The expanding world of e-commerce is rapidly and forever changing the way that goods are bought and sold — as well as how they are transported, stored and distributed. Brick-and-mortar retailers are adopting multichannel distribution models, many “pure play” e-commerce retailers are growing exponentially while also expanding into physical storefronts, and the warehousing and logistics industries are innovating and adapting to gain and maintain market dominance. Industrial developers, owners and investors who can provide the types of facilities that e-commerce needs will survive and thrive during the next decade. But forecasting and understanding those needs is no easy task.
Almost 300 industry members gathered at NAIOP’s inaugural E.CON — the E-commerce Conference, subtitled “Industrial Real Estate in an On-demand World,” in Phoenix on March 27 and 28 to learn more about the impacts of e-commerce and the opportunities they present for commercial real estate. As NAIOP Chairman Jean Kane noted in her welcome to the conference, “The speed at which e-commerce orders are processed and goods are transported through a variety of channels is changing industrial facilities — how we’re building them, how we’re operating them, how we’re managing them.”
Keynote speaker and supply chain guru Dr. Jim Tompkins, CEO of Tompkins International, kicked off NAIOP’s inaugural E.CON conference, which focused on “industrial real estate in an on-demand world.” Gudenschwager Photography Inc.
The Pace of Change
Supply chain guru Dr. Jim Tompkins, CEO of Tompkins International and a recognized authority on e-commerce, kicked off the conference by addressing the pace of change now taking place in the retail world. “It’s my view that the pace of change in 2013 is 10 times greater in retail than it was 10 years ago. In the last decade, the rate of change in retail has been multiplied by 10. And [the rate of change in] 2014 is going to be substantially greater than 2013.”
“Industrial real estate in an on-demand world,” Tompkins continued, means that “you need to develop the capability to identify land, buy it, do the environmental stuff, get it permitted, get it built, get it commissioned, put in the equipment and be ready to go… in 30 days!” While that’s clearly impossible, “you need to anticipate, to come up with the plans, well in advance of what you needed to do in the past,” he said, adding that “the dude that’s got the building wins the business.”
What trends will have the biggest impacts on industrial real estate in the coming months and years? Tompkins cited two: omnichannel and “get local” (GL). He described how customer retail connectivity is evolving from single-channel sales (in a store or online) to multichannel, cross-channel and finally personalized omnichannel sales (where the channels are invisible, the sales process feels the same no matter how customers interact with the retailer, and each customer has a unique experience with that retailer). Providing a personalized omnichannel experience, he said, can result in sales figures as much as four times higher than single-channel retail sales.
Rene Circ, director of industrial research for PPR/CoStar, moderated a panel titled “Getting a Grip on the New E-commerce Marketplace,” at which Garrick Brown, director of research, Cassidy Turley Northern California; Chris Caton, vice president, research, Prologis; and Maria Sicola, executive managing director and head of Americas research, Cushman & Wakefield, discussed how retailers are adapting to today’s omnichannel world. Gudenschwager Photography Inc.
What does all that have to do with real estate? It is having a huge impact on distribution channels, as retailers move from using distribution centers (DCs) that supply goods to stores, to using combined distribution and fulfillment centers (DCs/FCs) that can supply those goods both to stores and to consumers placing orders online. Those facilities create valuable synergies and allow retailers to maximize their real estate, labor, automation and technology expenditures. Thus many traditional DCs now are being converted to DCs/FCs and new mega-DCs/FCs and FCs are being built.
The locations of those DC/FCs and FCs will be critical to their success. That’s where GL comes in.
“Getting local is probably the largest trend that will occur in 2015 that people are thinking about in 2014 that they couldn’t even begin to think about in 2013,” stated Tompkins. What does GL mean? Customers in major U.S. cities have very different expectations for service than those in small towns and rural areas. For many retailers, future sales — and profits — will be dependent on how quickly goods can be delivered to customers in major metro areas, Tompkins asserted: “the quicker you deliver, the more you’re going to sell.”
Increasing speed of delivery means creating a quicker supply chain in which goods have less distance to travel from FC to customer — which is what GL is all about. The bottom line, according to Tompkins, is that:
- DCs, FCs and DCs/FCs should be located in highly populated areas;
- Speed of delivery drives revenue;
- The network of DCs, FCs and DCs/FCs is complex and changing; and
- Third-party logistics providers (3PLs) have a different role to play than they have had in the past.
