There’s been a lot of discussion about the Internet’s effect on retail real estate and how it’s changing retailers’ strategies for brick-and-mortar stores. While many industry experts believe online shopping is a negative for retail real estate owners, they often overlook another important consequence of e-retailing—increased demand for warehouse and distribution space.
“Technology has created a structural shift in the way people shop, and that has been a negative for demand for retail space,” says Peter Muoio, PhD, chief economist and managing director for Auction.com and New York City-based research firm Maximus Advisors. “But on the flip side, industrial real estate is actually benefitting from this shift. There’s enhanced demand for industrial space as e-retailing grows.”
Demand from the e-commerce sector for industrial/warehouse space for online fulfillment has doubled over the last three years and will continue to grow at a healthy clip, according to a recent report by industrial real estate developer Prologis. E-commerce is lifting long-term demand growth as retailers consolidate traditional in-store activities into fulfillment centers, the report says.
In fact, it’s estimated that 30 percent of U.S. industrial big-box warehouse demand is correlated to e-commerce, according to Jones Lang LaSalle.
Industrial is doing well in its recovery from the financial crisis, Muoio notes. “It’s cyclically ahead of the office and retail segments,” he says. “E-retailing is creating demand for both distribution and fulfillment space, over and beyond what it would be getting from a typical recovery.”
More people shopping online
Roughly 185 million people shop online in the United States alone, and as a result, U.S retail e-commerce sales are projected to reach $304.1 billion this year.
On a global basis, e-commerce sales are growing 20 percent annually and are expected to reach $750 billion this year. Online transactions, which accounted for 6.2 percent of all retail sales in 2013, are projected to increase to 10 percent of retail sales by 2017. In developed e-commerce markets, online retail sales typically account for between 5 to 15 percent of total retail spending.
The increasing number of shoppers using smart phones is driving much of the growth in online sales. In the United States, for example, the number of mobile shoppers is predicted to rise from around 95 million in 2012 to 175 million by 2016, according to eMarketer.
Consumer behavior is evolving faster than supply chains can adapt, notes the Prologis report. As such, retailers and distributors are experimenting with different order fulfillment models.
“Smart retailers understand how important an efficient distribution network is,” Muoio says. “They understand that their customers will stop shopping online if they can’t get the merchandise in a convenient and quick way.”
In fact, retailers increasingly view logistics facilities as “revenue drivers,” according to Prologis. A retailer’s decision to shift from in-store to online may be driven by a customer service perspective, but a side benefit is significant real estate cost savings. Logistics rents range between $3 and $10 per foot per year, while traditional retail rents can be $20 to $50.
An appetite for space
E-commerce tenants have a big appetite for industrial space, notes the Prologis report. These retailers require three times—or more—the logistics space of their brick-and-mortar counterparts. That’s because they usually offer a significantly greater variety of products. And as the point of sale continues to shift from stores to logistics facilities, retailers must carry greater levels of buffer stock, requiring larger buildings.
The process of picking and packing individual orders and shipping them directly to consumers also requires more space than in-store distribution. Online retailers must allocate floor space to returns processing and re-stocking, as well.
Because of these requirements, the strongest demand is for mega e-fulfillment centers, parcel hubs, and local parcel delivery centers.
As their e-commerce fulfillment requirements increase, retailers will initially grow within existing distribution networks, and then leverage multi-tenant facilities and third-party logistics providers. Ultimately, they’ll require dedicated facilities with different building specs and location drivers than more traditional warehouses and distribution centers.
In fact, more and more retailers are constructing their own logistics facilities. Walmart, for example, announced plans earlier this year to invest heavily in its e-commerce infrastructure. At this year’s World Economic Forum in Davos, Walmart global e-commerce CEO Neil Ashe said the company would continue to build out new warehouses across the country to enhance its distribution infrastructure. The plan is to be able to match Amazon’s product offerings and shipping times within two years by augmenting fulfillment from existing stores with online-only facilities.
Proximity to population centers
As online retailers reach sufficient size and scale, fulfillment models will emphasize proximity to major population centers, allowing for faster delivery times, higher service levels, and greater flexibility in the supply chain. Amazon, for example, has started to open smaller-scale distribution facilities to offer same-day delivery services.
Third-party industrial property owners like Prologis are following suit, establishing warehouse space close to major transportation hubs and densely populated areas. For example, warehouse construction is booming in the Riverside-San Bernardino metro, which has easy access to large cities like Los Angeles, San Diego and Phoenix. More than 16 million square feet of space is being built in the region, accounting for about 14 percent of all industrial space under construction in the nation.
“When it comes to e-retailing and real estate, there are going to be some losers,” Muoio says. “But there are also winners, and industrial looks to be one of them.”