Supply chain disruptions, logistics, location technology and “last mile delivery” started making front page headlines as the retail world became defined by home delivery of practically everything. With the worst of the pandemic now behind us, what’s the state of retail, where’s it headed and from where — and how — will our treasures bought online be shipped?
Transformation
In February 2022, the U.S. Department of Commerce reported that e-commerce sales in the U.S. were up by 14.2% from 2020 to 2021. Going back to the pre-pandemic days shows an increase of 50.5% from 2019 to 2021.
During the pandemic, U.S. shoppers rang up an $870 billion shopping spree led by purchases of furniture, electronics and building supplies. These surges in demand for online goods during the pandemic highlighted the need to rethink aspects of supply chain management.
The transformation of retail is now facing a new set of challenges posed by inflation resulting from supply chain snafus and compounded by the war in Ukraine. In August 2022, the U.S. Department of Commerce released new e-commerce figures for Q2 pegging the sales estimates at over $250 billion, an increase of just 2.7% over Q1.
Things have flattened out, but buying things online isn’t going away. E-commerce sales in Q1 of 2022 accounted for 13.9% of total sales — a figure that’s expected to grow.
Let’s Get Phygital
The numbers indicate that the brick-and-mortar model is not quite dead yet, but it is changing. Several large retail chains are embracing phygital, a made-up word that mashes digital shopping together with the physical store experience to create a new type of retail space.
Online powerhouses, including Bonobos, Allbirds, and Warby Parker, have all gone old school by opening real stores. Buying online is efficient, but it eliminates the experience of walking through aisles while hunting and gathering goods. These retailers and others are betting that consumers will continue to seek three-dimensional shopping.
The digital end of a phygital transaction includes ordering something online and picking it up at the store. Selecting an item at the store and having it delivered also counts. Retailers are also using more self-checkouts and deploying sales associates with handheld point-of-sale devices.
The Rise of Industrial
To make the digital half happen in the phygital world, goods need to be stored in industrial CRE locations along the supply chain, ideally somewhere in the last mile from the consumer. Demand for this warehouse space has caused an explosion in the once sleepy CRE segment, while supply chain adjustments have further pushed that demand to unseen levels.
According to a report from Cushman & Wakefield, “E-commerce companies had accounted for 28.2% of all industrial absorption from 2016 through 2019, and that number increased even more to approximately 40% from 2020 through 2021 as COVID-19 shifted consumer shopping patterns to more frequent online purchasing.”
E-commerce supply chain operations require more warehouse and logistics space — typically three times more than a traditional brick-and-mortar supply chain. The increasing demand for land that can be converted into warehouse space has spilled over into other industries, including housing.
In June 2022, just outside the Austin suburb of Round Rock, Texas, nearly 200 acres went up for sale. Austin is a booming town for tech firms and in desperate need of affordable housing. Potential buyers for the property included homebuilders, private equity giant Blackstone and industrial landlord Prologis. The winner of the coveted acreage turned out to be the world’s largest e-commerce company, Amazon.
The Amazon Effect
Once content with renting warehouse space from companies like Prologis, Amazon has shifted its strategy into buying land and building its own industrial space. According to numbers from CoStar Group, between 2020 and 2022, Amazon tripled the amount of built industrial space it owns in North America by buying existing buildings, defunct call centers and bare land.
During the same period, Amazon scooped up about 4,000 acres, spending a total of $2.2 billion. In March 2020, in the deep recess of the pandemic, it spent $30 million for a 63-acre plot between San Diego, California, and Tijuana, Mexico, to build a same-day shipping facility.
The goal is to tighten delivery times so Amazon can compete with the instant experiential gratification of going to a store, finding the right product and buying it. “There’s going to be something on the other side of all of this investment for the consumer,” said John Blackledge, an analyst at Cowen and Company LLC. “People will buy more on Amazon when they see they can get it in five hours instead of in two days.”
Illustrating how quickly things are changing in the marketplace, Amazon appears to be reacting to a slowdown in consumer spending. Amazon has abandoned plans to open 42 additional warehouse facilities across the country. Two sites in Maryland have closed, laying off 300 people as the supply chain continues to thrash around while looking for balance.
Amazon attributes the closings as a move to more modern buildings. “We regularly look at how we can improve the experience for our employees, partners, drivers and customers, and that includes upgrading our facilities,” said Maria Boschetti, an Amazon spokesperson. “We have dozens of fulfillment centers, sortation centers and delivery stations under construction and evolving around the world.”
Delivery giants, such as FedEx and UPS, are also competing for land against grocery stores, restaurant chains, car dealers and mixed-use CRE developers. New buildings required for e-commerce use enormous amounts of electricity and are designed around a high level of automation. A typical not-so-smart warehouse costs about $200 per foot to build. The newer, smarter, more electrified versions cost nearly twice that amount.
