Prologis weighs retail-to-logistics conversions

As struggling retail property owners explore the opportunity to convert retail space for other uses, researchers at Prologis have measured the potential implications for the logistics industry.

Below is an edited extract from the five-page Prologis report.

Takeaways

• Retail conversions are complex. Prologis has examined many conversion candidates across a range of formats, centre sizes and markets. While challenges are many and varied, there are four main themes:
• Conversions will vary widely by retail format.

• • Conversion of enclosed malls are likely to be among the most complex and long-lasting re-entitlement projects in the coming years. Yet, excess mall supply and stress among these retailers mean conversions will be more commonplace compared with other categories
  • For open air shopping centres, conversions to logistics are likely to be small due to the better health of retailers in this category and site-specific barriers including small site sizes, inefficient geometry and zoning
  • Freestanding retail is the largest category in the US and, even though conversions may be rare due to site sizes and locations, this category should prove to be the largest source of conversions. Those on the peripheries of mall complexes are easier to convert.
  • Small-scale. Retail conversions to logistics could amount to 5-10m sq ft per year.

Background

Online spending is generating significant demand for logistics real estate.

Covid-19 has pulled forward five years of expected online sales growth into just five months. Already a fast-growth category, online sales have accelerated dramatically and are on pace to reach $340bn globally in 2020.

This growth generates substantial demand for logistics real estate. The share of US retail goods sold online is now expected to reach more than 25% by 2024. This higher revenue share will require multi-channel retailers to make new and material investments in their supply chains, including new reverse logistics to handle return volumes. The repurposing of existing retail real estate has begun to be seen as one way to address this significant increase in anticipated demand.

Considerations

There are four main challenges each retail site faces when considering conversion to logistics.

• 1. Economic, including re-tenanting as retail; other higher and better use cases including apartments; and, high costs basis as logistics alongside the frequent presence of locally competitive alternative logistics submarkets.
  2. Political, including restrictive zoning and entitlements; community opposition; and, downzoning concerns including a perceived loss of sales tax revenue.
  3. Physical, including poor reconfigurability of existing structures; inefficient site layouts/geometry; and, sites as too small for logistics uses.
  4. Legal, including reciprocal easement agreements (REAs); co-tenancy limitations; and, multi-party negotiations that prevent or elongate redevelopment to logistics.

In summary, retail-to-logistics conversion rates will be low and time frames will be long. The rate of conversion is likely to be the most active among malls, where supply is highest and the shift to online has been the most disruptive. Conversion among smaller formats is possible but will be comparatively rare due to competitive uses (retail or otherwise), site challenges and local community preferences.

Market

This trend is still in its infancy and will likely be a slow rising tide as the rezoning/entitlements and repurposing for larger scale projects play out over years. This analysis focuses only on Prologis markets (the top 25 U.S. markets). Ultimately, Prologis estimate that about 50-100m sq ft out of 7.5bn sq ft of retail – in all types from street strips to mall – will be converted to logistics over the next decade.

This estimation is based on the following assessment by retail category:

Full mall redevelopment. As the category facing the most disruption from online spending and challenged retailers, we expect conversion opportunities to be highest for malls. For the most part, Class-A and Class-B malls remain viable as retail real estate, whereas comprehensive redevelopments are unlikely. Class-C and Class-D malls face greater challenges (sales <$500/ft with owners facing heavy re-tenanting costs, often for weaker credit tenants) and full redevelopment opportunities exist. We estimate that 10-20% of C and D malls, totaling about 11m sq ft (7-15m sq ft), could be fully redeveloped for logistics use.

Mall anchor redevelopment. For Class-A and Class-B malls, anchor redevelopment, generally 80,000 sq ft to 100,000 sq ft, has begun to become feasible. Prologis estimates there will be anywhere from 60-110 malls with an anchor redevelopment among the roughly 400 malls in Prologis markets. Of roughly 200 Class-A malls, the company estimate that one in 20 may have an anchor-logistics conversion. Of the nearly 150 Class-B malls, the estimate is that one in five may have an anchor-logistics conversion. Of the roughly 50 Class-C malls, many (50% or more) may have an anchor logistics conversion in our markets. Taken together, this amounts to 85 retail-to-logistics conversions and approximately 8m sq ft in new supply in the US.

Mall anchor reuse is constrained by insufficient building specs for logistics uses. Class-B and Class-C malls often have lower clear heights, inefficient column spacing, limited capacity for dock doors and reduced load capacity on slabs relative to modern logistics facilities. These specs pose challenges and cost considerations for adaptive reuse.

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Freestanding retail will be another source of opportunities. The largest category of retail is stand-alone facilities. While experience tells us that conversion of freestanding retail will be rare, opportunities exist. Further, the sheer scale of the category means it may be the leading source of conversion candidates, although only larger sites are feasible, such as larger than six-eight acres. Prologis has already converted multiple facilities for our customers’ use, in markets ranging from New York to Los Angeles. The total trend could amount to roughly 45m sq ft over the next decade.

Conclusions

Opportunities for retail conversion vary widely by format. Conversions are likely to be most pronounced in the mall space, although as a modest sized overall category, does not translate to significant new logistics supply. The rate of potential conversions among smaller formats will likely be substantially lower. In total, Prologis estimates retail-to-logistics conversions will amount to 77m sq ft of logistics over the next decade, or 8m sq ft per year in the top 25 US markets studied.

The retail-to-logistics conversion trend will take a long time to play out. Even when strategy and economics align, conversions will not happen quickly. Conversions will trend up over time. Existing agreements will be a near-term hindrance, with considerations including REAs and co-tenancy clauses. Complex equity and debt ownership groups, plus permitting and approval considerations, post further complications and delays.

Prologis is a global leader in logistics real estate with a focus on high-barrier, high-growth markets. As of June 2020, the company owned or had investments in approximately 963m sq ft in 19 countries.

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