The moniker ‘dark store’ may have an ominous ring to it, but that’s a misnomer. A dark store is essentially a brick-and-mortar site that has been closed down and converted into a fulfillment center for ultrafast grocery delivery. Like ghost kitchens, dark stores are tech-forward and asset-light business models that have boomed throughout the pandemic. These distribution centers are not open to the public, shoppers access their stock by using an app to select their items, giving the dark store more room to stash merchandise and fulfill orders quickly. Granted, we’ve been familiar with this song-and-dance for a while now: Target, Walmart, Whole Foods, and plenty of other retailers have actualized variations of this approach already. However, while physical establishments suffered throughout the lockdowns, the number of dark stores skyrocketed, and its shockwave is driving up demand for commercial real estate.
Not with a fizzle, but with a bang
COVID-19 may have accentuated the dark store craze, but consumer demand for convenience existed long before the virus. James Famularo, president of New York leasing at Meridian Capital Group, told The Real Deal, “way before the pandemic, people were lazy, myself included.” Whether or not that sentiment is true, Meridian Capital Group is in the process of negotiating on behalf of six landlords across Manhattan, Brooklyn, and Queens for on-demand grocery delivery services. Investments in ultra-fast grocery delivery lept severalfold in 2021 in the first six months of 2021. The last-mile delivery sector raised $16.2 billion in venture capital funding in the first half of this year, according to Pitchbook Data. Needless to say, this has been a stellar year for dark store operations.
The hunger for fast and efficient delivery is driving up the demand for storage and distribution space in hyper-localized areas. Many dark stores tout delivery within fifteen minutes, but that’s only logistically possible in dense urban settings. Most dark stores are usually within a one-to-two-mile radius from the locations to which they deliver. “They’re really driving rental growth in very urban areas in inner-city locations,” said Claire Williams, industrial research lead at Knight Frank to Forbes. “There’s no option for them to go outside of that location, and competition in those markets is driving strong growth.” And so it goes that as the demand for more storage space to operate dark businesses grows, city rents will naturally rise, potentially causing these dark stores to cannibalize their profit margin by having to allot more funding to inflated rent.
A lease of the action
Ultrafast delivery is a little bit of a departure from the software intermediary model of UberEats or Instacart. Instead of partnering with an existing restaurant or grocery store, a dark store requires its own space and commercial real estate lease. Landlords with extra space in low-profile areas with less foot traffic seem to be eager to rent it to these new types of renters. Dark stores typically range from 250 to 5,000 square feet, so they’re the perfect tenant for these redundant retail units.
But that doesn’t mean that dark stores are the only player in the market, co-working spaces have long leaped on excess warehouse space. The allure of non-traditional buildings for co-working spaces has been around for a while and doesn’t look like it will slow anytime soon. “Co-working and short-term rental operators once thrived on their ability to start new locations fast,” says Kunal Lunawat, co-founder & Managing Partner at Agya Ventures. “The lease arbitrage model seemed to work well as entrepreneurs sold short term, and bought long term, profiting from duration arbitrage.”
As the pandemic wrought one lockdown after another, revenue drops forced many commercial lease payments to go unpaid and threw many businesses off of their growth trajectory as COVID-19 changed the world.
Vast tranches of funding have poured into the major-player apps like Gorillas and Jokr, both of which are less than a year old. Considering that another industry has already fumbled with an uncannily similar business model, the velocity of dark store leasing seems troubling. “Whenever there’s a lot of exuberance in the market, as evidenced in the co-working boom, you kind of tend to gloss over the risks associated by assuming too many liabilities on your balance sheet, and we’re seeing a repetition of that all over again,” says Lunawat. “You can still grow pretty fast, but you need to do it in a more capital-efficient manner.” Nevertheless, dark stores continue to snatch up real estate faster than their brokers can blink.
Building a substantial network of physical real estate that allows for lightning-fast delivery is critical to the success of dark stores. Venture-backed investors commonly sign real estate leases, with companies entering into multi-year agreements to lock in their cash outflow. But financing this kind of real estate is costly, not to mention that it’s a textbook asset-liability mismatch. Dark store enterprises must fulfill a certain number of orders each month to cover their real estate costs. Signing lease agreements that can last for several years using venture-backed dollars is a huge risk, especially since many national and regional supermarkets have already formed alliances with e-commerce/tech firms to establish proprietary fulfillment operations. Again, the rapid delivery model is different from supermarket chains with tech company partnerships, but the market is so saturated with large grocery retailers and fledgling delivery apps that the dark store model may not seem as sustainable as the venture capital investors might think.
Dark store operators need to think about how to strike the right balance between the rate of growth and their level of operating leverage, in tandem with the inevitable rent hike they may cause. In the venture capital world, the deceleration of quick growth is frowned upon, especially in a huge market saturated with competition for evolving consumer preferences. The first-mover advantages of building a network effect, both in real estate and in online presence, are the crux of the business strategy of dark stores. However, dark store operators should take a page from the pain that co-working spaces endured in order to mitigate risk while still focusing on long-term growth.