Dot-Com Companies' Needs' and Fortunes' Shape Today's Warehouse Market.

Perhaps no other real estate sector reflects the ebb and flow — and convergence — between new-economy dot-com companies and traditional old-economy providers and suppliers than warehouse and flex space. Warehouses traditionally were reserved for use by suppliers of goods as links in their supply chains. However, they have become favored spaces for dot-com locations for several reasons, ranging from the traditional logistical ones to more sector-specific reasons.

Businesses that supply and feed off the dot-com/electronic commerce trend, specifically companies such as telecommunications providers, telecommunications hotels, and light manufacturing, also favor warehouses over other kinds of space.

“We've been inundated by dot-com companies and related companies looking for light-assembly space,” says Teresa Shell, CCIM, of Shell Consulting and Associates LLC in Austin, Texas, a favorite dot-com location. “Warehouse occupancy is way up and they are building as fast as they can.”

But the tide has turned for some Web-based companies, and the related changes, mergers, and closures will affect warehouse properties as well.

Looking at warehouse trends across the country is akin to looking at a microcosm of where the nation's dot-com economy is at and where it might be headed.

Dot-Com Emergence When the Internet was created more than 35 years ago, it was a combination Cold War defense system and research tool, forged by the Defense Department and some of the nation's top researchers. The initial intent was to create an unstructured, decentralized communications system that, in the event of a nuclear attack, would survive.

As everyone knows, today the Internet encompasses a world of information and e-commerce. The earliest dot-com retailers offered the opportunity to purchase goods from the comfort of home, though initial efforts were halting at best. But moving forward — and accelerating at light speed over the past five years — the loosely structured electronic infrastructure of wires, routers, and servers has exploded into an economic tool that now has made its way into millions of homes and the very core of the corporate world.

Web sites offering virtually everything for sale or auction have sprung up at an amazing rate. Worldwide domain registrations increased by more than 20 million between January and June of last year alone, according to a recent survey sponsored by the Internet Software Consortium. As of June 2000, 93 million addresses existed — many selling goods that need to be housed and distributed.

The resulting dot-com demand for warehouse space actually stems from two distinct sources — the dot-coms themselves and the companies providing needed telecommunications and other services to both dot-com and related companies.

Dot-Com Demand Dot-com companies come in two basic varieties: business-to-business sites, such as FreeMarkets, that deal with companies and business-to-consumer sites, such as, that sell products directly to consumers. While B-to-B logistics are more in line with the traditional methods associated with distribution, B-to-C sites are very different in their logistical and material requirements.

“These online distributors are like a catalog company on steroids,” says Scott Andrews, CCIM, director of development for Trammell Crow Co. in Memphis, Tenn.

Many dot-com companies like to locate all of their functions, from administration to Web hosting and hardware, under one roof. The reasons for this vary, but the most commonly cited are cost — warehouse space generally is cheaper than office space — and the ability to expand quickly without searching for more space. The amount of office space needed would be costly and prohibitive for many of these relative newcomers, making warehouses an ideal alternative.

Seasonal needs affect warehouse demand, says Michael Shelton, vice president of industrial services at Grubb & Ellis in Orlando, Fla. “While the telecom companies are leasing for 15 years or more, some of the dot-com companies only need space for the holiday season, and they are actually coming in and renting for three to four months,” he says. Late last year, “three big boxes ranging from 200,000 [square feet] to 500,000 sf [were] being rented just to handle seasonal distribution needs.”

Dot-com companies sometimes can't justify renting for a full year, Shelton says, but landlords are bumping up their rates on such incremental leases, which enables them to make the equivalent of a year's lease.

Not surprisingly, lease structures vary widely across the dot-com spectrum. Some online retailers take relatively short leases to fill seasonal needs, as noted. Others, because of the amount of capital being invested in infrastructure improvements, want to lease at least five years or more.

Some, like, are well established and can command better lease terms. Others negotiate a base lease plus a piece of equity in the company (see “Swap Rent for Dot-Com Stock? Ask Tough Questions Before Proceeding,” CIRE , May/June 2000). “I know of one developer who is doing this,” Shell says. “Even if only one-in-10 of these pan out, it will be terrific.”

Regional Clusters Dot-com warehouse demand itself largely is confined to two types of markets: distribution routes and cities where dot-com companies are centered. Dot-com retailers — or e-tailers — such as, gravitate to distribution locales where they easily can ship product to individuals. Therefore, dot-coms are located in many of the same logistically important markets as traditional distributors.

