E-COMMERCE TRANSFORMING DEMAND IN THE INDUSTRIAL CRE SECTOR

By Alexander Harrold

Explor ing the ro l e e - commerce i s p lay ing in today’s indus t r ia l space , how i t has molded the new core indus t r ia l proper ty mode l , and what the future looks l ike

for the indus t r ia l s e c tor.

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2017 is turning out to be another solid year for industrial real estate. Property values are at an all time high, and demand is superseding supply. According to CoStar data, current vacancy rates for industrial properties are at 5.4 percent, declining over 140 basis points from Q4 of 2016, and are at the lowest level since the dot.com boom era of the early 2000s. Since 2011, rent per square foot has been on a steady rise in the industrial space. As of August 2017, industrial properties exceeded an average of $5.30 per square foot in rent and can be expected to continue rising with the same trajectory. Over 65 million square feet were absorbed in the first half of 2017 and over 63 million in the last quarter of 2016.

Of the 65 million square feet of industrial real estate absorbed in the first half of 2017, 57 percent is classified as distribution and warehouse space. This overwhelming demand for distribution and warehouse space can be attributed to recent years’ shifts in consumer spending and the explosion of e-commerce. Increased consumer spending online correlates directly to the wave of industrial space needed to store and distribute the influx of inventory being moved. For this reason, as the popularity of online consumer spending increases, so will the value of industrial real estate in this space.

“Th is overwhelming demand for distribution and warehouse space can be attributed to recent years’ shifts in consumer spending and the explosion of e-commerce.”

100

80

-80

60

-60

0

20

-20

40

-40

20%

18%

2%

16%

4%

10%

12%

8%

14%

6%

07 08 09 10 11 12 13 14 15 16 17

Absorption Deliveries Vacancy

Industrial Warehouse and Distribution CentersAbsorption, Deliveries & Vacancy rates

Source: CoStar

08 09 10 11 12 13 14 15 16 17

16%

14%

12%

10%

8%

6%

4%

$5.40

$5.20

$5.00

$4.80

$4.60

$4.40

$4.20

Vacancy Rate Rental Rate

Industrial Real Estate Vacancy & Rental Rates

Source: CoStar

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E-COMMERCE: THE CATALYSTDemand for industrial real estate has doubled in the past three years due to a shift in consumer spending preferences. In a recent study, BigCommerce found that 96 percent of Americans have made an online purchase at some point in their lives, and 80 percent have done so in the past month. According to a survey of 5,000 online shoppers, conducted by the United Postal Service (UPS), consumers say that they have made more purchases on the internet than in stores for the first time in history. The National Retail Federation projects e-commerce to grow by 8 to 12 percent in 2017 alone, compared to just 2.8 percent for overall retail. This movement is expected to continue gaining momentum as millennials and generation Z take hold of the consumer market in the coming years.

With a rise in online purchases, came an increase in parcel shipping. Pitney Bowes’ 2016 Parcel Shipping Index unveiled the massive influx of parcels due to the growth of e-commerce. The index revealed that in 2015, volume grew by 3.6 percent, and is expected to grow at an annual rate of five to seven percent through 2018. Altogether, U.S. businesses spent $85 billion on parcel shipping, up by 1.2 percent from 2014. Amazon alone, reports spending in excess of $5 billion a year contracting with the United States Postal Service (USPS), United Postal Service (UPS), and FedEx. Moving forward, it is a necessity for e-tailers and their logistics partners to invest in the expansion of new warehouse and distribution space in order to house and deliver the influx of inventory.

THE EFFECT – AN INCREASE IN DEMAND FOR WAREHOUSES AND DISTRIBUTION CENTERSThe shift in consumer spending and rise in parcel shipping is leading to a dramatic increase in demand for warehouse and distribution space. Global bank, Jeffries, estimates that e-commerce retailers need three times as much warehouse space as brick-and-mortar retailers, presenting a huge window of opportunity for warehouse landlords, especially industrial REITs. Nationally, the rental rates for warehouse space rose by more than ten percent in the past year. Owners and developers of industrial property outfitted for warehousing and distribution are in a great position to profit from the rise in demand.

FedEx and UPS have been quick to respond to the influx of parcels. The two courier giants announced that they are now offering new routes that were historically only provided by the

United States Postal Service (USPS). Having less central parcel destinations, these routes have the longest lengths of haul and are more expensive to deliver to. Companies such as UPS and FedEx generally declined service to these zones or slapped on a heavy surcharge fee to the delivery price, commonly leaving the routes solely to USPS. But, with the growth of e-commerce and increasing customer needs, the demand for these local deliveries have risen, giving FedEx and UPS a reason to supply and turn a profit. The phenomenon is being felt in the industrial distribution and warehouse space as the two largest private sector couriers look to expand their growing footprint across the nation.

