City leaders should be more proactive in crafting municipal policies that capitalize on the e-commerce changes transforming commercial real estate and their tax bases.
ALTHOUGH IT MAY seem that brick-and-mortar stores are becoming obsolete, a more accurate way to think about this change is that these stores are no longer the only customer-facing conduit in the retail distribution chain. Fulfillment centers and sortation facilities, which enable goods to be delivered directly to consumers, are playing an increasingly important role. As Jason Tolliver, head of logistics and industrial research at Cushman & Wakefield, explains, “The idea that retail is dead is overplayed – rather, it is undergoing a structural change.” In fact, he says, retail continues to expand, make gains in employment and launch new concepts. The retail supply chain is simply being overhauled as a consequence of the digital revolution.
Leasing data from Cushman & Wakefield’s North America Industrial Forecasting Report 2018-2019 sheds light on this transformation. In 2013, the share of industrial leasing in the U.S. that was e-commerce-related stood at 5 percent; today, the share ranges between 20 and 25 percent. Research by Cushman & Wakefield shows that e-commerce leasing is surging well beyond this range in some metro areas. In 2017, 30.6 percent of industrial leasing in Los Angeles was related to e-commerce, in North and Central New Jersey it reached 31 percent and, in the Inland Empire region of California, e-commerce leasing was a whopping 50 percent of industrial leasing.
Brick-and-mortar locations are being downsized and are playing a different role in the supply chain because of advances in mobile technology. In the U.S., 10 percent of retail sales are conducted online; in Europe, the figure is twice as high, at 20 percent. “We’re going in the same direction as Europe, and even today there’s three times the demand for Class A industrial space than there is supply,” says Robert Kossar, vice chairman and head of the Northeast Industrial Region for JLL. Patrick Daniels, CEO at CapRock Partners, adds that the way Amazon allows smaller companies to sell on its platform is also driving demand for industrial space. “Amazon has five different levels of partnerships with product-direct companies that expose them to the customer base of Amazon.”
Changing Industrial Space Needs
So, while some brick-and-mortar retail locations are struggling, surging online sales are ushering in a growing need for industrial real estate. Retailers are looking for warehouses to store inventory, as well as fulfillment centers and sortation centers from which to send orders directly to consumers. According to Daniels, “The price of storing inventory in a retail space is between $3 and $6 per square foot; retailers are realizing they can take that inventory and put it in a warehouse or last-mile facility for 30 cents to $1 per square foot and reduce costs.”
New types of online businesses are also expanding the e-commerce sector. Conwell says, “There has been a significant explosion of ‘digitally native vertical brands,’” a phrase coined by Bonobos founder Andy Dunn to refer to brands that began as exclusively online retail platforms and are “maniacally focused on the customer experience.” At the same time, many of these brands are increasingly building a complementary physical presence. Marketing strategies like “omnichannel” and “unified” commerce, in which companies integrate the customer experience across all platforms, both online and physical, are also bolstering e-commerce. (See “Unified Commerce: The Future of Retail?” on page 14.)
Although people can now purchase items in more flexible and streamlined ways than ever before, Tolliver says the fulfillment side of online retail has not evolved as quickly and is struggling to catch up to consumer demand. “While there is technological advancement on the fulfillment side – such as robots and drones – that adoption is occurring more slowly,” he says. “Consumption is really what has experienced a sea change.”
Retailers must also consider how their new supply chain will process returns. Traditional brick-and-mortar retailers can often simply put returned goods back on their shelves, but retailers with only an online presence find returns to be an expensive proposition. According to Tolliver, “It takes considerably longer for returned items to find their way back to a ‘shelf,’ if they ever do. Often, retailers offload returned items for pennies on the dollar through outlet stores, online auctions and salvage dealers.”
Millennials Drive The Market
Cities that do not try to satisfy the growing market of millennials will not experience growth themselves, says Kossar, who cites the millennial-rich boroughs of New York City as examples. Larry Kosmont, principal at Kosmont Companies, is an economic development expert who works with municipalities to help them create forward-thinking policies. To get millennials out of their homes, he says, retail spaces must offer unique experiences. “Retail isn’t retail anymore, it’s blended use. You need to put services, housing, etc. alongside retail; create amenities that will allow millennials to text each other; and lead with food and curated, invented products, in order to get people or sales.”
CapRock Partners plans to construct four buildings in Norco, California, that will cater to companies that specialize in online sales and direct fulfillment. Courtesy of RGA, Office of Architectural Design, Inc.
