There was a time when an abandoned school building in the neighborhood ended up being converted to an art gallery. These days there's a better chance that a retail distribution center run by the likes of Amazon, Walmart or Home Depot will be the new neighbor.
The highest value of urban industrial property has changed as a result of the altered pattern of consumer purchasing. E-commerce is increasingly becoming a preferred channel for how we buy our products. In 2015 total e-commerce sales were estimated at $341.7 billion, an increase of 14.6% from 2014, according to the U.S. Department of Commerce. Projections are for this figure to more than double by 2019.
With this convenient method of purchase comes the expectation of high-speed delivery—next-day in many cases and even two-hour delivery in some cases. This new consumer model is based on what's been called the "Amazon effect," after the online retail giant that created this model and is still the dominant player, accounting for almost 26% of all U.S. e-commerce sales.
To hit the desired delivery times, DCs need to be where the customers are, and there's been a definite shift to urban areas in recent years. Looking at one particular group of consumers—Millennials—the number of college-educated people aged 25 to 34 living within three miles of city centers has surged 37% since 2000.
"Today there is robust demand from e-commerce and third party logistics companies for warehouse and distribution space in urban areas, which includes smaller in-fill locations within major metro areas," explains John Morris, executive managing director, with Cushman & Wakefield, a global real estate services firm "This trend is reshaping the industrial market and driving up costs for urban locations, which can now reach $50 per square foot."
That real estate includes abandoned schools and government buildings which can be retrofitted as distribution centers. Areas are being rezoned for this higher and better use, and the private sector is quickly picking up these properties.
About 10% of industrial leasing and 30% to 40% of total industrial development are now tied directly to e-commerce fulfillment activity, according to research compiled by Ben Cornwall, a managing director at Cushman Wakefield.
Staking a Claim to the Last Mile
What Amazon and other retailers (both Target and Home Depot's online sales are growing 40%-50% per year) are after is the last mile delivery. This portion of the supply chain can eat up to 28% of the total cost to move goods and faces logistics challenges due to congestion.
But Amazon is out in front in this race and already has 25 DCs within large urban centers, with more opening seemingly every month. What's more, Amazon is putting further pressure on land use with its new service called Prime Now. Moving into hyper-speed territory the service promises customers they'll be able to receive "thousands of items" within a two-hour window of clicking the little yellow "checkout" button on their phones. Twenty-five major cities are already being serviced by the program.
Another innovator in the field is Peapod, which is a virtual grocery store that is operating small warehouses, ranging in size from 5,000-8,000 square feet. Peapod cross-docks shipments in its parking lot, which greatly reduces the need for infrastructure and real estate.
As more of these services are created, they will put further pressure on urban real estate. In fact in Manhattan Amazon has a delivery depot on 34th Street, right across from the Empire State Building.
The depot dispatches couriers onto bikes, buses, or subway trains to bring customers their packages.
Other cities experiencing urban growth, such as Denver, San Diego, Nashville, Salt Lake City and Portland, are starting to see real estate purchased for distribution purposes. In fact a recent study conducted by Cushman & Wakefield found that U.S. industrial vacancy reached a 15-year low in the last quarter of 2015.
The low vacancy rate can be tied to the 66 million square feet of distribution space nationwide occupied by Amazon. Walmart is getting into this game as well as it has 1 million-sq. ft. projects under development in six major markets. Home Depot, Target and Kohl's are also making major investments in e-commerce-related facilities throughout the U.S.
The demand will continue with projected occupancy gains of 380 million sq. ft. in warehouse/distribution space from 2014-2017.
Much of this real estate demand is predicated on the need for next-day delivery. Morris questions how the market will shape up as other retailers join the free shipping model, as currently this part of the business is not a profitable one. In fact Amazon just recently raised its shipping rates for non-Prime members to cover the cost of the Prime losses.
Given these cost considerations, other retailers looking to find that last-mile delivery might not choose the costly urban space, but instead opt for secondary cities that have strong intermodal logistics that are close enough to service the urban area. "The biggest unknown in the next five years is the value retail is going to place on the shipping piece of the business," says Morris.
One of the issues that will affect the market is the level of involvement of large retailers in the distribution business. "Walmart and other large retailers have been slower to enter this market since they operate from a brick-and-mortar perspective," says Tom Caporaso, CEO of Clarus Commerce. "Amazon was born as an e-commerce pure play and approaches issues from a very different perspective that involves a lot of flexibility."
Another twist to the influence that e-commerce is having on industrial real estate is the viability of the big box stores. Recently Walmart announced its plans to close a number of stores, as have other large retailers. What will happen to these coveted locations? Some speculate that perhaps they will either become DCs for the original retailer or Amazon could move into these locations. Would Amazon eventually become its own shipper, offering its distribution services to others? There are already such partnerships between Amazon and other companies.
"For commercial real estate, the lines are blurring between industrial and retail," notes Thomas Bisacquino, CEO of NAIOP, a real estate association, in a recent whitepaper. "Some retailers are directly developing and operating their own technology platforms, logistics and distribution facilities, and others are outsourcing all of these functions. Still others are taking a hybrid approach, keeping some tasks in-house and outsourcing others. It's fundamentally shaping the way both retailers and industrial create work spaces and workplaces."