Last-Mile Delivery Is Game Changer in Industrial Sector, Says SIOR President
Del Markward will be logging a lot of frequent flyer miles over the next year as he travels around the country and abroad to meet with several chapters of the Society of Industrial and Office Realtors (SIOR), an organization with more than 3,200 members in 685 cities and 36 countries.
In addition to serving as the 2018 global president of SIOR, Markward is founder of the Markward Group, a real estate consulting, advisory and brokerage firm based in Allentown, Pa.
Markward was officially inducted as president of the organization in October at the outset of the SIOR World Conference in Chicago. He most recently served as president-elect of SIOR and before that was vice president.
The commercial real estate community recognizes professionals who have earned the SIOR designation as among the most capable and experienced brokerage practitioners in any market, according to the organization.
On the heels of the SIOR World Conference, REBusinessOnline interviewed Markward about some of the dynamic changes taking place in the industrial real estate sector today, including the sharp rise in demand for space driven by e-commerce companies. What follows is an edited transcript of the Q&A.
REBusinessOnline: Supply chain logistics is an industry undergoing a dramatic shift due to changing customer expectations in an e-commerce world. What opportunities and challenges does that shift create for the industrial real estate sector as a whole, and brokers in particular?
Del Markward: In the past 15 years, we’ve seen a huge uptick in big boxes — ranging from 500,000 square feet to 1 million square feet — all around the country to accommodate e-commerce. In that time, we have approximately quintupled the amount of cubic feet in the market. We’ve watched these buildings go up to 1 million square feet and 36-foot clear heights. That gives us 36 million cubic feet of space in one property.
We’re losing Sears and Kmarts, which are 1.2 to 2 million cubic feet of space (they only store product on the floor for display purposes). Those buildings are going away and being replaced with 36 million-cubic-foot buildings for retail purchases via home delivery. The sheer scale of available capacity for retail and other products is an interesting dynamic.
While we’re seeing lots of those 1 million-square-foot buildings still go up, slowly in the big cities we are seeing a dynamic shift toward the last mile of delivery. They’re taking older, in-city warehouses and beginning to convert them — even if they’re multi-story — into storage depots to be able to deliver product the same day to customers.
And that’s just beginning to emerge. It’s going to happen in the big cities first, but it’s going to start infiltrating some of the other mid-size cities over a period of time. It’s crazy, but consumers have begun to expect things not just overnight, but same day in many instances, which is truly a different dynamic than what we’ve been used to.
REBO: Your company is based in Pennsylvania. Where do you see this trend occurring most visibly in Pennsylvania?
Markward: The big growth in Pennsylvania for the big-box warehouses has been occurring from Allentown and Lehigh Valley all the way down through Harrisburg and to the Maryland border. Those two corridors have seen a multitude of 1 million-square-foot type product over the past 10 to 15 years. The last-mile items really haven’t hit the state yet, but you will start to see that in Philadelphia in your more densely populated markets. You’ll also see that to a lesser degree in Pittsburgh. None of the other cities in Pennsylvania will be ripe for that in the near future just because we have enough land within close proximity of those cities to do backfill with the last-mile type of warehouses, which are smaller warehouses.
REBO: According to Zac Rogers, assistant professor of operations and supply chain management at Colorado State University, there is more demand for industrial real estate today than there is supply. That’s largely because of the explosion in e-commerce business and the need for e-commerce firms to be near their customers. What effect has that had on rents and prices paid for industrial real estate?
Markward: We have watched land prices go up by as much as 30 percent in the last two to three years in many markets. Where there is land constraint, like in Los Angeles, you can’t find a piece of ground. If you do, the land values are rising up to $3 million to $5 million an acre just for an industrial lot, which is remarkable.
The rents have increased between 4 and 11 percent year-over-year in certain markets over the last three to five years. We have seen a significant rent increase partly because the cost to build has gone up. The days of constructing a building with land for $60 per foot are over, and it’s more like $100 to $150 per foot in many markets. Rents are running commensurate with those increases in costs to build.
REBO: How rapidly have land prices risen in California?
