Column by Charles Canale, Senior Vice President, Colliers International
Bigger is better…Or is it?
In the last 20 years, Chicago-area industrial brokers have seen National Retailers and Consumer Goods Companies take larger and larger distribution facilities, with many of these types of users now focused on ‘Mega Distribution Centers’ of 1 million+ Square feet in size.
As the size of this user group’s distribution center requirements has grown, the average size of speculative buildings being developed has grown as well. Developers along I-55 and I-80 have built many facilities that exceed 600,000 square feet in size, with several speculative buildings constructed that were 1M square feet or larger. Based on this trend, one could assume the next round of speculative buildings will be even larger, with 1 Million SF (or larger) building sizes becoming the norm.
However, the question we need to ask is how will the two issues below will affect the size of distribution centers requirements in the future, and how should speculative building developers react:
- The Ever-Evolving Facility Requirements of Mega-DC Users
- The Proliferation of E-commerce and Increased Expectations from Consumers
Will these two factors make the size of the ‘typical’ speculative building self-limiting or even reduce the sizes of typical speculative buildings? Or are 1 Million+ Sq. Ft. speculative buildings the right answer to meet the demand for larger Mega-DC’s that are required by these types of users? Let’s explore these ideas…
The ever-evolving facility requirements of mega-distribution center users
If we examine large distribution center transactions over the past three years (as well as users currently in the marketplace for large DC facilities) by retailers and consumer goods companies, we can see that a majority of these users did build-to-suit (BTS) developments versus taking an existing spec building.
Even when there were several speculative buildings available in the 850,000 – 1M SF range, users were more likely to build a new facility than lease an existing one.
Some of the most common factors affecting a user’s decision regarding Spec vs. BTS are as follows:
- Often users have such large requirements (e.g. Home Depot with their 1.6M SF DC in Joliet or Amazon.com with their 1.5M SF Kenosha DC complex) that no existing speculative building can meet their needs
- Some users have a requirement of such a unique nature (e.g. Michelin’s 3-building 1.7M SF campus in Wilmington) that speculative facilities were not considered
- Certain users have a locational requirement (e.g. Home Depot again, with the desire to have their Mega-DC close to the BNSF/UP Intermodal facilities (which are the terminus of their containerized imports from Asia) that precludes them from considering existing speculative buildings elsewhere
The proliferation of e-commerce and increased demands from consumers
Another factor affecting the demand for 1M SF speculative buildings is the relatively recent proliferation of e-commerce retailing. This is a trend that is heavily driven by the individual consumer, with consumers expecting to be able to purchase (and return) product via online shopping portals, mobile shopping portals, etc. and not simply during a typical retail store visit.
Many consumers are switching from typical retail shopping to e-commerce platforms, with online transactions expected to encompass 8% to 10% of all retail sales in 2015, and the trend continuing to grow year-after-year. In fact, some futurists are predicting that 60% of all retail sales will be e-commerce based by 2025.
In addition, consumers now want instantaneous delivery of products to their doorstep – or as close to instantaneous as possible – without incurring additional shipping costs. Retailers have realized that speedy delivery can be highly-differentiating trait; making their platforms grossly superior to their competitors (a good example is Amazon Prime). In fact, 1-day or 2-day delivery to the consumer is seen a core-competency by many online/e-commerce retailers.
How do these e-commerce trends affect the market for 1M SF speculative buildings? Let’s examine the distribution center trends for companies focusing heavily on direct-to-consumer shipping below:
Companies are increasing their ‘omnichannel’ capacity; they need additional distribution centers (non-Mega DC’s) to handle increased fulfillment to individual consumers, as well as the typical delivery of product to their network of retail stores.
- A typical regional DC requirement will be 600,000 – 1M+ SF, in line with the size range of large speculative buildings across the U.S.
- In many cases, the company is seeking to add this capacity as soon as possible and would rather take an existing spec building (versus doing a protracted BTS process), so long as the building meets their basic specifications
- With significant ‘pick-and-pack’ mezzanines being installed in the facilities, they must have a 32′ minimum clear height (with 36′ being preferred)
- These operations often have a very high employee count, with 500 + employees being common, so a speculative facility must have a parking area to accommodate this level of employment
- A fully-secured, single-tenant facility is often preferred or mandated. In these cases, 1M SF speculative facilities will be too large given that the user won’t consider a multi-tenant option
- Developers understand these specifications and most new speculative buildings are designed to be suitable for these types of requirements
Companies also have a significant desire to service a majority of the nation’s population via 1-day or 2-day delivery; this is often accomplished by adding new ‘Local Distribution Facilities’ near major population centers (even if a Mega-DC exists nearby).
