The COVID-19 pandemic pushed even the most die-hard technophobes to do their shopping online, while seasoned online shoppers extended their purchases to include goods they had traditionally bought in-store, such as groceries. If even just some of these shoppers elect to stick to their new shopping patterns, the impact on commercial real estate (CRE) will be significant.
Last year, the Wall Street Journal reported that US warehouse demand might increase by 400 million square feet over the coming two to three years. E-commerce typically requires as much as three times the distribution space of the distribution operations that serve traditional retail outlets. You can add to that the fact that many businesses look set to increase inventories by 5 percent to 10 percent in the long term to avoid repeats of the shortages experienced at the onset of the pandemic.
The Suez Canal’s accidental blocking in late March 2021 further heightened the vulnerability of global supply chains. According to Lloyd’s List shipping news, the Ever Given mega-container ship held up an estimated $400 million in trade every hour she remained stranded.
Industrial Real Estate Bucked COVID Trends
Overall, CRE deals were down 36 percent year on year, according to the Deloitte 2021 CRE Outlook Report. However, some sectors were positively affected—industrial real estate being one of them.
The report attributes this to:
- Higher volumes of e-commerce and the need for “last-mile distribution” centers
- Increased orders for takeout food, which led to the advent of “ghost kitchens”
- More data centers to support the data usage required by work-from-home initiatives
Retail to Industrial Conversions
Retail real estate was one of the CRE sectors most negatively affected by the pandemic. Stay-at-home orders and subsequent social distancing regulations meant many tenants were forced to default on rent. With no clear end in sight, transactions in the sector have been slow.
But retail-to-industrial property conversions accelerated, according to a CBRE Research survey that looked at projects completed, proposed, or underway from 2017. At the start of 2019, there were 24, and by mid-2020, the number had grown to 59. Approximately 13.8 million square feet of retail space is expected to be converted to 15.5 million square feet of industrial space.
The cost of real estate is negligible compared to transport costs to get goods to customers. Retail sites located within population centers are ideally situated and equipped for last-mile warehousing concerning utility connections, parking, and accessibility. Big-box stores even have existing dock doors and clear heights compatible with industrial use.
The top five market cities for conversions are Milwaukee, Cleveland, Chicago, Omaha, and Dallas/Ft. Worth, all of which account for more than a third of the projects surveyed. If e-commerce trends continue, and thus the need for industrial space grows, this development strategy could extend to higher growth markets in the Southeast and West regions.
Blended Retail Real Estate
To think of brick-and-mortar retail and e-commerce as competitors, however, is erroneous. Increasing numbers of brands have moved to “blended” or “omnichannel” retail models, which are a combination of physical stores and online sales. In the pandemic, e-commerce kept many of these afloat while their non-blended competitors crumbled.
This convergence of retail and industrial presents a challenge to investors accustomed to single-use real estate. Multi-use environments complicate both valuations and management. Existing tenants may object to non-retail elements being introduced into traditional retail environments. Plus, there are zoning restrictions to consider.
Investors at the forefront of this new movement will need to develop collaborative relationships with municipal decision-makers and give careful thought to the right tenant mix. In some cases, developers are addressing concerns by creating facilities with retail façades backed by distribution infrastructure.
Converted multi-use spaces will likely have a longer return on investment due to the time it may take to reshape the tenant mix, but the investment could pay off if it accurately predicts the future needs of retail tenants.
Don’t Forget Hospitality and Office Space
Consumers aren’t buying less—they’re buying differently. Blended retail tenants are also willing to pay market rates for the right spaces to give them what they want. Traditional retail spaces are not the only ones with the desired attributes.
Hospitality, office, and even residential real estate can present opportunities for reconfiguration. Remember, it’s about being able to get goods to the customers, not necessarily about getting the customers to you. Distressed asset sales may be ripe for the picking in 2021 and 2022.
Far from being a knee-jerk reaction, the convergence of traditional retail and e-commerce was an established trend before COVID. Investors wishing to ride the wave should be sure to partner with developers who have experience in multi-use spaces and the potential to form the necessary relationships with municipal decision-makers.