Growth in E-commerce Driving Larger Warehouse Designs

E-commerce’s explosive growth, an emphasis on speeding up supply chain fulfillment, and robust leasing demand among traditional warehouse users are dramatically influencing the industrial property market. Several quarters of healthy absorption and strong rent growth across most U.S. markets not only have turned the cavernous boxes into commercial real estate darlings, but also are driving a warehouse construction boom that is churning out larger buildings designed to enhance rapid delivery.

E-commerce’s explosive growth, an emphasis on speeding up supply chain fulfillment, and robust leasing demand among traditional warehouse users are dramatically influencing the industrial property market. Several quarters of healthy absorption and strong rent growth across most U.S. markets not only have turned the cavernous boxes into commercial real estate darlings, but also are driving a warehouse construction boom that is churning out larger buildings designed to enhance rapid delivery.

Warehouses constructed from 2012 to 2017 average almost 185,000 square feet (17,200 sq m), which is 143 percent larger than the typical warehouses built during the previous peak period from 2002 to 2007, according to research by Los Angeles–based CBRE. What’s more, the average warehouse clear height has climbed to 32.3 feet (9.8 m), an increase of nearly four feet (1.2 m) over the same period.

CBRE attributes the expanding size to e-commerce users, who need the extra floor space and ceiling height for storage racks, conveyors, and other sophisticated equipment to quickly break down bulk shipments and prepare goods for distribution. Such warehouses may be the last place where goods are packaged before they reach consumers—the “last mile” in the delivery network—or they may just be one stop in a longer chain, said David Egan, global head of industrial and logistics research at CBRE.

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“It just takes more space to do that kind of work—more people, more machinery, and more racks for the actual stuff,” he said. “It’s like entropy; it becomes more chaotic as things break apart.”

While e-commerce companies are influencing building designs and distribution models, they are hardly the only driver of leasing demand, Egan added. E-commerce accounts for about 10 percent of non-automobile retail sales, but at best it represents only about a third of industrial property occupancy, he estimated. Conventional warehouse users and third-party logistics companies still fuel the bulk of leasing activity.

“E-commerce is the driver to get bigger and higher, for sure,” he explained. “But this is not a situation in which we have a new type of user that’s pushing other users out of the market, or where a new type of building is making other buildings less functional. Everything is in demand.”

Indeed, the average industrial vacancy rate of 5.2 percent in the third quarter was the lowest on record in the United States and a decline of roughly 100 basis points from the first quarter of 2016, according to Colliers International’s most recent industrial property report. Similarly, industrial property rental rates averaged $6.32 per square foot ($68.02 per sq m) in the third quarter, which was also a record and 10 percent higher than a year earlier, the Toronto-based brokerage reported.

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Those fundamentals combined with year-to-date net absorption of 183 million square feet (17 million sq m) and expectations for warehouse demand to remain strong in 2018 have sparked a development boom: Some 170 million square feet (15.8 million sq m) of warehouse space was completed in the first three quarters of 2017, and 222 million square feet (20.6 million sq m) was under construction at the beginning of the fourth quarter, according to Colliers.

The ballooning pipeline has created concerns about overbuilding, particularly for a real estate cycle so long in the tooth. But Pete Quinn, national director of industrial services for Colliers, suggested that the industrial market had room to run.

“There are so many changes going on in e-commerce and logistics that I don’t think the cycle is going to slow in the near future,” he said. “E-commerce sales are growing at a rate five times faster than traditional retail sales. Unless you think the internet is a fad, that’s not going to end.”

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Still, signs of overheating have surfaced. Roughly 70 percent of industrial developments started in the past couple of quarters were launched on a speculative basis, according to the most recent industrial report penned by Chicago-based JLL. What’s more, in some markets—including Dallas, Chicago, Cleveland, Indianapolis, and Kansas City—construction has begun to outpace absorption and could lead to some short-term vacancy rate flattening. Nevertheless, JLL pointed out that healthy leasing activity should eventually fill the new buildings.

“A lot of the speculative development is a function of the fact that we’re in such a low-vacancy environment—about 200 basis points lower than we were at the peak of the last cycle,” said Aaron Ahlburn, managing director for industrial and logistics research at JLL. “There is a push toward high quality and very functional high-bay type of space.”

That is the case in the Inland Empire, a southern California industrial stronghold where more than 26 million square feet (2.4 million sq m) of industrial space is under construction. In the third quarter, the market’s average vacancy rate dropped 400 basis points to 3.4 percent, and warehouse tenants absorbed some 14.8 million square feet (1.4 million sq m).

Brett Dedeaux, principal of Los Angeles–based industrial developer Dedeaux Properties, said that his firm was pursuing conventional and last-mile logistics development, including a 46,560-square-foot (4,300 sq m), 101-door warehouse that is scheduled to break ground in the first quarter of 2018, and a 1 million-square-foot (93,000 sq m) warehouse that is still in the planning stages. Among other deals, the 50-year-old company recently signed a handful of logistics companies to long-term leases in its City of Industry, Compton, and Fontana properties.

“Our assessment is that we think there’s a good balance between supply and demand right now,” Dedeaux said. “But there are a number of 1 million-square-foot buildings going up or approved for development, so it’s something we need to keep an eye on.”

Joe Gose is a freelance writer and editor based in Kansas City, Missouri. His work has appeared in the New York Times, Investor’s Business Daily, and Barron’s.
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