Last-Mile Access to Customers Drives Distribution Center Conversions
E-commerce has been driving demand for industrial real estate for several years, but steadily increasing online sales coupled with growing consumer expectations for speedier delivery continues to put pressure on merchants to bridge the last mile to their customers. Considering that these projects are located in densely populated areas where land and available product are typically scarce, developers are increasingly converting obsolete warehouse and other properties into fulfillment centers.
For space that matches their needs, tenants are less price-sensitive than they have been historically, says Kenneth Salzman, SIOR, executive managing director and principal for commercial real estate service provider Lee & Associates. But tenants are avoiding taking more space than they need just to have it available in the future, he adds.
“It’s less a space race and more that businesses want to reach their customers more quickly,” explains Salzman, who is located in the company’s New York office. “And the demand is not just coming from Amazon and other online retailers — traditional companies want to be able to ship their products to their customers more quickly because they’re competing with online resources, as well.”
Online retailers and shippers are typical tenants of the buildings — even the U.S. Postal Service occupies last-mile space temporarily during the holiday season, Salzman says. But not any old building will do. Developers are hunting for ceiling heights and floor loads that can accommodate high-tech robotic racks and multistory buildings that have truck ramps on each level. In some cases developers are considering popping the tops of buildings to create more height, Salzman says.
Developers also look for sufficient power to run robotic storage and retrieval systems to pick and stage orders prior to shipment, as well as early suppression fire response (ESFR) sprinkler systems tailored for distribution buildings. Often that infrastructure isn’t readily available, requiring developers to upgrade the buildings. For example, in New York, Prologis acquired the former 205,000-square-foot ABC Carpet & Home Outlet Center in the Bronx in 2017, and improvements included adding loading docks that could accommodate 53-foot trailers and installing LED lighting and an ESFR system.
Another example of a last-mile conversion project is Innovo Property Group’s acquisition of an old 150,000-square-foot warehouse in the Maspeth community of Queens last year. Because of the topography, the building features loading docks on the first two of its three floors.
Not to be outdone, retailers are also pursuing conversions. Walmart is turning dozens of closed Sam’s Club stores around the country into last-mile distribution centers.
“There’s a lot of interest in properties that have good transportation and truck access, as well as access to employees,” Salzman declares. “In New York, the majority of last-mile projects are just outside of Manhattan — Nassau and Suffolk counties are served just as easily from Long Island City (in Queens) as Tribeca is.”
Last-mile distribution centers are fetching rental rates of $35 to $50 a square foot in the New York metro area on a triple net-lease basis — generally double or more than typical warehouses, Salzman states. But the scarcity of suitable candidates and the demand for conversion projects drive a hefty price.
Case in point: Early this year, Innovo, Atalaya Capital Management and Nan Fung Group paid $75 million for a roughly 280,000-square-foot property in Long Island City. Built in 1960, the warehouse formerly housed online grocer FreshDirect and was considered obsolete, but the price was $27 million more than the previous owner paid for it in 2016. As Salzman points out, the building has air rights to build an additional 175,000 square feet, and the new owners plan to convert it into a state-of-the-art last-mile distribution center.
It’s unlikely that conversion activity is going to slow down anytime soon. Estimated e-commerce sales on a seasonally adjusted basis totaled $137.7 billion in the first quarter of 2019, a year-over-year increase of 12.4 percent, according to the U.S. Department of Commerce. The first quarter estimate represented 10.2 percent of all retail sales in the U.S., an increase of 80 basis points from a year earlier.
What’s more, e-commerce represents 25 percent or more of sales for some omnichannel retailers, according to the latest Emerging Trends in Real Estate, a report covering the U.S. and Canada by the Urban Land Institute and PwC. In some cases that’s the fastest growing segment for the stores.
Just as e-commerce is growing, so too is demand for quicker shipping. In fact, one-third of shoppers surveyed ranked fast delivery as the most important consideration when buying goods online, and two-thirds expected delivery within three days, according to E-Commerce Shipping: Feeling the Need…For Speed, a recent white paper published by LaserShip, a Vienna, Virginia-based last-mile delivery service.
Additionally, 31 percent of online shoppers took advantage of same-day delivery in 2018, nearly double the amount in 2017, according to an annual consumer delivery expectation survey released by Dropoff, a same-day delivery company based in Austin, Texas.
“Amazon originally set the bar with two-day delivery, and then it set the bar with one-day or even same-day delivery,” Salzman says. “Now everyone else is trying to compete with that.”