Conversely, the centers of dot-com activity such as San Francisco/Silicon Valley, Atlanta, Boston, New York, and Austin are where venture capital and research universities combine. These centers experience varying levels of dot-com warehouse rental/building, because many dot-coms, some on cash-constrained budgets, have found that warehouse space not only is cheaper than office space but also provides the distribution space they need.

E-commerce companies tend to congregate together. For instance in Austin, home of Dell Computer, companies doing business with Dell often look to locate close to their much larger partner, driving demand for warehouse space in particular, Shell says.

Regulatory and environmental constraints because of the water table Austin sits atop, coupled with high demand, have put Austin squarely on the upside of the long-term cycle, according to a recent industrial real estate analysis by Baltimore-based Legg Mason Wood Walker.

The analysis notes that e-commerce demand remains strong, but not at the frantic pace seen early in 2000 before the meltdown in technology and dot-com stocks. However, this demand should continue through 2001, the analysis predicts, because of the ties to Dell.

Memphis and its surrounding region is another example of a hotbed of dot-com distribution activity, Andrews says, because of its location in general, and the presence of FedEx's hub in particular.

“Unlike traditional distributors, [which] ship cases and pallets of product, dot-com retailing companies are shipping single items,” Andrews says. “The way to ship those is through distribution channels like FedEx, UPS, and the post office,” he continues. “Memphis is the hub for FedEx and has a UPS satellite and a bulk mail facility, giving it an ideal location for online retailers.”

That distribution advantage is reflected in the volume of packages being shipped, he says. “Traditional distribution facilities may ship upward of 20,000 packages a day. An online retailer is shipping between 30,000 and 100,000,” he says. “From a logistical standpoint, that means having access to ground transportation that can handle those. It also means a tremendous investment in mechanization and material handling systems to handle that type of flow.”

Because they handle different types of products, each dot-com has differing needs when it comes to warehouse facilities, Andrews says. “But regardless of what they are handling, companies have been coming in wanting more space than they need at the moment, so they can grow without moving or looking for additional space.”

Generally the trend has been the bigger the better, with dot-coms taking warehouses from 70,000 sf to more than 200,000 sf. Because of the amount of mechanization, particularly among e-tailers, companies look for high ceilings and lots of doors to handle the flow of trucks.

The need for speed — to be up and running as quickly as possible — has meant companies often are willing to take an existing property vs. a build to suit.

“Companies want to come in, plant their flag, and run like the wind,” Andrews says. “While a build to suit with complete air conditioning might be better in the long run, most of these companies want to get to market as fast as possible.”

That has meant upward pressure on lease rates, despite the fact that Memphis has ample land in outlying areas to build. It takes 19 to 24 months to establish and complete a new facility, a time frame that can be a lifetime for a dot-com.

New/Old Competition Some old-economy companies are jumping on the e-commerce bandwagon, and their warehouse needs have changed as well.

One example is suburban Pittsburgh-based Genco Distribution System. The company handles reverse logistics, or store returns, for some of the biggest retailers in the world including Wal-Mart, Kmart, Sears, and Target. Genco set up a subsidiary, e-genco, to handle returns for online retailers in much the same way it has handled them for brick-and-mortar companies for years.

“Our selection of warehouses is based on being able to receive a package within 24 to 48 hours,” says Pete Rector, senior vice president of strategic initiatives for Genco in Pittsburgh. Genco receives individual packages, so to expedite delivery, the company must know where U.S. Postal Service, UPS, and FedEx hubs and satellite facilities are located. “It's not really rocket science or anything like that,” Rector says. “Speed is very important to providing good customer service ... and then moving those products out to wherever they are going to next, whether that is back to the vendor or offshore.”

The nature of online purchasing, according to Rector, differs from the company's traditional business in a very fundamental way. “With our traditional returns business for Sears or Kmart, we look for properties in and around dense population centers since this is where most of the stores are located,” Rector says. “But online purchases are much more scattered. The nature of the Internet and online buying allows someone in a rural or remote area to purchase things as if they were living next to the biggest mall in the world.”

The e-genco subsidiary, established in May 2000, has set up two warehouses in Reno, Nev., and Atlanta to handle package returns from online buyers on the east and west coasts. The company is in the process of looking for at least two additional sites to handle northern- and southern-tier customers. “By putting a facility in Dallas or Chicago or Des Moines, [Iowa], we will quadrisect the country and be in a position to receive and turn around a package from anywhere in the country,” Rector says.