Inflation and Interest
The Fed’s decision to gradually step up interest rates to cool inflation has some analysts watching for a decline in demand for industrial space. Any softening isn’t expected to have much of an effect on a segment that’s still flying high.
Numbers from CRE brokerage house Newmark show that warehouse rent has grown an average of nearly 3% a quarter nationally since mid-2020, reaching $9.56 per square foot in Q2 2022. In certain markets, including Silicon Valley and Los Angeles, California, and Long Island, New York, rents exceed $15 per square foot.
It’s also worth noting that in areas where there are geographical and existing development and zoning constraints, prices are higher due to an inability to provide new supply.
Some analysts have suggested that the market has topped out. In August 2022, Cedrik Lachance of CRE research firm Green Street said, “The industrial business has risen very far and very fast in recent years, and it clearly benefited from the pandemic as we all became addicts of online shopping. But as normalcy returned and consumer behavior changed again over the last 12 months or so, you can tell that e-commerce growth is just not going to be at the same pace as what we would have expected.”
At the same time, e-commerce firms are convinced they can beat brick-and-mortar retail at their own game, and the current slowdown is temporary. In August, Prologis proclaimed that less than 4% of its warehouse was available. It followed up by announcing it would acquire Duke Realty, an industrial CRE investment trust, for $26 billion to expand its range and holdings. Prologis believes that the 13.9% total e-commerce sales figure seen above will grow to 25% of all retail sales by 2025.
End of the Industrial Golden Age?
Nobody knows if or when the industrial bubble will burst. Current trends show that e-commerce growth will continue driving demand for space. Putting the genie back into the brick-and-mortar bottle seems unlikely. Experts believe that e-commerce occupiers are projected to account for between 35 and 40% of industrial demand as consumer shopping habits refuse to reverse course. Younger digital native generations who grew up shopping online will also continue to increase in numbers.
Pioneered by Amazon, new real estate development wrinkles are redefining how warehouse space gets financed and built. In recent deals, the company has shied away from paying a developer fee and eventually leasing the building from a bank. Instead, it’s cutting deals with investment firms. The new financial arrangements lean more toward the structure of corporate bonds as opposed to build-and-lease arrangements. Tax advantages are already baked in.
“Unlike developers who worry whether the building will appeal to the next tenant, these investors focus more on the creditworthiness of the borrower,” said Eric Frankel, CRE consultant and director at Validus Capital. “They’re also often willing to accept a lower return — paid by Amazon over approximately 20 years — since the real estate can shelter profit from other investments from taxes. These new warehouses are so specialized they’re more like manufacturing facilities. So Amazon needs to find different financing partners.”
Along with the new development options, rent growth is also expected. Assuming continuing improvement in the supply chain, the pace of growth will likely slow down due to economic shifts but will never completely dissipate. CRE mixed-use development will also continue to thrive.
Robots and Drones
The opportunity to capitalize on high-growth areas will remain as investors constantly seek out smart places to put their money. To earn investor interest and deliver returns, the major players are pursuing emerging technology. Amazon now has over
200,000 robots helping deliver 350 million products. The warehouse robotics business is ballooning with a 15% growth rate every year. It’s expected to double by 2027 and be worth over $23 billion. The projected increase in productivity is estimated to be between 200 and 300%.
A survey by the Material Handling Institute confirms the tremendous potential. The move to fully automate is happening on several fronts. While e-commerce giants are building smarter warehouses, robot builders are developing more adaptive robots. Jonathan Hurst, chief technology officer and a founder of Agility Robotics, said, “Instead of designing the whole warehouse around the robots, we can now build robots that are able to operate on our terms, in our spaces, in our environments.”
The robot revolution is going beyond mechanical arms and smart conveyor belts. “Our robots know what the item is; nobody has to look at a list,” said Karen Leavitt, CMO, Locus Robotics. “By doing it that way, we are doubling or even tripling the productivity of the humans in that warehouse, and we’re cutting down on the amount of walking that they do by probably 75% or 80%.”
The tales of air delivery via Amazon drone have been going on for years. And yes, it’s a real thing. In 2020, the company was granted a Part 135 Air Carrier Certificate by the FAA. This special permit means Amazon has been authorized to operate as an airline and deliver small packages via drone. In August 2022, Amazon announced plans to start conducting deliveries to Lockeford, California, and College Station, Texas, via Prime Air. The future will arrive any minute now and will be delivered by Amazon.
The pandemic’s rippling effects continue to influence the world of CRE. Regardless of how it all shakes out, the voracious appetite for e-commerce should sustain interest in retail and industrial CRE.
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