Markward: What happened in Los Angeles is that there is no more [available] ground inside the belts, if you will. That market has shifted a great deal to the Inland Empire, 60 miles to the east. That’s the nearest place where there is available land. A little bit to the north, up in Kern County, you see a little bit of activity, but most of it is in the Inland Empire. And the price of land in the Inland Empire has shifted significantly upward over the last five years for that same reason — pressures of population and the need to be near the population. The prices have followed.
It’s tough to answer the question with regard to L.A. proper. There’s almost no ground that’s ever made available. People are buying buildings there that would give them a land value of $3 million to $5 million. They’re tearing down existing product to put up a new warehouse, and the rents have to run with that new price structure.
REBO: Do you have any thoughts on the evolution of supply chain logistics from this point forward and the potential impact on industrial real estate?
Markward: We’re seeing high-density markets. We’re beginning to see multi-story warehouses, which is something we hadn’t seen before. Historically, we always tore down multi-story buildings to put in single-level buildings. A lot of textile mills in the old cities were either converted to apartments or torn down to turn into some other use.
Now, multi-story warehouses are making a comeback. Prologis is building the first one in the United States — Prologis Georgetown Crossings, a three-story warehouse in Seattle. It is an extremely land-constrained area with a high population density.
There is a seven-story warehouse in Tokyo for the same reason. The warehouse in Tokyo rises about 140 feet. Trucks are going up in a circular, spiral pattern to get to reach the upper-level floors, and they have a great network of elevators that help carry the product.
As for the next big wave that is coming at us, in the densest cities you’ll potentially see old warehouses converted to last-mile buildings. You will see multi-story warehouses in more dense areas.
Automation is coming fast and furious at the warehouses. Within two to 10 years, many if not most warehouses will be fully automated, eliminating the need for forklift and crane operators inside the warehouse. Some of the smaller companies and some of the 3PL companies don’t have the capital to do it fast and furious right now, but the Amazons of the world do and they’re beginning to implement full automation into their warehouses.
REBO: Is there some inefficiency created by going vertical versus doing it on one-story?
Markward: It will not be inefficient when it’s fully automated. The efficiencies will actually improve when it’s automated. There are 80- to 100-foot tall warehouses in the markets now that are fully crane-served inside their space, but they are human-operated cranes in many areas. It is a movement toward a type of warehouse that is going to be more fully automated and taller — whether it be multi-story or just high-bay (80 to 100 feet high) with full crane operations.
The cranes get more difficult to be accurate the higher they go just because of the sway and the movement of the equipment. That’s why multi-story warehouses are a viable option as opposed to craning straight up and down.
REBO: Beyond e-commerce, what other industries are having a positive impact on the demand for industrial real estate?
Markward: E-commerce is obviously retail-oriented, so that’s been the No. 1 player driving a lot of what’s going on. Data centers are also proliferating all over the country. The volume of data that is now being utilized is expanding at an incredible rate. It used to be in 18 to 24 months you’d see double the capacity, and it’s going much faster than that now.
We’re now seeing exponential increases in the amount of terabytes and petabytes of data being used every day. It’s only going to increase, especially with “blockchain technology,” which never overwrites anything. It just adds to everything. The volume of data is getting so extraordinary that the data technologies are going to continue to expand. While computers can get smaller, you actually need bigger buildings because you need more of those computers.
REBO: There’s always been a need to store data, but why has this demand grown so much and so rapidly?
Markward: Think about it. This year there is going to be multi-trillion sensors built for all things Internet-related. Everything is going to have sensors. If you look at every Tesla built, they have sensors all over the car. All cars now are having multi sensors, and that’s just one industry. You’re seeing sensors being placed on refrigerators and microwaves. Sensors are being placed throughout buildings to measure the heat as the sun rotates around the building.
All of that data is being created from all of these sensors all over the world that has to be accumulated. And that accumulation doesn’t get overwritten, it just gets added to [the existing volume].
There is a huge industry just to manage that data because that data is going to be coming on so fast and furious. It’s going to require virtual reality, or artificial intelligence to help manage it.
REBO: So the information from the sensors in our vehicles needs to be stored somewhere?
Markward: Exactly. That data all gets pumped into the cloud (a network of servers), which then gets stored in the data centers. You also asked about the other industries driving this demand for industrial space. It’s the supporting industries to this new technological wave that’s coming. Whether it be robotics, or the sensor industries, all of those continue to grow, and some of that manufacturing is coming back into the U.S.