While time and logistics determine where to lease space, the nature of online returns determines what type of space e-genco needs. Unlike telecom companies, where lease price is less important because of the heavy capital being invested in the building, e-genco is much more price conscious because of the lower margins it deals with.

“We look for a flow-through design and a facility that is close to fiber-optic lines,” Rector says. “But if we can't get that type of facility at the price we want, we will take an existing facility and put in a T1 line.”

Telecommunications Centers Some locations, such as the traditionally strong — and logistically important — northern New Jersey area, have seen less dot-com activity than might be imagined, according to Andrew Zezas, managing director of Insignia/ESG in Saddlebrook, N.J. “If dot-coms were exploded tomorrow, it would have virtually no impact on this market,” Zezas says.

But, he continues, if those dot-coms did disappear, there still would be demand from the telecommunications industry for warehouse space.

The lasting legacy of the dot-com emergence is the remarkable creation of an entire e-commerce sub-economy that spans both traditional and new-economy companies, enabling consumers and companies alike to buy and sell goods and services more efficiently.

The growing need for more Internet speed through cable and conventional phone lines has led telecommunications companies to establish major centers combining traditional telecom equipment and new-economy services like Web hosting. The floor-space requirements for telecom companies are considerable and, in a high-growth environment, require quick reconfiguration, which makes warehouses ideal sites.

“Over the last two years we've seen a major move,” Shelton says. “The first telecom hotel sprung up in a converted Costco warehouse,” he says. “Since then, we've seen a number of other free-standing warehouse properties, and even an old JCPenney store, converted.”

Fiber-optic telecommunications lines are the key to attracting telecom and dot-com tenants, according to Shelton. “There is an extreme cost involved in creating one of these hotels or a telecommunications center,” he says. “The biggest cost is in the fiber-optic lines. If a potential tenant can locate close to a backbone, they will jump all over it.” Backbones are the main telecommunications and fiber-optic arteries created by carriers such as AT&T that carry all-important data to and from a region.

For example, Qwest Communications came to Orlando looking to establish a communications center and telecom hotel, Shelton says. After viewing a number of newer properties, the company discovered an older warehouse that was only 100 feet from a backbone. The result: Qwest rented more than 100,000 sf under a 15-year lease.

Warehouse rental costs are not as much of a factor for telecommunications centers as they are for traditional distributors, according to commercial real estate professionals. Telecommunications companies' primary concerns are finding locations near fiber-optic lines and the amount of money being put into equipment inside those warehouses. “These companies are realizing extreme costs in equipment inside these buildings,” Shelton says. “That makes the relative cost of the rental property less a factor.”

Such is the case in northern Virginia, says Jon Lawrence, senior director of Advantis Real Estate Services Co. in McLean, Va. Like Orlando, the prime location in Virginia is as close to the fiber lines as possible. “Most of these lines were built near railroad tracks because it was easier to lay them there,” Lawrence says. “Not so coincidentally, those tracks also serve warehouses where these data storage companies are looking to locate.”

These companies bid up the price of leases in a race to expand in the market, and lease rates become a non-factor. “These companies — like Qwest, AT&T, and others — are spending millions and millions inside these buildings. They want big blocks, entire buildings as big as they can get for future expansion, and they want location,” Lawrence says.

The bidding war has forced rental rates from the $5.75 per square foot to $6.25 psf range up to $13 psf to $15 psf within the last two years, he says. Despite this increase, warehouse vacancy rates hover around 2 percent.

Signs of Ebbing For several years, public and private investors seemingly threw money at almost anything that smelled like a dot-com company in hopes that it would become the next Yahoo! or America Online.

But in the spring of 2000, a significant shift in attitude swept Wall Street as investors began to flee the promising but cash-hungry dot-com sector. Public and private investors have demanded an end to the cash burning and want to see not just revenues, but profits.

After the steep slide in public dot-com stocks, the valuations for once sky-high Internet companies fell to earth with a thud, resulting in reduced expectations and even wholesale closings at some companies.

About 70 dot-com companies failed in 2000, according to data tracked by The Standard , an Internet and technology publication. Those failures, coupled with cost-cutting measures at other struggling dot-coms led to about 33,000 layoffs.

Demand from e-commerce companies will continue but not at the same frantic pace previously experienced, according to the Legg Mason Wood Walker report. The 2000 holiday season put online retailers under pressure from investors to turn it all around and make money. According to various industry sources, overall 2000 holiday sales were up about 3.5 percent, led by a roughly 120 percent increase in online purchases, leading to an upswing in temporary warehouse usage, but not enough to stem the ebb.

