Michael Jones was quoted in Jennifer LeClaire’s article, "Tailor-Made Facilities"

January 2016 IssueAs Published in: Real Estate ForumAttorney: Michael E. Jones

E-commerce is changing the face of industrial real estate—literally. Although e-commerce is nothing new—Amazon came on the scene in 1994 and survived the dot-com bubble bursting six years later—e-commerce has surpassed early pundit expectations to revolutionize retail.

For many retailing giants, e-commerce has become as much an industrial and logistics function as a storefront function—and some 21st century retailing giants don’t have a storefront operation at all. At the same time, technologies like drones are allowing delivery of many household items in less than an hour. But, again, it all comes back down to warehousing and logistics.

In response to e-commerce trends, as well as newfangled technologies and government requirements, developers are shifting commercial real estate strategies. Instead of building massive industrial facilities based on historic specs—or even constructing warehousing with more loading docks and higher ceilings—developers are catering to the exact requirements of tenants with build- to-suit development.

E-commerce is the primary driver of a new wave of BTS development trends. According to market research firm eMarketer, online retail grew 20% in 2015 compared to 2014 and should grow at about the same rate in 2016. E-commerce currently accounts for 6.7% of all retail globally and will grow up to 7.4% by the end of the 2016, the firm reports.

“E-commerce users are looking for a specific type of asset –with clear heights, trailer parking, washrooms, HVAC within the warehouse, light, power, a mezzanine—and until now, these really weren’t available in second-generation buildings,” says Scott Marshall, executive managing director of industrial services for the Americas at CBRE. “So because of this, they had to turn to new buildings, driving BTS.”

Most of Amazon’s distribution centers are BTS. Likewise, Home Depot has shifted its development strategy from new stores to BTS fulfillment centers, like the one at Prologis Park 1-75 South in McDonough, GA that came on line in 2013. Prologis has built several distribution centers for Home Depot. And Mars/Wrigley Candy occupied a 1.3-million-square-foot, multi-temperature BTS development in Joliet, IL in 2015.

While e-commerce is requiring newer, state-of-the-art, ware-house space, technology is affecting how warehouse and distribution facilities are operated, according to attorney Michael Jones of Cole Schotz, a law firm that works with Fortune 500 companies in the Mid-Atlantic.

“Governmental regulations are changing the manner in which warehouse facilities are developed,” Jones explains. “For example, new governmental regulations further limit the maximum average work week for truck drivers, thereby increasing the need for more trailer parking.”

Charbel Farah, senior principal, Syska Hennessy Group, says the trend goes beyond e-commerce. As he sees it, BTS or design-build provides an opportunity for collaboration, accountability and innovation while keeping construction budgets under control.

“Tenants are increasingly seeking innovative solutions, and those tailored specific solutions are being delivered via both new and off- the-shelf technologies in engineering, construction and architecture,” says Farah. “We are seeing sustainable design applications and strategies such as harvesting the sun, the micro climate and the wind being implemented to create healthy and cost effective spaces.

Some of CBRE’s industrial tenants, especially e-commerce clients, are seeking high-end material handling systems inside the four walls of the building so they can move product throughout the warehouse with scanning and conveyer technology.

“The tolerances of these technologies need to be so tight, because the products need to be scanned and end up in the right spot within warehouse,” Marshall says. “We’re also seeing auto- mated racking, clear-height racking that exceeds 36-foot clear— and it’s all mechanized; it’s all robotics.”

Industry watchers agree that industrial and logistics tenants are seeking bigger buildings to accommodate the increase in product being stored and shipped. Forty-foot ceiling heights are the new benchmark and the buildings demand more power for the robotics and conveyer systems that are employed. Wider column spacing— 50-foot by 60-foot and 60-foot by 60-foot as opposed to 30-foot by 40-foot—has become more common.

“More land is required to accommodate increased trailer parking,” says Jones. “Roof loads need to be increased in order to accommodate solar panels on the roof. Office space within a ware- house building is being constructed to accommodate a higher density of workers, with less private offices therein, consistent with the new trends in office design. These buildings require more loading doors. It’s not uncommon to see two loading doors for every 10,000 square feet of floor area, an increase from one loading door for every 10,000 square feet.”

Jones recently represented a national big box retailer that wanted to improve the efficiency of its logistics to lower its distribution costs and keep its stores stocked continuously. To that end, the company invested in a major project to replace its older warehouse facilities with state-of-the art rapid deployment centers across the US and entered into BTS leases for facilities to its specifications.

