Last-mile industrial facilities, which are crucial to the logistics of getting products from retailers to consumers, are one of the most in-demand commercial real estate asset classes in 2021. These properties have become fundamental links in the nation’s all-important supply chains, helping to fulfill the immediate demands of both retailers and consumers.
As investment vehicles, these last-mile warehouses should catch the attention of commercial mortgage lenders, brokers and investors. There are a number of inventive ways to finance these projects.
While the COVID-19 pandemic has been a difficult time for most business sectors, one area of the U.S. economy, e-commerce, has continued to reach new heights. At a time when many people have been working from home and avoiding physical retail spaces, they have been increasingly turning to online shopping for nearly all of their needs.
This habit appears to be continuing even as vaccines, masks and social distancing have lessened the pandemic’s grip. But such success has resulted in a difficult logistics problem: Not only have consumers grown to appreciate the choices and convenience that e-commerce offers, they also expect to receive items almost immediately.
Retailers big and small are rising to this challenge. They’re finding new ways to diversify their inventories and bring goods to consumers more quickly — including many same-day services. These changes are creating new opportunities for investors who are thinking about diversifying their commercial real estate portfolios.
Current needs
Of course, the “click over brick” phenomenon in retail has been going on for years. But the pandemic has sped up this transition by forcing many people to avoid stores out of necessity. Consumers have grown accustomed to having an endless selection of items at their fingertips. Even consumers who are now returning to malls and big-box stores are still frequently buying online since they can expect to receive their orders within 24 to 48 hours — at no extra cost.
This shift in consumer behavior presents unprecedented challenges for retailers. To meet consumer demand, distribution warehouses need to be large enough to accommodate growing inventories, but they also must be close enough to where consumers live to allow for packages to be delivered at an increasingly faster pace.
Unfortunately, older warehouses and complexes are not always a good fit for the demands of the modern supply chain. Many of these facilities are built to dispatch large amounts of cargo along fixed routes. They tend to be located in rural areas, offer limited shipping docks and have low ceilings that are often unsuitable for modern vertical racking systems. What is needed are innovative, last-mile industrial facilities to quickly handle smaller items and diverse inventories.
Urban landscape
Finding the space to build appropriate warehouses has become a major headache for e-retailers. Large parcels of land that are close to urban centers, include abundant parking and have easy access to shipping routes are scarce and expensive. Additionally, such properties are often subject to competing offers from other buyers.
Given the limited supply of these resources, e-retailers have been seeking inventive solutions to repurpose existing facilities. Empty shopping malls and defunct industrial facilities have been two primary sources. Some big-box stores have opted to reconfigure their existing retail spaces to accommodate in-store distribution facilities where customers can pick up online orders.
Retailers also have turned to more unexpected sites, such as an abandoned naval base in Bayonne, New Jersey, and a mammoth underground parking garage in Chicago. With a growing number of people working from home for the foreseeable future, office buildings could be the next target. And some retailers are considering building additional stories on their last-mile industrial complexes to maximize utilization of the footprint.
All of these conversions and developments are transforming the urban landscape in various ways. This includes the revitalization of neighborhoods through new jobs, the redevelopment of obsolete or underutilized retail properties (greyfields), and the cleanup of toxic waste from former industrial sites (brownfields).
Self-sustaining growth
The changing ways that we shop, and our increasing expectations for fast delivery services, are awakening investors and lenders to a new reality. Capital sources understand that last-mile industrial complexes are the most in-demand assets to fulfill growing consumer and business needs.
According to commercial real estate services company Cushman & Wakefield, the demand for warehouse space pushed U.S. industrial rents to a record high of $7.03 per square foot in second-quarter 2021, marking a 6.8% year-over-year increase. Similarly, the vacancy rate of 4.5% at this time was lower than it was 10 years ago, while construction was underway to add another 476 million square feet of industrial space nationwide (and 36% of it was already preleased).
Efforts to build and transform underutilized spaces into distribution facilities that fit with the 21st century are helping to accelerate the economic recovery. What’s more, establishing last-mile industrial facilities creates jobs, many of which are located in economically distressed communities.
Related sectors — including logistics, manufacturing and construction — are benefiting from this ripple effect as they help to meet the demand for more space. And the research and development sector is creating innovative ways to help last-mile facilities be more efficient, including through the use of self-driving vehicles, drones and other logistics solutions.
Project financing
Despite all of the upside, the creation of last-mile industrial facilities presents financial challenges. It’s often a cheaper solution to refurbish existing structures and sites than to build new facilities from scratch, particularly given the rising costs of both materials and labor. Still, the scarcity of suitable locations, coupled with the need to adapt older buildings to the demands of modern e-commerce, lends credence to investing in new developments.
Industrial properties are in high demand and availability is limited across the country, resulting in expensive bidding wars in which investors often come ready with all-cash offers. Commercial mortgage lenders, however, are typically solicited in post-closing periods to refinance projects or fund construction efforts.
At the same time, commercial mortgage brokers are competing with joint ventures to finance last-mile industrial complexes. Lenders are working with brokers to secure developers by offering low interest rates (below 3% in some cases) and other attractive terms. They also are considering lower capitalization rates (3% to 4%) in gateway markets such as San Francisco, Los Angeles and New York City.
The ongoing market restructuring has catalyzed this race and has reinforced the urgent need for these assets. As things currently stand, these developments are considered secure and lucrative investments. The assets offer the advantages of low vacancy rates, long-term leases and tenants with strong credit.
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The pandemic dramatically accelerated trends in consumer behavior that were growing for the past decade. Consumers want everything — and they want it now.
This surge in demand has forced e-retailers to get creative with last-mile industrial sites that offer the security of long-term tenants and stable investment returns. Investors and lenders are doubling down on this niche market to meet intense demand, and mortgage brokers also stand to benefit from this growth as retailers of all types embrace the online shopping experience. ●
