Key Takeaways
From a valuation standpoint, these assets make for attractive sale leaseback (SLB) candidates because food production and cold storage facilities typically rent out for anywhere from 1.5 to 3 times what a dry industrial building would rent for. There are a variety of reasons for this. For starters, these specialized facilities are very expensive to build, and their replacement cost is very high, as refrigeration systems and climate control needs are factored in. As a result, these facilities carry a higher rent to justify the higher build costs. Thus, they trade for two to three times as much as dry industrial space trades for on a price per foot basis. Newer freezer/cooler facilities can trade north of $200 per square foot (compared to construction costs of $300 per foot or more). Older facilities with freezer/cooler components will typically trade in the mid $100s per square foot. Also, since there’s a limited inventory of freezer/cooler facilities, vacancy rates tend to be lower than they are for dry industrial space.
Tenants of these assets tend to be stickier to their facilities because the facilities are very specialized with the refrigerated fit-out, and because tenants tend to be heavily invested in the properties. It’s cost prohibitive for tenants of food production and cold storage facilities to pick up and relocate elsewhere. It’s and also tricky to do so given the limited availability of this asset type. We have found SLBs in this sector to be fairly safe due to the tenants’ long-term commitment to these sites.
Cold storage facilities vs. food production facilities
There is a distinction between cold storage facilities and food production facilities that have freezer/cooler components. Generally, cold storage refers to refrigerated warehouses that are meant to store perishable goods by maintaining temperature controls. Serving as storage space, cold storage facilities are typically located in high population areas in proximity to key distribution networks. Major markets in the U.S. for cold storage space include Los Angeles, Philadelphia, Dallas Fort Worth, and Chicago.
By contrast, food production facilities containing freezer/cooler capacity refer to production or processing facilities used for manufacturing purposes --they’re not warehouses used for storage. Food processors and manufacturers are often located in more tertiary and remote locations, since they are focused on production instead of storage and distribution. Often these operators are located in non-core markets. Food production facilities can be even stronger SLB candidates than cold storage because they are characterized by high replacement costs, and because they have “bolted down” tenants who’ve made a significant investment in the property. Also, food production facilities maintain a specialized fit-out that is difficult to replicate. Further, they check a critical box for SLB investors in that these production sites are true profit-centers for the business, without which the company could not operate.
Given the headwinds the food manufacturing/storage industry has faced this year, including labor challenges, supply chain issues, and inflation, the SLBs can be a great way for these businesses to tap into capital to reinvest into their operational initiatives. Additionally, given the disproportionate impact of rising interest rates on cap rates compared to the cost of debt, many businesses in this sector have used SLB capital to pay down debt in this environment.
With an SLB, the food producer or cold storage business secures operational control of their footprint through the long-term nature of the lease, typically 15 to 25 years in length.
Another thing I like about food production facilities is that geographic location doesn’t impact value as much as it does for other RE asset classes. These types of SLBs rely heavily on the underlying credit of the company, and the mission-criticality of the subject property. Therefore, a food production facility in a tertiary or even remote location remains attractive even if the tenant is never likely to leave, and if the subject site is a strategic asset for the business’s operations.
Arbitrage
Finally, the arbitrage potential of SLBs makes them even more attractive for owners of food production/processing and cold storage businesses. Food production/processing and cold storage operators can sell their real estate at a valuation multiple that is often much higher than the operating business’s valuation multiple. When implied cap rate multiples are higher than business valuation multiples, business owners benefit from immediate equity value creation.
Example of food processing and cold storage sale leaseback
We recently structured a $54 million SLB on behalf of a leading, private equity-backed manufacturer and marketer of protein products, snacks, and appetizers. The company operates many production facilities across the country and was looking to generate capital by executing a SLB of three of its refrigerated production facilities in Tennessee and Virginia. The portfolio was composed of over 50% freezer/cooler space by square footage.
The locations were mostly tertiary industrial markets. We set rents at roughly $10 PSF as the facilities were on average between 25 and 30 years old and were not fully refrigerated. If the facilities were more than 50% freezer/cooler, we would have set rents higher, likely in the mid-teens. The more freezer/cooler space there is, the higher the rent and pricing will be – all else being equal.
Mid-Year Review
The market seems to have stabilized for the most part. Cap rates are lower now than they were earlier this year. Recently, we’ve received many valuation requests, which means those M&A deals are likely to close three to six months from now. Hopefully this will make for a busy year-end. There’s definitely a lot of dry powder on the sideline waiting to be deployed.
Why Ascension
While the upside potential for food production and cold storage is considerable, deals can be complex to value and execute properly. When food production and cold storage facilities are not viewed through the right lens, significant value can be left on the table. While food production/cold storage may not yet be fully understood by the market, the asset class is just as viable for SLB deals as for any other type of industrial or commercial property. Again, that’s because tenants are so sticky and so committed to their sites.
Conclusion
If you’re an owner operator or private equity owner of a cold storage of food production business, let’s discuss how we can help you monetize your real estate through a SLB transaction.