Retailers Prompt Shift in Industrial

Vienna, VA-Big box retailers are stocking more merchandise in their warehouses to keep up with an increase in online orders. The resulting rise in demand for industrial facilities is causing a jump in net absorption rates across the country as retailers respond to the latest shopping trends.

Consumer confidence is on the upswing so more products are flowing through the supply chain. More retailers are also incorporating online sales into their business models. And Internet-only retailers are beefing up their offerings to accommodate swings in consumer spending and online shopping.

US consumers are increasingly making purchases through check-out carts instead of cash registers. Total e-commerce sales for 2012 were estimated at $225.5 billion, an increase of 15.8% from 2011, according to the Census Bureau of the Department of Commerce. E-commerce sales accounted for 5.2% of total retail sales in 2012, an increase from 2011, when online sales accounted for 4.7% of total sales. Not only are consumers buying more online, but they want their purchases delivered to their doorsteps as quickly as possible.

The trend is taking place in gateway hubs such as Los Angeles, Houston, Seattle, Miami, San Francisco and the Inland Empire. Also impacted are major industrial markets like the Washington, D.C./Baltimore region and Chicago. Net absorption of flex/industrial space in the Washington/Baltimore region, for example, was 4.3 million square feet in 2012, compared to 1.4 million square feet during 2011, according to Delta Associates, Transwestern's research affiliate.

The overall vacancy rate was 9.5% in 2012, down from 10.6% the year before. Effective rents increased by 3.2% in 2012 in contrast to a 2011 increase of 0.2%. And the region posted $1.2 billion in investment sales of flex/industrial space during 2012, up from $726 million in 2011. Likewise, the overall industrial vacancy rate in Chicago dipped to 9.3% at the end of 2012, compared to a 10.8% vacancy rate a year prior, according to Delta. The vacancy rate is expected to decline to the high 8% range during 2013.

Before this major shift in the supply chain, online retailers relied on local distribution companies to ship goods to the customer. Those middlemen, primarily located in secondary markets, are being cut out of the equation. That is causing higher industrial vacancy rates in markets such as Shreveport, La.; Chattanooga, Tenn.; Sacramento, Calif.; Memphis, Tenn.; Phoenix and Detroit.

Retailers are looking for warehouses in gateway hubs/primary markets preferably built in the last five to 10 years that have 24- to 30-foot ceiling clearances, favorable column spacing, multiple loading doors and expansive truck courts. These properties will experience the majority of net absorption and uptick in rent pricing during 2013. Consequently, these assets will be in high demand by institutional investors. While warehouses don't have significant appreciation swings, they are favored by investors for their steady incomes and the minimum amount of tenant improvements required for re-leasing. A great example was the Chantilly Distribution Center II in Chantilly, Va. Transwestern garnered more than 15 offers on the 160,000-square-foot warehouse when Principal Life Insurance Co. sold it last year for $17.55 million, at a sub-6% cap rate.

The best way for owners of older facilities in hub gateway markets to capitalize on the e-commerce sales shift is to upgrade their assets into modern warehouses to accommodate modern users. Investors should focus on these primary markets for buying opportunities because this is where they will find the lowest vacancy rates, highest absorption rates and highest interest from users. They can expect higher pricing and a lot of competition as a result because there will be a lot of money chasing class A industrial product in the best markets. Development is an attractive option in these markets, as well, especially since there is less risk for high dollar re-leasing expenses because of the low level of office improvements.

In the secondary markets, owners of older or functionally obsolete warehouses need to think more creatively about alternative uses to ensure positive cash flow. Owners may want to consider non-industrial uses such as retail/warehouse, indoor sports facilities, data centers and recreational uses (i.e. laser tag, trampoline jumping or paintballing). Also, the land underneath some of these buildings might be more valuable than the buildings themselves so redevelopment to higher and better uses might be a viable option, especially for well-located, older warehouse buildings in mature markets.

Caulley Deringer is an executive vice president at Transwestern. The views expressed in this column are the author's own.