Warehouse conversions are far from a distressed retail silver bullet

National Partner /
Nov.November 05, 2020 03:30 PM

Warehouse conversions are far from a distressed retail silver bullet
Many questions have been presented to the commercial real estate community in recent months. How to keep occupiers safe, where to invest in a post-Covid-19 world, and how to know which tenants might default are all important considerations that many are wrestling with. But one of the most impactful decisions, for both a real estate portfolio and our actual communities, is what to do with the glut of shattered, shuttered retail space left sitting empty on street corners and in malls the country over.

America has long been over-supplied with retail space. As the Lincoln Institute think tank points out, the U.S. has 24.5 square feet of retail property per capita, compared to the European average of just 4.5 square feet per capita. Such a glut of supply makes the American market much more rapidly impacted by disruptions like the Covid-19 pandemic. This bears out in the numbers of American businesses closed due to the outbreak: over 160,000 at the end of August, according to data from Yelp.

Once these businesses close, retail buildings are left dealing with the vacant space left in their void. Finding another retail tenant in this environment is a difficult proposition, so many owners have looked at the possibility adapting these spaces for different uses. Predicting which uses that these properties are best repurposed towards is by now a familiar topic. We’ve made several comments on it ourselves. Familiar candidates include event space, food courts, or similar dining concepts, or other experiential retail options.

In another line of reasoning, oft-discussed by real estate companies, adaptive reuse evangelists are quick to point out the potential of big box stores and malls to be repurposed into warehouse space. Even before Covid-19 put all-new stresses on the nation’s delivery infrastructure, big internet retailers were working hard on improving their warehousing and delivery systems. And now, things are heating up even more. JLL reported earlier this year that half of its industrial leasing activity was going toward space related to ecommerce, and that total warehouse space will grow by a billion square feet by 2025.

This can make it tempting to view retail conversions to warehouse space as an exceptional opportunity to kill two birds with one stone, tapping a strong demand for industrial property while capitalizing on the distressed pricing currently seen in the retail world.

These projects are possible, and are certainly happening. As we discussed in our report Retail & Robots: New Trends and Technologies are Upending Warehouse Real Estate, CBRE reports 59 retail to industrial conversions across the country since 2017. In many cases, these well-located buildings offer great opportunity for retailers to deploy last-mile logistics solutions, more important now than ever with so many people wanting extremely quick shipping times. But this doesn’t tell the whole story. Real estate decisions are made based on highest and best use, not simple feasibility. And in many cases where it could be possible to convert a retail property into a warehouse, the answer may be that it shouldn’t happen.

For one thing, zoning properties toward this goal is not an easy proposition. According to Curtis Spencer, president of IMS Worldwide, a logistics real estate service provider, “The real sticking point is convincing local governments that the local mall is indeed a zombie that needs action,” said Spencer. “If that mall can be converted to last-mile delivery, all or in part, huge benefits will flow to the city. The reality is that this type of conversion will actually cut traffic in the area, it will reduce air pollution, and it will bring in sales tax revenue if it is a last-mile retail operation.” But it may not be easy to bring local decision makers to that acceptance. Many may see a real estate firm looking to transform a locally-famous mall into boring warehouse space as an opponent, not a source of community benefit.

There are physical barriers to conversion, too. For one thing, warehouses are trending toward a 40-foot ceiling height, something that not every retail property can offer. Matt Powers, JLL’s executive vice president of retail and ecommerce distribution, told us in our recent report that “I think developers are building to that higher clear height to facilitate the future growth, however the demand is so high that it’s not necessarily a driver for some companies. They’re willing to take a less than ideal, maybe a functionally obsolete building, just to have a presence to a population base.” But subpar solutions won’t be desirable forever, particularly in markets that aren’t quite dense enough to justify the “presence at any cost” approach. And even then, loading docks and parking availability are important concerns that converters need to be aware of. While none of these obstacles are insurmountable, each one adds additional costs to the overall project budget.

At a certain point with some of these scenarios, the attractiveness of retail as a cheap source of property goes out the window, and it becomes clear that non-warehouse uses are more beneficial for obsolete retail spaces in the end. Consider the option of self-storage, which is also a growing field. Many retail buildings that don’t check all the warehouse boxes, perhaps with lower ceilings, make ideal candidates for conversion to this use. According to Steven Weinstock, a Marcus and Millichap first vice president who leads the firm’s self-storage team, “This year, we are expecting about 60 million [square feet of self-storage space] to be delivered; eight million of it is forecast to be conversions.” While this quote is from early March, Covid-19 likely doesn’t limit the need for self-storage space. In fact, with more people at home for much more of the day, it stands to reason that the outbreak actually increased this demand.

The microcosm of New York City is also bearing witness to a range of creative reuse strategies, like medical space, more important now than ever, or even fitness centers for long-term investors looking past the sunset of the outbreak. “You can’t just wait until [Covid-19] is behind us, said CBRE retail broker Michael Kadosh, based in NYC. “You want to be ready, and you want to do as much as you can as long as there’s a pause. Think about if we have a vaccine in the spring. It may take some time for people to feel comfortable going back to in-person classes.” When they do, though, the investors and operators who are primed and ready to meet their resurgent demand could stand to win big.

While warehouse conversions are certainly a menu option for the huge amount of obsolete retail space around the country, they aren’t always the best choice. They need to check some stringent physical design boxes, and then pass zoning hurdles, while still working better than other uses from an investment perspective. The demand is there, no doubt, but in reality there are often better uses for these distressed properties. [Propmodo]


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