Published October 19, 2017
Along with the expanding strong interest in industrial real estate, especially that close to population centers, has come more and more discussion of rising warehouse space costs. According to real estate services firm JLL, rents on average for smaller warehouses closer to metro areas across the U.S. have risen this year to a record $5.40 per sf.
While rental rates vary across the nation, some higher and some lower, depending on the metro area, the average rate of $5.40 is considered by many to be a major concern. This rate is at a record high for many renters and lessees, who for years have been more focused on facilities in suburban or rural areas.
In our consulting work for many types of client retailers, wholesalers, CPG’s, and 3PL’s, we come across various rates that change as supply and demand factors change over time. There is no question that in many of today’s eCommerce markets, where online sellers want to get closer to consumers for final product deliveries, demand exceeds supply. This, of course, drives rates up. The overall eCommerce industry is under-supplied and new construction takes time to catch up. Many properties are 100% leased prior to their completion, depending on their locations. JLL has also reported that the national average vacancy rate is at a remarkable 5.2%.
Costs are important, of course. Most sellers are not profitable in their eCommerce business and are under stakeholder pressure to keep costs down to protect the often low (or negative) margins for fulfilling online orders. When rent is evaluated as a percentage of the total logistics costs of running an order fulfillment facility, the space rental costs percentages amount to only single digits. Whether rent is at $3 or $10, its percent of total operations costs ranges anywhere from 3% to 9% for a warehouse providing fulfillment with medium levels of automation. When we consider the major cost drivers of labor, information technologies, maintenance and utilities, equipment and supplies, shipping and freight, insurance, material handling, security, parking, offices, and other costs, the total monthly expenses to operate a $200K sf fulfillment center, using a 3PL, can easily exceed $1.5M. Clearly, rent at $3-5.35 per sf is a small item in this total cost. Negotiations to reduce this amount are not making a material difference in the operation.
Facilities for efficient eFulfillment are requiring at least the medium levels of automation, as highlighted above. The manual operations of receiving, putaway, picking, sorting, packing, and shipping are less capital-intensive, but are more operationally expensive, slow, and error-prone. Sellers are often learning this difference as they analyze their total costs against the revenues for eFulfillment. It is no surprise that the PwC survey earlier this year showed that 90% of sellers report that they earn negative margins on their eFulfillment operations.
The summary point is that, while warehousing lease rates are increasing, especially in urban areas due to market forces of supply and demand, they represent only single-digit percentages of the total costs to operate an eFulfillment facility. What matters significantly more are three critical success factors:
1. Location, location, location: is the facility located in the right place for fulfilling orders for the sellers or tenants? Will it enable the facility mission in the company’s supply chain strategy to be achieved?
2. Facility size, height, structure, etc.: is the facility built and ready for eFulfillment, with electrical capabilities, ceiling heights, and other requirements in place? Are entry/exterior requirements, interior/utility requirements, and office space, suitable?
3. Total operating costs: is the facility able to be designed, planned, ready for at least medium levels of material handling equipment, and scalable; are total operating costs estimated effectively?
If these three factors are favorable, the lease costs should not be the deciding factor. Companies needing space should consider the primary factors that make the facility attractive, not just the space costs themselves.