- On the average, these Local DC operations are smaller facilities (300,000 – 500,000 SF in size) and can be located in part of a larger (1M SF) speculative building
- Speed-to-market on the part of the retailer is often a factor in starting up these operations, so existing speculative facilities are a very desirable option vs. the additional 6-12 months required for build-to-suit
- Clear-height and parking requirements for these facilities are less-stringent, allowing the typical specifications of most speculative buildings to work for Local DC operations
Given the two major factors just discussed:
- The Ever-Evolving Facility Requirements of Mega Distribution Center Users
- The Proliferation of E-commerce and Increased Demands from Consumers
How do these two factors affect the viability and relevancy of large (1M SF+) speculative buildings moving forward?
- Future Mega-DCs (and Mega-Fulfillment Centers) will be Build-to-Suit Developments
- Given the sheer size of these facilities, as well as unique buildings specifications, desired geographic locations, changing trends in design and warehouse technology, etc. these facilities will continue to be BTS developments.
- Additionally, these Mega-DC’s often have large lead times of 24-36 months, allowing for a long planning, construction, and outfitting time frame (and further reducing their interest in existing speculative developments)
- All things considered, this is a not a tenant segment that will consider 1M SF speculative buildings
- Companies Will Add Regional Multi-Channel DC Operations to Meet Consumer’s Expectations
- Consumers expect a full, multi-channel solution from retailers that incorporated on-line shopping, mobile applications, easy returns, and the availability of well-stocked retail stores
- Meeting this consumer demand will require companies to expand their DC networks, adding these new regional facilities, typically 600,000 – 1M SF in size
- With speed-to-market being a factor, these operations will focus on speculative buildings (versus BTS), provided the available speculative buildings meet their basic specifications for this type of use
- This is an excellent tenant segment for developers to pursue via speculative developments – provided they can accommodate tenants from 600,000 to 1M SF in a single-tenant facility
- Given the retailer’s preference for a fully-secured, single-tenant facility, a 1M+ SF speculative building may prove too large in many situations
- Companies Will Add Local Distribution Centers Near Major Population Centers
- This will allow for expanded 1-day or 2-day delivery times to consumers
- On the average, these Local DC operations are smaller overall facilities (300,000 – 500,000 SF in size) and can be located in part of a larger (1M SF) speculative building
- Speed-to-market on the part of the retailer is often a factor with these operations, making existing speculative facilities a desirable option vs. BTS
- Clear-height and parking requirements for these facilities are typically less-stringent, allowing most speculative buildings to work for these operations.
- This is an excellent tenant segment for developers to pursue via large speculative buildings of 1M SF (or larger), provided the building has the flexibility and a design to accommodate smaller (300,000 – 400,000 SF) tenants and allow for an efficient 2-3 tenant layout.
With any type of facility, even a Mega-DC, it is important to remember that the motivations of a particular user can outweigh their need for a ‘perfect’ building. Sometimes having a large building available (or under construction) is what makes a deal happen. Many retailers and consumer goods firms (such as Amazon.com, Williams-Sonoma, and Proctor & Gamble) have leased 1M+ SF speculative buildings across the U.S. over the past 10 years – typically in situations where timing was a critical factor. In some cases, these were smaller speculative buildings that were expanded to meet the larger Mega-DC size required by the user.
Also, not every 1M SF speculative building is going to be aimed at retailers and consumer goods companies (although they are the top utilizers of distribution space nationwide). Here in Chicago, we have a number of large distribution buildings that are occupied by food companies and third-party logistics firms. These types of users often take very large blocks of existing space (with 500,000+ SF being common) and typically operate distribution operations within the local MSA. They are great candidates for 1M+ SF speculative developments, provided that a 2-tenant, fully-secured scenario is possible if required.
Given all of these factors, the 1M+ SF speculative building is still relevant in today’s market. However, in many cases, developers will be better served by building a smaller speculative facility, with the potential for future expansion to 1M+ SF. This will allow access to the widest possible pool of users.