The industrial real estate market has grown at an unprecedented rate, buoyed by e-commerce growth and increased safety stock during the coronavirus pandemic. With more and more shippers and 3PLs seeking warehouse space to catch up with e-commerce demand, predicting accurately the amount of real estate needed to store and prepare goods for transport has become a fool’s errand.
Making matters more complicated is real estate being a long-life asset that most brokers are incentivized to lease for terms of five, 10, or even 20 years. At the end of the day, the decision to lease industrial space represents a large fixed cost investment, and can be a meaningful barrier for new logistics providers who often need to make a leap of faith when planning real estate. Inevitably, many will find themselves with residual space that is underutilized. What's more, if the tenant goes under, the property owners are often left with an empty warehouse and no tenant to pay the rent.
Dealing with Underutilized Dark Space
Today’s warehouse owners have a few options to remedy this challenge. One is to “go dark,” which refers to a common legal provision that allows retail tenants to temporarily cease operations at a given location, cutting their overhead significantly but keeping them on the hook only for bare minimum rent expenses. This is a somewhat complicated legal scenario whose primary benefit is to stop the financial bleeding on the tenant’s side.
Historically, going-dark provisions were put in place to allow for temporary closures in the event of a natural disaster or other unforeseen event. In the meantime, tenants who are considering going dark should weigh the pros and cons carefully. For example, the going dark provisions in a lease are usually all or nothing, meaning that the tenant cannot choose to go dark in only part of the space they lease. This is because the landlord needs to be able to count on the rent from the space, and if the tenant goes dark in only part of the space, it may create an unsafe or unsightly condition for other tenants in the building.
Alternative options are proliferating: Many warehouses today are able to sell power back into the grid using more energy-efficient solar power systems. Others allow other businesses to use the warehouse for storage or production. Finally, the owner could use the space to host pop-up events or to create a co-working space. But these solutions are difficult to achieve at scale.
Another option is to use new services that let warehouse owners sub-lease their space to other retailers or 3PLs. With online sub-leasing services, warehouse owners are able to generate additional income and improve their overall occupancy rates without resorting to dramatic decisions about their lease agreement.
However, there are some drawbacks to this approach. First, it can be difficult to find tenants who are willing to pay the same rate as your current lease. Second, you may have to make significant sacrifices in terms of space and amenities in order to accommodate a new tenant. Finally, if your current tenant decides to leave, you may be left scrambling to find a replacement.
A More Active Solution: Sortation
Instead of simply leasing out that extra space for a flat fee, today’s warehouse owners can take a more active role in managing their dark real estate—by actually sorting packages.
By serving as an active host for other shippers and retailers, the warehouse owner is taking a more active role in generating revenue from their residual space. Instead of simply subleasing it for a flat fee, they can increase their margins by doing sortation for multiple shippers. This potentially creates advantages for the shipper because they can save on delivery costs by having the fulfillment center operator do the sorting for them.
We have already seen similar innovations along the last mile. Take online grocery shopping as an example. In order to keep up with increased online ordering, grocery stores and last-mile carriers have started using "dark stores." Dark stores are warehouses that are used to store groceries and other items that people might order from an Instacart or DoorDash. These “stores” (in quotes because they are not generally open for actual browsing) are typically located in urban areas, close to the digitally savvy customers they serve. This allows for quick and easy deliveries, as the items do not have to be shipped from a store that’s farther away. Dark stores also allow for a greater variety of items to be stored, so that customers can enjoy more options when they are shopping online.
Ultimately, there are a number of creative ways middle-mile warehouses can maximize profit on their real estate holdings. But offering sortation services is perhaps the most sustainable of all. When you take a more conventional approach, such as sub-leasing your space, you are effectively giving up control of that space and may need to accommodate the needs of your new sub-tenant. But more critically, when you sub-lease your space, you are also giving up the potential to earn income from that dark real estate. If your sub-tenant is successful, they will be the ones generating income from the dark real estate, not you.
By offering sortation services, the warehouse operator can generate additional income without having to give up control of the property. Additionally, by sharing labor and equipment, sortation services can help to improve the efficiency of the existing warehouse operations. Having sortation as a core competency can lead to more customers and more business.
As the demand for e-commerce and onshoring of goods continues to grow, warehousing and fulfillment are becoming increasingly important parts of the supply chain. The decision to lease an industrial space is a large investment and can be risky, especially for new logistics providers seeking space during this period of high demand and rent growth. By taking advantage of dark real estate in their warehouses, warehouse owners can make sorting packages a core competency. This not only helps to generate additional income, but also serves a compelling need in the logistics space.