Location and End User Needs
Tompkins’ comments were echoed by many of the conference’s more than two dozen other speakers throughout the next day and a half. At a session titled “The End User’s Perspective on Site Selection,” industry experts stressed the importance of location and end user needs. It quickly became clear that while retailers want new fulfillment centers that can become operational as quickly as possible, most are not looking for speculatively built properties.
Questions from E.CON attendees sparked riveting discussions. Gudenschwager Photography Inc.
“Every end user has different specific needs,” noted session moderator Scott Belfer, senior vice president at CBRE Inc. and a leader in the firm’s e-commerce group. Executives from retailers Newegg Inc. and The Home Depot agreed that build-to-suit projects make the most sense for their businesses, as did Doug Armbruster, senior vice president and regional marketing director for developer IDI Inc.
All of the panelists noted that they expect these specialized facilities to take longer to build than a traditional warehouse or distribution center. But the need for additional time to complete complex internal buildouts puts developers under increased pressure to complete construction of the base building as quickly as possible. Mark Holifield, senior vice president for The Home Depot, estimated that it can take more than a year to get a new Home Depot FC up and running. Kunal Thakkar, senior vice president of operations for e-commerce retailer Newegg, noted that the technology alone can take five to eight months to install. (Panelists at other sessions concurred, and several noted that installing servers and material handling systems can take as long as building construction.) To speed up Newegg’s ability to start producing at a new facility that IDI began building in Indianapolis last year, the developer is completing the FC in phases, launching an area for bulk shipments in April while aiming to have its individual fulfillment capacity up and running in August.
In terms of location, panelists noted the importance of locating facilities within a two-day delivery radius of major population centers and near parcel delivery and other transportation hubs. The availability of transit service for employees also is becoming important, added Holifield.
Jon DeCesare, president of World Class Logistics Consultants, moderated a panel on the role of 3PL providers that featured speakers David Parks, managing director, FedEx Trade Networks, Lonny Warner, vice president of operations, technology and logistics services for Menlo Worldwide; and Bruce Welty, CEO of Quiet Logistics. Gudenschwager Photography Inc.
Because technology and customer expectations are evolving so rapidly, even build-to-suit properties need to be flexible enough to adapt over time, panelists stressed. Armbruster advised developers to design new projects that are bigger, deeper, taller, and have stronger floors and more widely spaced columns than traditional DCs. New properties also should be expandable and well insulated, with smart lighting and temperature control systems. “Think future changes in environmental controls and stormwater requirements, not just e-commerce needs,” he advised.
Because technology and consumer demands are changing so rapidly, Thakkar concluded, “you have to be flexible enough to cater to any changes right away.”
Vital Building Elements
Panelists discussed changing site selection and building element requirements at several additional E.CON sessions. During one titled “Building Elements 101: Specific Factors to Accommodate E-commerce,” Jim Condon, chief development officer for Seefried Industrial Properties, noted that “finding sites is especially important as it grows harder to line up desirable locations.” Once identified, he added, getting those sites entitled for DC/FC use early on helps speed up the development process. Condon also noted that in terms of the level of investment required for complex material handling systems, today’s DCs/FCs are more like manufacturing facilities than traditional warehouses. “From an investment standpoint, you have to feel really good about the tenant being there for a long time.”
Philip Prassas, senior vice president, KTR Capital Partners, moderated a panel titled “Technological Advances to Manage E-commerce,” at which Steve Johnson, principal, Johnson Stevens Consulting; Bryan Jensen, principal, St. Onge Co.; and Carlos Vega, western region sales manager, Dematic Corp., discussed the impacts of automation and other leading-edge technology on e-commerce fulfillment center designs and operations. Gudenschwager Photography Inc.
Matt Brady, regional vice president/architect for Ware Malcomb, advised developers to ensure maximum flexibility as they plan for development, suggesting that buildings be designed so that they can be converted from single- to multitenant use or vice versa. He also urged developers to be aware of building code changes, such as one that has reduced the allowable distance that an employee has to travel to reach an exit. As e-commerce facilities get bigger, with more mezzanine levels, such code requirements become more challenging to meet.
Building heights also are critical, Brady added, since they determine how many mezzanine levels can be accommodated. More e-commerce facilities are now being built with 40-foot clear heights, which can accommodate an additional mezzanine level and thus significantly increase productivity.
