E-Commerce and the Pandemic Have Driven Record Demand for Industrial Real Estate. Technology is Playing a Critical Role in Optimizing this Sector.
Most of the articles that I have published so far have been focused on Office, Multi-Family, and Single Family Residential Real Estate. However, the real estate sector which is currently experiencing the biggest growth is Industrial. Prior to my research for this article, I honestly didn’t fully appreciate the critical role that technology plays in the future of Industrial Real Estate.
I recently had the opportunity to interview a member of the leadership team at Prologis. Prologis is the industry leader in logistics real estate. They own nearly 1 Billion Square Feet of Real Estate. Unlike a traditional landlord whose role in the relationship is generally limited to providing space, Prologis partners with their tenants to provide solutions to create efficiencies in the workflow of their business.
By combining the effects that the pandemic has on consumers staying home, along with a growing appetite for online shopping, and expectations for immediate shipping, it should be no surprise that industrial real estate is so hot right now. But some of the statistics that Prologis shared with me added a lot more color around the reasons why this sector is growing so rapidly.
According to Prologis, for every billion dollars in traditional retail store sales (in-store purchases), companies require between 300k - 400k square feet of warehouse space. For every billion dollars of e-commerce sales, a company requires about 1.2 million square feet of warehouse space. As companies shift to omni-channel or online buying, the demand for warehouses increases, but so does the need for technology in and around the property. Consumers are starting to expect same day delivery, so that means that companies need to have the right inventory, at the right place, at the right time, so that it can be moved out as quickly as possible. Prologis is leveraging technology to address these challenges and more.
As the owner of the largest industrial portfolio in the world, Prologis made the decision to create a VC division named Prologis Ventures. By investing in technology companies that have solutions that they can deploy throughout their portfolio, Prologis has the ability to nearly guarantee the success of a portfolio company, while playing an active role in creating solutions that benefit their customers. Below is the interview that I conducted with Prologis Venture’s Managing Partner - William O-Donnell.
We are starting to see more Real Estate owners getting into Venture Capital. What is the history behind Prologis’s venture arm?
“We founded Prologis Ventures back in March 2016. We saw a lot of change and disruption starting to happen in our industry. Some of the changes were obvious, but a lot of what we saw was that our customers’ underlying business models were evolving in ways that we believed were really going to impact how real estate would be utilized in the years to come. Although we are a beneficiary of E-commerce, we saw a fundamental change in how customers thought about location, the types of buildings they occupied, and how they were operating within those buildings.
We also started looking at opportunities in areas such as data analytics. We were interested in the initiatives and progress that other industries were starting to make, and then figuring out what was transferable to the real estate industry. Another opportunity that we have focused on over the last couple years is how to provide value in services beyond just four walls and a roof, and that led us to launch something called Prologis Essentials. The goal was moving beyond just providing space and collecting rent, to helping our customers move in faster and create efficiencies within their operations. Prologis owns almost a billion square feet of real estate, so we wanted to see how best we can leverage that scale in unique ways that provide our customers value that they otherwise would not be able to capture.”
When evaluating an investment, what are the important factors that you look for? Are there any specific characteristics of a company that are immediate deal-killers for you (Poor Leadership, Small TAM…)?
“We are a very thesis driven investor. We understand where pain points are, and how we, as a company, can find opportunities to improve our operations. But we also spend a ton of time with our customers understanding really what's driving change within their organization and where they're experiencing friction. So with that insight, we go out and find solutions that match those opportunities. With technology, it’s easy to be enamored by whatever flashy new things are out there, but if it isn't tied to a pure business outcome, you're often spending time searching for a solution versus solving an identified problem. Identifying a real pain point is a major filter we start with.
Second, a strong management team is a prerequisite. You can have a great idea but if the team's not a place to execute against it, you're not going to go far. TAM is also something we're looking at as part of our thesis; Is this a big enough opportunity that will fundamentally change the industry? We spend a lot of time looking at the competitive moat. Additionally, does the business model make economic sense?
Lastly, we really like to find opportunities to partner with our customers to co-innovate and develop solutions together to solve identified pain points. And when we can find technology to help solve these challenges, it is really exciting for us. Those are things that we look to invest in.”
When speaking with other Real Estate companies that either have an investment arm, or are moving to centralized decision making, I've seen instances where the operation teams that are deploying the strategy push back a little bit because they have their favorite vendors that they would prefer to use. Oftentimes, this happens because decisions have been made without their input. Do you bring your operations team into the due diligence process to help you analyze the acquisition or the investment before you make it, in order to get their buy-in?
