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Emerging Trends Say Get Long Industrial Real Estate

Posted on April 19th, 2011 by John Reeder

In the past few weeks I’ve been looking at things like expansion plans of big box retailers (here and here), relative performance of online retailers versus brick and mortar retailers, and then yesterday I looked at the Digital Realty Trust and their near term expansion plans.  I think it all adds up to a future where investors should be long industrial real estate.

The movement of the sale of goods from profile/image-important locations to logistically important locations, along with the migration of our stored data/media to the cloud should provide wind in the sails of the industrial market going forward.  This is not a departure from the importance of location/location/location.  Rather, it will be a redefining of what is important in terms of location based on the two trends that are emerging.

Change to Retailing

We know that Wal-mart will be shifting its expansion plans away from their Supercenters in favor of neighborhood markets.  They aren’t abandoning the Supercenter format, they’re just mixing in more neighborhood markets.  Wal-mart isn’t going away.  They have an extremely powerful marketplace advantage through their physical locations.  But their plans to change the way that they use real estate, along with the emergence of retailers like Amazon, mean that our notion of the retail powercenter will likely be tweaked in the coming years.

Retailing can largely be done from an industrial big box now.  Amazon has no retail locations to speak of.  They have only warehouse distribution space.  Below is a graph that shows Amazon’s revenues since 2007.  They’ve more than doubled in that time.

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However, it’s important to note that while Amazon is showing strong income growth, their share of the retailing pie is small for now.  They are less than 1/10th the size of Wal-mart.  So if you are a real estate investor, you have time to plan for the future.  Amazon is merely the canary in the mine… the early warning sign of what’s to come.

Move to the Cloud

Below are two graphs that show revenues for Rackspace and Salesforce, two leading cloud companies.  Both have doubled their revenues since 2007.  Noticing a trend?

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What kind of real estate are cloud computing companies likely to use?  They’ll some amount of office for their staff and corporate headquarters, but primarily they will use industrial space in the form of data centers.

I discussed yesterday other changes that are coming that will only add to the move to the cloud. 

Movie rental stores appear to be a thing of the past.  In the near future movies will be rented from Redboxes and Netflix.  In the slightly more distant future they will be streamed.  Streaming will require that they are stored online, and that will require data centers.  Similarly, music stores are already obsolete (unless you have an ironic moustache and a fixed gear bicycle, in which case you no doubt know of a music store that beats the experience of getting your music online).  For now you might get music from Apple, or by stealing it.  In the future (or now if you choose) you will stream your music.  That will require online storage.  Online storage = data centers.  Books are moving online.  The web is exploding in content (this very post is a small piece of that explosion).  The pictures of your family vacation posted to Facebook require storage.  Your small business data will be hosted online, in the cloud, and it will be cheaper than having an IT guy come to your office once a month to maintain your server.  Education will be dominated by online video, which will require storage.

Tweaking Location, Location, Location

So what is to come?  I said that we aren’t abandoning the 3 L’s.  We’re just tweaking them.  I think retailing will rely more heavily on logistically important industrial locations.  The move to cloud computing will be different though as cloud companies will seek industrial locations where they can be geo-diverse, keep their costs low, and avoid service interruptions that natural disasters might bring.

Let’s focus on the change in land use that the changes in retailing will bring.  First, I think that some big piece of retailing will be online only, administered from big box distribution hubs.  That’s already happening.  But that won’t be all of retailing, and it won’t be the only part of retailing that moves to industrial space.  We know that Amazon can sell all of its goods with 100% industrial space and no retail space.  I think the future will be somewhere between where we are today, and the pure-industrial future of retailing that Amazon embodies. 

What’s more likely I think is that we see a hybrid model like Wal-mart is planning on rolling out where you can order online and then pick up that same day.  Let’s say you have your weekly grocery list that includes your core items.  The online store will remember your weekly order and also suggest things that you might be complimentary to your list, and where you can also add whatever else you might need.  You place your order and then you go through a drive through where you can have your box of items loaded into your car.  What’s important about this is that it doesn’t require a parking lot.  It requires a drive through.  So you swap out some of the parking lot in these locations for more warehouse space.  You’ll have enough warehouse space in these locations to serve a significant part of the long tail, but not all of it.

The move to the cloud will affect land use in a different way because in part it will disrupt the media retailers that I mention above, and it will also disrupt brick and mortar education facilities, in favor of industrial locations.  But the constraints in terms of locations will be driven by different forces than the move to online retailing.  In the case of online retailing there will still be an important proximity to population that will be required.  In the case of the move to the industrial cloud, only access to the internet will limit location.  Access to the internet and a host of other location criteria like low incidence of natural disasters, cheap electricity, and low ambient temperatures.  If you put these constraints in a map of the U.S. it looks like this:

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Hello Salt Lake City, Boise, Cheyenne and Colorado Springs!

Near Term Opportunity

Here’s the actionable investment intelligence.  Industrial real estate is becoming oversold.  There’s such a hangover from the supply-chain-reconfiguration bubble of 2007 that industrial real estate is starting to look attractive again.  Vacancy rates are high, but largely due to overdevelopment, not contraction in space used.  That will self-correct over time.  Also, a lot of the industrial real estate is owned by public companies who are often under near term earnings pressure and don’t have the luxury of thinking long term if they want to support their share prices.  You could also think of it another way:  In 2007 industrial real estate became heavily overbought on the story of the supply-chain reconfiguration.  However, since that time the change in retailing has advanced and the move to the cloud has also advanced, and yet you can now buy industrial for cheaper than you could in 2007. 

There are opportunities out there, and I believe that the long term trends outlined above will favor investors willing to get long industrial in this climate.

Disclosure: I’m just a broker/blogger and really you should do your own homework before you do anything.

April 19th, 2011 | Category: Uncategorized

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