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Date: June 25, 2018
Category: Real Estate

Is Industrial Real Estate Boxing Out Small-box Retailers?

Imagine you had an epiphany. Waking from a dead sleep, you stumbled over the kids’ toys in the hall, quietly slipped down into the kitchen, and wrote every early-morning thought that came to mind, capturing a vivid dream that would become career changing. Little did you know, your concept for a revolutionary ecommerce shoe company would be a game changer, but then ultimately run into roadblocks during the latest industrial revolution.

Challenges to making the dream a reality

The complex production and distribution of goods has come a long way since water and steam power. The advent of electric power and the use of information technology empowered mass production and automation, leading a business’ supply chain to today’s latest shift, a digital revolution that started in the mid-1990s. This fusion of technologies has already had a significant impact on business’ scope and speed. Demand for warehouse space is robust, as retailers, like your “Zappos of the future,” are laying out 21st-century supply chains that include distribution centers as close as possible to densely populated areas with well-connected infrastructure advantages.

Online retailers need roughly 1.2 million square feet (msf) of distribution center space for every billion dollars of sales. And traditional retailers branching into ecommerce are discovering the need for three times the distribution center space they currently utilize for brick-and-mortar stores.1 The balancing act includes keeping in-store shelves stocked for maximum cost efficiency, while meeting the one-, two- and even same-day shipping guarantees of online competitors.

The increased demand for square footage is impacting industrial lease rates, land pricing, and development costs in every city, state, submarket, and metropolitan statistical area (MSA) … in the world! In 2017, net absorption reached 246.3 msf of industrial warehouse space, the fourth straight year over 240 msf.1

Today’s supply cannot meet this increased demand. The lag in new supply started earlier in this cycle (2010-2013), as the market was working its way through significant supply left vacant after the Recession. But now that vacancy issues are a problem of the past, new building constraints include more stringent financing, strenuous entitlement processes, lack of suitable land sites, and skyrocketing costs. While the development forecast has improved, finding quality, cost-effective land sites has proved difficult.

Breaking ground is hard to do

This supply-demand disconnect is impacting today’s entrepreneurial dream. The ambitious goal of starting that ecommerce shoe company requires more than blood, sweat, tears, and shoes. It requires the capital and the supply chain to build the facilities integral to delivering this concept to the customer in an on-demand world. Unless you star on Shark Tank, this is the issue facing many start-up and small-box retailers trying to get their market share in a competitive, and pricey, industrial landscape.

By any numbers, current supply is expensive. Costs per acre are increasing for larger first-mile sites with warehouses often exceeding one msf and for last-mile facilities. These facilities are smaller warehouses and fulfillment centers located close to major population hubs or high-quality transport networks that offer rapid access to area consumers. Typically, these last-mile facilities must be designed or upgraded to facilitate rapid turnover of goods with a significantly smaller footprint than traditional warehouses.

The average price for a large parcel of prime warehouse development land in northern New Jersey reached $1.75 million an acre in 2017, up 17 percent from 2016. Inland Empire, California – one of the biggest areas of industrial growth – saw average prices jump 35 percent year over year, while industrial locations in big cities like Chicago, Houston, Las Vegas, and Atlanta rose anywhere from 14 to 17 percent in 2017.2 These escalating land prices are a major reason why new supply hasn’t kept pace with demand, and it’s impacting smaller or start-up companies who need the land, but may have difficulty finding the funding.

Moving outside prime real estate

Less-established companies are expanding their search beyond the expensive urban core. Just 60 miles outside New York City, distribution centers get bigger and less expensive, reaching nearly one msf on average along I-78 in Pennsylvania, one of the Northeast’s largest regional distribution hubs. The area’s warehouse sector employed 27,300 people in 2017, up from around 10,000 one year earlier.3

Where will your revolutionary online shoe company find the space to quickly deliver the goods to the customer?

So, while Amazon and other ecommerce mega brands are snatching up expensive land with a built-in infrastructure edge, start-ups and small-box companies are finding real estate a day’s drive from the urban core, putting them at a slight disadvantage and making the cost-to-customer and advanced supply chain even more important.

The impact on industrial investors

This supply-demand disconnect is advantageous for real estate investors who are looking for specific sector outperformance at this stage of the cycle. Industrial REITs experienced a 20.58 percent total return in 2017, more than five core real estate sectors combined.4 This outperformance may endure as demand trends show no signs of slowing down.

This “Amazon effect” may continue to push Internet giants in the race for the scarce large-scale space in major markets. Smaller- and mid-size warehouse demand will also increase, as companies like the revolutionary shoe company push outside preferred areas and instead look for proximity to FedEx and UPS shipping centers. And overall, industrial real estate investing sees tailwinds ahead, including a 17-year unemployment low, moderate gross domestic product (GDP) growth, and increased demand caused in part by today’s digital revolution.

1 Logistics Management. State of Industrial Real Estate: It’s crunch time. 3/1/18.

2 The Wall Street Journal. Industrial Land Prices Spike in 2017. 12/26/17.

3 The Morning Call. In age of Amazon, warehouses are a solid investment. 4/20/18.

4 FTSE NAREIT. 1/1/17-12/31/17.
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