The New Infill Economics

Last year Staley Point Capital and Bain Capital Real Estate acquired a 55,000-square-foot industrial infill property in Santa Fe Springs, CA. As far as some industrial operations go, it is a rather standard building. Formerly owned and occupied by Astro Paper, a family-owned distributor of fine papers and envelopes, it underwent a renovation prior to being purchased with refurbishments including a new roof and 3,500 square feet of renovated office.

But make no mistake: this facility is helping to plug a hole in the Los Angeles area’s distribution networks. The property has direct access to the rest of Los Angeles County and is within eight miles to Long Beach Airport, 25 miles to the Los Angeles International Airport and 20 miles to the Ports of Los Angeles and Long Beach. Regional port activity in May 2021 saw a 74% increase from the previous year, the highest annual gain on record.

Infill industrial operations have been an important component of many, if not most, companies’ supply chains for decades now. Since the pandemic, though, their role has been heightened given the changed buying habits of many US consumers.

Namely, there has been an explosion of e-commerce activity that developers and providers have been rushing to accommodate with not only new product but also new distribution strategies.

The average quarterly increase in e-commerce sales from the end of 1999 to just before the pandemic set in, 82 quarters worth, was $1.8 billion. During the pandemic, the increase jumped to $2.8 billion per quarter: a 55% increase in dollar volume. That represented a lot more packages that had to get delivered.

“The pandemic accelerated everything that was already happening,” Eric Rapkin, a real estate attorney with Akerman, says. “E-commerce is garnishing more and more of retail sales—that was already happening. But it immensely accelerated the trend.”

The other reason pushing the need for infill locations is customer expectations of instant gratification through rapid order fulfillment.

“The younger people want it now and they’re the tip of the sphere on demand,” Steve Buss, founder of real estate investment firm Like-wise Partners, says. “What [someone older] may be patient to get, they’ve grown up getting it immediately. You have a younger demographic that doesn’t look at it the way someone pre-Internet commerce does.”

The people getting what they want also are returning what they’re not so fond of. “There are a lot of things that go back as well, which is part of the reason things are changing,” Turner & Townsend director Terry Dunn says. “You’ll buy four, you keep one.” The other three need to return efficiently.

INFILL MATH

More stuff needs to get places faster than ever before. The economics of prior forms of distribution don’t. Consider how long it took the last time you tried traveling across a major city in regular traffic. Now consider that, according to NAI Hiffman, a semitrailer truck runs $110 an hour.

“If deliveries are to Chicago’s Lincoln Park neighborhood, they don’t want that semi spending half the day coming from Joliet,” Chris Gary, an executive vice president with NAI Hiffman, says. “It’s not significantly different from the concept of the Post Office branch. They’re delivering within a zip code.”

But there’s no one single way of achieving these levels of distribution. A company could ring a city with a handful of locations, all fed by a major distribution point in a spoke and hub model. “While they might have only one large fulfillment center where they’re keeping the majority of their inventory, they will have multiple last mile facilities around major [metropolitan statistical areas, or MSAs],” Steve Backman, founder and partner at Phoenix-based BH DevCo, which specializes in build-to-suit delivery for national tenants, says. “And even secondary and tertiary MSAs with multiple last mile facilities.” With multiple locations, a company can conceive of the urban area as several sectors, each served by one of the last mile facilities.

But that’s only one approach. Another Backman calls micro-distribution centers that manage deliveries but also keep some inventory on hand. Leslie Lanne, an executive managing director of the lead urban infill group at JLL, refers to it as a depot model.

“The depots are much more embedded within these densely populated urban areas,” Lanne says. The closer the location with properly selected inventory, based on local customer demand, the easier it is to run smaller loads and get people what they want faster. “Traditionally we’re all used to seeing some of the larger box trucks showing up at your door.” Now, customers are more likely to see sprinter vans. “They’re using even smaller cars, bicycles, even push carts, to get to their consumers in a timely manner.”

DESIGNING FOR CHANGE

Flexibility is key for infill. “There are people that are designing on spec and are in production building facilities that are trying to capture all of the challenges that the existing tenant pool is facing right now,” Lanne says. “It’s happening in New York City. It’s going to happen in San Francisco, Chicago, LA, [with developers] that will try to deliver modern buildings for these occupiers.”

