Warehouses Think Big
Today's high-tech facilities encompass storage and distribution under one roof.
If you asked a commercial
real estate industry outsider to describe a warehouse, most likely he
would answer "cramped, dark, and dusty."
today's industrial market, that reply is far from the truth. New
warehouses are mammoth concrete structures through which goods move
with lightning-fast speed thanks to the latest technological
innovations. Due primarily to customers' desire for quick product
delivery, warehouse users are migrating to these functional properties
that expedite package dissemination. In many regions, users are
consolidating both warehouse and distribution functions into industrial
behemoths. Company consolidation, technological improvements, and the
increasing prominence of third-party logistics companies have
precipitated this evolution.
Bigger Is Better
A decade ago, a 200,000-square-foot warehouse was a large property,
says Gerry A. Shear, CCIM, president of Genco Distribution System's
real estate group in Park City, Utah. Yet today's buildings approach
800,000 sf or more.
Why the trend toward
bigger space? Manufacturers and distribution companies are
consolidating into fewer properties to save costs. "There are more
economies of scale with all operations under one roof," says David
Miles Williams, CCIM, senior vice president of Grubb &
Ellis/Harrison & Bates in Richmond, Va. By centralizing logistics
functions, companies can realize greater cost efficiencies, serving
more customers from one distribution center.
and equipment advances make consolidation easier, Williams says. "You
don't need as many people; technology allows [companies] to leverage
their staffs." And driving these innovations is customers' desire for
next-day delivery. "You don't make any money with products sitting in
warehouses," explains Michael A. McMahon, CCIM, SIOR, owner of McMahon
Properties in San Antonio. Just-in-time distribution mandates the
ability to get goods in and out of storage quickly.
example, new logistics software systems allow companies to better use a
building's cubic capacity; however, such systems are expensive. "Small
warehouses are just not economically feasible," says Sam Foster, CCIM,
of Jones Lang LaSalle in Los Angeles. Yet since companies are
consolidating into fewer buildings, they can afford to pay for such
amenities. "It's a matter of function versus cost of space." For
example, Toys 'R' Us recently built an approximately $30 million
distribution center containing a Lockheed Martin-designed
racking-and-picking system that allows workers to track individual
items at any time, he says.
factor influencing building expansion is the move toward third-party
logistics companies, or 3PLs, which handle warehouse, fulfillment, and
distribution functions for manufacturers. "Companies are pushing their
[distribution] requirements to logistics companies, which aggregate
operations in specific markets," Williams says. "They co-locate several
clients in one building."
What Users Want
Due to company consolidation and the preponderance of 3PLs, today's new
class A warehouses are more functional than their predecessors. "Warehouse users are savvier than 10 years ago," Shear says, forcing
developers to offer more flexible space to attract attention. 3PLs are
very sophisticated tenants that build relationships with real estate
investment trusts to procure the best deals for the best space, says
David D. Nesbit, CCIM, president of Nesbit Development in Camp Hill,
Functionality is an important factor
in space decisions. For instance, to accommodate heavy trailer traffic,
tenants prefer cross-dock, or flow-through, setups in which docks are
placed on both sides of the building, many experts say. Since
mechanical upgrades allow warehouse users to stack products higher,
tenants also look for ceiling heights up to 36 feet in some markets.
to the soft industrial market and consumers' desire for quick delivery,
tenants demand flexibility in their leases as well. "Companies want to
be able to move in and out of markets quickly, as well as the ability
to expand to meet inventory," Williams says. Thus, short lease terms
are in vogue. "Lots of tenants want three-to-five year leases or longer
leases with the right to cancel," says Norman Khoury, CCIM, SIOR, a
principal and vice president at Colliers Turley Martin Tucker in
Cincinnati. Brett C. Preston, CCIM, a partner at RJL Real Estate
Consultants in El Paso, Texas, recently closed a lease deal with three
out clauses for a 200,000-sf building. Shear has encountered tenants
wanting three- to six-month temporary space leases, especially for
seasonal goods. Due to economic uncertainty and tightened budgets, "companies are pressured to reduce stored goods," he says.
many older warehouses do not offer the space and functionality that
users desire, class B and C markets are faltering in many cities. For
example, lease rates in San Antonio's class B and C properties are
dropping because there is too much available product, while class A
properties are commanding lease rates of $3.24 per square foot to $4.45
psf triple net, McMahon says.
