Will the Pandemic Kill Dark Store Distribution?

As shopping in stores becomes more popular again, the trend of turning empty stores into small warehouses is likely to slow down.

During the pandemic, many stores closed their doors. This gave online sellers the chance to turn empty stores in cities into small warehouses. But now that the U.S. retail sector seems to be doing better and many people are eager to shop in-person again, will this strategy still work?

Benjamin Conwell, senior managing director and practise leader for the e-commerce and electronic fulfilment specialty practise group in the Americas at real estate services firm Cushman & Wakefield, says that the demand for “dark stores” in urban neighbourhoods is not a passing fad but a trend that is here to stay. He says that’s because e-commerce and omni-channel businesses see them as a cheap way to get close enough to their customers to offer delivery in 30 to 60 minutes.

High fuel prices and a huge rise in industrial rents are keeping this demand going, says Brandon Isner, head of retail research for the Americas at real estate services firm CBRE. This is because logistics companies now spend more than ever on transportation costs. He thinks that costs related to transportation now make up between 45 and 70% of their total costs. On the other hand, fixed facility costs, which include real estate, only make up 3–6% of the total.

Isner also points out that the growth of industrial rents over the past few years has been much faster than the growth of retail rents. This means that it makes sense for e-commerce and multi-channel operators to have a large network of dark-store distribution sites, even if they only offer curbside pickup. Savills, a real estate services company, says that the average growth in industrial rent across the country over the past year has been 12.5%, which is considered a slowdown. Isner says that during the same time frame, retail rent growth has only reached 2.5%, which is the highest level seen since the first quarter of 2017.

Isner also points out that there are benefits to using retail space in cities as distribution space that go beyond making operations run more smoothly. For example, these places give retailers a chance to keep in touch with their customers in person instead of relying only on third-party representatives. “And the great thing about using a retail space for this kind of thing is that it’s already set up to handle a lot of traffic,” he says.

Who is shopping in empty stores?

Jacob Ryan, an investment sales broker with real estate services company Northmarq, says that most retailers that use dark-store space as distribution centres already have a large e-commerce platform or have partnered with a third-party e-commerce operator. Demand for direct-to-consumer delivery went up at a record rate because of the pandemic. This meant that retailers had to find ways to cut costs and get products to customers as quickly as possible.

“The best place to start would have been to use the assets they already had and turn underused retail space into space for distribution and logistical support,” Ryan says.

Conwell says that many of these tenants are grocery stores, like Whole Foods and regular grocery chains. He also says that clothing and soft goods stores were among the first to use the dark store idea.

Gorillas, Jokr, Fridge No More, and Gopuff, which promise to deliver anything from eggs to pizza to your door in as little as 10 minutes, also use dark stores. But at first, these ideas attracted a lot of investment money. Some, like Gopuff, opened hundreds of locations across the country and grew faster than their services and infrastructure could support, says Conwell. Some of them are now backing off.

During the height of the pandemic, this alternative use helped boost retail occupancy. In the past few years, retail has had to deal with a lot of problems, such as low consumer sentiment, competition from online shopping, and supply chain problems. Isner says, though, that the slowdown in shopping has ended quickly.

Ryan agrees that shopping in person is back. “Consumers did very well after the pandemic, and data on discretionary spending backs that up. The in-store experience gives us what we all want: the chance to touch and feel.

CBRE research shows that the average national retail vacancy rate was 5% in the third quarter. This was one of the lowest levels ever recorded. Isner says that in the first half of 2022, there were 2,517 more stores that opened than closed.

He says that the dark store distribution strategy is getting harder to use in these situations because retail rents are going up. But overcoming community opposition to using dark stores as distribution centres is an even bigger problem. For example, the corner grocery store becomes a mystery space when paper is taped over the windows.

“City councils don’t like these because they don’t make for lively streetscapes,” says Conwell. So, he thinks that people will still want these kinds of spaces, but “it doesn’t come without hair.”

According to an Insider report, people in New York City complained about dark stores being used as quick delivery spots. The city responded by making it illegal to cover store windows with paper and requiring tenants to keep their storefronts open. Some of the tenants set up indoor kiosks so that people who bought things online could pick them up in person.

Ryan thinks that if shopping in person comes back strongly, these problems might go away on their own. He says that he doesn’t think there will be a big increase in new leases signed so that dark stores can be used as distribution centres. Instead, when it’s time to renegotiate a lease, a tenant may ask to use some of the space they already have in the store for e-commerce.