Warehousing and distribution oriented operations are experiencing an incredible transformation that is impacting different operating characteristics and pushing the envelope of overall facility utilization. Perhaps the greatest impacts and changing characteristics of the warehousing and distribution industry are the predominance of eCommerce business models and the modern-day expectations of businesses and consumers for next-day delivery service for most everything. In many of the traditional large distribution hubs around the U.S., buildings are getting bigger, staffing requirements are generally going up, and the need to be close to either major population centers or an air cargo hub are critical. While many traditional warehousing operations continue to operate with perhaps little change, a smaller but highly-disruptive segment focused on eCommerce and customer fulfillment needs is driving huge change into the market, from both a design and operational perspective, and major implications of these changes are the focus of this article.
Real Estate Trends
Industrial real estate was relatively slow to recover from the last recession, and therefore the pipeline of new construction was slow to ramp up again. After this initial lag, industrial development is now among the strongest segments of the national real estate landscape. In many markets across the country, supply is generally struggling to keep pace with the recent surge in demand. An increase in nationwide building development activity has delivered nearly 50 million square feet of new industrial product to the market on average in each of the last nine quarters. Combined with net absorption averaging nearly 55 million square feet over the same time frame, the average national vacancy rate for industrial has declined steadily and is approaching five percent, a 30-year low. In certain key distribution markets, industrial vacancy is less than two percent. This constrained inventory is also driving a sustained increase in lease rates that has been on-going for more than 21 straight quarters.
The development pipeline remains robust. As of Q2 2017, NGKF was tracking 52 mega projects in the U.S. A mega project is defined as an individual industrial building of 1,000,000 square feet or greater.
In a turnaround from the recent past, eCommerce has dominated industrial leasing activity. While manufacturing users accounted for approximately 28 percent of industrial leases by square footage in the first quarter of 2017, the wholesale and eCommerce sectors accounted for nearly 66 percent of industrial leases by square footage. These users are seeking a large cubic solution and have been driving a steady increase in building clear heights from 24 to 28 to 32 and 36-foot clear over the past decade. In fact, as recently as 2013, the conversation around building clear height was whether it was worth the additional cost to build to 36-foot clear height from a more traditional clear height of 32 feet. By 2017, the next iteration of buildings is sprouting up at 40-foot clear as eCommerce interior operations evolve. At this pace, can 44-foot clear or higher be far off? And which industrial market after Seattle will host the next multi-level warehouse facility?
Some of the building boom can be attributed to the need for higher cube buildings and the fact that buildings less than 40-foot clear are nearly obsolete in the world of eCommerce for items such as apparel, electronics and other consumer products, let alone businesses leading in the eCommerce segment such as Amazon and Walmart. The need for height comes as operations move from high bay racking solutions to maximizing the number of mezzanines available to essentially pick and pack product. A 36-foot clear height building set up with three levels of mezzanines would only allow for eight feet between floors, which including structural support, is not realistically achievable. A 40-foot clear building set up with three levels of mezzanines will allow for 10 feet between floor levels, which is a reasonable solution even with the required structural support, but employees working in that environment may feel a bit cramped. The need for buildings with clear heights exceeding 40-foot clear may not enable a significant increase in product capacity, but could yield advantages by providing a more comfortable and sustainable workplace environment for employees, which may be more important to some companies than others.
The steady increase in eCommerce and other customer-centric operations has also resulted in more of a focus on development in urban and suburban areas. Years ago, many warehouse and distribution oriented operations typically selected a rural or exurban location that was well situated to service a vast store or customer network, often reliant on trucks and store – specific or bulk – replenishment runs. Today, for larger and more complex companies operating numerous warehouse facilities, there tends to be a need to be proximate to the urban centers they are supporting. As on-line sales continue to grow, and eCommerce has grown to represent more than 10 percent of all U.S. retail sales, time-to-market is a critical expectation of customer service. E-commerce, and the warehousing and distribution space required to support it, are also having a huge impact on retail real estate as well. With more than 8,000 announced store closures in 2017, which is only half way through the calendar year at this point, retail real estate is experiencing an inverse trend to industrial, as vacancies raise and rates are falling. Clearly the impact of eCommerce and omni-channel supply chains are having a huge impact on consumer shopping trends and those looking for products to be accessible on their terms, from electronics to clothes to groceries.