Getting Close to Customers
Consolidation and quick product delivery also are changing the
warehouse site-selection process. Since warehouses are an integral link
in the chain between manufacturing and consumption, transportation,
especially interstate access, seaports, and available intermodal
systems, is a critical factor, Nesbit says.
and outbound costs can be about 60 percent of a company's annual
expenses, so site-selection specialists must analyze where products are
coming from and going to before determining where to locate warehouses,
Shear says. The distribution operation's purpose also determines what
transportation type is needed. For instance, since numerous companies
have moved their manufacturing operations to Pacific Rim countries,
West Coast port cities such as Long Beach, Calif., and Los Angeles are
popular with distribution companies, he says.
near a large concentration of the population is another critical
aspect. Distribution companies "need cities from which trucks can
deliver goods [to other markets] within 24 hours," Foster says.
example, 60 percent to 70 percent of the nation's total population is
within an overnight truck drive of central Pennsylvania, making it an
attractive distribution center location, Nesbit says. In addition, due
to their accessibility, northern New Jersey, Atlanta, Chicago,
California's Inland Empire, and Dallas-Fort Worth have snapped up
two-thirds of the national distribution market in the past six years,
according to Foster, citing Torto Wheaton Research statistics.
the primary markets in these areas are not necessarily distribution
companies' first pick. "A location can be prime without being near a
24/7 city," Nesbit says. In fact, that aspect sometimes works against a
location because of increased traffic and higher land costs, he says.
transportation is almost as important as ground. For example,
Cincinnati is gaining attention because the Cincinnati/Northern
Kentucky International Airport is Delta Air Lines' most recent hub, and
plenty of developable land exists near the airport, Khoury says. Hubs
for package delivery companies such as UPS, DHL, FedEx, and Airborne
Express also offer attractive locations, Nesbit says.
developers also are encouraged by economic factors such as tax
abatements, affordable and abundant labor, and inexpensive land. For
example, Ohio offers both real estate and real property abatements to
companies building warehouses there, Khoury says. Although Reno, Nev.'s
$4.50 psf to $6 psf land sales prices are the highest in the region,
warehouse developers are attracted to the city's 10,000 acres of
available industrial-zoned land near the international airport, its
diversified economy, and the state's right-to-work status, says David
L. Schuster, CCIM, SIOR, senior adviser of Grubb & Ellis/Nevada
Commercial Group's industrial services group.
Dare to Be Boring
Although REITs dominate the warehouse investment scene, smaller
investors, especially people pulling money out of the stock market,
recognize this property's potential. Even though they aren't glamorous,
warehouses offer flexible space that owners can transform into
different uses such as call centers or self-storage, McMahon says.
Warehouses also offer a low cost of debt and steady appreciation, says
W. Erik Foster, CCIM, a senior investment specialist with Marcus &
Millichap in Chicago. "Dare to be boring - buy industrial," McMahon
In the Midwest, "I am seeing
interest from all types of investors," Erik Foster says. "There is
tremendous competition [in Utah] for buildings with long-term leases
with credit tenants," Shear agrees.
warehouse users and developers may be willing to locate in secondary
markets that offer cheap land, economic incentives, and transportation
benefits, many of today's warehouse investors, especially institutional
ones, are hesitant to stray from primary cities. Institutional
warehouse investors want to have their money in the best place; then
they spread out to secondary markets for cost and diversification
reasons. "If institutional investors are not in a market, it probably
is a tertiary market," Nesbit says.
money is consolidating into major markets,' Williams says, because the
depth of such markets makes investing safer. Also, investors can expect
to receive greater returns from properties in primary markets due to
risk-adjusted capitalization rates. "Assets are more valuable in bigger
markets," Erik Foster says.
last year First Industrial Realty Trust sold its high-performing
warehouses in Milwaukee and Indianapolis because analysts said they
would treat the REIT more favorably if its portfolio contained only
properties in primary cities with less economic risk, Sam Foster says.
However, "the factors that make a market secondary or tertiary for office
investment are different from those for warehouse investment," Nesbit
says. Geographic location, building construction quality, and
high-credit tenants are more important factors to warehouse investors.
instance, most office investors would consider Reno to be a secondary
or even tertiary investment market, but it's an ideal distribution hub,
Schuster says. Located on Interstate 80, the city easily serves truck
traffic going to the western states. A main Union Pacific railroad line
runs through Reno, and the city is UPS' western regional hub.
tertiary markets must offer amazing benefits to attract national
attention. Institutional investors "won't even look at an El Paso
warehouse without at least a 10 percent cap rate," Preston says.
Luckily for that city, ground-lease properties currently offer an 11
percent cap rate. Yet Preston thinks some investors like the stability
tertiary markets offer: "You can get pretty good returns compared to
primary and secondary cities," he says. For example, East Group
Properties purchased an El Paso warehouse several years ago and have
expanded their presence in the city ever since.
Warehouses of the Future
Even when the economy strengthens, industrial experts don't expect the
consolidation trend to cease. "Companies can save on operating costs by
combining several warehouses into one and still serve the same markets
with technology and transportation refinements," Nesbit says.
However, "At a certain point, size breeds inefficiency," Shear says. Until
technologies and material-handling equipment become even more refined,
warehouses in the 2 million-sf range are just a developer's pipe dream.