Property income, value and investment yield in the last mile

As headlines focus on record last mile real estate asset sale prices and surging lease rates due to macro-economic & geopolitical issues, supply chain disruptions and highly competitive sub-market conditions among investors and users, we examine strategies for maximizing investment yields and property values. We discuss income & expense line items, ‘stacking’ uses and services to maximize revenue and how new business models may be needed to increase investment yield.

Revenues & expenses: changing line items for property owners and tenants

Starting with the tenants first, retail or e-commerce (e-comm) businesses for the purposes of this discussion. Online retail sales were already steadily growing as a percentage of total retail sales prior to the last 24 months. Headlined by the Amazon juggernaut, acceleration and market share of online sales was also a boon for many other retailers with both bricks & mortar (b&m) stores and existing e-comm websites. Most omni-channel retailers hadn’t previously broken out b&m versus e-comm sales revenue in financial reporting. Dramatic increases in online sales, coupled with reduced b&m foot traffic sales, throughout the sector presented an opportunity for retailers to retool their digital marketing, advertising and sales strategies to compete in the near term and sustain existence as a going-concern in the long term.

Retailers able to generate stronger sales through multiple channels are now more meaningfully able to bifurcate revenue (and accompanying expenses) to the extent that some household names established from vast b&m footprints are splitting e-comm units from b&m units altogether. As sales are being generated through various channels, businesses are spending money differently to generate those sales. Occupancy costs for real estate are different, payroll, advertising, marketing, inventory, supply chain, back-office operations and overhead expenses - are all incurred and allocated differently than under pure b&m models. These shifts in both revenue and expenses, and shifts to occur during the projection period, impact the entity's bottom line and value. 

In the property owners’ corner, income and expenses, based on contractual tenant lease terms, have seen much less transformation in how revenue is generated and expenses are incurred (with the exception of  more percentage rent-heavy retail lease deals). Generally, property revenues consist of some combination of tenant base rental revenue, possible percentage rent, proportionate share of total or increases over base year amounts for reimbursable expense items and ancillary income– telecom leases, license agreements, storage and other income line items. Property expenses–real estate taxes, CAM, insurance, operating expenses– are generally either paid directly, in full or partially by the tenant creating some form of net lease. The resulting net operating income (NOI) and forward projections during any given holding period are significant components of the property’s value. 

‘Stacking’ uses and service to achieve accretive income growth and higher investment yields

Investors have an opportunity to take advantage of dynamic industries and innovative businesses operating within the last mile, some are more visible than others. When the last mile ecosystem is looked at holistically, property owners and acquirers can identify opportunities that go beyond mixing uses by ‘stacking’ revenue generating uses and services, and implementing expense-reducing technology in the back-office and on-site. Investing in areas that position a property favorably particularly against its competitive set, make it possible to increase ancillary income so that it is a more significant component of total revenue. Interconnected innovations throughout the last mile ecosystem allow investors and owner-occupiers to position existing assets or seek investments in locations that maximize income potential and monetize competitive advantages of being optimally connected to telecom networks, energy sources, essential infrastructure and transportation routes. Location intelligence is more important than ever when taking into account transforming industries and changing business models in the last mile.

‘Stacking’ uses and surgically reducing expenses via capital investments and addressing operating inefficiencies establishes a framework to meaningfully reconfigure revenue and expenses for last mile real estate. Stacking refers to adding uses and services that are technology-driven and either do not occupy significant physical footprints or make use of underutilized space on-site. Examples include renewable energy or urban agriculture on rooftops, battery storage facilities, EV fleet charging infrastructure, software, robotics and warehouse automation. All present opportunities for new business models with OpCos contributing to overall profitability and optimal use of the real estate. Designing and siting last mile facilities to incorporate public-facing use components such as reverse logistics, ghost kitchens and delivery hubs are additional ways to generate revenue from OpCos via new business models that depart from typical landlord/tenant arrangements.

Market context and strategy

While we have been in a compressed cap rate environment for a number of years and now look forward to four projected fed funds rate increases in 2022, market participants question and debate whether or not finance interest rates have a lock-step effect on cap rate expansion. Or, will an abundance of capital in the market competing for supply-constrained investment product continue to keep the lid on cap rates across competitive asset classes such as industrial & logistics, multifamily, healthcare and net lease investments? 

One thing seems clear, last mile real estate, given its proximity to population and employment centers, transportation networks, utilities and connectivity infrastructure- along with the dynamic economic activity going in these areas, competition from a range of sophisticated and deep-pocketed investors will prevent land and building asset prices from experiencing any significant reduction in value or pricing. High barriers to entry due to finite land area in any given metro zoned for ‘industrial’ use favor experienced developers who understand specialized industries, technologies that operate in these districts and those that think strategically about the ecosystem. 

With the easy money having been made in last mile real estate years ago, these factors establish a sense of urgency for investors to maximize net income by understanding the landscape beyond the walls and property lines, ‘stacking’ ancillary revenue line items, reducing expenses by making strategic capital investments and creating entirely new PropCo and OpCo structures that make today’s bottom line and value calculations seem antiquated. 

Thanks for reading.