Owners need to future-proof warehouses

Logistics, the darling of the real estate sector, may be in for a reckoning as technological advancements make some warehouses obsolete.

Over the past several years, warehouse and distribution properties have grown from one of the smallest of the main real estate property types with an unexciting but dependable return profile to the hottest sector. Investors have been overweighting industrial properties to take advantage of consumers’ growing acceptance of online shopping, with investor demand rocketed into high gear during the COVID-19 crisis and increased stay-at-home orders. U.S. online retail sales are expected to reach $1.1 trillion in 2023, which would be a 10% increase from the prior year, according to FTI Consulting projections in a July online sales report.

Industrial assets managed by the top managers of U.S. institutional tax-exempt clients increased by 13 percentage points in just five years to 28.4% as of June 30 from 15% as of June 30, 2018, Pensions & Investments real estate money manager data shows.

And yet, 82% of the total logistics stock was built before 2000, said Mary Lang, head of Americas direct logistics strategies at CBRE Investment Management.

For warehouse tenants using robotics, artificial intelligence and other property-related technology, those logistics properties are “quickly becoming obsolete,” Lang said.

Industrial returns might drop until the industry moves to logistics 2.0 properties, she said. Even warehouses that are “extraordinarily well located” could be left to compete for a much smaller pool of ten- ants if their buildings do not meet the technological needs of potential occupiers, Lang said.

The results of the latest Pension Real Estate Association’s consensus forecast survey predicts industrial property returns represented by the NCREIF Property index will fall to -5.6% by the end of 2023, regain- ing some ground to 4.5% in 2024, but both far below the 14.6% return just last year.

Even relatively newer warehouses are outmoded. Logistics buildings constructed prior to 2014 are more likely to have thinner concrete slabs that are not reinforced and have less clearance, Lang said.

Today’s warehouse tenants need higher clearances, 40 feet vs. 32 or 36 feet, to stack pallets higher, and reinforced concrete without the seams in typical concrete slab warehouse floors, in part, to accommodate robots. Only 11% of U.S. logistics stock by square footage was built after 2014, she said.

“That’s the kind of design most sophisticated logistics occupiers are looking for today,” Lang said.

Indeed, 75% of supply chain leaders surveyed by the international trade organization Material Handling Institute expect to use artificial intelligence solutions and 80% expect to use robotics within five years, according to MHI’s annual report released in March. Seventy-four percent of survey respondents plan to increase their investments in supply chain technology and innovation, with 90% planning to spend more than $1 million, up 24% from the prior year’s survey and 36% expecting to spend more than $10 million.“If you look at the rate of adoption (of new logistics technology), it’s extraordinary,” she said. “I’ve never seen an environment as ripe as it is today for collaboration and cooperation between occupiers and developers,” Lang said. “We need to be tied into one another’s needs to get (logistics) 2.0 right.”

What’s more, the power requirements of warehouses have doubled in the last 10 to 15 years to 8,000 amps of power because tenants are running more sophisticated technology. This power usage is expected to increase as warehouse tenants switch to electric truck fleets, Lang said.

“What we will see more and more of are closed loop circuits” with solar panels on the roof, battery storage and electric vehicle trucks charging stations on the property, she said.

The No. 1 feature that warehouse tenants want is more power, said Bob O’Neill, senior vice president, acquisitions for real estate manager CapRock Partners. They want more electrical capacity than the older buildings can offer, O’Neill said.

Not only do tenants want automobile charging stations but they are preparing for future delivery of EV semitractor-trailer trucks, he said.

In addition to AI, another development to watch will be the impact of drone delivery on the industrial sector, O’Neill said. Walmart is conducting pilot studies on drone delivery on e-commerce, he said. If widely used, drones could lesson truck usage.

While warehouse vacancy rates are still low with record absorption of new industrial properties, that rate is beginning to increase, O’Neill said.

Net absorption — the amount of space occupied minus the amount of vacant space — of industrial properties is expected to average 52.6 million square feet over the next two years, down from the peak rates of the last two years, according to the newest Industrial Space Demand Forecast, released by the NAIOP Research Foundation on Aug. 31.

The overall vacancy rate for industrial properties increased in the second quarter for the third consecutive quarter, up by 30 basis points to 3.7%, which was still below the 10-year average of 4.7%.

At the same time, port traffic has slowed by 26% due to the slower growth in China, he said.

But whether a warehouse would be considered obsolete also depends on the location. For example, older warehouses in certain, highly sought-after portions of Los Angeles and Orange counties in Southern California have been remodeled, O’Neill said.

In the past, some warehouses had been improved to add offices so that the tenants could use the property as it headquarters, he said. CapRock has remodeled those buildings, reducing the office space to increase the warehouse space, O’Neill said.

However, there is a limit. For warehouses that aren’t tall enough, O’Neill said that warehouse owners are better off tearing down the building and starting over, he said.