The larger staffs required by e-commerce facilities means these buildings have increased parking, power, HVAC, bandwidth (WiFi and fiber optics), lighting and security needs, noted several panelists at a session titled “E-commerce Logistics: The Role of 3PL Providers.” Bruce Welty, CEO of Quiet Logistics, which provides fulfillment services for small luxury apparel companies, also commented on the importance of cleanliness. Painted floors and dust filters can make a real difference in keeping goods clean, he noted. High ceilings also are important, as much from the lender’s perspective as the FC operator, Welty added: “Even Amazon has problems filling up the space above the racks … but understand that if you don’t have high ceilings, banks won’t lend you money.”
Other speakers at the 3PL session focused on the importance of understanding and complying with global import/export regulations and requirements and managing associated expenses. David Parks, managing director of FedEx Trade Networks, spoke about the importance of understanding “what’s prohibited where” in the rapidly growing arena of international e-commerce, the differences between international and domestic regulations and the importance of understanding total transaction costs which, for international e-commerce, include duties as well as shipping costs and taxes. Lonny Warner, vice president of operations, technology and logistics services for Menlo Worldwide, commented on the importance of speed in getting an FC up and running, noting that Menlo recently was able to take a 2 million-square-foot Amazon facility operational in 65 days (from taking the keys to the building to being able to ship product out); it did the same for three smaller facilities (365,000 to 695,000 square feet) in less than a month last summer.
John DiVall, senior vice president of Liberty Property Trust, moderated a panel on investment in e-commerce properties. Gudenschwager Photography Inc.
Process, Incentives and Taxes
Security also plays a particularly important role in location decisions, noted 3PL session moderator Jon DeCesare, president of World Class Logistics Consultants: “Facilities in high crime areas are unattractive to shippers and 3PLs; … that’s one of the elimination factors.” Panelists at a session titled “Process, Incentives and Taxes, Oh My!” discussed this and other additional site selection criteria. Brian Camp, a partner with ProVenture LLC, echoed DeCesare’s comment about security, noting that “you may have $1 billion of inventory in a [FC] building,” and adding that the location of parking as well as building entrances and exits are important elements in any security plan.
On the transportation side, foreign trade zone (FTZ) status is becoming more important, noted panelist Curtis Spencer, president of IMS Worldwide Inc. FTZ, a federal program started in 1934 that is now in use in all states, allows federal taxes and fees to be lowered, eliminated or exempt from payment for businesses located within FTZs. (In Texas and Arizona, businesses located in FTZs also pay much lower state taxes.) A business located in an FTZ, Spencer noted, could save almost $800,000 a year in merchandise processing fees, making these zones extremely attractive to e-commerce players.
Marcus Panasewicz, senior manager with Deloitte Tax LLP, commented on the types of incentives packages that states and municipalities are offering e-commerce facility developers and operators: “A lot of these are the same incentives you see all over the country for manufacturing operations: property tax abatements, sales and use tax exemptions or rebates” and provisions of infrastructure. Camp added that these incentives can be significant; for two recent Amazon fulfillment centers in Tampa and Lakeland/Winter Haven, Florida, the e-commerce titan received incentives worth about $7.5 million for roughly 374 jobs and $4.5 million for about 100 jobs, respectively, primarily in the form of property tax breaks and jobs incentives.
E.CON attendees enjoyed meeting and networking with colleagues at a welcome reception. Gudenschwager Photography Inc.
In addition to the jobs they bring to an area, FCs also represent significant capital investments, Camp added, ranging from $10 million to $20 million in material handling equipment. Spencer took that example one step further, estimating that the value of the equipment in an e-commerce FC typically is at least as valuable as the building itself: “If it’s a $50 million building, it’s going to have $50 million worth of equipment.” A regular DC, he noted, might have only $5 million worth of equipment.
Panasewicz reminded attendees that developers and business owners often forget that they can get credits and incentives for that equipment, including income tax credits, property tax abatements and sales tax exemptions. But all of those need to be negotiated upfront and documented afterwards in a timely manner, something that many fail to do.
Gopika Parikh, financial services credits and incentives leader for Ernst & Young LLP, added that incentives packages for e-commerce data centers typically are driven by capital expenditures, noting that “15 states have data center-specific incentives.” Green (energy efficiency) incentives also can be layered with other types of incentives, she noted, resulting in incremental benefits.
Investing in E-commerce
The final E.CON session examined “The ‘Do’s and Don’ts” of Investing in E-commerce.” Moderator John DiVall, senior vice president with Liberty Property Trust, focused on underwriting, how some e-commerce facility transactions are structured and how developers exit out of e-commerce projects. Investors, he noted, are still struggling to get comfortable with the idea that what were once considered above-standard tenant improvements (TIs) in these types of facilities are rapidly coming to be viewed as standard.
