Paul Ruff, President

The future of industrial real estate is now thanks to retail

As appeared in…Colorado Real Estate Journal

A few months ago, the manager of a major brokerage firm asked me whether we were interested in buying any retail projects right now. It was a reasonable question, because he knows we’ve been opportunistic investors and developers in all of the major commercial property types over our 15-year history. But, for once, my answer was uncharacteristically short: “No,” I said, “the truth is that the more we study retail, the more we want to buy industrial.”

The fact is that both retail and industrial real estate are undergoing a historic, fundamental shift in their utility. And as a firm that puts rigorous economic, demographic and political analysis at the forefront of its business decisions, that fact has us rather interested.

This isn’t to say that retail real estate is dead, it’s just that we believe it doesn’t know what it wants to be when it grows up yet. In many ways, the evolution of retail real estate is being forced to follow innovation led by the industrial/distribution sector. We believe the growth in the worldwide movement of goods coupled with shifts in consumer delivery expectations and highlighted by urbanization are forces that already have declared what the future of distribution must look like, and only after efficiencies are maximized in that sector will retail finally see what it needs to do to adapt. For those reasons we believe that as an asset class, industrial real estate has seldom been a more attractive long-term investment than it is now. After years of incubation, these forces are coming together and will change the economics of industrial real estate for decades in the future.

Fundamentally, industrial real estate is used for the production, storage and distribution of consumer goods. Manufacturing facilities are used to make products and, until now, a warehouse’s place in the supply chain was primarily a storage spot in between the manufacturer and the retail store, where the retail store played the role of final point of delivery to the customer. However, the manner in which products end up in consumers’ hands is being morphed by technological and sociological changes, and it is happening very rapidly.

The goal in today’s retail economy is to allow the customer to “buy anywhere, deliver anywhere and return anywhere.” This is the world of e-commerce: an interesting but miniscule purchasing trend just a few years ago that is now evolving into a fully disrup – tive agent in the b u s i n e s s of supply chain manage – ment. It w o u l d a p p e a r in broad terms that the future of retail does not necessarily consist of more stores and shopping centers, but that the future of retail is warehouses, trucks and sophisticated logistics software. For retailers, efficient movement of goods trumps “location, location, location.” Physical stores still have a purpose, but the way people are using technology, retailers may not need to keep much inventory on site and it may become rare for people to actually walk out of the store with their goods.

This is forcing industrial real estate to adapt first. According to the World Trade Organization, over the past 63 years, global trade has been increasing at an average rate of 9.5 percent per year. Trade has nearly tripled since 2001, when China joined the World Trade Organization.

A recent article by Cushman & Wakefield research speculated that by 2021, approximately $45 trillion in goods could be moving around the world every year, compared with only $6.1 trillion as recently as 2001 (Cushman & Wakefield:“The Changing World of Trade, 2013”).

Further, the U.S. Census Bureau indicates that population in the United States is growing at an average of 2.5 million people annually. An article by Avison Young recently cited an estimate from Dr. Glenn Mueller of the University of Denver’s Daniels School of Business that “Each person consumes goods that require approximately 50 square feet of warehouse space” each year. Combined with population growth, “This equates to new demand for 125 million square feet annually.” (Avison Young: “E-commerce fueling demand for industrial distribution space,” June 2013).

Distribution logistics must become more efficient to handle that kind of growth, in the face of increasing population density in existing cores and consumer demands for fast delivery of products purchased online. All of which requires significant adaptation at the facility design level and strategic location analysis.

OmniChannel models of goods procurement puts the greatest pressure on the logistics of delivering goods quickly and efficiently. Omni-Channel refers to the practice of consumers shopping and purchasing through multiple, rather than dual, channels; in this model customers can buy anywhere, fulfill anywhere and return anywhere. QR Code readers and barcode scanners are now everyday apps, and smartphone purchases are soaring. Digital Strategy Consulting reported that 59 percent of smartphone owners made a purchase with their device in 2012. (“Mobile shopping trends: Smartphone purchases doubled in 2012,” March 21, 2013). Some experts predict the use of the smartphone as a wallet will eliminate physical credit cards as soon as 2020.

In the new world of e-commerce, in-store distribution of goods will continue to exist, but by adding direct-toconsumer orders, “click-andpick” outlets, “dark stores,” courier services and possibly drone delivery to the mix, it becomes crystal clear that the status quo must change. In the new e-commerce supply chain model, import (portrelated), inland-hub (regional distribution), fulfillment centers and just-in-time facilities all run simultaneously.

Already, according to Jones Lang LaSalle in its “Industrial Outlook, North America 2Q 2013,” “retail-related (chiefly consumer goods distributors) and logistics companies (are creating) the bulk” of demand for industrial space, a trend that has been consistent over the past several years. As such, the next phase of e-commerce will have a dramatic impact on the industrial real estate market. To satisfy customers’ desire for quick turnaround, site selection by distributors is driven by proximity to customer demand for their products. “Multiple, well-placed distribution centers are being employed to minimize the time and distance spent on the final leg of delivery,” notes the C&W report. Backing these up will be large distribution facilities that support both the online and the in-store inventory, so these facilities will be farther out from central cores to lower costs but must still be close to an affordable workforce and have access to rail, highways and air transportation. Location decisions will be strategic for each supplier and there will be fewer industrywide location trends.

Demographic estimates by the United Nations indicate that some 3.6 billion people live in urban locations, which is roughly half of the world’s population. More importantly, the U.N. predicts that number may more than double by 2050. In order to get products into consumers’ hands in these dense locations, retailers must solve some difficult logistical challenges, particularly traffic congestion and real estate prices in urban cores.

“The large Generation-Y demographic cohort orients away from the suburbs to more urban lifestyles, and these young adults willingly rent shoebox-sized apartment units as long as neighborhoods have enticing amenities with access to mass transit,” notes PricewaterhouseCoopers and the Urban Land Institute in “Emerging Trends in Real Estate, 2013.” Further, not only do they not care to get in their cars to go to the suburbs to shop for what they need, but also they don’t even want to own cars.

One key impact from this trend is that urban distribution centers will necessarily be more expensive due to higher land prices compared to outlying locations, and rents will be correspondingly higher, but only relative to the opportunity cost of having facilities farther away. For many, there is an algorithm for their particular product line that determines the tradeoff. Most importantly, it is key to note that in the U.S., efficient urban distribution facilities do not yet exist in any great volume.

Lastly, multiple locations will be required for each retailer/distributor in order to maximize logistical efficiency. So the advantage will go to the warehouse provider that can support automation and offer the best location options.

Obviously, we are witnessing dramatic changes in the global movement of goods, technological and sociological changes which are driving change in the methods of delivery of goods to consumers and transportation logistics, all of which affect industrial real estate in the U.S. and globally. As the world’s largest economy and importer, the United States must immediately initiate a significant overhaul of its industrial facilities in the coming decade and dramatically add to the supply of space, particularly in critical locations. Building modifications and retrofit of functionally obsolete buildings in top-quality locations will provide some of the most rapid solutions, while immediate ground-up development is required in a number of the fastest-growing areas. The future is now, and the time is right for distribution to come of age.