Companies can meet this expectation in one of two ways—either a multi-facility network with critical goods and components duplicated and located in numerous facilities near the end customer or market, or through a single, centrally-located operation with access to critical supply chain partners for overnight delivery to a majority of the U.S. market, typically UPS, USPS, and FedEx type solutions.
Companies with broad retail store networks will continue to deploy the first approach with multiple logistically-efficient warehousing solutions for a large portion of their business. Many of these same companies also deploy an eCommerce specific facility in a single location or a few key markets that can provide more effective customer solutions in terms of time to market. The eCommerce model also provides an opportunity for new entrants to the retail and customer service markets for those companies that cannot reasonably deploy more than a single solution warehouse and effectively manage the costs and inventory associated with multiple warehouses. Companies can build a following and build a brand from a virtual online store and occupy a single warehouse to service their entire customer base. Again, the herding effect of this model results in increased competition for labor in those markets that can support the supply chain needs.
With only a handful of markets able to accommodate the core operational characteristics of air cargo and cherished late-night cut off times for next-day service, some markets are seeing continued growth in operations but are also experiencing more challenging labor dynamics.
As location trends drive operations to cluster in or near significant metro regions, or near supply chain nodes for express services, there has been a significant increase in labor competition. Furthermore, eCommerce operations tend to require a significant amount of labor to support their daily core operations. Whereas traditional warehousing could be considered reliant on forklift and lift trucks to move pallets of materials into high-bay racking and storage systems, today’s eCommerce operations likely entail a single item or SKU being picked and packed for final customer delivery, typically with human participation in some point of the process. A single apparel oriented eCommerce operation may track more than 100,000 SKUs and may ship in single SKU units. The labor required to stock, pick, pack and ship an item can be tremendous. Even with this increased labor demand, it’s not that fulfillment centers are avoiding making capital investments in machinery, equipment and material handling systems. On the contrary, expect a modern eCommerce warehouse and distribution operation to invest tens of millions of dollars in racking and conveying but also in automated storage, scanning, sorting, and packing, as well as ever-increasing opportunities for the integration of robotics, autonomous forklifts, and evermore complex inventory and warehouse management systems. Even with the advancement in automation, material handling and robotics, many eCommerce operations are staffed with 500 or more employees, perhaps even up to 2,000 employees, for a one million square foot operation. One can imagine, it does not take too many of these operations near one another to have a dramatic and disruptive effect on local or regional labor market conditions.
The combination of an increased number of operations in a market along with a much higher labor requirement at each facility is leading to labor availability challenges and potentially hefty wage increases in many markets. Some distribution-saturated markets have seen hourly wages increase of nearly two dollars per hour for warehouse employees over the past 18-24 months, or 8-10 percent annualized increases. Some markets simply don’t have the labor resources to support the exploding growth in distribution markets. However, in a just-in-time mentality with an immediate need to meet customer demands, many companies are evaluating existing building solutions or find themselves at the whim of developers who have speculative buildings to house their operational needs. This is only increasing the labor challenges associated with the industry today. As developers see low vacancy rates and increasing lease rates, they would be foolish to miss out on the market conditions and so additional square footage and market capacity is constructed, but often in the same locations that are struggling to support the businesses that are already there.
Another growing trend in the warehouse operational profile is the growth of 3PL service providers operating the warehouse for a company and providing a leased workforce in turn. As companies seek to optimize the management and staffing of their distribution facilities, this is an increasingly-popular solution to manage the ever-increasing challenge of attracting and retaining labor and talent. More sophisticated companies that hold a building lease directly and outsource the labor to a 3PL can leverage and utilize their actual building as an employment attraction and retention tool to aid in the development of company culture and potentially reduce other labor challenges, such as turnover and absenteeism.
Consider two warehouse operations in proximity to one another: Company A and Company B, that offer similar wage and benefits packages for their employees. In many markets, these employees will change places of employment for an hourly difference of $0.25 or $0.50 an hour. However, if Company A can provide a competitive wage, and facility amenities such as improved lighting, seasonal air conditioning, and food services, plus cultural amenities such as effective shift management, training opportunities, and on-site health services, these amenities may provide the differential between experiencing a 15 percent rate of turnover versus something more ruinous like 50-75 percent turnover in a market.
This means buildings are not only getting larger from a cube standpoint, but are also evolving in their ability to store product and comfortably house more than 1,000 employees daily, often 24 hours a day.
