Few empty offices likely to transition to logistics centers, Prologis says

Expanding e-commerce demand and the incremental inventory and space it takes to run a successful e-fulfillment platform has pushed logistics real estate availability to new lows. But don’t expect an abundance of vacant office spaces to bridge the gap, according to a Monday report from logistics real estate investment trust Prologis.

The company’s research division concluded in a report that differences in building requirements and tough zoning regulations would lead to minimal conversions of office space to logistics centers. The group estimates between 40 million and 80 million square feet of office space could be properly converted over the next decade.

That’s less than 1% of the existing logistics space in the market and less than 3% of annual new completions. The number is also estimated to account for less than 10% of the additional space required to store the higher inventory levels needed to avoid future supply shocks and supply chain disruptions.

Prologis (NYSE: PLD) said logistics property vacancies hit an all-time low at 3.4% in the fourth quarter while vacant offices surged to 16.6%. The trend for office space has worsened throughout the pandemic as employers have implemented work-from-home options. The percentage of empty offices has increased 440 basis points since the fourth quarter of 2019.

“Surging demand and rising barriers to new development have collided to create an extreme scarcity of logistics space where it’s most needed,” the Prologis Research report read. “This contrast might suggest high potential for office-to-logistics conversions, but challenging economics add hurdles to the land availability, regulatory and competitive fronts.”

The report cited several reasons why most of the empty space won’t be converted.

Logistics centers require much larger land parcels, usually at least 8 acres. The group said in its top 25 markets in the U.S. there is 1.2 billion square feet of office space on the ground floor that meets the criteria for conversion. But when eliminating high-rent, Class-A spaces and accounting for increased zoning hurdles and smaller land parcels, only a small fraction is likely to be converted.

“Offices have limited reuse potential as logistics facilities and must be demolished, adding to an already complex process, lengthening development timelines and boosting the rents needed to financially justify conversion.”

The undertaking in many instances is simply too costly. A demo and rebuild extends carrying costs, brings rezoning risks and often requires the removal of many different tenants. However, the report noted that office sites with only one tenant are “more attractive targets.”

“Only locations that can achieve premium rental rates justify the high cost to convert,” the report continued. “Large, coastal markets with high land values and limited logistics supply are likely targets, and include the suburbs of New York, Southern California, San Francisco and Washington, D.C.”

The report said converting office properties to logistics facilities has a bit of an easier path than converting shuttered shopping malls and retail spaces. Office conversions may not see the same level of “community resistance” as they aren’t in residential areas and are sometimes already located in industrial zones. Also, the loss of sales tax revenue isn’t a concern.

However, the “implied loss of whitecollar jobs” in high-cost markets was noted as a risk.

“Despite potential opportunities, the office-to-logistics conversion trend is likely to be minimal,” the report concluded. Areas with high land values and minimal competition from other logistics centers present the best opportunities.

“New supply from this source will take time to come online because resolving existing agreements, demolition, rezoning, entitlement, permitting and approvals take much longer than a typical greenfield logistics development.”

Prologis Ventures is an investor in FreightWaves.

Click for more FreightWaves articles by Todd Maiden.

• ArcBest sees record Q4 fundamentals carry into Q1
• Hot LTL market carries into 2022
• Trucking, logistics companies unite to raise money for Ukrainians

Watch: Middle mile primed for autonomous trucks

Source: https://www.freightwaves.com/news
Editor: Todd Maiden