A typical facility included a 450,000- to 650,000-square-foot building on approximately 50 to 80 acres, with 30-foot clear height, 400 trailer parking spaces, heavy power, 170 loading doors and a state of the art racking system. Jones says the building is designed as a cross-dock facility to have product delivered, in bulk, to one side of the building, then broken down and sorted in the interior of the building, then loaded onto trucks parked at loading docks on the other side of the building for delivery to the retailer’s stores.

“We’re no longer just helping a client locate its requirement at the corner of Main and First,” says Marshall. “Now, we’re helping our clients evaluate their supply chains and full transportation costs. We’re not just providing industrial brokerage services, but helping clients with all of their logistics needs.”

Are we witnessing a sea change in development or just a short-term trend? How big is the demand for BTS industrial and logistics facilities? As long as e-commerce, the primary driver, continues growing the BTS trend should continue growing right along with it.

“This is not a short-term trend,” says Marshall. “This is a systemic change in our business, where retailers are looking at e-commerce as a going concern. The way people are buying products, and therefore the way retailers need to fulfill orders, is a change in the landscape of our business not soon to disappear.”

Marshall sees plenty of developers building on spec, and says they need to anticipate both an e-commerce fulfillment requirement as well as a “standard” warehouse or distribution requirement. Therefore, he says, they design for the building to accommodate mezzanine, additional power or additional washrooms but it is anticipated as an “addition” and the base building would be constructed without these improvements.

From his perspective, Jones sees a lot of pent up demand for new state-of-the-art warehouse buildings, which should take a significant period of time to satisfy.

“There are also many developers and tenants which are new to the New Jersey market while there’s a shortage of state-of-the-art buildings to accommodate their requirements,” says Jones. “I anticipate that we will see robust development of spec buildings and BTS construction to accommodate the changing needs of ten- ants, particularly as more existing buildings become obsolete.”

With every opportunity come challenges—and BTS is no exception. Clearly, the BTS trend is gaining momentum, especially in the Western United States and should continue driving through major markets in the years ahead. But it won’t always be easy to get the buildings out of the dirt.

“Securing financing and ensuring that the right partners are in place—such as engineers, architects, manufacturer, and opera- tors—are the primary challenges,” says Farah. “However, after these elements are in place, a BTS project is in an excellent position to meet the goals of property owners and tenants. Heightened collaboration drives innovation while delivering the best value and performance.”

Jim Martell, president of Ridge Development, a private REIT in Chicago, sees pricing as the big issue today. The spread between the going-in yield and the exit cap rate is very thin, he says, maybe 50 basis points or even less in some cases where the developer will do it for a fee. This would require the developer to have a core buyer as a capital partner.

Meanwhile, Jones says the biggest challenges developers face today is coping with the shortage of vacant land while needing to construct larger buildings with more parking. “Developers must be willing to take on more risk by trying to tackle environmentally challenged sites that they might have stayed away from in the past, and they must be able to entice tenants to want to lease these sites,” he says.

Developers also need to be more flexible in the way that they are designing BTS buildings. Marshall says, for example, developers have to be able to design and build an asset that can be used either for e-commerce or a normal distribution stream.

“You don’t want to build an e-commerce ready building and have it be taken by a straight distribution user, because those e-commerce-specific improvements are going to go to waste,” he explains. “Conversely, if you build a straight distribution building and an e-commerce user takes the space, sometimes you can’t go back.”

With so much new construction, the question is this: How is the BTS trend impacting the overall industrial and logistics market? Are older buildings becoming obsolete?

“Older buildings aren’t becoming obsolete in an overall market sense, but obsolescence is certainly an issue when it comes to buildings that cannot accommodate trailer parking, car parking and ceiling height demands of the users today,” says Martell. “That said, certainly there are users that can backfill some of the facilities that do not meet the requirements for an e-commerce building.”

While some owners of older industrial and logistics buildings are racing to upgrade or retrofit facilities, especially if they have any extra land, others are looking for ways to create healthy and pleasant environments for ten- ants. At the same time, new delivery methods are emerging to meet client-specific needs for tenants who will lease buildings for 20 or 30 years.
“We are seeing a shift in the building sector with various delivery methods such as performance design build, CMAR, public-private partnership and integrated project delivery,” says Farah. “With these methods, we are seeing more collaboration and shared responsibility among teams that harness the best talent in engineering, architecture, construction and financing.”



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