Urban Warehouses: What’s Old is New Again?

Last-mile deliveries spur new demand for urban warehouses.

The growth of e-commerce is changing the landscape of commercial real estate. It starts with the growth of the subsector itself—according to the National Retail Federation, online and non-store sales are projected to grow at nearly triple the year-over-year growth rate for the entire retail industry in 2017; growing 8 to 12 percent, as compared to a projected 3.7 to 4.2 percent growth rate for the retail industry as a whole (excluding automobiles, gas stations and restaurants).

While online buyers were once content to receive their merchandise in three to five days, today’s consumers shop not only on price points, but also on speed and convenience. Three- to five-day delivery expectations are a thing of the past as Amazon and other retailers changed the game with two-day and even same-day delivery options. This emphasis on speed has spurred e-commerce retailers to expedite deliveries in the “last mile,” when merchandise is transported from warehouses to the customer.

In 2017 alone, e-commerce companies will require an additional 50 to 60 million square feet of warehouse distribution space. Further, National Real Estate Investor reported that every $1 billion in e-commerce sales requires 1.25 million square feet of distribution space. This surge in demand is prompting retailers to secure additional warehouse space, whether on the outskirts of populated areas or in the heart of urban locations, where they can more quickly deliver their merchandise to consumers who “want it now.”

Speedy Delivery—the Impetus for Burgeoning Warehouse Space

According to the National Retail Federation, Amazon tops the e-commerce sales list, followed by Apple, Walmart and Macy’s. These top retailers, along with others such as Bloomingdale’s and Staples, are responding to the consumer demand for speed by leasing or building suburban warehouses close to major highways as well as repurposing obsolete urban industrial buildings. These older buildings, some of which were built in the 1950s or ‘60s and would have otherwise been left vacant, are now taking on new life to support faster delivery to customers.

While the industry term for merchandise’s final journey before it arrives on a customer’s doorstep is termed the "last mile," CBRE research showed that the buildings are actually between six to nine miles from the population centers they serve and are typically no larger than 200,000 square feet. Average vacancies for potential last-mile buildings are about 3.5 percent, well below the broader U.S. industrial vacancy rate of 6.7 percent.

In Illinois, Amazon is on its way to nine distribution centers that will employ 8,000 people. In July, they announced the leasing of a 438,150-square-foot warehouse in southwest suburban Crest Hill, a sorting center that’s less than two miles from Interstate 55 and about nine miles from Interstate 80. From its super-regional bulk distribution sites in Kenosha, Wisconsin and Channahon, Illinois, to two distribution sites in Chicago’s urban core on Goose Island and on the south side of the city, Amazon has set the bar high in bringing speed to market on merchandise delivery.

Having brick and mortar stores is an advantage for some retailers in delivering merchandise quickly to customers, however. For example, Staples, Bloomingdale’s and Macy’s are boosting their same-day delivery options by tapping their store inventory to fulfill customer orders.

And, as some big-box retailers such as Circuit City, Sports Authority and Sears go out of business, the NAIOP Commercial Real Estate Development Association suggests that the retail spaces they leave behind may also be viable candidates for warehousing, thanks to their flexible industrial flooring and ample parking.

On the other hand, Walmart is taking a different tactic. In addition to using its distribution centers, Walmart is also testing a new delivery mechanism to delivering on the last mile—using store associates to deliver customer items on their way home from work. The service is being piloted in three stores (two in New Jersey and one in Arkansas) before a full rollout is decided.

A New Purpose for Urban Industrial Buildings and Storefronts

This continued emphasis on the speed and convenience demanded by today’s online shoppers is causing a surge among institutional investors who are competing for warehouse space which provides proximity to urban customers.

Since most urban areas usually have little land available for development, obsolete industrial buildings in these areas are providing an attractive opportunity to meet e-commerce warehousing needs. Investors are repurposing old industrial buildings to suit prospective e-commerce renters rather than rezoning for alternative uses like residential or office or simply demolishing them.

Investors are finding it’s more beneficial to rehab and renovate a warehouse property, rather than building to suit, because of the high cost of land and accelerated speed-to-market. For example, ground-up construction usually requires approximately one to two years versus the potential six to nine months for a rehab and renovation.

Further, prospective last mile tenants don’t usually have a sophisticated list of demands. Ceiling heights under 24 feet, dock space and street availability for van traffic—are usually the minimal requirements to transform industrial buildings into last-mile warehouses.

As always, potential investors should have a long list of due diligence items for older urban buildings such as environmental issues, zoning restrictions, or the possibility of additional capital improvements that may be needed, such as a new roof or other major upgrades. Investors should also consider potential risks during the leasing process. Typical lease terms for last-mile tenants are less than five years and can often be to newer companies that might not have much credit to underwrite. Investors and landlords should consider if other types of credit enhancements are available, such as security deposits or a guarantee from a parent company or owner to give additional comfort and make the lease financeable.

Winning the Race Along the Last Mile

Dedicating resources to quick delivery of merchandise on the last mile is a win-win-win for investors, retailers and consumers. Investors can reap the benefit of increased demand for what would otherwise have been obsolete industrial buildings, retailers solidify their brand and enhance the customer experience and customers can shop online with the assurance that their chosen items will appear on their doorsteps much quicker than they could have even imagined only a few years ago. With the continued growth of e-commerce, those who are successful along the last mile could truly win the race.

The views expressed by the author are not necessarily those of Fifth Third Bank and are solely the opinions of the author. This article is for informational purposes only. It does not constitute the rendering of legal, accounting, or other professional services by Fifth Third Bank or any of their subsidiaries or affiliates, and are provided without any warranty whatsoever.