Scaling retail space to warehousing

Scaling retail space to warehousing

Rarely in logistics do we encounter something so sensible in theory but so challenging in execution as converting retail space to e-commerce distribution and other industrial uses.

It’s a common and logical question these days from clients and media alike: with many big-box retail spaces coming available amid store closures, and with warehouse space in such short supply in many markets, why not transform that retail space into distribution centers (DCs)? The answer: it can work in some cases but not all.

CBRE has found 24 such conversions in the United States since 2016, including entire malls razed and rebuilt as warehouses, as well as standalone big-box stores repurposed for industrial uses. Examples range from obvious applications — including membership warehouses such as Sam’s Club converted to DCs — to the unusual: a former Toys ‘R’ Us store in Milwaukee now houses a transmission-remanufacturing business.

The 24 conversions were more than double what we expected to find. Collectively, these projects represent roughly 8 million square feet of retail space transformed into roughly 11 million square feet of industrial space. Still, that’s a tiny fraction of the 14 billion square feet of industrial space in the United States. These conversions are a niche market, but a healthy, growing one nonetheless.

To consider whether this might become more than a niche, we must examine the pros and cons of converting retail space to industrial uses. There are plenty of both, and they vary dramatically from site to site.

First, the pros

Big-box retail space is far more available these days than distribution space. While the overall retail market is healthy, certain retailers including Sears Holdings Corp., Toys ‘R’ Us, and Sports Authority have closed hundreds of stores. Those big boxes of roughly 30,000 square feet to more than 100,000 square feet are challenging to backfill with new tenants, especially with many retailers now expanding more slowly and deliberately than in the past.

In contrast, the industrial market, which includes warehouses as well as manufacturing space, is at its lowest availability rate (7 percent) since 2000. Demand for industrial real estate has outpaced supply for the past 35 consecutive quarters. It’s not all because of e-commerce distribution, but most of it is.

This tightness makes any available space worth considering. And vacated retail space offers a few advantages. It often is located along major streets or highways, providing easy truck access. While many stores are vacated because their surrounding neighborhoods deteriorated, those locations still are within ideal distance of large populations for same-day or next-day delivery.

Structurally, standalone big-box stores make far more sense for e-commerce distribution than do malls or strip centers. They offer wide-open spaces; backend, dock-height doors for loading and unloading; and reasonable ingress and egress for trucks.

Some have the high ceilings often found in DCs, although that’s not as important as some might assume. E-commerce distribution requires rapid access to a wide assortment of products, which are most often picked individually for e-commerce distribution rather than by case or pallet. Thus, it’s more efficient to keep that inventory on shelves easily accessible to human pickers than to bundle it in a case or on a pallet stored high on a rack.

Now for the cons

One of the biggest hurdles for most of these conversions is obtaining approvals from the many parties potentially affected by the change. That can include nearby neighborhoods, which might not appreciate the increased truck traffic; city officials, who might balk at forfeiting any further sales-tax generation from the site; and other retailers in the center, who might object to truck traffic impeding shopper traffic.

By far the most powerful stakeholders in these discussions are lenders. Most retail real estate carries mortgages predicated on retail rents. Those are, on average, much higher ($17.57 per square foot per year) than industrial rents ($7.37 per square foot). Therefore, accepting a much lower rent just isn’t feasible in many situations.

However, the opportunity for a conversion can arise if the property goes through an ownership change that eliminates some or all of its mortgage, such as a foreclosure or a sale by the lender. In those cases, the buyer comes into the property at a far lower cost and can consider an industrial use — if, of course, all of the other stakeholders approve.

Physical structure can be an impediment, too. Malls are rarely, if ever, converted directly to warehouse and distribution use. They have too many features incompatible with warehousing — escalators, stairs, relatively low ceilings, confined spaces, multiple floors, and inadequate docking.

Rather, a mall conversion entails razing the mall and building DCs in its place, as has happened or is happening with the North Randall Mall and the Euclid Mall near Cleveland, the Six Flags Mall in Fort Worth, Texas, the Schuylkill Mall in Pennsylvania, the Summit Place mall near Detroit, and the Perryville Outlet Center near Baltimore.

How will this conversion trend unfold from here? It’s a safe bet to say we’ll see more of these. It’s also safe to assume that this will remain the exception rather than the rule. We’re likely to see more hybrids of stores with sizeable distribution facilities on the back end, or in the case of wholesale brands, warehouses with small showrooms at the front. This is a niche that will endure.

Joe Dunlap is managing director of supply chain advisory for CBRE, the global commercial real estate services company. His career spans 25 years of supply chain experience at Fortna, Accenture, various Siemens business units, and United Parcel Service. At CBRE, he oversees a global team of supply chain professionals, project managers, modelers, data scientists, and business analysts. Twitter: @_JoeDunlap. Read CBRE’s report on conversions here.