Jack Fraker, vice chairman and managing director of CBRE’s capital markets and industrial practice, presented three brief case studies of e-commerce building sales. Cap rates for these sales, all in secondary and tertiary Southeastern U.S. markets, were plus or minus six; if they had been in Dallas or Los Angeles, he added, they might have been closer to five. Big pension fund advisers, Fraker noted, who “for years were pure financially oriented acquisition officers and underwriters, now really buy into this supply chain story,” and are extremely interested in e-commerce facilities.
Other speakers agreed that major changes in how investors view e-commerce buildings have taken place during the past three or four years. “There has absolutely been a shift [in the way institutional investors look at e-commerce facilities]; it’s the norm now,” said Bo Mills, head of Western U.S. Industrial Capital Markets for JLL, adding that “if you’re not buying e-commerce, you’re probably not in the real estate business right now.”
E.CON Attendees Tour Macy’s Fulfillment Center
A tour of the Macy’s and Bloomingdale’s state-of-the-art, direct-to-consumer fulfillment center in Goodyear, Arizona, was a high point of E.CON for many conference attendees. The 1 million-square-foot facility, which opened in 2008 and was expanded by 360,000 square feet in 2013, contains 2 million square feet of operating space. It employs 800 year-round associates and as many as 3,500 workers during the busy fourth-quarter peak shopping season.
After being welcomed to the facility by Macy’s Vice President of Operations Leonard Velazquez and city of Goodyear Mayor Georgia Lord, participants got an up-close look at how this massive facility operates, from the receiving dock through various “back-of-store” storage areas, the “nerve center” (where employees monitor nine large screens displaying operations information), 17 miles of conveyor belts, more than 430 packing stations and an area where goods returned by customers are processed and clothing items steam-cleaned before being returned to stock.
The center, which is the only one to serve the western part of the U.S. (the next closest facility is in Tennessee), receives 20 million units of merchandise per year via truck and processes orders from customers for almost all product types (everything but fine jewelry and large furniture). Watching many of those items — shoeboxes, polybagged shirts, toasters, bedding and more — zip by on the conveyor belts before being deposited onto tilt trays that dropped them into packing stations, where employees check and pack each order, was a fascinating experience.
In addition to fulfilling e-commerce orders, the center also services Macy’s stores in the Phoenix area and as far away as Las Vegas. During the busy winter holiday season, the facility operates 24/7 with three shifts and stocks 250,000 to 350,000 distinct items. It sits on a 25-acre site within the 250-acre Goodyear Crossing Industrial Park. The park is still being developed by Duke Realty, which built the Macy’s center as well as an Amazon.com fulfillment center on the same street.
On their way to and from the center, participants enjoyed a windshield tour of Goodyear’s many other industrial parks, infrastructure and development sites narrated by tour organizer Harry Paxton, project manager for the city’s economic development division’s development services department and his associate Christian Green.
Speed of Delivery
Are all e-commerce retailers chasing the holy grail of same-day delivery? The answer from E.CON is a resounding “no.” While some customers in some markets will pay a premium to get some kinds of goods within a few hours, most customers in most places are willing to wait longer for most goods — particularly if it means paying a lesser or no delivery fee. Mark Holifield, senior vice president with The Home Depot, explained that while most Home Depot customers like having the option of two-day delivery (and professional customers already have the option of same-day delivery — which Home Depot fulfills from its stores), most currently chose the lower-cost option of third-day delivery. Research conducted by online retailer Newegg indicated that fewer than 10 percent of customers are interested in same-day delivery, a very small segment of the market.
Same-day delivery is a bigger issue for pure play e-commerce retailers, Holifield noted, since most customers have the option of going to a store if they really need an item “same day.”
Keynote speaker Jim Tompkins framed the discussion of “how fast is fast” with the comment that it depends on many factors, including location, customer age and gender and, most importantly, product type. “Fast,” for grocery deliveries, he noted, means same day; for luxury items, it means next day; for electronics, two days; for small kitchen appliances, three days; for larger appliances, four days; and for garden items, seven days. Customer expectations continue to increase, he added, noting that “fast for 2014 is next day to two days; fast for 2015 will be same day to next day.”
What does all of this mean for commercial real estate? Faster-than-two-day delivery for many products will require e-commerce retailers to set up more (but smaller) fulfillment centers in more urban areas, meaning that multistory facilities (like those Prologis and others already operate in Japan) may begin to make sense because of higher land costs.