Last-mile distribution facilities focused on direct service to customers could be poised for growth.
The stratospheric growth in e-commerce in recent years, which was accelerated by the COVID-19 pandemic, has led to the convergence of industrial and retail under one roof. While the trend is in its infancy, it could revolutionize how products are delivered to consumers in the future. Whether it’s called microfulfillment, retail industrial or last-mile fulfillment, these properties have the potential to become an important part of the investment mix for retail developers.
“It was just a couple of years ago that 10% of all retail sales were online, and we’re now creeping up to 20%,” Craig Meyer, JLL’s president of Industrial Services, said during a recent NAIOP webinar. “We expect that over time to go to as much as 40%. There’s a lot of runway in our business.”
In the past, retail was very much an industry focused on “location, location, location,” according to Kris Bjorson, head of JLL’s Retail Industrial Task Force. Today, that formula is starting to look more like “logistics, labor, location.” Logistically, retailers face challenges around the final leg of transporting the products. And in recent months, supply chain issues have forced them to think about their inventory selection.
“If there’s a shortage of inventory, where does that inventory go?” Bjorson asked. “Is it at the last-mile fulfillment center or is it at the retail store?”
Bjorson noted that a lot of the micro-fulfillment trends that are taking off in the U.S. began in the Asia Pacific region more than a decade ago. Over there, many stores in that niche have been converted to 60% retail experiential showroom and 40% microfulfillment.
“The evolution of what’s happening in the U.S. actually started a couple of continents over,” he said. “I think the pandemic has expedited a number of concepts that retailers are trying out in different ways. You see an electronics retailer that converted a percentage of its stores into darkstores for fulfillment with a showroom.”
What’s the Right Size?
Because of these changes, retailers are having to think about rightsizing their store footprints to accommodate both walk-in customers and those who place orders online, said Geno Coradini, executive vice president for national retail tenant representation with JLL.
“For years, people have said that the retailer who gets the right size wins, but truth be told, it’s a challenge to understand what the right size means,” he said. “How much depth of product do you need? How many different SKUs do you need, for example? And now your customers can have their products shipped to your store, so you’ve got to make room to store products for that.”
Coradini said microfulfillment facilities can range in size from about 1,500 square feet to 10,000 square feet, though the average is between 4,000 and 5,000 square feet. They’re generally located in densely populated urban areas, and they operate like small-scale distribution centers. Because these facilities are so new, retailers will have to react to consumer demand by changing store layouts as well as the expectations for the labor force.
Some retail anchors use their existing premises as a fulfillment space. Coradini said the dynamic of right-sizing those spaces has changed because retailers are straddling two boxes.
“One is that traditional retail sales floor, the other is a stock room or receiving room that’s actually acting like a distribution center in some respects,” he said.
Coradini likened these new processes for storing products and getting them to consumers to trying to figure out “a complex jigsaw puzzle.”
Landlords in urban areas are seeing an influx of grocery microfulfillment operators such as GoPuff, JOKR, Fridge and others. That’s because investors are pouring money into these operations: As of October 2021, PitchBook reported that fast-delivery grocery companies had raised more than $10 billion from venture capitalists.
However, Commercial Observer reported in February that some of these companies in places such as New York could face a difficult financial future. According to the report, many of the products they deliver have low margins, and running a service such as this in Manhattan can have high overhead.
“There’s going to be consolidation in the industry,” Kunal Lunawat, co-founder and managing partner of real estate-focused venture capital firm Agya Ventures, told the publication. “We’re going to see some of these businesses fail.”
Coradini said the COVID-19 pandemic forced landlords and investors to diversify their retail portfolios so they have a broader mix of uses in their properties. Because some of these microfulfillment centers are open to the public and others are not, it has created confusion for local municipalities, many of which aren’t sure whether these concepts can be permitted in shopping centers zoned for retail. Learning what’s accepted by local municipalities in a particular shopping center can be a challenge.
“I think local municipalities are starting to listen to what’s being driven by the consumer,” he said. “These businesses bring dollars to the community, and we’ve got to figure out a way to work together. We can’t just say microfulfillment belongs in an industrial park, for example.”
Because of that, Bjorson said it’s crucial for developers who are interested in building microfulfillment centers to be fully prepared when they talk to municipalities.
“We’re not showing up in a given neighborhood without having all the math completed, meaning we understand what the e-commerce potential for that retailer will be,” he said. “We understand the underlying transportation costs savings to [locate] there. We understand the population density and the labor opportunity for them to properly automate and set up that facility. Real estate is the smallest bucket of the things we’re trying to solve for when we’re trying to get any type of fulfillment deal done.”
Movement at the Malls
The conversion of shuttered retail facilities at shopping malls into distribution centers has received a fair amount of attention in recent years. For example, CBRE research shows that around two dozen retail-to-industrial projects that have broken ground since 2016, mostly involving former malls or big-box stores. (See “Retail to Warehouse Conversions Gain Momentum” in the Fall 2019 issue of Development magazine.) However, converting these “darkstores” can present another set of challenges for owners. Bjorson said it’s important for developers to figure out what hurdles they must overcome to repurpose these properties.
“You have to know if there are any reciprocal easement agreements or other type of tenant restrictions in place with a complex,” he said. “It’s also vital to know the zoning, the traffic patterns, and whether, for example, you have the opportunity to have separate ingress or egress for trucks. We’re digging back into that model to almost reverse-engineer how we’re doing our site selection for our clients. We’re looking at how the density of e-commerce sales may impact future transportation patterns and costs. There are several different hurdles that must be addressed on the front end before you even start underwriting the rent.”
Bjorson said a major advantage of many of these larger, vacated retail big box facilities is their large land-to-building ratios. These can provide ample areas for parking as well as outside storage capabilities. Some of the limitations include a lack of loading dock doors and inadequate clear heights. However, clear heights may be less of an issue at microfulfillment centers than at traditional distribution facilities because the products will only stay there one to two days.
“Often straight trucks or vans are being loaded through drive-in doors, which are easier to put in than traditional loading docks,” Bjorson said. “From an operational perspective, there’s not as many limitations as you think in these conversions.”
Coradini said microfulfillment users are putting a lot of thought into how they transport products to consumers, particularly those focused on delivering the kind of goods that might be found at a local convenience store. Many of these have a goal of getting products to customers within 20 minutes of an order being placed.
Meyer said rents for last-mile facilities can be fairly aggressive, but he added that it’s more about a high street location vs. a warehouse location, because it’s all about the costs to get those products to the end customer.
According to Bjorson, real estate typically only makes up 5% to 7% of that total cost.
“Whether you’re paying $20 a square foot in rent or you’re paying $35 a square foot in rent, that goes from 5% to 7% of the total costs,” he said. “Clients are still looking at the total landed delivered costs, and it’s still predominantly driven by transportation, inventory carry and labor before you get to the real estate. That’s been one of the opportunities that property owners have been able to take advantage of in understanding that these locations are unique, and unique locations can command a premium rent.”