“We do. One of the critical things that we do is we spend a lot of time upfront working with our teams and our customers to understand what their problems are. So when we come back with a solution, it’s generally a solution that meets the needs we were looking to solve. But within that, there is a significant amount of change management that goes into any organization when you're adopting a new process or new technology. So having people from our operation side, capital side, or a construction group involved in the process is key. They're the ones who have identified this as the pain point and know what they're looking for. You want them to be advocates for adoption and really drive the technology. If you're coming in from the outside and just saying, ‘Hey, I found something great, it's going to make your life better’, then there is going to be a lot of pushback. When you make that team part of identifying the problem and finding a solution, you get great synergies. We are very thoughtful about bringing in appropriate thought leaders within our company and having them be the advocates and champions behind why we should be doing this investment or why we should be adopting this technology.”
When you make an investment in a company, do you automatically deploy their solutions across all relevant assets, or is there still some local decision making taking place?
“Yes, there is definitely local decision making taking place. When we make investments in areas that are relevant to our customers, the local property manager would not actually impact the decision because that resides with the customers. When they are internal facing technologies, we’ll do a lot of piloting and understanding to make sure that we have data that demonstrates that it actually improves the process or the experience that our employees have. But since we are in 19 different countries, there may be solutions that we find that work better in Spain than they do in New Jersey, and our employees always have the autonomy to figure out what's best for them in the organization. But we do view it as a very collaborative process and part of the reason why we run pilots and tests is to get the data that shows this is a better way of doing things and clearly define why it is better. As we realize that nothing is ever perfect, piloting helps us to identify points of friction, and allows us to use our team to help improve it and make it even a better solution.”
What are some of the investments that you have made so far?
“I’ll begin by talking through some of the themes that we've invested in. Approximately 50% of supply chain costs are related to transportation. Rent accounts for only 3% to 4%. So for us, another way to look at it is every dollar our customers spend on rent, they spend $10 on transportation. So we've made a number of investments there because we've seen a lot of inefficiencies, between how trucks will arrive at warehouses and unload and then the operations inside. In most organizations, transportation is split from the warehouse operating side. They both are highly fragmented industries with a lot of different players, so getting visibility into where trucks are for example, is actually a challenging problem. So we've made an investment in a company called Platform Science. They provide an operating system for vehicles. It facilitates our trucking companies to comply with the electronic logging devices ELD mandates, but it also is an open platform so you can build apps that allow better visibility, integration, and better technology for the drivers.
We've also invested in a company called Freight Waves, which is one of the best data platforms for visibility into logistics and transportation data. So for us, there's actually a ton of value because we can look at our buildings and understand the transportation metrics around them: What's the average price per freight lane coming out? What are our predicted costs going to be? If there's variabilities related to transportation network, Freight Waves is a fantastic repository of that data.
We've made an investment in a company called Wise Systems that does dynamic routing of vehicles on last mile local delivery. And because a big strategy of ours as a company is investing around real estate with last touch, having an understanding of how our customers are using technology to optimize routing is key.
We have made an investment in a company called Outrider that does autonomous yard trucks. A yard truck is a truck in the court (or yard) of a warehouse that transports containers or other cargo around that facility. It's actually one of the most dangerous jobs within a warehouse. If you think of port facilities or railroad facilities, there's always trucks going in and tons of different containers moving around in different directions. The same thing happens at very big fulfillment centers. So being able to automate that and create a much safer environment is important from a labor aspect, but it’s also a key component from a transportation management and cost perspective.”
Are you able to quantify efficiencies, either cost savings or time saved, as a direct result of your portfolio companies?
“For any investment we are making, whether we're using it internally or it’s something we are bringing to our customers, it’s something we pay very close attention to: What is the ROI, how closely does this actually solve a real pain point, or how does it improve upon the current process in a material way? For automation as an example, we're looking across the board at what type of efficiencies are achieved. We've invested in a company called Archipelago, which is an insurance marketplace that our risk management team uses in our process of procuring insurance. Historically it's been a very manual process where we bring reams of papers and folders with every single one of our buildings’ characteristics. Insurance companies will look broadly at it and say, ‘Okay, you have this much in California. This is what your seismic risk is going to be and this is what you're going to pay’. But with digitizing it, we can actually quantify how much we spent on seismic upgrades. We are able to see how that compares to everyone else in the industry and then it allows our adjusters to write the policies that recognize the actual characteristics of our buildings. They can look through and see it digitally and they can see the backup data behind it. It allows for a much more dynamic insurance procurement method, and allows us to differentiate our portfolio because we have the actual data behind it, which in turn drives value for the company. Our risk management team was actually one of this company’s first customers and helped them drive the product to where it is today. They have a super strong management team, and we’re excited to be part of it.”
I would assume that for most of your vendors, you're probably their biggest customer. Is that an accurate assumption?
“Yes, we are. And it's something that we are very thoughtful about. If you are a very small Series A startup and someone like Prologis demands that you roll out across nearly a billion square feet in 19 countries, it could break the company. So we're very, very careful about making sure that the assets that we have can be handled by the company in a way that's productive and helps them grow their business. But we're also very careful when we invest into a company to ensure it aligns with where we are. As a company, over the last four or five years, we have become much more adept at partnering with startups and helping innovate and create solutions together. When you're buying a traditional off the rack software, you receive a finished product along with reams and reams of training and documentation on how to use it. With startups, you're really helping them build a solution. So it's very exciting, but it takes a very different approach. It ends up being much more rewarding because you help build the solution versus just adopting someone else's process or someone else's solution while trying to adjust your business to have it make sense.”
