Cloud kitchens: Hungry for investment

A whisk the size of my head, covered in globs of cake batter, is perched precariously on top of a sink full of dirty mixing bowls and interesting-looking utensils. It will be a hard job for one of Karma Kitchen’s many washer-uppers to tackle, but one woman seems to have embraced the challenge. She’s rolling up her sleeves, eyes focused on the mountain of dishes before her, mentally preparing herself like an athlete before a big game. In the kitchen area opposite her, the clatter of dishes and ladles on steel tabletops signals that there is more washing up to come. Bowls of quinoa and fistfuls of parsley are being prepped by three chefs on the tables around them, all set to be turned into an Indian feast for a client. It’s 10am and Karma Kitchen is gearing up for another busy lunchtime. There is no dine-in facility here, though. This 3,000 sq ft warehouse space in the heart of Hackney, E2, is one of an emerging number of food production units for takeaway outlets. These cloud kitchens are so called because of the high proportion of orders that are placed online. They provide restaurants with overflow kitchen space to focus solely on preparing and delivering food to meet the boom in demand and have been growing in numbers across major cities off the back of the rise of food delivery apps such as Deliveroo and Uber Eats. Co-founders Gini Newton and her sister Eccie set up Karma Kitchen in September 2018 after struggling to find cheap, flexible kitchen facilities for their lunch delivery company Karma Cans. But this emerging sector goes beyond individual start-ups as delivery apps themselves have pivoted to focus on the bricks and mortar side of food delivery. In May 2016, Deliveroo launched its Roobox concept – surplus kitchens to ensure its busiest restaurants are able to keep up with demand. Roobox uses Deliveroo’s database to calculate where the most demand is for a brand’s product and offers restaurants extra kitchen space to keep up with growing takeaway orders. The big question is whether this move from tech platform to bricks and mortar could signal the emergence of a new asset class. With high-profile investors starting to take a punt on cloud kitchens, could this be an investment trend to watch? A ripe market There is no doubt that the value of the foodservice delivery market is on the rise. In the UK, the sector saw an 18% growth between 2018-19 and is currently valued at £8.4bn, according to the MCA’s UK Foodservice Delivery Market Report 2019/20. And, according to a report by Deloitte and Uber Eats, the food delivery market in Europe will grow by 10% year-on-year to be worth $25bn (£19bn) by 2023, with food delivery apps helping restaurants to grow their sales by 20%. In the US, research by investment bank Morgan Stanley shows that the value of the food delivery market could stand at $220bn by 2022 and make up 11% of the food sector, compared with 6% in 2019. This year alone, Mumbai-based cloud kitchen start-up Rebel Foods raised $125m (£97m) in its latest Series D funding round; Uber founder Travis Kalanick raised $400m for his CloudKitchens brainchild; and Beijing-based Panda-Selected secured $50m in a Series C funding round. While proptech fund Fifth Wall is yet to invest in the sector, it is carefully monitoring the rise of the kitchen-as-a-service market. According to real estate tech investment managing director Roelof Opperman, Fifth Wall sees the value in cloud kitchens as a “turnkey operation” to provide restaurants with “an opportunity to capture new demand that they couldn’t serve efficiently on their own”. [caption id="attachment_1009134" align="aligncenter" width="847"] Karma Kitchen founders Gini and Eccie Newton[/caption] Whether Fifth Wall invests its own capital into this market is another story. This is because the returns that VCs want are “very high” says Opperman and setting up and fitting out cloud kitchens requires a big injection of capital. “The question really is this,” he says. “Are you able to provide a sufficient return for the money in the ground? That’s the big thing. There’s only so many players that can provide that quantity of capital and be patient enough to sit there and provide the capital as the company continues to scale.” He is quick to add that this caution does not mean Fifth Wall never will invest. Rather it is keeping a close eye on the sector at an early stage. “The reason we pay attention to it [cloud kitchens] continuously is because we think there is going to be a tremendous amount of money made by landlords,” says Opperman. “This is a really good repurposing [opportunity] for real estate. If you’re able to buy light industrial that trades at a very high cap rate, put one of these ghost kitchens in and stabilise it[…] at a lower cap