Industrial Trends To Watch
By: Ron Derven, contributing editor to Development magazine
Winter 2016 2017
Principal Real Estate Investors’ 393,000-square-foot 10000 Franklin distribution center in White Marsh, Maryland, features 41.5-foot clear height ceilings and 52 loading docks. Photo courtesy of Transwestern
The marriage of retail and industrial real estate continues to disrupt the warehouse and distribution center industry.
INDUSTRIAL DEVELOPERS, investors, brokers and architects on the front lines of the rapidly evolving warehouse and distribution center industry regularly come together at NAIOP conferences to share observations and best practices. The trends below were identified by speakers at NAIOP’s 2016 I.CON and Commercial Real Estate conferences, held between April and September. They indicate that e-commerce warehouse and fulfillment center networks are still under construction and generating demand for various types of industrial facilities. In particular, last-mile delivery is driving demand for infill locations, even for some older industrial facilities previously thought to be obsolete.
Will 2017 be a time to buy, hold or sell industrial projects? According to speakers at the recent NAIOP conferences, the definitive answer is ... it all depends. Why sell? Because in baseball parlance, the industrial real estate cycle might be late in the seventh or even the ninth inning, depending on who you believe. Why buy or hold? Because the typical market cycle might be skewed by a little or a lot, thanks to the dynamic effects of e-commerce growth.
NAI Global President Jay Olshonsky, speaking at I.CON: Trends and Forecasts in June, said that if an industrial property owner plans on selling a project within the next five years, then he or she should sell it now. If that owner plans a hold time of 10 years or longer, “borrow as much money as you can and buy as much industrial [real estate] as you can.” He further suggested that for the diversified real estate fund that has not yet invested in industrial real estate, “you need to buy right now: hold it for 10 years or more because it is a wonderful investment,” he exclaimed.
His analysis was affirmed by speakers at the Commercial Real Estate Conference in September. Here is what three of them had to say:
Bill Petsas, senior vice president, Western U.S., EastGroup Properties, said that the fundamentals for industrial real estate have never been better. Although supply is increasing, it seems to be increasing at the right pace. “Barring an economic catastrophe—some exogenous variable that we don’t see right now—it is steady as she goes.”
Susan Bergdoll, vice president of leasing and development, Duke Realty, said that the industrial market will probably continue at its current pace, but Duke’s strategy has recently changed. The company had been buying land to hold for development within the next seven to 10 years. “Now we are looking at an 18- to 36-month window; land we can buy, put into play and then move on to the next project.”
Al Pontius, senior vice president and national director, specialty divisions, Marcus & Millichap, said: “Everybody is waiting for things to change [in the industrial real estate market], because they must change. But unless someone can predict a major unpredictable event, we are probably looking for a lot more of the same [a well-performing industrial market]. The market is very healthy and I see no slowdown in capital demand for industrial in general.”
Here are 14 other trends gleaned from NAIOP conferences in 2016:
1) Industrial real estate is rapidly becoming “the new retail.” According to James Eckenrode, executive director of the Deloitte Center for Financial Services, analysts estimate that 50 percent of the malls in America will close by 2030, as overall demand for traditional stores continues to weaken. Offsetting that will be more fulfillment centers located closer to the end consumer, said Eckenrode. Ultimately, retail stores may double as fulfillment centers. Some physical stores will remain, particularly those selling goods that consumers expect to touch, feel or try on before they buy.
2) Small warehouse design is being influenced by features that have already been added to larger products. Lawrence R. Armstrong, LEED AP, CEO at Ware Malcomb, said his firm is designing smaller warehouses with features influenced by those going into larger facilities, including 36-foot ceiling clear heights, 56-foot column spacing and 70-foot speed bays.
3) Manufacturing will remain critical to the U.S. economy. “The idea that somehow [U.S.] manufacturing will once again regain the significance that it had in the past is simply not accurate,” explained Jason Tolliver, J.D., head of industrial research, Americas, at Cushman & Wakefield. He said manufacturing is still extremely important, but its contribution to the U.S. GDP has declined from above 30 percent in the 1940s and 1950s to well below 10 percent today. However, it is still a significant driver for the U.S. economy and for industrial real estate.
First Industrial Realty Trust operates the First Park @ Ocean Ranch development in Oceanside, California, which Ware Malcomb completed in December 2015 for McDonald Property Group. The park includes three speculative tilt-up industrial buildings totaling 237,000 square feet. Two of the buildings are occupied by Suja Juice.
4) E-commerce companies are in a big hurry to add facilities in infill locations. While e-commerce retailers have created very large and sophisticated fulfillment centers, they are now in a big hurry to begin operating smaller infill centers, according to Ware Malcomb’s Armstrong. “We are doing a lot of work on functionally obsolete industrial buildings right now because the e-commerce people cannot wait for us to design [and construct] new buildings,” he said.
According to Duke’s Bergdoll, although Amazon already has massive fulfillment centers around Chicago, “it is leasing 75,000 square feet on Goose Island, which has to be the most congested part of Chicago. But because they are now doing one-hour delivery, they have to be there. As they get into the city, they are using what we in the industry call shallow-bay industrial buildings [those with bay depths of 120 to 200 feet and clear heights between 18 and 24 feet]. Now, all of us developers are looking for infill opportunities,” she explained.
