The Surprising Impact of E-Commerce on Urban Real Estate Markets
Distribution is moving closer to end customers, and that means more distribution centers in urban environments.
That’s hardly the case, at least not in many major cities where e-commerce has actually had the opposite effect by increasing the demand for real estate. That may seem counterintuitive until you explore the dynamics of the e-commerce market. First is the consistent, strong growth that shows no sign of peaking. According to Statista, U.S. retail e-commerce sales grew from $298 billion in 2014 to $452 billion in 2017, an average of better than 13 percent growth per year.
But, if accommodating growth was the only issue, retailers would simply expand existing regional distribution centers in areas where land is relatively inexpensive and readily available. That’s not a viable strategy because the e-commerce market is dominated by a major player with the market power to reset consumer expectations for e-commerce delivery. First, it was two-day delivery, then next-day delivery, and now same-day delivery.
Everyone in the market must adapt to these changing expectations or risk losing market share. It simply isn’t possible to consistently provide next-day or same-day delivery from regional warehouses. The only way to meet these expectations is to move products closer to large groups of consumers.
In addition, there is the challenge of reverse logistics. Return rates for in-store purchases average less than 10 percent, while e-commerce return rates can be 30 percent or higher. The challenge is not only how to get returned goods back from the consumer but how to do so without destroying all of their economic value. One solution is the development of small, dedicated sites where consumers can return goods more efficiently.
Those factors are driving e-commerce companies and their 3PL partners to increasingly supplement their network of regional distribution centers with smaller, satellite facilities capable of reducing lead times and providing greater flexibility and service consistency. According to a March 2018 report initiated by the Industrial Asset Management Council (IAMC) and the Society of Industrial and Office Realtors (SIOR), “The rise of e-commerce is a primary reason for the growing demand for new warehouse space, strategically located within closer proximity to consumers.”
Not only is a new type of urban warehouse emerging, the impact of this trend is rippling well beyond the e-commerce and supply chain industries.
The New Urban Warehouse
It would be nice if we could simply shrink down the design of large regional warehouses to fit in the smaller footprints available in urban areas, but that isn’t necessarily practical or what’s needed. These new facilities are much more about product movement than product storage and so have different requirements than traditional warehouses. In some areas, such as the U.K. and Far East, where population density is high, they have already emerged.
The multi-story industrial real estate phenomenon is still in its infancy in the U.S compared to some of the higher-density urban locations in the Far East Spencer Levy, Americas head of Research, senior economic advisor, CBRE According to my colleague Nigel Godfrey, head of Real Estate Solutions for DHL Supply Chain in the United Kingdom and Ireland, “We are seeing a number of specialized cross-dock facilities being developed. These are basically very fast-moving shipment facilities. They don’t have significant amounts of storage space, but they have as many doors as possible. They are relatively small buildings on a low-density site with a lot of parking for vehicles, and a lot of docks for the trucks that come in and the delivery vans that go out.”
Another trend that is emerging internationally, particularly in gateway cities like Hong Kong and Singapore, is the development of the multi-story warehouse. This trend has now expanded from the Far East to the U.K.
“At a point it becomes economical to look at developing on a multi-level basis so that you can actually justify the high land values that are being demanded,” Godfrey says. “We reached that tipping point in the first half of 2018 where we’ve seen developers taking the first steps in planning multi-level development in the areas where there are highest land values, such as west London.”
Spencer Levy, Americas head of Research and senior economic advisor for CBRE, isn’t sure that tipping point will be reached in the U.S. “The multi-story industrial real estate phenomenon is still in its infancy in the U.S compared to some of the higher-density urban locations in the Far East,” he notes. “There are a few such developments happening, but it’s still not really cost-effective here, if you have the land available.”
Levy points out that the economics don’t favor multi-story development because of the increased dependence on automation. “Racking systems are able to pick and clear assets from the higher areas of a facility more efficiently and cheaply, so the average roof height of a DC has gone up significantly,” making multi-story development less of a necessity.
At a point it becomes economical to look at developing on a multi-level basis so that you can actually justify the high land values that are being demanded. Nigel Godfrey, head, Real Estate Solutions, DHL Supply Chain - United Kingdom, Ireland The IAMC report referenced earlier suggests that more innovation is on the way: “Efficiency along the last mile — from outside the city into the city center and from within the urban core to direct end-user delivery — will become harder to achieve using traditional freight transportation modes and approaches. It translates to a need for transformation, including inner-city warehousing capabilities and a new design approach.”
The future, as always, isn’t entirely clear, but one thing is certain: distribution is moving closer to end customers, and that means more distribution centers in urban environments.
The Impact on Real Estate
While there are some differences in the design of urban distribution centers in different parts of the world, there is consensus on their impact.
“Land values have increased sharply,” says Godfrey in regard to the U.K. market. “There’s been a marked increase in land values to satisfy the burgeoning demand for space associated with the increased demand for e-commerce requirements.”
Levy notes that it isn’t only land prices that will be affected. “There are many knock-on effects that we are seeing as a result of this, but one that’s not so well-known is that the average length of lease of an industrial building is now longer. For example, in New Jersey, during the last five years the average lease went from about five years to around eight years. The relevance of that is profound. Not only are you seeing increases in rent, and not only are you seeing increases in demand, you’re actually seeing an increase in the value of the asset itself, because the stability of its income base has improved.”
Levy continues: “From a capital markets perspective, industrial real estate has been performing so well for so long in terms of the ‘big box’ space that we are now encouraging new players in the space to look harder at the smaller, last-mile product, which is only now starting to get an institutional audience.”
The bottom line for real estate professionals: There is a shift under way in the definition of what constitutes institutional-grade industrial real estate, which previously was confined to properties like large warehouses and distribution centers. In urban centers, that is driving up demand, prices, and the length of leases.
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