What Happens Next? Despite the ebbing fortunes of some dot-com companies, many commercial real estate professionals see the tide continuing to roll.

“A lot of the dot-coms are losing money right now,” Shelton says. “We are seeing a slowing and a repositioning to a limited extent in Orlando. But the long-range potential is really huge.”

Similarly, Andrews says the short- and long-term impact will mean more warehouse and related business in Memphis. “The conventional wisdom is that there will be a shake-out,” he says. “But the impact of the dot-coms is really twofold. First, it has forced the brick-and-mortar, and even the catalog companies, to do business in a different way. You used to see advertisements for products saying allow four to six weeks for shipping. That is gone,” Andrews says.

“Second, a lot of the brick-and-mortar companies have sat back and watched what was going on and are just now beginning to enter the market. They don't have to spend millions to establish their name and will take the best features of e-commerce and the dot-com business practices and apply it to their existing businesses,” Andrew says.

For example, traditional retailers like Dick's Sporting Goods not only have created Web sites offering their goods, but also have melded this function into their traditional distribution network. The result was a need for new space that was highly automated, could be reconfigured easily, and could handle traditional pallet shipments as well as the individual orders of online shoppers.

To meet those needs, Dick's built a new 200,000-sf expandable warehouse in suburban Pittsburgh, complete with communications and software that tied it to both its online e-tail site and stores across the country, resulting in more-efficient order delivery.

In a survey earlier this year by the Fantus Corporate Real Estate Solutions group of Deloitte & Touche LLP, more than one in five retailers planned to expand or add new distribution facilities within the next year, while nearly half intended to do so within three years. E-commerce fulfillment played a large role in their response.

“The dot-com companies have created a secular trend toward more rapid movement of goods through the supply chain,” says W. Blake Baird, president of AMB Property Corp., a San Francisco-based real estate investment trust that owns industrial and flex properties in most major distribution markets. “This is a fundamental shift in how companies do business that now affects more than just the dot-com companies,” he says.

“All of the things that dot-com companies look for when they came in — telecom, fiber, floor loading, high degrees of mechanization — are now part of the secular trend in how traditional companies approach their distribution chains and moving goods more rapidly,” Baird says.

The shakeout of dot-com companies undoubtedly will continue, following a long-established pattern in business that weeds out weaker or less-efficient operators. But the ultimate lessons of e-commerce and increased mechanization are forever part of how business is done.

Larry Seben

Larry Seben is a free-lance writer based in Lower Burrell, Pa. He has written for CIRE about seniors housing. Lessons From the Gorilla One of the main dot-com companies that other retailers have learned from is In a world of Lilliputian electronic start-ups, is a 600-pound gorilla. The company started modestly in 1995, selling books online at reduced retail prices. Since shipping its first book, the Seattle-based e-tailer has grown rapidly into an international player. operates 10 warehouses worldwide, ranging in size from 90,000 square feet to more than 800,000 sf, according to Julie Benezet, director of global real estate and facilities. “Most of them tend to be on the larger side,” she says. “When we look to establish a facility, we look primarily at two things — location and the local workforce.” Unlike start-up dot-coms and telecommunications companies, both of which are rushing to get big in a market as fast as possible,\'s methodology is more like a traditional distributor, Benezet says. “We don\'t have to rush in and take the first thing that is available. We are an adolescent company that is moving to adulthood, so our approach is more deliberate.” When considering locations to lease, initially looks at fiber-optic lines. “We receive an incredible amount of data through our system,” Benezet says. “Plus, our customers want to know the status of their packages and where they are. That is all done through the Internet. That means we need a redundant broadband connection.”, like any distributor, also takes into account the logistics and arteries in the area, she says. “We don\'t have to be on top of an airport, but we need to be in close proximity,” she says. “We also look at both the carriers, like UPS and the post office, and the ground arteries because a lot of units are ground shipped.” considers the physical characteristics of buildings as well. “We need buildings with high ceilings that support a lot of conveyance, good, solid structures, and tons of parking because these warehouses employ a lot of people,” Benezet says. Equally important to all of the real estate-related considerations is the depth of the local workforce. “We look for an area where there is a strong workforce that is deep enough for seasonal demands and communities that want us there,” Benezet says. Those seasonal swings can be crushing. From early November 2000 through Christmas, shipped more than 31 million units, putting all of that planning, electronic communication, and logistical networking to the test. But it is the way that grew — through a combination of electronic data, rapid warehouse reconfiguration, and making use of mechanization — that has imparted important lessons to distributors everywhere.


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