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Are Dark Stores Becoming a Real Estate Risk?

Dark stores, which were once proliferating at lightning-speed thanks to insane amounts of venture capital, are hitting some speed bumps. These fulfillment centers that exclusively cater to online shopping were heralded as the future of retail at the beginning of the pandemic, but some cracks in the business model are beginning to form. Not only are many prominent investors scratching their heads at the projected profitability, but the industry is also getting throttled in certain parts of Europe. 

The dark store model relies on condensed urban areas, which already poses a problem when it comes to acquiring real estate in an already saturated market. Plus, the aggressive signing of so many leases has also prompted a discussion about a change in zoning regulation. While the “click-and-collect” service that dark stores offer is undeniably appealing, thanks to the industry’s rapid expansion, dark stores are running the risk of becoming a real estate red flag.

The Dutch crackdown

Over the past year, dark stores in the Netherlands popped up quicker than sunflowers as grocery delivery apps competed for dominance in the Dutch market. There were 31 dark stores in Amsterdam alone as of January 14th, and almost all of them had opened during the COVID-19 pandemic, according to Reuters. But the pandemic wasn’t the only driving factor for the rapid spread of dark stores in the area. The Netherlands is a small, densely populated country with a low and flat landscape, perfect for couriers to deliver groceries in a short amount of time. Demand for dark store deliveries is also on the rise. 700,000 Dutch consumers currently use flash delivery, more than triple the amount in the first half of 2021, according to data analytics and brand consulting company Kantar

Despite favorable conditions and enthusiastic consumer demand, the competition for dark store space in the Netherlands has culminated into a flurry of complaints from residents. The backlash against noise pollution, careless delivery couriers whizzing past, bikes obstructing pathways, and the headache of increased traffic have ultimately led to crackdowns. Both Amsterdam and Rotterdam have put a one-year freeze on new dark stores as they increasingly look like a blight on neighborhoods, and four other Dutch municipalities are drafting policies to ban dark stores in certain areas as well. These bans may not be limited to the Dutch market, dark stores are inciting a similar ire from residents across several European metro areas. Officials in London and Paris, both very competitive markets for dark stores, are hearing a volume of similar complaints and weighing bans as well.

If these restrictions become widely adopted, they will pose a challenge to the business models of ultra-fast delivery apps, and thus dark stores. To meet the apps’ 10- or 20-minute delivery deadlines, delivery companies require real estate in residential areas, forcing residents to live close to the businesses. Of course, this model only works if the residents are happy to deal with them in the first place.

A wolf in sheep’s zoning

New York City is the crown jewel for the dark store industry as it is the densest urban market in the U.S., but one elected official could change that. NYC Councilwoman Gale A. Brewer is putting dark stores under fire by calling their operations “illegal.” Brewer, who represents District 6 (which encompasses most of the Upper West Side), argues that dark stores are unfairly stomping mom-and-pop bodegas out of business not just because of the billions in venture capital that allow them to fund marketing blitzes and the characteristic discount for first-time purchases. The idea that dark stores are shirking local zoning laws is the real bee buzzing in Brewer’s bonnet.

In an email to the West Side Rag, a spokesperson for the New York City Department of Buildings explained that “these types of quick-service fulfillment centers are a new type of business in the city, and they are not specifically mentioned in existing city zoning regulations. We are actively working with our partners at other agencies to explore the appropriate zoning districts for these types of establishments.”

Brewer has since called for oversight and regulation from City Hall, but it is unclear how that will affect dark stores as a whole. Reclassifying dark stores from retailers to warehouses would, in Brewer’s mind, banish them to the city’s manufacturing districts and free up commercial space and no longer “stymie active street life.” Forcing dark stores to operate elsewhere would derail their operating structure since they rely on proximity to their customers in order to successfully make deliveries in a short amount of time. However, since dark stores aren’t explicitly defined in NYC zoning laws, there’s a possibility that they could just get lumped in with retail, at least on paper.

Margin call

Kunal Lunawat, co-founder and managing partner of Agya Ventures, is not buying into the dark store hype, despite the $8 billion of venture capital investments that have poured into the industry. “There was a concern about the lack of a clear pathway of profitability when you look at the extenuating circumstances of dark stores,” he said. Despite the buckets of venture capital that investors have washed over the industry, it looks like the business margins may not be enough to support the model in the long term.

For Lunawat, the red flags began at the high rate and fast pace in which commercial leases were signed by dark stores using their venture capital funding. At a time when it wasn’t totally necessary, many of these leases were medium to long-term. “There appeared to be no consideration given to the economics of these leases over a 1-3 year period,” Lunawat said. Due to the pandemic, landlords were more liberal with lease agreements, which is why Lunawat believes there to be a bubble in the dark store industry. Slim margins and persistent price-reduction loss leaders are another reason Agya passed on investing in dark stores. 

Another variant that we’re seeing which threatens the already razor-thin margins is that some dark store companies are launching additional bells and whistles to their business by adding their own product lines. “Presumably, companies that are launching their own brand of things like water or milk will have higher margins, which is another manifestation of the premise that the core business model of dark stores might not be that profitable,” said Lunawat. Also, if embellishing dark stores’ appeal by tailor-branding grocery items wasn’t an initial part of the business model, then the pivot could signal trouble for the industry since it could not have come at a more inopportune time. Inflation and food costs are rising at staggering rates, higher than they were in the early 1980s. Granted, this cost could easily be passed to the consumer, however that may undermine the promotional appeal that dark stores have been using their venture capital to lean into. Dark stores are currently able to offer prices on goods that are actually cheaper than those available at traditional convenience stores, something that surprised Lunawat months (again, it’s one of the reasons that Councilwoman Brewer is incensed by the prevalence of dark stores). If dark stores were banking on their ability to lower costs in order to gain market share, the unexpectedly high inflation and food costs could be a serious issue.

Overall, Lunawat believes that dark store investors are gradually coming to a “reckoning,” as they realize that the dark store business model has grown too much, way too fast. So many venture capital investors may have succumbed to the fear-of-missing-out when it came to dark stores thanks to their promising headlines with insane amounts of growth each month, but that obviously didn’t truly reflect the heavy promotions to grow the user base and the losses that these companies were sustaining to grow. People are no longer trapped inside their homes as they were during the height of the pandemic, and are more inclined to physically visit a store as opposed to having their groceries delivered, which is another thing that concerns Lunawat.

Ultra-fast grocery delivery does have its allure, even after lockdowns have eased. But the cracks in the model may be indicative that the industry is not as sustainable as initially promised. With bans in Europe becoming more prevalent, and stopgaps in New York City becoming a possibility, dark stores need to be mindful of how they acquire space going forward.

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