Retail to Industrial? That Depends on the Location

Doing the retail-to-industrial conversion groundwork.

October 1, 2020 | by Nils Kok Ali Ayoub

The demise of brick-and-mortar retail as we knew it started more than a decade ago with the ascent of online shopping. The COVID-19 pandemic only accelerated the downward spiral. From shopping malls to neighborhood retail centers, from the well-known strips of retail to high-end Main Street retail, landlords of all stripes are feeling the pain. Look no further than the delinquency rates on mortgages collateralized by retail CMBS (12%) or the stock prices of retail REITs, which are down almost 40% YTD.

But as the Dutch saying goes: “one’s dead is another’s bread.” Industrial and logistics assets have fared phenomenally well over the same decade, and even throughout the current crisis. Riding the growth of online retail, warehousing space demand has been on a tear – for both big box properties and smaller buildings closer to city centers. Indeed, the stock prices of industrial REITs are up by 12% YTD, on average. CMBS delinquency rates on industrial assets are merely a blip: 0.5%.

From Retail to Industrial?

Investors, lenders, cities, and local communities are grappling with the oversupply of retail space. The U.S. has a whopping 25 square feet of retail space per capita, compared to just 5 square feet per capita in Europe.

And yet, investors and lenders in the industrial space are desperate for more supply. Could there be a win-win in repurposing some of the redundant retail stock into logistics facilities? Something similar has happened before. Oversupply of office space has been turned into hotels and multifamily apartment buildings in the past. Amsterdam in the Netherlands was the poster child, reducing vacancy rates from near 20% to a current 5%. (A rebound in demand helped a bit along the way.)

Much has been said about the (im)possibilities of converting retail into warehouse space. Prologis, one of the world’s largest owners of logistics assets, is somewhat skeptical of the prospect of large-scale retail transformation.

Prologis’s skepticism is centered on four issues: economic (there may be better use cases, such as multifamily for repurposing the asset), political (zoning), legal (equity and debt holder objections), and physical. The last, in particular, focuses on shopping centers with space for large anchor tenants – traditional malls.

The current need in the logistics supply chain, however, is for smaller spaces. These locations are suitable for so-called “last-mile” distribution and potentially even customer pick-up and returns.

The recent news is about Amazon setting up warehouses in the malls of Simon Property Group, one of the largest retail REITs in the U.S. That begs the question: who else owns retail assets that would potentially be interesting for conversion into logistics facilities? And where to find these assets?

It Starts With…Location Location Location.

Before focusing on the structural aspects of converting a mall into a logistics facility, which needs on-the-ground inspection, an investor first needs to determine which sites make the most sense. The key to answering the question of which retail asset is suitable for repurposing into logistics lies once again in the old real estate adage: “location location location.” The quality of a location from a logistics/delivery perspective is critical to determining demand for the goods shipped from a last-mile facility.

Interestingly, there is significant overlap between what a retailer wants and what an online shop needs: customers and their disposable income. Looking at the almost 13,000 retail locations owned by U.S. REITs (including Main Street retail, well-known districts such as New York’s 5th Ave, malls, and local retail strip centers), we can analyze the suitability and desirability of each asset using demographics, supply, and other location data.

For example, take Realty Income’s 250,000 square-foot Shelbyville Road Plaza mall outside Louisville, Kentucky. In our analysis, we calculated catchment areas reachable within 15- and 30-minute drives for this and every other retail asset (including the effect of each area’s average congestion delays). We then looked at households and household income within each catchment area. (See image 1 below.)

Will demand support this location?

For Shelbyville Road Plaza, a 30-minute drive reaches 485,000 households, with a median income of $39,000. The aggregate household income that can be reached in 30 minutes from the mall is about $38 billion. That headline number sounds impressive, but we need to compare it to existing industrial/logistics assets across the U.S. Is this location suitable for logistics purposes?

To enable a quick comparison, GeoPhy developed a “Last Mile Score.” This score takes into account the aggregate household income, the number of households with annual income >$100,000 within the catchment, and other metrics. Higher scores indicate more attractive last-mile distribution locations.

The Louisville asset has a Last Mile Score of 59, making it roughly average across all industrial assets in the U.S. Note that overall, retail assets perform quite well on the Last Mile Score with many REIT-owned retail assets scoring above average. (See table 1 below.)

Can you staff it?

Of course, the suitability of a location isn’t just dependent on the potential demand for goods. Another important factor is the availability of labor. Pre-COVID, finding employees with the right skillset was increasingly difficult for industrial/logistics providers. With recent announcements of hiring sprees by Amazon and Wal Mart, there seems to be no end in sight for demand for logistics jobs.

Going back to Shelbyville Road Plaza, the labor force counts 649,000 people within a 30 minute drive (the labor force participation rate is 63%) and 910,000 people within 60 minutes. Of those people in a 30 minute drive, 113,000 are already employed in Production, Transportation, and Material Moving jobs (PTMM). These are the employees a newly established logistics facility would be competing for. We compared the availability and suitability of labor for Shelbyville Road Plaza to the remainder of the country using the GeoPhy Labor Score. Here, the asset scores 77, which ranks it quite high as compared to all industrial assets across the U.S. (See table 2 below.) Again, higher scores indicate more attractive locations from a labor perspective.

Diligence from a distance

We are scoping this location’s suitability, of course, from a higher-level perspective. Before conducting a more in-depth assessment “on the ground,” we can conduct further desktop assessments of the Shelbyville Road Plaza’s desirability for logistics purposes. Without jumping in a car, we can analyze its amenities such as public transportation (frequently used by logistics company employees) and by “dis-amenities” such as crime.

Data from GeoPhy Evra shows the presence of a bus line right next to the shopping mall. The location does have some crime, but the rate of crime around the mall is quite low compared to the national average: 174 violent offenses per 100,000 people, compared to 531 per 100,000 nationwide. (See images 2 and 3 below.)

These are just some of the hyperlocal stats that can be used to assess the quality of retail assets for conversion to logistics/warehousing facilities. Many other important and relevant characteristics – such as distance to highway ramps, as well as potential ports and airports – can easily be assessed and tracked, without the need to actually visit the asset. Such “diligence from a distance” is a first step for real estate analysts. Whether during the COVID pandemic or in the years after, data-enabled desktop analysis is increasingly useful to investors and lenders looking for investment opportunities and assessing risks in their portfolios.