Lanne points to 2505 Bruckner in the Bronx, a two-level facility with 968,000 square feet of logistics and office space, ceilings up to 32 feet in height for vertical racking systems, 111 loading docks, and ramps for tractor-trailers on both levels.

That comes at a cost. “They’re starting to double stack to get the necessary square footages,” Dunn says. “The trucks are pulling up to a loading dock on the second floor. It’s got to be a lot more load bearing. The foundations that have to go deeper. Rather than light-weight steel beams, I’m using heavier gauges to support that weight.” The price per square foot rises faster than the building.

In and around any city, space is limited. Ground-up construction will often not be an option, and that can mean adaptive use. Maybe there’s an old retail center, a former retail box store, fitness club, or theater.

“Could I use an asset and make it something that worked for me,” Backman asks. He answers his own question with “yes,” but says that was up through the last few years. “As those opportunities are being more and more picked over, the strategies have shifted to more teardowns, more creative conversions of nonindustrial facilities. Is it an old office building? Is it a public use? Maybe there’s a retail building that provides part of what I need.”

Adaption brings compromises. “You can’t have everything in a 40-year-old infill building,” Buss says.

“A lot of people call it the big experiment,” Geoff Kasselman, partner and senior vice president of workplace strategies at CRG, a subsidiary of Clayco Enterprises, says. “Everybody’s trying different things in different cities to see what is working and what isn’t, what can scale and what can’t scale.”

“Every time we look at a property, that’s the first thing we do, [ask the question of] how close is the substation and what is the capacity?” Kasselman says. “And when is more capacity coming? Right now, it’s a hit or miss.”

Power is a big issue not just for normal operation, but if a company wants to go with electric vehicles. “We had a customer for a big warehouse, and we suggested we put in a bank of five to six EV chargers,” says Kasselman. His firm thought workers might start driving electric cars themselves. “We did a design modification, and we were all proud of ourselves and [someone from the client] said, ‘Where are the EVs for the truck?’” There is already commercial electric transport on the road. “‘The truck just drove 300 miles to get there,’” the client representative said. “‘I guarantee they’ll need to charge when they leave.’”

“A major challenge to all this adaptive reuse a lot of times is governmental,” Kasselman says. “The applicable zoning may not apply at all to industrial use. Why would they want to change from retail use to industrial use? It has nowhere near as many employees or drives far less people to the site.”

“Now with continued strain and stress on the retail market, I know there are landowners and developers willing to sell those opportunities now and buyers interested in those opportunities if they can be entitled for industrial,” Backman says. “Sometimes that’s a rezoning, sometimes it’s an interpretation of the existing zoning. Sometimes it’s a whole neighborhood process that’s not easy to achieve.”

Then there is the general question of parking rights. “It’s really fleet storage,” Lanne says. “In many of these areas, land is at an obvious premium. There’s a need for your inside the box space, but there’s also a need for space for queuing to load whatever you’re loading, whether it’s bicycles, box trucks, or sprinter vans.”

If trucks must park, they may need to do so at a separate site. “It’s got to have enough access and turnaround that during the morning or throughout the day, there are all sorts of vans, cars like Uber drivers, who need to get there, pick up their packages, and then immediately leave,” Rapkin says. For any operation, there may be traffic restrictions in types of use and hours of access.

“Are there access and parking easements and rights granted to others?” Backman asks. “These last mile users want unfettered access to the building. They’re not going to allow for sharing parking with a retailer or [resident] in the master plan.” Someone else may have the rights for access to the space at times that are inconvenient to you.

“I think that when you’re looking to do any kind of reuse of an infill site, the due diligence is critical,” Rapkin adds, and the due diligence extends everywhere. If the site is for a ghost kitchen, water, grease trap, and odor control issues come to the fore.

And when a company develops a solution for one location, it’s not an answer that can be abstracted and applied everywhere else because the conditions are never exactly the same. Managing infill is complex, challenging, and demanding. It’s also necessary. Falling behind gives competitors opportunities to offer services that scoop up customers.