The pandemic-driven surge in e-commerce and stress on the retail real estate market has spurred much speculation regarding converting vacant retail space into distribution or last mile facilities. The general public seems to think this is a sure thing with many people assuming much of the vacant retail space will eventually be warehouse or industrial space. However, converting retail space to industrial is extremely complicated and not necessarily the best option for retail owners.
There are few case studies on the topic. Conversion rates for this kind of transformation are still very low despite the sub-5 percent vacancy the industrial market saw pre-pandemic and the 5.3% vacancy seen in Q3 2020. The instances of retail-to-warehouse conversions are a mere sliver in the overall amount of new industrial deliveries.
Since 2016, there has been 1.4 BSF of new industrial supply, of which 1.2 BSF was logistics, according to Cushman & Wakefield Research. In terms of this recently delivered industrial supply, retail-to-warehouse conversions account for 1.2 percent of total industrial deliveries and 1.3 percent of new logistics supply.
When we consider the bigger picture, what’s significant is retail-to-warehouse conversions make up less than one-tenth of one percent (0.073%) of the total industrial inventory and just one-tenth of one percent (0.107%) of existing logistics inventory. Prologis stated in a report in September 2020 that with some 250-260 MSF of annual completions in Prologis markets, they estimate retail conversions will amount to less than 3% (2.9%) of annual completions over the next decade.
A major deterrent to these types of conversions lies in community needs. What does the community want in that location? Retail real estate owners and investors are taking a hard look at these assets with a focus on creative redevelopment. Potential opportunities for defunct retail centers and malls could include multi-family, education, experiential retail, food halls, healthcare, concert venues, and more.
Furthermore, converting retail properties to industrial or logistics facilities is a rather difficult task. Our Cushman & Wakefield industrial experts examined this phenomenon and provided a rundown of the challenges involved, which fall into four categories: community acceptance, location, lease considerations, and building design.
Empty retail facilities equal lost jobs and tax income for a community, so it may seem intuitive to think residents would want these vacant buildings filled. But many people associate warehouses and industrial buildings with noise, pollution, congestion, and eyesores, and these attitudes can be detrimental to retail-to-warehouse conversions.
Community concerns include:
- Proximity to residential neighborhoods and schools
- Traffic congestion
- Noise pollution
- Environmental pollution
- 24-hour operations
There are, however, strategies to mitigate these impacts. Limiting the hours of operation, screening truck court lighting, and banning air braking and engine idling within a specified area around a community can be all it takes to quell community worry, especially when the property was previously a retail center. Electric vehicles can also make a difference because they reduce noise and emissions.
In addition, educating community residents about the reality of these facilities can be a critical tactic. When neighbors are informed about the safety precautions developers adhere to, the environmental considerations enforced, and the economic impact these facilities create locally in both jobs and tax revenue, community concerns are eased and can result in one less barrier to conversion.
As with most real estate, the location of a potential retail-to-warehouse conversion can make or break the development.
Questions to consider include:
- Demand – Is there a need for an industrial warehouse, distribution center, or last mile delivery facility in the area?
- Zoning – Can zoning be changed from retail to industrial?
- Neighborhood restrictions – Will existing neighborhood Covenants, Conditions & Restrictions (CC&Rs), including go-dark prohibitions or surviving retail neighbors, cause hurdles to conversion?
- Proximity to arterial and interstate access points – Can vehicles and products be moved efficiently to and from the center?
- Population – Is the location near a densely populated urban area that is effective for a last mile delivery facility?
Most retail tenants won’t benefit from having a warehouse as a neighbor, nor will many landlords be able to resolve the lower rents historically paid by warehousing tenants.
Elements to consider include:
- Co-tenancy lease clauses – Most retail leases have stipulations regarding co-tenancy, which include rules on what other tenants and business types are allowed within a mall or retail center.
- Loss of retail foot traffic – Tenants rely on the overall foot traffic of consumers within an entire mall or retail center. So, filling a large retail space with a non-retail tenant could decrease visitors to the center.
- Potential loss of lease revenue due to lower rates for warehouse space – Landlords need to weigh the pros and cons of leasing to a warehousing tenant, with the understanding that alternative tenants, like healthcare, daycares, etc., could command a higher rental rate.
While it sounds simple, renovating a retail building to work for an industrial user is not a small task. There are numerous obstacles to overcome, both inside and outside of the four walls.
Elements to consider include:
- Adequate dock doors and/or truck bays
- Floor loads not capable of supporting machinery and racking, leading to concrete disintegration and costly repairs
- Floors that aren’t level and flat enough for equipment and racking systems to function properly
- Floor joints that can cause rocking and spalling
- Column spacing that is usually too tight for efficient racking
- Ceiling heights that limit vertical stacking
- Sprinklers that often need to be raised
- Odd buildings layouts that don’t efficiently maximize space
- Lack of utilities or power to adequately facilitate automation
- Maneuvering room for trucks to turn around or circle a building
The Silver Lining
Having design challenges in a building doesn’t necessarily mean there aren’t any benefits. Retail typically is equipped with large parking lots, which afford room for truck parking, truck maneuvering, and possibly even room to expand. It is also likely that traffic patterns surrounding a retail center are already engineered to limit congestion and are typically accessible to population density, interstates, and advantageous distribution corridors.
Big Box retailers can also be an easier sell. It is likely retail-to-warehouse conversions for Big Box retail centers could be easier than converting a mall. Big Box retail is typically square or rectangular, often has taller ceilings, and may not receive as much resistance from a community. It can be easier for the public to digest the conversion of a home improvement store into a warehouse versus the conversion of a high-end fashion boutique. Malls are typically more challenging to utilize because they are irregularly shaped and span multiple floors.
Is This Really Happening?
Although it isn’t widespread, retail-to-warehouse conversions are happening. But it isn’t necessarily a game changer for industrial – or for retail landlords. While provocative, this trend will likely only grow if developers are able to generate a successful conversion formula that balances the cost of community acceptance, location, and the design requirements of these unique transformations. Also, retail landlords and investors are transforming the industry by reshaping the vision of what retail can be. Creative adaptive reuse of vacant retail space is pushing the prospect of converting assets to warehouse further down the list of options.