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The New Big Box Investment Criteria: What Real Estate Investors Need to Know About Multichannel Retail Strategies

The New Big Box Investment Criteria: What Real Estate Investors Need to Know About Multichannel Retail Strategies

Same-day delivery from major e-commerce retailers during the 2012 holiday season introduced e-commerce as a viable option for last-minute shoppers. Some lucky last-minute consumers both ordered and delivered gifts to friends and family on Christmas Eve—setting a new standard for retailers everywhere. This new expectation from customers is now rippling through the supply chain for all retailers, prompting executives to re-evaluate their real estate strategies, according to a new report from Jones Lang LaSalle (JLL).

JLL’s Big Box Outlook report chronicles the transformation of “big box” warehouse and distribution facilities—those exceeding 250,000 square feet—that form the backbone of the retail supply chain. Retailers are transforming their distribution strategies from outsourcing e-commerce fulfillment operations to third parties as a short-term solution to taking fulfillment in-house and building operations that can handle both individual and store orders in the same facility, aka a “multichannel” distribution strategy.

To meet service commitment goals such as same-, or next-day delivery schedules, one solution that is gaining traction among retail supply chain executives is locating e-fulfillment facilities even closer than before to the major metropolitan areas with large concentrations of customers. This trend has huge implications for real estate investors because, by definition, facilities “close to the customer” suggest an even stronger premium for distribution center sites in proximity to major population centers.

The market for big-box space

The market for these large blocks of contiguous space is strong and growing stronger for facilities with the features that best support multichannel strategies. In fact, several years without widespread construction means that big-box space is scare and, consequently, rents for current facilities are rising. Major e-commerce companies continue to aggressively sign new build-to-suit agreements and are willing to pay a premium to have facilities built to their specific fulfillment and operational needs. Additionally, large corporate retailers have acquired many of the most significant blocks of modern big-box space to support their multichannel strategy. Such activity comprises approximately one-third of the recent leasing activity for big boxes. 

In addition to supply shortages, investor demand for big box space remains strong. A fully occupied big box is one of the most stable assets in commercial real estate when occupied by a single, credit-worthy tenant on a long-term lease. Long-term credit-tenant leases are pushing up sale prices and creating an attractive environment for developers. Through the recession and into this new cycle, the major players in the industrial space have shifted dramatically. Prologis and AMB Property Corp. merged, Dexus Property Group has exited the market, Goodman-Birtcher and IndCor have entered. TA Associates Realty continues to divest itself of industrial assets, while companies such as Industrial Income Trust, KTR Capital Partners and Exeter Property Group continue to add to their holdings.

Rise in multichannel building requirements pitches certain facilities above others

The building criteria for a multichannel facility limits the search for big-box space to scarce opportunities, if any, and drives retailers to require customized build-to-suit developments. In general, bigger is better: If a distribution center originally served just stores and now also provides e-commerce operations, more space is critical to serve the additional customers. More-specific criteria driving higher market values for multichannel big-box facilities include: 

  • Mezzanine areas are multiplying. E-commerce companies need larger mezzanine areas on multiple levels – requiring higher clearance from 36’ to 40’. New buildings can typically accommodate two or even three levels of mezzanine for picking, packaging, gift-wrapping, returns and other back-office tasks.
  • More parking for more employees. Many e-commerce companies employ labor-intensive picking and packing strategies to fill online orders, thus requiring larger sites to accommodate employee parking.
  • Consumer-driven location selection. Consumer demand is playing a larger role in site selection when goods must arrive on quick turnaround. Distributors need an available and affordable labor force to staff distribution centers, as well as access to rail, highways and air transportation.
  • Life system and HVAC requirements are increasing. With an increased warehouse workforce, other upgrades are necessary to building life systems, such as better lighting and ESFR fire protection. Formerly driven by inventory, now heating and cooling systems must be employee-driven.

Site selection plays a pivotal role

Facilities in a retailer’s supply chain do not exist in isolation. Questions to consider when investing in big-box space:

  • Where is the source of final demand? Big-box product tends to cluster in areas where product can most quickly and cost-effectively reach the end consumer.
  • What is the retailer’s service commitment? Distribution site selection is often determined by the percentage of customers or stores that can be reached within a certain time period. For example, most of the population in the Midwest and on the East Coast is reachable from Chicago within two days by truck.
  • Where can the retailer find a deep pool of labor? Distribution centers (especially e-commerce) can be very labor-intensive, which is one reason they are typically clustered on the outskirts of major metropolitan areas. These areas offer a deep pool of labor, but wages are lower than they would be closer to the urban core.

Chicago, New Jersey, Long Beach (Calif.), Philadelphia / Eastern Pennsylvania, Dallas and Atlanta remain the top-tier big-box markets in the United States. However, such cities as Indianapolis, Memphis, Houston, Phoenix and Kansas City are emerging as strong second-tier big-box hubs, primarily because of population growth, which helps multichannel retailers meet e-delivery benchmarks. In addition, these markets are well connected for transportation, with a mix of seaports, rail connections and cargo airports.

The industrial real estate market for facilities sized in excess of 250,000 square feet is likely to stay strong in the foreseeable future as retailers increasingly convert traditional supply chain facilities into multichannel warehouses. When evaluating big-box assets, investors would be prudent to consider whether available land meets the requirements for a multichannel site.

According to a recent RILA Retail Supply Chain conference survey, only six percent of retailers so far are currently implementing a fully agreed-upon integrated multichannel strategy. However, we can expect this trend to continue as traditional retailers look for ways to compete with pure e-commerce retailers like Amazon on service benchmarks such as same- or next-day delivery. Site-selection decisions that prioritize customer proximity will also pay off in the long-term as  retailers compete to provide a seamless "omnichannel" approach to the customer experience in the next state of retail distribution.

Kris Bjorson is with Jones Lang LaSalle's retail distribution group.