What solutions/companies are you most excited about, and where do you see the biggest opportunities for technology to make an impact?
“Sustainability is an area that we as a company are very focused on. It's a huge space that really will drive positive change. As an example, we just launched an EV charging infrastructure business. So in this case we're not investing in other companies, we're going to build out this EV charging infrastructure business ourselves. Our customers are ordering thousands and thousands of these trucks, but none of the infrastructure is in place to actually charge them. One of the biggest barriers that customers have right now is that landlords (generally speaking) have made it difficult to put infrastructure in. Understandably, if they put the infrastructure in and the tenant moves out of the building, it's kind of a lost cause. But if we as the landlord actually take that on and help provide turnkey solutions, we can make the investment coterminous with the lease. When the tenant leaves, we will continue managing the infrastructure and bring in a new tenant who can utilize it. This allows our customers to get up to speed and run their fleets much faster, and it takes out a significant portion of the friction by doing that.
Another aspect that we're really excited about is that we are the third largest operator of rooftop solar in the world. Less than 2% of our roofs have rooftop solar on them at the moment, so we can continue to significantly grow our solar business. But if you start adding in EV charging, suddenly you have a huge opportunity to produce energy consumed by the EV vehicles. So for us, the energy business that we're building out by leveraging our portfolio is one of the more exciting opportunities both from a complete whitespace with a massive TAM. We very rarely have an opportunity as a company or as individuals to fundamentally change the world in a much better way. Because of our scale, we have the opportunity to partner with best in class companies, whether through the providers or our customers, and really drive adoption of the vehicle fleets. The end result will be a better climate, and that is something that I'll be proud to tell my children. Sustainability and helping our customers get to net zero is very important for the company as a whole. But this in particular is an initiative that I'm really proud and excited that we're taking on.”
One of the biggest issues which has been in the news everyday is the current supply chain challenges at the ports. Has this had a big adverse effect on your customers?
“Anyone who's trying to move goods around right now is facing this challenge. And it goes through from ships being unloaded in the ports, to the warehouses trying to get the inventory. The railroads in Chicago have major backups right now. It's just a really challenging environment. That said, we're actively working with our customers to figure out ways that we can help drive change and to see if there are things that we could be doing to help alleviate the effects. It's a challenging situation though because with supply chain, there's a ripple effect that if something occurs over here, then you start seeing the impacts across the supply chain. There are a multitude of ripple effects that all hit at once, and then they compound on each other. The ships aren't being unloaded because there's not enough labor, but then you also don't have the chassis in the right spot. We just had our earnings call where we talked about how we are almost essentially full in a lot of markets, and there's more and more inventory putting through so we're trying to work with our customers to figure out ways that we can help provide more space. It's an interesting dilemma that a lot of people are focused on now. And then we're actively working with our customers to try to figure out how we can partner to create better solutions.”
Is there anything that we haven’t covered that you would like to add?
“One of the things that is really important to us is the co-innovation with our customers. We have created a lab that is really an experimentation site where we test different technologies both for our own usage, and testing on behalf of our customers. We've been testing things like drones and automated forklifts. It's really become a unique offering as we found that many of our customers aren’t able to test new technology in an active warehouse since they don’t want it to impact their operations. By creating this lab, it gave our customers ways that they could actually test technology. Everything looks great on PowerPoint, but it really requires putting it in a functioning warehouse environment to experience the wear and tear of a real environment. For startups, it's a great opportunity because they can really refine their technology and make sure that they're hitting the metrics that are important to our customers. This type of customer engagement is very important to us because it allows us to truly understand our customers' businesses. The more that we can help them problem solve, it allows us to help our tenants think about things like how to improve labor, how best to train labor, and how we as a real estate company can provide a better environment for their workers. It allows us to determine if there are different amenities or designs that we could be using, or if we can put things like air filtration centers in. There's a lot we can do to really help the labor environment, and we've made a number of venture investments around it. This is a key way that we're partnering with our customers to really understand where these pain points are.
Once we look across enough customers, if we keep on hearing the same problem coming up over and over again, we can then go out and find the solution that helps, not just one customer solve their issues, but our entire customer base. We are in a pretty unique position where we are really viewed as a partner of choice by a lot of our customers and that allows us to identify these trends, connect the dots, and go out and figure out the best options. Is there a company we should invest in, or maybe there's an existing incumbent tech company that we should be partnering with? In some cases, like the EV charging business, we will actually go out and incubate a new company because we didn't see one that met exactly what we needed. I get excited just because our platform affords us so many different opportunities and really gives us insight into supply chain and logistics that few people have.”