Amazon and the changing face of industrial property

20 June 2018

Amazon’s entry into Australia at the end of 2017 has been heralded as a positive force for change – and a catalyst for efficiency improvements within the supply chain. Amazon’s influence will have implications for the way that the retail sector uses warehousing and for industrial property markets more widely. Here Ross Lees, Trust Manager for the Centuria Industrial REIT, looks at the effect of Amazon’s entry so far – and asks whether what we are seeing is a revolution, or merely an evolution in the way we shop, and what all this ultimately means for industrial property.

Ever since announcing its intention to set up shop in Australia, Amazon has been the name on everyone’s lips. Their first distribution centre opened in Dandenong at the end of last year and a second operation centre has since been announced in South West Sydney. Property investors are asking themselves how Australian retailing will be affected – whether we are witnessing the slow death of traditional retail, as e-commerce becomes ever more sophisticated and prevalent – and, most importantly, what this means for property markets.

As the manager of a large industrial property portfolio, I am asking myself the same questions: “What will the real effect of Amazon on the retail market be, and what are the implications for our portfolio?”. These are important considerations, because even if Amazon’s effect is felt more on prices and margins than on overall sales, which seems likely, there may still be a flow-on effect to property markets. Whether retail landlords suffer, and industrial landlords benefit in direct proportion, or whether the status quo remains largely unchanged is the big unknown.

For my part, the answer lies somewhere in the middle. The real question is not whether Amazon has the power to completely disrupt online retailing in this country, but rather what the effect of the rise in online shopping, including the entry of the world’s largest retailer1, is having on industrial property markets.

Demand for traditional retail space will fall as e-commerce grows, but it is also true that e-commerce retailers, like Amazon, require space too, albeit of a different nature. This means that investors and landlords are right to think seriously about how to tailor their portfolios to respond to a changing retail landscape.

And it is changing, fast. According to the NAB Online Retail Sales Index the total Australian online retail market was worth $24.2 billion last year, up almost 12% from 20162. But what is more interesting, when it comes to the impact of Amazon, is the acceleration in the shift from traditional retailing to online retailing. According to the 2017 eCommerce Industry Paper, online spending grew 6.9 percentage points more than spending in bricks and mortar stores3, up 10.2% compared with just 3.3% for traditional spending.

The online share of our retail spend is growing, and growing quickly, and there’s no reason to expect it will slow anytime soon. It isn’t, however, consistent across states. In cities like Canberra, where traffic is light and parking plentiful, going to the shops in person is easy – whereas in Sydney, where traffic is heavy, parking impossible and crowds large, it’s easy to understand why online shopping is more popular, and growing more rapidly.

So what changes are we already seeing in industrial markets as a result of online shopping and how should investors position their portfolio?

The good news: the move from shop to shed requires more industrial property

On the one hand, as online purchasing increases, demand for warehousing also increases – a phenomenon we refer to as the move from shop to shed. This is because the vast majority of online purchases pass through a warehouse or fulfilment centre before being dispatched to the consumer. And it makes sense that this demand for warehousing will underpin demand for industrial property looking forward.

On the other hand, the type and location of the warehouse favoured by retailers is likely to evolve in line with consumer expectations of delivery times. Three years ago, 63% of consumers said that 2 days was a fast delivery, whereas today over 96% consider ’same day’ as fast delivery, and these expectations are having a real effect on sales. Online retailers report that most sales are abandoned at the checkout stage if expected delivery is two days or longer – providing strong incentive to respond. This means that retailers need to look to speed up the delivery cycle.

The challenge: shorter delivery times

There are two things that can help in this regard. If success in online retailing requires short delivery times, the flow-on effect is that processing centres must be located as close to the consumer as possible. And we are already seeing a downstream effect on demand in industrial markets. Two smaller or medium-sized facilities (20,000 sqm or less) located in different markets suddenly become more attractive than one large facility (80,000 sqm) located further away.

At the same time, building new facilities in locations close to consumers is often not possible, because greenfield land in centrally-located, high-demand infill areas is very rare. This means that adapting existing properties is key, because location is everything. Proximity to a motorway access point, distance from the CBD; these are the kinds of factors that make the difference to delivery times – and therefore to sales volumes in online retailing.

In addition to location, there is frequency of delivery. If the growth of online retailing can be described as a move from shop to shed, what we are now seeing in the push for fast delivery is a move from the big truck to the small, nimble white van.

The role of technology and its effect on industrial markets should not be underestimated

The evolution of technology is changing more than just retailing. Manufacturing has also evolved substantially as a result of more and more sophisticated technology. Automation has become more prevalent, which is positive for consumers, but the flipside is that the cost of technology is higher, and requires large financial commitments from businesses.

The effect of these higher costs can be seen in the length of lease terms. Businesses are not willing to invest in expensive technology unless they are confident of their financial strength, and expect to be operating for the long term.

Fifteen years ago, a 5-year lease was considered to be a long lease in industrial markets, and 3 years was far more usual. Now the average lease length in our portfolio is 5 years, and leases of 7-10 years are not uncommon. This is certainly a positive for industrial landlords.

The bottom line? Amazon is more a symbol of the shift to online retailing, than a fundamental game changer

To date, Amazon has taken a lease on a warehouse in Dandenong, Victoria and announced recently that it will lease a new 43,000 square metre fulfilment centre in Moorebank in South West Sydney. This second centre will become operational in the second half of 2018. This take-up of space is important because it is evidence of Amazon’s commitment to the Australian market, but when seen against the backdrop of the approximately 600,000 to 800,000 square metres of new warehousing built in Australia each year, it is not as significant as some may expect.

Whether or not Amazon’s direct demand will grow so quickly that industrial property markets will be fundamentally affected is difficult to predict with any certainty, but its journey in Canada is a case study that offers some insight.

Canada is good proxy for Australia – the population is larger, at around 36 million compared with our 24 million, but its demographics are similar and its relative physical size and population density similar. Given this, it would be ambitious to believe that Amazon will achieve a greater rate of penetration into the Australian market than it has in Canada.

Currently, Amazon occupies 12 industrial facilities in Canada, adding up to a total of around 300,000 square metres of warehousing. Yet, when we consider the 600,000-800,000 square metres of new warehousing built each year, we can safely say that even if Amazon were to take up the same amount of space that it currently occupies in the larger market of Canada, it would occupy only half of the new warehousing already being built here annually.

In conclusion, there’s no doubt that the entry of Amazon into the Australian market is a significant event. However, in my view, it is better seen as evidence of an evolution in retailing that is prompting demand for space change: affecting traditional retail space and industrial property markets alike.

Demand for warehousing in different forms and in more central locations is growing, and in this respect, portfolios which invest in smaller warehouses – located close to consumers, with easy access to transport and the CBD – are likely to be the winners over the next few years. Amazon is certainly at the centre of this evolution in retailing, and its effects will continue to be felt to a degree in property markets, but whether it is not fundamentally changing industrial markets on its own.

2January-December 2017; $21.65 billion between January-December 2016
3for the 12 months to December 2017