5) Shallow-bay buildings may be better investments than larger industrial structures. According to EastGroup Properties’ Petsas, a Cushman & Wakefield study of shallow-bay versus bulk warehouses revealed that rent growth over 10 years for shallow-bay buildings was 58 percent higher than for bulk warehouses. The study also looked at total returns over a one-, five- and 10-year period. For each of those periods, shallow-bay buildings outperformed bulk warehouses. “That’s why, at my company, 81 percent of the product we own is shallow bay or, as we call it, 'business distribution.’ We are really focused on the infill markets,” he said.
6) Infill project tenants demand truck parking away from buildings. If there is one deal-breaker out there for tenants seeking infill locations, it is inadequate truck parking. Truck parking must be located away from the building, according to Duke’s Bergdoll. “In the deals that we have been doing, that is the No. 1 thing that tenants are demanding, because they want to max out the number of docks against the building itself,” she said.
The Canaveral Port Authority operates the 246,000-square-foot Flagler Global Logistics building in Titusville, Florida, which was completed by Ware Malcomb in May 2016. The shallow-bay facility is 210 feet deep and features 50 by 54-foot bays, a 32-foot clear height ceiling and 29 dock doors.
7) E-commerce companies need “just the right location” for new fulfillment centers. According to Kim Snyder, president, southwest region, with Prologis, e-commerce tenants are looking at total operating costs for a new facility, not simply the lowest price per square foot. Today, the real estate portion of the total operating costs for an e-commerce facility could be only 5 to 7 percent. Because transportation and labor costs represent a greater share of overall costs, a building in the wrong location, even with a reasonable rent, would be useless to an e-commerce company.
8) LEED certification is losing its luster with industrial developers and tenants. Ware Malcomb’s Armstrong said that his firm is no longer designing many LEED-certified buildings, because building codes have caught up to LEED standards. “LEED served as a very good catalyst to sustainable thinking,” he said, but his clients are no longer willing to pay for the process or the plaque.
9) Industrial buildings are moving quickly from the “horse and buggy era” to the “space ship era.” According to Geoffrey Kasselman, SIOR, LEED AP, executive managing director, national industrial practice, with Newmark Grubb Knight Frank, the speed of change in industrial building design is phenomenal. He reported that e-commerce companies are already looking at building designs that include accommodations for autonomous trucks, drone docks and microgrids that enable warehouses to generate their own power.
10) 3-D printing may have profound impacts on industrial development. Deloitte Center for Financial Services’ Eckenrode said that 3-D printers are now being used to “print out” buildings in China. “In the consumer environment,” he said, “should 3-D printing costs come down to the level of ink jet printers, we can think about bypassing all of the supply chain, from the manufacturer to the retailer, and print out whatever we need at home.”
11) Demand for refrigerated warehousing is growing. NAI Global’s Olshonsky described meeting with a very large institutional owner who wants to invest only in industrial buildings occupied by e-commerce food delivery tenants like Fresh Direct and Hello Fresh. His rationale is that even if one of these e-commerce companies goes out of business, there will be another tenant ready to occupy the space. “We believe that this trend will continue around major cities where you have just-in-time delivery,” he said.
12) The 3PL industry will experience tremendous growth. According to Ben Conwell, senior managing director and practice leader, e-commerce and electronic fulfillment, at Cushman & Wakefield, the third-party logistics (3PL) industry will experience tremendous growth over the next five years because all retailers, with the exception of Amazon and Wal-Mart, will need the services of these companies to compete in e-commerce going forward. “You have to pay someone to do this; you have no choice, and you do not have much time to set this up,” he said.
Ware Malcomb’s master plan for the 98-acre Flagler Station III in Miami includes nine shallow-bay industrial buildings ranging from 140 to 210 feet deep, with 50 by 54-foot bays and 30 to 32-foot ceiling clear heights. Seven of the buildings are completed and occupied; the final two are under construction and expected to be completed by the end of 2016.
“I agree that 3PL will increase dramatically,” said Curtis Spencer, president, IMS Worldwide Inc., “because Amazon and Wal-Mart have set a high bar. Other retailers are going to have to compete with them because they are not simply going to quit. They will compete with a 3PL platform that already exists out there.”
13) Warehousing designs are changing. According to James Martell, president, Ridge Development, there will be a continued “push” past 40-foot clear height ceilings, to 45-foot clear, in order to get two levels of materials handling equipment in warehouse space. He said that cross docks and drive-throughs will be needed to accommodate the uberization of e-commerce, as retailers contract directly with individual drivers for the “last mile” of package delivery. Close-in, infill warehouses will not simply be smaller versions of large distribution centers; they will be designed for massive throughput for small-vehicle drive-through. Truck docks may not be required.
14) Use of multistory warehouses will grow. With urban land prices sky high and competition from residential developers increasing, multistory warehouses will likely be needed in some parts of North America, but only in the densest urban settings, Martell added.
How will these trends play out in 2017? What new industrial trends will emerge? Find out at NAIOP’s I.CON ‘17: Impact Projects, March 8-9, in Toronto; I.CON ‘17: Trends and Forecasts, June 8-9 in Long Beach, California; and Commercial Real Estate Conference 2017, October 10-12 in Chicago.