rate then sell it, you can make a lot of money.” Fingers in the pie So there is money to be made. Potentially just not at high enough levels for VCs yet. But if they aren’t investing, then who is? Chief executive of New York-based RXR Realty Scott Rechler for one. In September this year he co-led Kitchen United’s latest Series B funding round, which closed at $40m alongside GV (formerly Google Ventures). Speaking at MIPIM Proptech NYC last month, Rechler outlined why the business is betting big on this asset class. Since 2018, RXR Realty has been investing in companies that specialise in data collection, analytics and innovative technology as part of a wider strategy to inspire and increase innovation within RXR. Rechler says that cloud kitchens are a good fit, especially in the US, where the online food delivery market is one of the largest in the world. But the investment doesn’t come down to a demand for intel alone. Rechler adds that it is his firm belief that this asset class is and will continue to be driven by necessity. “Restaurants are going to have an increasingly hard time servicing their customers on site at the same time as servicing the delivery requirements,” he says, before adding that cloud kitchens are a solution to this problem. If preparing takeaways and in-house food orders is slowing down the efficiency of the kitchen, then separating the two and dedicating a kitchen space solely for deliveries will help increase efficiency – and also keep up with the rising demand for online food orders. Rechler predicts that cloud kitchens will take on more of a Roobox approach to ultimately become places where customers can pick and choose dishes from multiple restaurants under one order. These restaurants, located in the same cloud kitchen, will be able to co-ordinate preparation to ensure the order is dispatched in one package. Good or bad egg? An interesting emerging sector perhaps but one that should be approached with caution. There is no reason why a savvy investor couldn’t see good returns on investment, says Opperman. But what are the risks? Pumping cash into them makes “absolute sense on paper”, he says. But in reality he outlines two key issues to be aware of: “One, [cloud kitchens] are operating companies, and real estate investors are terrible at assessing operating companies. They are really good at running assets, but what they are not good at, generally, is private equity-type bets. “The other compounded problem here is that the barriers to entry are very low, there are tonnes of cloud kitchen companies,” he adds. “Zipping through all the mess to figure out who is real and who is not is really challenging.” It’s all about backing a winner as a number of balance sheet blows indicate the challenges of operating in a bustling market where a power struggle is playing out between rival businesses. Recent reports of food app giants making big losses have not gone unnoticed by investors, as Opperman adds that cloud kitchens are being given venture-style valuations, and within these there lurks a venture-style risk. “That means there are going to be a tonne of failures,” he says. “And I don’t know if a real estate investor has that type of risk appetite.” Acquired taste It seems that, as with many emerging asset classes, high-risk tolerance will be required. But as Opperman says, that “tremendous amount of money” is there for those who back the right horse and are happy with a more modest return on investment in the short term. Karma Kitchen has certainly not seen a lack of interest. The Newton sisters secured £350,000 to open their kitchen last September. Now the start-up is just about to close its Series A funding round and is raising £3m. It is mainly the angel investors that backed Karma Kitchen’s launch who are investing in the next funding round. But a new type of investor has also thrown their hat into the ring: VC and private equity investors. Gini says while VCs have been slightly spooked by the business model, interest is high. “Obviously its capex heavy, so it’s not your typical tech business,” she says. By April, the sisters expect to open two further locations in London: a 14,000 sq ft site in Wood Green, N22, and a 5,000 sq ft hub in Camden, NW1. Within the next eight years, they want to open close to 100 more sites, expanding across the UK and into Europe. They have even been approached by US businesses to launch across the pond. With 83 businesses on the books, Gini says the demand is there for these kinds of kitchen spaces. As Gini finishes the tour of Karma Kitchen, we weave past the chefs, the maintenance team and the cleaning staff. I wonder how long it will take to scrub the cake batter off that giant whisk. To send feedback, e-mail lucy.alderson@egi.co.uk or tweet @LucyAJourno or @estatesgazette