The other day, I was asked about my knowledge of Cold Storage facilities. It struck me that understanding the DNA of these asset classes is crucial, as there is still some uncertainty in the market regarding their valuation. Due to the substantial investment and expertise necessary to run a successful operation, limited information is accessible to the market, and herein lies the problem around accurate valuations.
Cold Storage facilities are far from your typical industrial buildings. They are highly specialized and complex, with location, construction specificity, infrastructure, and health and safety playing crucial roles from storage, distribution, manufacturing, and logistics perspectives. Typical areas include freezers, defrosting, cold rooms, preparation areas, and dry storage with set-up depending on whether it is used as a processing plant or exclusively for storage and distribution. Their unique nature is underscored by the need to adhere to specific health regulations and standards, such as the South African National Building Regulations and Building Standards Amendment Act No. 103 of 1977 (as amended) and the Occupational Health and Safety Act No. 85 of 1993, amended by the Occupational Health and Safety Amendment Act No. 181 of 1993.
Apart from the generic construction elements, additional construction specificity includes expanded bead polystyrene and polyurethane insulants with frost heave prevention flooring, floor insulation and vapour-sealed floors, to mention a few. The design of a cold storage system includes four key elements: (1) Compressor, (2) Condenser, (3) Expansion device, and (4) Evaporator. Cold storage refrigeration plants typically utilise reciprocating compressors with flood-mounted air handling units equipped with finned or bare tube cooling coils.
Cold Storage facilities are not just buildings; they are a critical part of the supply chain. These facilities are designed to create temperature-controlled spaces for the safe storage, distribution, production, processing, and packaging of perishable goods. What started as a simple concept of housing these facilities in generic industrial buildings has evolved into the construction of highly specialized buildings that are now a sought-after asset class. This evolution showcases the progress and innovation in the industry, making it an exciting and dynamic field to be a part of.
The internal environment of a cold storage facility is regulated using refrigeration and air conditioning systems to maintain specific temperature and humidity levels. Cold storage spaces can be as cold as minus 100°C, with humidity varying from 95% to very low levels, depending on the stored products. The required temperature and humidity are determined by the type of products being stored. For instance, vegetable storage typically necessitates temperatures between 0°C and 5°C and a high humidity level ranging from 80% to 90%. The facility must operate continuously throughout the year, accommodating substantial fluctuations in load.
Cold storage establishments are expensive and are operated by a small number of highly capitalised firms. These cutting-edge and often tailored buildings require more coordination, focus on construction specifics, and examination of major building systems to ensure they are safe, function efficiently, and operate effectively.
Investing in cold storage facilities involves a significant capital layout, and investors expect a significantly higher return than standard industrial properties. The income from the investment is twofold: one from the physical asset plus the other from the infrastructure required to run a successful operation. This potential for financial gain is a critical factor in the attractiveness of investing in cold storage facilities. However, due to their high cost and specialised nature, careful valuation and consideration of factors like the age of the infrastructure and risk should be a priority.
The costs of developing a modern facility could be anything north of R20,000/m², depending on the construction specificity. Insofar as this is concerned, it is recommended that the investor seek advice from industry specialists when deciding to develop a cold storage facility. So, depending on the specification, a net rental of R175/m² can be expected at a hypothetical return of 10.50% based on the assumption mentioned earlier. The rental price will be determined by the market and will heavily depend on the age, condition, location, construction elements, and the modernity of the cooling infrastructure. It’s essential to conduct thorough rental investigations and make adjustments for specific elements before applying or running it through a model, especially weighing in on the lifecycle analysis of the operational infrastructure. Key to note when approaching a valuation of this nature is to determine whether the operational aspects are movable or whether the infrastructure is fixed to the property. In this regard, refer to the case of “Macdonald Ltd Appellants v Radin NO and the Potchefstroom Dairies & Industries Co Ltd Respondents 1915 AD 454”. (Feel free to contact us for a copy of this case at admin@jsvals.co.za)
Caution must be applied to the rental application, which will require adjustments to on-site specific components compared to other facilities. Given that the valuer can capitalise the income stream into perpetuity, sinking funds must be accounted for to elements with a finite lifecycle. Please also note that only market-related rentals can be capitalised. Therefore, it is vital to determine whether the income stream of the various components is not over or underestimated. The valuation can also be run using a DCF model, where sinking funds can be easily accounted for. In this instance, be mindful of the age of the infrastructure; if it is new, then it should be accounted for in the terminal value of the model if a short-term cash flow model is being used. Risk of the specialised nature should be accounted for in the capitalisation and discount rates after the tenant covenant and lease term are accounted for.
The above provides a summary of the valuation of cold storage facilities and the main factors influencing their value. The analysis is intricate and requires in-depth analysis and advanced models to consider life cycle analysis. Interviews with the owners and operational managers are crucial, as they better understand their facility compared to those conducting the valuation.
At J Squared Property Valuations, we take pride in applying our extensive knowledge to most asset classes to determine the right outcome for the client’s valuation needs. For more information, please feel free to contact us.