Sometimes we have a need for speed, and the only way you get the product back in the U.S. fast enough is to make it here. We’re starting to see some of those technological industries come back into the U.S. for some of the manufacturing.
REBO: Many investors are bullish on industrial real estate due to the property sector’s strong fundamentals. Is there a particular type of industrial product that investors are most interested in such as newly built, high-cube distribution facilities or mid-size modern, multi-tenant facilities?
Markward: Certainly the big-box warehouses are hot with investors. Very few of those trade regularly because the owners of those buildings hold onto them. Most of the REITs, for example, are not big traders of their real estate.
Beyond the big boxes, the triple-net leases such as the retail and other industrial triple-net leases are in demand because they are the easiest to manage. You have one tenant, one building and you have the ability to manage it very easily.
Then you fall off into multi-tenant industrial product, which is mid-market product. The cap rates on those buildings will begin to go up because they are a little more management-intensive, and there is a little more risk attached to them. The more management you inject in the projects, the higher the cap rate will go because that involves additional risk.
REBO: To what extent has the industrial real estate sector experienced cap rate compression in recent years? Do you expect cap rates from this point to compress further, hold steady or begin to rise?
Markward: Cap rates on the bulk of the items have reached their nadir at somewhere between 5 and 5.5 percent on a Class A, high-quality-tenant, big-box market. That’s pretty close to the bottom of the market. There have been trades of McDonald’s and some other triple A-rated, triple-net product that have been under 4 percent.
But when you hit 3.5 percent, I think we’ve bottomed out on where the cap rates could be because now your risk has gotten to a level that marries up to putting money in safer investments.
REBO: What advice do you have for prospective buyers or sellers in today’s dynamic industrial real estate marketplace?
Markward: It’s all about the credit of the tenant. It still can be a buyer’s market. The challenge is finding a seller who is willing to sell right now at a number that makes any sense for the future. We’re in balance. That’s how I would look at it. The balance is such that most of the sellers are recognizing that if they sell today it’s difficult to find a replacement product that marries up to their return expectations.
That’s why a lot of the product is not selling this year. I suspect that by 2019 we will begin to see some additional movement — it will be time to start moving the capital.
REBO: How serious of a threat is overbuilding and oversupply in the industrial real estate sector today given that so many investors have the property sector on their radar screen?
Markward: Overbuilding is a distinct possibility, but I don’t see that happening for another 12 to 24 months because land constraints are restricting the volume of new construction. It’s not the Wild, Wild West where people can go willy-nilly and build. It takes a long time to get projects permitted, and land constraints in all markets are putting some restrictions on how fast and furious you can put this product up.
REBO: Emerging Trends, the commercial real estate forecast compiled by the Urban Land Institute and PriceWaterhouseCoopers, writes the following regarding the industrial sector: “Today, there are far fewer non-institutional developers than in past cycles, with many having closed shop during the Great Recession.” Do you concur with that statement, and if true what does that portend for development activity in the near term?
Markward: I agree there are far fewer entrepreneurial developers than there were back in the 2005 to 2007 period. A lot of the consolidation has occurred in the well-capitalized, larger REITs and private development companies. In many markets, you’ll still have 15 developers, but back in the 2007 to 2008 period you had 40 to 50 developers that were running around doing one-off deals in multiple markets. It’s not the same today. It’s a little more consolidated than it was back then.
REBO: What are the hallmarks of a Class A warehouse and distribution facility today and how have those features changed over time? (Ceiling heights, truck bays, etc.)
Markward: There is more truck parking than there used to be. You need trailer parking because there is so much product moving in and out of the trucks and coming from multi-modals and such that finding locations for trailers and trucks is a big deal.
Newer models of buildings over the last seven to 10 years have had more truck turn area and more truck/trailer space to store. The buildings have gotten taller. In 1995, a 24-foot clear height was a standard, high-bay building. That evolved into a 30-foot clear height in the early 2000s, then 32 feet. Now 36 feet is the norm and a standard. Most developers would like to see us be able to go to 40 feet as a standard.
We’ve seen that evolution in those buildings. Overall, you have broader, taller and wider-spaced buildings. And certainly square footage has increased significantly.
— Matt Valley