In addition to the changing investment and labor dynamics, consider the design differences for restrooms, lockers and food courts that were never contemplated for a warehouse employing 50 to 100 full-time employees but can be a major challenge if not designed, and located properly, to support thousands of employees. To top it off, how do you accommodate site access and parking for not only your trucks and delivery services, but also more than a thousand employees coming to and from the site each day? The overall site acreage is increasing on a per-building basis and potentially reducing the total buildable footprint that a developer/owner may have to drive profit on a project.
Accommodating truck traffic, trailer storage and multiple shifts of employees can result in acres and acres of asphalt, which also has impacts for on-site storm water management, local traffic control, and neighboring land uses. Companies may well find that the ability to have public transportation accessible to the facility may also provide a differentiation when it comes to attracting and retaining the required labor.
Location Strategy Best Practices Approach
As discussed, industrial development as influenced by warehouse and distribution-oriented facilities is one of the most active segments of the current real estate market. The continued surge in eCommerce is perhaps the leading indicator of how the near-term trends will continue.
Consumers demanding and flocking to what is essentially on-demand services represent a larger and larger component of today’s retail and consumer environment. Perhaps someday the evolution of robotics in the workplace will replace an even larger component of the required work done by the people in this industry. Until then, current trends are such that more and more people are being sought after to support this explosive growth in eCommerce oriented warehousing activities.
Several best practices can support a smarter, more efficient deployment for warehousing needs:
- Be sure to develop and evaluate a current network model of the full supply chain network to identify areas of opportunity for improvement as well as identifying key zones of opportunity for deployment of new facilities. If not done in-house, a supply chain consulting firm can help with the data collection and validation as well as benchmarking the current network model prior to developing alternative scenarios for consideration. Keep in mind that the geographic “zones of opportunity” found in the output of a network model do not equal site selection. After identifying these regions of interest, there are many other factors to consider as well.
- Once the network model results have been taken into consideration, specific markets meeting the logistical considerations can be evaluated for real estate solutions. As mentioned previously, many large markets are experiencing low vacancy and limited existing solutions for large format industrial needs. While developers are busy developing new inventory, it is likely being built in a location that is more advantageous to the developer than to the end user. Building large industrial parks with users sharing property lines can be especially challenging for the end user that needs to attract the labor to support the operations and consider the implications of competitive labor markets. Companies must also balance the timing considerations of a project. Urgency to enter a market and begin shipping goods may create significant trade-offs. For example, choosing an existing building for speed-of-market entry may entail accepting high labor competition, as opposed to waiting for a new building to be built in a more advantageous location for logistical and labor considerations. A six- or nine-month delay in getting an operation up and running can result in significant loss of potential revenue or loss of market share.
- Develop a keen understanding of the labor requirement for the facility, for both the start-up of operations and long-term operational needs. It is critically important to understand the nature of the local and regional workforce that will support the internal operations of the facility. The availability and competitive market conditions can vary somewhat across a single metropolitan market and can vary drastically between different communities and candidate locations. Considering a warehouse with 500 full-time employees, the annual payroll costs can vary, before benefits, by more than $1,000,000 per year between locations if the hourly wage varies by just $1.00 per hour. In addition to cost, it is vitally important to understand the local dynamics of a market, including who are the new employers, who are the employers that have been in the market for many years, which companies are considered the employers of choice, and with this knowledge structure the wages, benefits, and operating conditions of a new distribution operation in the proper competitive position to be successful. Finally, it can be very helpful to access the government and other economic development resources in the local market to assist with employee attraction, screening, and training to support the required skillsets.
- Evaluate the total cost of occupancy. The “last mile delivery” for most eCommerce and direct-to-market operations is likely a money-losing operation, so it is important to maximize the efficiency of the operating costs that can vary by geography. Cost of transportation and inventory are by far the greatest costs to a distribution operation.
After that, labor costs can easily exceed real estate (leasing) costs by three to five times. The recurring costs of labor can also vary greatly with local competition, and will rise faster than facility costs as operational throughput is increased. The magnitude of these differences, and the associated risks, must be well considered and modeled before a location decision is made.
There are many considerations to incorporate into warehousing and distribution location decisions. Having a well-grounded strategy and a well-rounded team of internal and external advisors with expertise in supply chain, human resources, real estate, finance, tax, legal, and public relations can lead to a better decision, made faster, and with a higher probability of success upon execution.