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Investing in last-mile warehousing? Be aware of multiple risks.

As investment in industrial real estate continues to gain speed, companies should take stock of potential risks and consider available risk mitigation and risk transfer actions to help protect their investments.
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By Paul Foye , 

US Real Estate Practice Leader

03/08/2022 · 5 min read

The rapid growth of e-commerce is accelerating the need for industrial real estate and warehousing space closer to urban centers as retailers seek quicker and more efficient ways to get their products to online shoppers.

Demand for warehousing and distribution facilities that support last-mile delivery is expected to continue, as is investor interest in this type of real estate.

For those new to investing in industrial real estate, it offers an exciting prospect and potential diversification of their investment portfolio, but also brings multiple risks to consider.

Hard-to-find urban locations

Because of the extensive variety of products available for online purchase, warehouses used for last-mile deliveries need to be spacious. According to CBRE, an additional 1.25 million square feet of distribution space is required for every $1 billion rise in e-commerce sales. And they have to be close to consumers, allowing for quick delivery of purchased products.

The required proximity to urban centers often poses real estate challenges. Empty lots that have the right space and location characteristics are rare. Instead, companies seeking warehouse space to lease to last-mile companies must often purchase and retrofit existing buildings.

But this practice opens owners and investors to multiple risks. Older buildings, for example, may not have been built to today’s health and safety codes, often requiring extensive and costly renovations.

In addition, last-mile delivery companies may need cold storage, which brings a new array of requirements, including upgrading electrical panels to cater for increased power needs and updating HVAC and cooling systems. Retrofitting existing buildings to make them suitable for cold storage can lead to new property hazard exposures.

Stretched supply chains, labor shortages delaying projects

The retrofitting process comes with a series of risks, including potential liability for injuries to workers and theft or destruction of materials, which require suitable risk mitigation and transfer solutions, such as workers’ compensation, general liability, and environmental liability.

As countries continue to respond to the COVID-19 pandemic, global supply chains have come under increased pressure, leading to delivery delays and supply shortages that often translate into higher pricing. Stretched supply chains could create new challenges for industrial real estate investors, affecting the cost and availability of materials needed to retrofit existing buildings. Further, availability and cost of labor creates new challenges, frequently leading to costly delays in project completion.

These challenges sometimes delay projects that require a fast turnaround. As they see their e-commerce sales increase, new tenants are typically eager to move into new warehouse space, putting more pressure on stretched availability.

Populated neighborhoods bring new challenges

The need for proximity to urban areas often means that newly converted warehouses are in populated neighborhoods. Delivery vehicles may take longer to get to and from the warehouse due to traffic, while loading areas in an urban setting may be restricted, creating logistical challenges.

Building or renovating in populated areas may also require addressing historical environmental liabilities such as asbestos, underground storage tanks, and soil contamination. At the same time, companies wanting to reduce their carbon footprint by investing in electric vehicles may have to consider whether they have sufficient space for charging stations on the premises.

It is also important to consider the impact of natural catastrophes, such as hurricanes or wildfires. Catastrophe modeling can provide accurate risk estimates about potential losses, allowing companies to purchase appropriate insurance coverage and reducing the risk of coverage gaps or purchasing unnecessary insurance. Understanding your risk can help when reviewing and updating preparedness plans.

Contract due diligence may uncover liabilities

As smaller companies and startups jump into direct-to-consumer delivery business models, it is becoming more common for urban warehouses to have tenants with a variety of projects, different lease terms, and varying levels of insurance coverage.

Whether a property owner is leasing a warehouse to one tenant or several, conducting contract due diligence is critical to understanding responsibilities and liabilities that are regularly established in lease agreements.

For example, consider a warehouse that’s being used by a tenant for the storage of meal kits that need to be refrigerated, running the risk that an hours-long power outage could lead to stock spoilage. Investors may consider reviewing lease agreements to ensure they contain insurance language covering such situations. For example, the lease should state whether the warehouse owner or the tenant is liable for the costs associated with a power outage.

To further complicate matters, tenants operating from the same warehouse may have different lease agreements, leading to an uneven liability landscape within the same building.

Underwriters often request lease agreements to determine the level of risk before providing a quote. Because responsibilities and liabilities outlined in lease agreements could influence coverage, owners and investors should consider having an insurance advisor or broker carry out a due diligence review of existing insurance contracts before purchasing a building. Your advisor may also recommend mitigation strategies to reduce existing risks, for example, by investing in generators to safeguard items requiring cold storage.

As investment in industrial real estate continues to gain speed, companies should take stock of potential risks and consider available risk mitigation and risk transfer actions to help protect their investments.

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