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Web Making Retailers Redo Warehouses

In a move to flex their muscles in the burgeoning e-commerce arena, many retailers are transforming their industrial real estate with a new genre of fulfillment centers designed to better meet the demands of the virtual-shopping crowd.

Some, such as giant discounter Wal-Mart Stores (WMT) and high-end department store operator Nordstrom (JWN), are bulking up with large-scale online fulfillment centers that enable faster and more efficient order delivery to shoppers' homes. In doing so they take a page from the strategy book of online commerce giants such as Amazon (AMZN).

Retailers' property push comes as e-commerce sales continue to explode. In 2013, total retail e-commerce sales surged 16.9% to $263.3 billion, according to the Census Bureau. That was atop a 16.2% jump in 2012 and a 16.4% rise in 2011.

The surge has sparked increased demand and development of dedicated online warehouse space. In order to meet the requirements of fulfilling and housing online inventory and accommodating the necessary labor force, retailers have changed the size and locale of these new centers.

Industrial Outlook Brightens

Retailers are increasing the size of their dedicated online fulfillment/warehouse centers to house the large volume of goods being stored in the centers and distributed to households in disparate locales, says Ryan Severino, senior economist at Reis. Many are "scaling up" the size of the centers to a range of 1 million to 2 million square feet vs. older buildings that weren't built that size, he says.

The transformation taking place in the space bodes well for the industrial real estate outlook.

"For developers and investors it could be boom times," said Severino. "These centers are a very new phenomenon. Historically, one tended not to see centers of this size. With the patterns of demand changing, it creates opportunities that wouldn't have been there.

The larger centers need to be built differently than warehouse/distribution centers supplying goods to brick-and mortar stores. The online fulfillment centers require higher ceilings to better utilize space and accommodate the larger stacks of goods that used to be on store shelves. They also require stronger floors to support heavier loads and more dock doors for the greater amount of trucks coming in and out of the centers, Severino says.

The new requirements have helped spur big demand for new warehouse space.

"The demand for industrial warehouse space has exploded in terms of what's used for e-commerce fulfillment centers or a combination of an e-commerce fulfillment center with a traditional retail distribution center," said Garrick Brown, director of research for Cassidy Turley.

A typical combination fulfillment center ships merchandise ordered either online or from a physical store directly to the consumer.

Brown sees demand for 80 million square feet of either e-commerce distribution centers or the combined centers over the next two years. He pegs the vacancy rate of existing space that can be used for these purposes at 30 million square feet.

The growing demand for large e-commerce fulfillment centers, he adds, has helped spark the start of a "massive construction boom.

He says there are more than 50 million square feet of projects either proposed or under construction in the U.S. that could be used for e-commerce fulfillment centers.

Developing these larger centers is not as easy as upgrading an existing distribution center or, say, "bringing an office building up to par," says Severino.

The older buildings, he says, are "functionally obsolete.

And, he adds, they're located in "submarkets that are so well built out that even the parcels of land they're on can't be knocked down to create the bigger space needed.

Land In Demand

That means more acquisition of land for development away from the more established industrial markets and submarkets, he says.

Wal-Mart, the world's biggest retailer, is among those riding the warehouse transformation trend. The company has announced two new centers dedicated to filling online orders, including one in Fort Worth, Texas, and one in Bethlehem, Pa., which will be its largest-ever, at over 1 million square feet. The new online facilities "extend Walmart's anytime, anywhere experience that lets customers shop seamlessly across online, mobile and stores," the company said in a statement. They are a part of its "next generation fulfillment network that will deliver U.S. customer orders faster and at a lower cost," it said.

In September, Wal-Mart began shipping orders from the new 800,000-square-foot online fulfillment center in Fort Worth. It is scheduled to open the Bethlehem center in the first quarter of 2015.

"In addition to adding large-scale fulfillment centers, we have a strategic advantage in e-commerce though the 4,200 Wal-Mart stores located within five miles of more than two-thirds of the U.S. population and over 130 distribution centers across the country," said spokesman Ravi Jariwala via email. "Our next-generation fulfillment network combines new and existing locations to get close to customers to deliver orders faster and at a lower cost.

Nordstrom is slated to open a large-scale fulfillment center in Conewago Industrial Park in Elizabethtown, Pa., next year. It will enable faster delivery for Nordstrom.com, its mobile app and catalog orders, the company says, and be about 672,00 square feet plus a 470,000-square-foot mezzanine.

Not only is the size of these centers changing, but so are the locales where retailers are looking to develop these centers, Severino says.

Before the advent of 'big box' retail industrial space, preferred locations for retail warehouse/distribution centers were not far from the big ports in cities , he says.

Now retailers are being "more pioneering" about the locations of the large centers, he adds, and are looking at locales such as eastern and central Pennsylvania.

Severino says the "jury is still out" for some retailers about whether they need centers this size. But the so-called "omnichannel" approach to retailing embraced by store chains from Macy's (M) to Wal-Mart has created more interest.

"Omnichannel means being prepared to meet customer needs however, whenever and wherever they prefer to shop — and to make the total inventory of the company no matter where it may be located — available to every customer," Macy's spokesman Jim Sluzewski said via email. Macy's omnichannel strategy has proven very successful.

If retailers in their "omnichannel" models are offering next-day or same-day service, they need to be in close proximity to a population density, adds Kris Bjorson, international director and head of retail distribution services for commercial real estate firm JLL (JLL).

The overall fundamentals for warehouse and distribution are improving. Severino calculates the warehouse/distribution vacancy rate was 11.6% in 2013, and estimates it will fall to 11.1% in 2014 and to 10.7% in 2015. He tallies that asking rent rose 1.5% in 2013, and forecasts a 2.3% rise this year followed by a 2.9% gain in 2015.

Investor demand, so far in the real estate recovery, has been mainly focused on multifamily housing and "trophy" office and shopping-center assets, says Brown. "I think this year, we'll finally see industrial getting its due," he said. "It's where the best deals are being offered."