Real Estate Indicators from Associate Alec Haley of HFF's San Francisco office.
With the national vacancy rate dropping to 5.3 percent in the first quarter of 2017, despite more than 220 million square feet of space delivered last year, industrial remains one of the tightest commercial real estate sectors in the country. Across the board, vacancy rates fell in nearly three quarters of all U.S. markets, as the national rate achieved an all-time cyclical low. Los Angeles, Orange County and the San Francisco East Bay areas are the tightest markets in the country with sub-two percent vacancy, followed closely by San Francisco Peninsula and Seattle at below three percent. Tenant demand for industrial space has never been higher, as pre-leasing rates for speculative projects increased by 370 basis points to nearly 50 percent. As a result, competition among developers is fiercer than ever, which has sent land prices soaring – especially in infill locations. Hamid Moghadam, the CEO of Prologis, feels that he has the answer: Build up.
The recent success of the industrial sector can be explained in part by the unparalleled growth in the e-commerce sector.
"Retail’s pain has been industrial’s gain, as e-commerce is forcing retailers and transportation/logistics firms to make significant changes to their respective supply chains," said HFF Senior Managing Director Rusty Tamlyn, who is also co-head of HFF's Industrial Group. "They are under increasing pressure to deliver consumer products and groceries into urban cities within narrow time frames. Amazon has become the largest tenant for large industrial developers/owners around the country as they continue to build out their fulfillment distribution network complemented by multi-story warehouses, locker/pick-up locations and infill service centers using AmazonFresh. E-commerce sales are only 10 percent of total retail sales, but they are growing at a 20 to 25-percent annual clip driven by the millennial generation and the theme of 'the quicker you deliver, the more you’re going to sell.' The driver of demand for warehouse space is switching from the place of production to the place of consumption."
Warehouses close to population centers are commonly referred to as “last-mile” distribution facilities. Amazon was the pioneer of this delivery model, and now more and more companies are following suit. Additionally, consumers are coming to expect either same-day or next-day delivery, leaving retailers feeling the pressure to find infill warehouse space as close to their customers as possible. This has become the single largest disrupter to the logistics industry, creating a supply chain arms race as companies try to keep up with the Amazon and other e-commerce giants who are able to reduce profit margins to gain market share. The increased tenant demand for infill warehouses has sky-rocketed land prices, leaving developers with limited development options in increasingly crowded and expensive U.S. cities. The search for efficiency within the last-mile continues to evolve as innovative strategies take shape to meet growing consumer demands.
Multi-story warehouses are common in severely land-constrained cities, including Hong Kong, Singapore and Tokyo, and, until now, have not been considered in U.S. cities. Construction costs for these warehouses are significantly higher as expected, on average surpassing $200 per square foot. However, by building upwards and effectively increasing the usable floor space per square foot of the land, developers are able to spend more on strategically located land by lowering their land basis.
Prologis, the world’s largest industrial owner in the world, was the first developer to break ground on a multi-story warehouse in the U.S. In April of 2017, Prologis began construction on a three-floor, 589,615-square-foot warehouse near downtown Seattle. Only five minutes outside of downtown, the building is uniquely positioned to service as a last-mile distribution center for e-commerce companies. The building will look like two warehouses stacked on top of each other, with truck ramps and loading docks on the second level and a third floor with lighter-scale warehouse operations.
Below is a summary of two projects that Prologis is currently working on and one that Amazon might be developing:
Status: Under Construction – Scheduled for completion in 2018
Level One – Fulfillment
Level Two – Fulfillment
Level Three – Warehouse Operations
Project Overview: The San Francisco Gateway Industrial Center is a unique industrial development proposed by Prologis that would add 1.16 million square feet of modern production, distribution and repair (PDR) space to the densely-populated San Francisco community. Currently, four single-story buildings with a total of 448,000 square feet of space are situated on the 17-acre site located on either side of Interstate 280 in Bayview. The Prologis redevelopment would be the largest of its kind in San Francisco in more than a decade. Dan Letter, managing director at Prologis, has said that the structure will be three to five stories high, helping to provide much needed density to the already crowded area.
Prologis is taking advantage of this opportunistic time in the cycle by providing San Francisco with a product class that they are in dire need of. Between 2011 and 2015, approximately one million square feet of PDR space was lost in the Mission District, Potrero Hill, SOMA and Dogpatch. Given the escalation of land values in dense areas like San Francisco, it makes sense to build denser and more efficient warehouses, which can bring PDR services closer to urban consumers. The target market/uses include light manufacturing, wholesale sales, wholesale storage, lab, parcel delivery service, internet service exchange and/or a transportation-related use involving vehicle staging, vehicle maintenance and personnel support and training spaces. If approved, the San Francisco Gateway Industrial Center will be roughly three times the size of the 100 Hooper Innovation Campus that is set to rise in Potrero Hill. Additionally, the project will help meet one of Mayor Ed Lee’s key goals of expanding good middle-class employment opportunities in San Francisco by increasing the number of jobs in PDR by a factor of eight or ten, according to Moghadem.
On the topic of innovative warehouse designs, Amazon has a patent pending on a beehive-looking structure that will enable drones to fly in and out delivering packages to its customers.
Status: Patent Pending
Project Overview: Amazon has recently applied for a patent that sheds light on how the company views the future of package delivery. Submitted in December 2015 and officially published on June 22, the patent outlines plans for a tower that can fit into an urban setting, where drones work in conjunction with humans to fulfill two-hour or same day deliveries. The patent draws an image of a building that receives shipments via truck or boat – if located close to a body of water – on the ground floor, with the upper portion of the warehouse dedicated to fulfillment windows that act as docking stations for delivery drones.
Amazon has been working on drone delivery and innovative warehouse design for years and appears confident that the miniature flying devices will be filling the air with packages in the near future. Though this project is only in the nascent stages, it is a valuable iteration of what the future of industrial commercial real estate may look like. If Amazon’s ability to upend the retail industry is any indication, the traditional industrial warehouse market may be next for a facelift.
Alec Haley is a real estate analyst in the San Francisco office of HFF and a part of the industrial investment sales team. He is primarily responsible for performing financial and market analysis, preparing offering documents and coordinating the due diligence process, developing new business and expanding the West Coast equity placement footprint. Mr. Haley joined the firm in August 2016. Prior to joining HFF, he received his bachelor’s in economics from the University of California, Davis. He is an active member of the Urban Land Institute, NAIOP and the Belden Club.