Why Retailers Are Converting Stores Into Fulfillment Centers

Over the past couple of years, brands have made considerable strides in setting their stores up to fulfill e-commerce orders. They’ve had to re-configure the in-store technology, train staff on new responsibilities, and perfect in-store pick-up services. A primary reason for the transition is the increasing demand for faster delivery.

In a McKinsey report released last month on store trends, the company shared that more than 90% of consumers see a two-to-three-day delivery time as a baseline, with 30% saying they expect same-day delivery. In many ways, Amazon has set this expectation with Prime. For physical retailers, it’s more challenging, but for those with hundreds of stores countrywide, they can provide a similar experience and may even pose to have an advantage.

The extensive real estate portfolio of traditional retailers can facilitate fast delivery.

Last month, on DSW’s earnings call, Roger Rawlins, Chief Executive Officer, shared that the company fulfilled nearly 60% of digital orders in 2021 from its stores. Its 2021 revenue of $3.2 billion was a 43% increase in sales from 2020, which was a rough year for the retailer that relies heavily on its store traffic. DSW will also be turning 20,000 to 25,000 square foot stores into 15,000 stores to create its “store of the future” and likely dedicate some extra space to fulfillment. This decision requires both physical and logistical renovations, which are costly and time-consuming.

However, department stores can implement the strategy given their vast square footage and reach across cities, suburbs, and rural areas. For instance, although Macy’s has closed many stores over the past couple of years, it still has over 500 locations. And over a quarter of Macy’s online orders are fulfilled by its stores. It’s also partnered with Doordash for same-day delivery. Similarly, Target owns and uses Shipt to provide same-day delivery in over 5,000 cities across the US.

According to a 2021 report by Newmark on retail-to-industrial transformations, Walmart is testing the conversion of part of its stores into fulfillment centers by converting the back half into a warehouse. Given that the company owns most of its real estate, it’s easier to make those changes. However, for most brands that are tenants, a change of use can be more challenging.

Permitting and lease structures make it challenging, but industrial real estate is key to the longevity of retail real estate.

The city and the landlord permit a store for the use of retail. Although the laws change depending on the location, it usually means a large percentage of the sales have to come from retail operations. If at any point the sales shift to another use, like fulfillment, there could be legal repercussions. In addition, one of the most complex and debatable elements of retail leases is the term of percentage rent. A landlord usually receives a percentage of in-store sales (more and more, including web sales tied to the store). If fulfillment occurs in-store, do brands have to include e-commerce sales in percentage rent? Or perhaps, the lease economics need to change altogether.

It’s complex, and there’s no easy answer. However, merging use-cases across real estate asset types is beneficial for landlords, tenants, and cities. According to Newmark’s research, 24.5% of commercial real estate investment in 2020 was dedicated to industrial, a significant increase from the 11.8% in 2016. Therefore, as e-commerce grows, demand for industrial real estate will continue to outweigh retail, making the mixed-use asset of industrial and retail essential to the longevity of stores.