Substantial shifts in what Kosmont calls “the three Cs: connectivity, consumption, and commuting” are transforming places, and municipal leaders are taking notice. However, he says city leaders are not being proactive enough in crafting policies to capitalize on these changes. Rather than getting out in front of the trends, they are lagging.
“These shifts are unavoidable and cataclysmic,” Kosmont says. “They’re driving design, investment, delivery modes, and they’re only going to continue to do that.” He makes presentations to municipal leaders about how they need to follow the market and adjust land use, zoning and entitlement processes or risk falling behind and losing population and investment to competing locations. All too often, he says, developers propose uses for retail strips with closed big box stores that get rejected because they do not fit strict, outdated definitions of zoning and land use. “No, you can’t put in a dentist’s office, that’s not ‘medical,’ you can’t put a university, that’s not ‘educational.’” As a consequence, he says, many cities are experiencing painful contraction of their tax revenues.
Although cities have largely adjusted their residential zoning and land use plans to accommodate millennials’ preferences for close proximity to amenities and for walking over driving, Kosmont thinks they have not yet planned for the full range of industrial and commercial real estate patterns required by the millennial market. “Residential has led the pack—density bonuses have been given for housing and transit—but the transition to blended uses where retail can coexist with attractive, authentic millennial space has not been prioritized.” Growing boroughs like Brooklyn and Queens have been largely rezoned for residential or creative office space but have neglected to zone for adequate industrial space.
Urban areas will experience a shortfall of industrial buildings in the coming years, according to JLL’s Kossar. For example, he says “Over the last decade, the city of New York has actually lost 8 million square feet of industrial space. So while stock is down – nearly zero – we’re actually on the precipice of significant demand.”
Meeting the Demand: CRE Strategies
“Even with technology, [goods] cannot get from New Jersey to Manhattan in two hours. There are just too many logistical challenges like traffic congestion and limited truck routes,” says Kossar. Increasingly, retailers are positioning a narrow set of products closer to their customers. Called “SKU (stock keeping unit) proliferation,” retailers use market research to determine the most popular items – sometimes referred to as “high-velocity inventory” – by small geographic area like ZIP code and store them in warehouses or fulfillment centers very close to consumers.
Microtargeting consumers in this way reduces a retailer’s space requirements in population centers, which are usually expensive areas with limited land. Benjamin Conwell, senior managing director and new Commerce Advisory Group leader at Cushman & Wakefield, explains. “In the past, retailers served all of their stores and catalogue customers – the old direct-to-consumer shoppers – via distribution centers in, for instance, St. Louis and LA. Back then, it was OK to put an order on a truck and deliver it to someone’s home five days later. Today, however, they must position inventory closer to more places with higher population densities. To do this, they need to have the right SKUs in the right places at the right times.”
As retailers adjust their supply chains to accommodate more e-commerce, they are also developing new transportation and logistics strategies. Conwell says, “The demand from retailers and shippers for having some last-mile depot or handling building is very new. Even five years ago, none of the big online retailers, including Amazon, were doing small last-mile buildings because they were exclusively using FedEx, UPS and USPS to do their deliveries.”
Online retailers are increasingly building their own transportation networks and urban delivery facilities rather than contracting solely with shipping companies like UPS. Conwell says Amazon has built its own sortation cross-dock buildings, where pallets are broken down and individual orders are sent out the other side. It’s also supplemented parcel delivery carriers with its own fleets of private contract vehicles for local deliveries. These transportation innovations are only adding to the demand for industrial space near population centers; with the creation of private delivery networks, last-mile buildings from which delivery vehicles depart are an even more critical piece of e-commerce companies’ logistics strategies.
The Opportunity for Municipalities
There are many reasons municipalities may want to consider attracting e-commerce fulfillment centers. According to Conwell, many of the same reasons that made certain locations good for retail a generation ago now make them good locations for logistics buildings. Their access to roadway infrastructure and established supply chains, as well as their proximity to population centers, are all assets that can be leveraged for the modern era of online retail.
“There’s substantial redevelopment potential for struggling or failing retail centers or big box locations,” says Conwell, “and I know of such projects that are currently in the planning stage that will likely be approved in two years.” One recent example is Sam’s Club, owned by Walmart, which announced in January that it would close 63 stores across the U.S., citing that the future of retail lies in speedy delivery. The big box retailer also unveiled immediate plans to repurpose some locations as e-commerce fulfillment centers.
