouse allows businesses to create a space that is absolutely tailored to their specific needs. This could include custom layouts, specialized equipment installations, unique architectural features and ideal site layouts. As great as this might sound, the current state of the development market includes extreme interest rate volatility, expensive construction costs and, sometimes, land to purchase can be cost-prohibitive.
That said, if these challenges can be overcome, once completed, the business benefits from ownership and can choose to sell the building and lease it back from the buyer, again unlocking equity.
Overall, development is a complex and lengthy process that requires significant financial, personnel and project resources. Businesses must navigate zoning laws, building codes, construction logistics, and last – but not least – land acquisition and construction financing. Because the occupier is the owner/developer in this scenario, they are also subject to guarantees, delays and cost overruns.
Engaging a Real Estate Developer
A unique option is what is known as a “built to suit” solution. This is where businesses that want the benefits of a custom space without the hassle of managing construction, engages a real estate developer to do the actual development, but for the specific use of the future occupier. The most obvious benefit is that a developer takes the upfront risk of purchasing the land and constructing the facility, while the occupier has only the obligation of signing a lease. Further, because developers have the expertise and financial incentives to complete the project on time and under budget, the process tends to go much smoother than when an occupier builds a building for themselves.
This solution still has drawbacks for the occupier. In addition to the negatives discussed in the earlier leasing section, a built-to-suit lease will be more expensive than a lease for an existing building. Aside from expense, the lease for new construction will typically be a longer term commitment than what is possible to negotiate for an existing cold storage facility. Lastly, even with an experienced developer partner, new construction can be too slow of a process for food and beverage manufacturers that need immediate occupancy.
Engaging a Real Estate Investor
A less common but viable option is to engage a real estate investor who purchases the property on behalf of the occupier and then leases it to the occupier post-closing. This arrangement can provide access to existing vacancies for F&B manufacturers or processors who don’t have, or are unwilling to deploy, the capital required to purchase a building. Once again, the negatives of leasing apply to this scenario, though they may be less onerous than a lease for new construction. One other possible opportunity in this arrangement is that a real estate investor can purchase a vacant dry warehouse and then retrofit the building for use of the occupier. This retrofit can be very intensive and may include providing heated flooring, insulated metal paneling, and of course, the refrigeration equipment. At such a magnitude of tenant improvement, this solution starts to look like a hybrid of a built-to-suit and an existing acquisition. This may be the best of both worlds for occupiers that need quick occupancy and/or those in markets with very little vacancy.
Rents for cold storage in Miami, New Jersey and other top-tier markets have crossed over $25 per square foot for existing buildings. Getty Images.
Becoming a Customer of a Public Refrigerated Warehouse
Finally, it wouldn’t be appropriate to talk about obtaining cold storage space without discussing cold storage third-party logistics providers, or 3PLs, otherwise known as public refrigerated warehouses. Most readers of this series are familiar with these services, but it is important to point out that using a PRW is certainly the most flexible option available to those who need storage and some value-added services. PRWs can offer nationwide services for distribution and storage, and can simplify operations for manufacturers by providing single point of contact for their distribution and storage needs. With that said, this flexibility comes at a cost. For some users, depending on their scale, size, and required services, it may be cost prohibitive to be serviced by a public refrigerated warehouse when compared to securing space to occupy directly.
Conclusion
Choosing how to occupy a warehouse is a critical decision for any food processor, manufacturer or distributor. Whether buying, leasing, developing, or engaging a real estate investor to partner with, the right choice depends on a variety of complex factors including, but not limited to, capital availability, local vacancies, speed to market needs, risk tolerance and internal expertise. In the articles that follow, we’ll dive into each option even further and discuss nuances and opportunities for each. Ultimately, occupiers may need to explore different options for each business case that is investigated. Market conditions may play a very large role in influencing the decision, but being familiar with the pros and cons of each real estate structure is critical for an appropriate evaluation.
