by Gary H. London

On the day after “Cyber Monday” it was reported that $1 billion worth of transactions took place on the Internet, the largest one-day Internet consumption on record.

Even at that, what consumers spend may just be a drop in the bucket compared to what we may spend online in the future. Online consumers also spend more money per purchase; and a growing share of their purchases is on the Internet.

Yet, this is not a story about the end of bricks-and-mortar retailing as we know it. It is more a story about changing consumer habits, proclivities and how this impacts our real estate inventories, which are currently highly vacant.

Retail and industrial properties have a longstanding relationship. Although online retail sales are growing, which undoubtedly is bad for status quo in the retail real estate sector, the goods purchased still need to be manufactured and distributed. This is good for industrial properties where goods are made, stored, and finally shipped to consumers.

Hamid Moghadam, who co-founded AMB Property Corp. in 1983 and is now one of the largest investors and managers of commercial and industrial real estate in America, recently spoke at USD’s Burnham-Moores Center for Real Estate. He suggested that two things must happen for manufacturers and inventories of retailers to recover:

1.) Gridlock in Congress — this means no changes in the taxing structure are likely, and

2.) Holiday season — which always takes demand for consumer items into the stratosphere.

Mixed Signs for Retailers

We now know that new consumer confidence numbers are up and consumption seems to be up, or at least the holiday season shopping is starting robustly.

But the key is on the other end: Inventory levels, which fell by 8 percent and have since recovered by 3 percent. So it makes sense that vacancy rates of industrial properties nationwide are generally 5 percent higher across America.

A gauge of the breadth of the recovery of the industrial market is air traffic and shipping: It now appears that air traffic is at a peak. Moghadam suggests that this is the “canary in the coal mine.” Air cargo deliveries cost 10 times as much as any other type, so distributors don’t make any money on these trades. The reason air deliveries peak is actually a “fail-safe” for companies — a way to deliver product and not lose the customer.

Because air traffic is peaking, this may suggest that soon inventories will rise. We may anticipate that there may very well be a recovery in the industrial market in the near term as larger inventories begin to fill currently vacant space.

Industrial, Retail Interrelated

The upswing in retailing could have a residual, and enormous, impact on the industrial sector. In expensive regions, including coastal California, the horizontal pattern of industrial tilt-ups do not sync up well with the costly economics associated with declining land inventories. Buildings that are built on what land remains must become more vertical or stacked, and they will inevitably contain activities that match the economics of the market, notably business services instead of warehouse or manufacturing.

However, the exception is industrial warehouses which contain consumer goods inventory — a cheaper way to store consumer goods than in a shopping center. In other words, retailers can have a small, efficient “showcase” operation in a shopping center and store the major inventories “off line” to be delivered by United Parcel Service of America Inc. or FedEx directly to the customer’s home.

I just described the future of many of the existing, formerly manufacturing neighborhoods of coastal California.

AMB Property sold its retail portfolio years ago. They were one of the few real estate firms that foresaw the immense impact of the Internet on brick-and-mortar real estate.

They concluded that the future was murky for brick-and-mortar retailing … that it would be better to sit on the sidelines until things are sorted out.

Yet, companies like AMB remain, in effect, in the retailing business without owning retail shopping centers. They are stewards of the property where manufacturing is transitioning to consumer item storage.

Procter & Gamble is another example, notes Moghadam, of industrial trends. Fifteen years ago it would have had hundreds of 100,000-square-foot warehouses, including one in San Diego, to supply local retailers with inventory.

However, with innovations in technology and distribution, they now have only five warehouses spread across the country to “blanket” the entire nation. But these warehouses are 1 million square feet in size, enabling P&G to save on real estate costs, labor, and other expenses associated with economy of scale.

Internet Involvement

Almost all retailing will include an element of cyber involvement as the future unravels. Most retailing already does. This has enormous consequences on how and where we shop, and thus portends a major downward valuation shift for the commercial sector.

We are now in the midst of a sorting out/transition stage of a changing economy where real estate-based consumption is moving to “cloud” based. It can’t have a happy ending to retailers grasping an old paradigm of consumption without dealing with the shift.

Here is a case in point: Walk into Restoration Hardware on Fashion Valley mall’s second level. I have not consulted them in preparation for this column as to exactly what their strategy is, but it is clear that they are running a very large retailing and distribution business out of a comparatively small store. In fact, I would venture to guess that most of its revenue is derived from Internet sales, because whenever I shop there (which seems to be too frequent!) they drive me to their Web site rather than put product in my hands as I walk out.

Instead, the products come by UPS delivery. Often, I don’t even walk into the store. I know they really don’t want me there.

So, in addition to the growing doctrine that consumers now and well into the future will have less money to purchase goods (and may not otherwise want to) we are in the midst of a generational paradigm shift in the way we purchase, store and receive consumer goods and products. It is not unlike the moment when the Sears catalog replaced the corner store.