Income and property taxes generated by e-commerce-related industrial buildings can help buoy local budgets by replacing lost tax revenue from closed brick-and-mortar retail locations. In fact, fulfillment centers maintain a high rate of employment. “Investments are being made in technology and robotics, which will increase efficiency, but it’s still a people-driven business that is labor-dependent,” explains Tolliver. “Given the cost, complexity and continued evolution of supply chain strategies focused on electronic fulfillment, people will remain a critical component of warehouse operations for the foreseeable future.”
Compared to distribution centers, fulfillment centers can employ two to three times the number of employees because much of the work is “pick and pack,” whereby workers pull products off shelves and pack specific orders. “While wages for logistics-related jobs are growing quickly and have surpassed those for retail jobs, they still lag behind wages for the manufacturing jobs that were lost, on an inflation-adjusted basis, in many metros,” Tolliver adds.
Norco, a town of approximately 27,000 in California’s Inland Empire, knows the benefits of e-commerce fulfillment facilities. E-Z Up, which manufactures pop-up tents commonly used at sporting events, maintains a 130,000-square-foot warehouse in the town, where it registers most points of sale. Although local taxes vary from place to place, Norco values the income tax benefit it receives from fulfillment centers like the one run by E-Z Up and has also managed to capture some sales tax revenue from such facilities.
In 2018, CapRock Partners plans to start construction on four buildings right off Interstate 15 in Norco. The buildings, totaling more than 400,000 square feet, are designed for companies with a large amount of online sales and direct fulfillment. “City leaders just need exposure to these buildings, to walk through them and understand them. There’s a lot of that in Norco; they’ve been one of the most cooperative municipalities with which we’ve worked.” According to Daniels, Norco intentionally waited for the right industrial developer to come along. “They did not let it get rezoned because they wanted to have dedicated space for job creation by other E-Z Up-type businesses,” Daniels says.
According to Tolliver, the increase in demand for e-commerce fulfillment centers has put strong upward pressure on wages for their workers. “It’s a simple supply-and-demand issue,” says Tolliver. The wage growth is much better than we’ve seen in other sectors. Logistics-related employment registered its largest quarterly increase ever in the first quarter of 2018, with wages growing 3.9 percent, nearly 1.5 times that of all civilian workers, according to the Bureau of Labor Statistics Employee Cost Index.”
The availability of high-quality labor is the top issue for Tolliver’s clients. After answering concerns about whether a location is near a population center, clients research the warehouse labor market to determine whether the labor pool has enough depth and breadth. “They are looking for places with a sufficient [pool] of labor so that when other fulfillment centers come and compete, the metro area can pull in enough [workers] to maintain them all,” Tolliver adds. He has also seen the competition for labor among e-commerce fulfillment centers lift wages across the broader industrial real estate sector by spurring a variety of associated economic activity for suppliers, couriers, messengers, warehouse workers and others along the last mile of the supply chain. By securing some of this economic activity, cities stand to gain not only increased employment for citizens but also increased income tax revenue.
Norco recognizes the economic opportunities, for both the municipality and its citizens, presented by e-commerce fulfillment facilities. To capitalize on this local industry and support its growth, Norco’s community college, Norco College, has developed training programs in logistics and supply-chain technology. Daniels explains, “If cities feel the space doesn’t serve the local community, they aren’t going to be interested. But now they [cities] are starting to realize that [fulfillment centers] employ more and more people, use more technology, provide fairly high-skilled, higher-wage jobs, and use multiple means of transportation – not just semi-trucks.”
Many e-commerce fulfillment buildings are being developed through adaptive reuse, whereby old, functionally obsolete spaces are retrofitted. Rather than waiting for new retail chains to occupy empty buildings, cities can allow e-commerce business to repurpose these structures. Although a building might not be an ideal height or have quite enough loading docks, John Warden, national director of site selection at Colliers International, says that companies are making trade-offs to land prime locations. “More cross-dock facilities are being designed to bring product in, break it down and quickly send it back out, rather than store any inventory.”
Like last-mile facilities that store only the most popular inventory, or the depots that send out delivery vans in specific neighborhoods, the latest generation of e-commerce logistics buildings need not be big. According to Tolliver, service-level depots in the urban core range from 10,000 square feet or smaller to about 40,000 square feet. A variety of locations that are currently underused can be adapted to some type of e-commerce function likely to offer high levels of employment.
Finally, experts agree that – whether the product of adaptive reuse, redevelopment or new construction – the industrial buildings housing e-commerce activity are good-looking, well-appointed, state-of-the-art facilities. They therefore pose great opportunities for municipalities looking to reposition their stock of industrial or retail space: They have the potential to increase real estate values, attract new jobs and generate additional income.
Camille Galdes (Camille.email@example.com) is an urban policy writer and researcher.