The FedEx Footprint

Recognizing the opportunity e-commerce has presented, small e-commerce stores are popping up every day, and traditional brick-and-mortar stores are catching on as well. Unfortunately, these companies are at a disadvantage and it is not easy to master what the internet giants have been able to do. Many find themselves faced with logistic challenges of housing, distributing, and delivering merchandise in the timely manner consumers have become accustomed to. Aware of these challenges, FedEx has found a way to further extend their breadth of services and capitalize.

Currently in pilot phase, “FedEx Fulfillment” is reconfiguring its warehouse facilities and offering to accommodate housing for third-party inventory. FedEx already has advanced inventory and product processing systems in place that smaller retailers can’t afford.

Revenue of +$50B

665 World Service Locations

20 North American Distribution Facilities

6,350 Authorized Ship Centers

1,200 FedEx Express Stations

+550 Ground Stations

36 Ground Hubs

1,800 FedEx Office Locations

1,200 FedEx Onsite Locations & More

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From here on out, FedEx’s only challenges in launching “FedEx Fulfillment” are tweaking its internal processes, marketing its services to retailers and small businesses, and of course purchasing the industrial space that will be needed to sustain their endeavor.

There is undoubtedly a need for more space in the industrial sector in order to fuel the developments and changes emerging from the rise of e-commerce. Developers are responding with market-specific products, which include omnichannel fulfillment centers larger than 500,000 square feet in markets that offer access to the nation’s key population centers. While Dallas Fort-Worth, California’s Inland Empire, Chicago and other areas that feed major metropolitan markets are experiencing significant growth, the hottest growth rates are in secondary markets in the Midwest that serve as distribution hubs for e-commerce.

WHAT YOU SHOULD LOOK FOR - THE NEW INDUSTRIAL PROPERTY MODELAs with all matters in commercial real estate, the big winners are those who meet the specialized requirements:

Amazon, the e-commerce behemoth, has paved the way for the new industrial property model. They already have 70 fulfillment centers featuring high-tech management systems, and employ more than 40,000 full-time workers. Much of Amazon’s phenomenal growth is based on its ability to deliver merchandise fast – often the same day – which requires real estate that is proximate to the “last mile” distance from a fulfillment center to a consumer’s

home or office. While a portion of the inventory is merchandise developed or owned by Amazon, the majority is third-party sellers who contract with Amazon to store and deliver their goods to consumers.

The Challenged: Smaller Warehouse Properties On the flip side, owners of smaller warehousing and distribution centers are experiencing declining demand. E-commerce companies need room to grow, and can fuel their growth with venture capital funding. Warehousing and distribution facilities that are under 100,000 square feet now lack the minimum footprint needed. Another challenge smaller warehouses face is that their income is not enough to fund expansion build outs or to make investments in costly Warehouse Management System(WMS) installations, even though failing to do so risks obsolescence.

The OutlookMany experts believe that the recent years of growth in e-commerce and warehouse demand are not cyclical, and predict that this is the beginning of a growth trend set to continue for many more years.

The traditional giants such as USPS, FedEx, and UPS will not be the only companies expanding in this new sector. When demand rises in the marketplace, history has proven that new challengers will arise to compete for the overflow of business. While some can question whether Amazon would jump into an industry as competitive as shipping and delivery, the e-commerce company has already made moves indicating their ambitions. Amazon has 4,000 trailer trucks emblazoned with the Amazon logo and leases over 40 cargo planes to transport goods between their warehouses and distribution centers. Amazon’s recent $13.7 billion purchase of grocery chain, Whole Foods, indicates the company is more than willing and capable of taking on new challenges. If they were to venture into this space, Amazon would require an incredible amount of additional real estate.

At the rate e-commerce is growing today, the need for square footage in the industrial sector will only increase, further igniting the demand for the new industrial property model.

As the new model requires significant investments to build out the large facilities desired, it remains to be seen how smaller warehouse and distribution centers will respond.

alexander harrold

e alexander.harrold@matthews.com

p 310-919-5790

» PROXIMITY TO MAJOR POPULATION CENTERS

» EASY ACCESS TO MAJOR TRANSPORTATION CORRIDORS

» HEAD-ROOM Up to 40-foot high clearances are necessary for specialized racking and material handling equipment to expedite delivery

» PRE-CONFIGURED Highest demand is for warehousing facilities with state-of-the-art inventory management systems in place

» SUPER-SIZED 150,000 SF or larger

» NO DOWN-TIME Back-up generators, AC, cross-dock configurations, big trailer parking areas to ensure uninterrupted operations

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