Garbe Industrial on how Germany still provides opportunities for smart investors

With elective acquisition and intensive asset management, capital providers can make attractive returns in German logistics – even amid tight land supply and waning cap rate compression, argues GARBE Industrial Real Estate’s CEO Christopher Garbe

This article is sponsored by Garbe Industrial Real Estate. 

Over the past 25 years GARBE Industrial Real Estate has become established as one of the leading players on the German logistics scene, developing into a fully integrated platform which develops projects, provides property and asset management services, and manages investment vehicles including funds, joint ventures and separate accounts. Chief executive officer Christopher Garbe shares his local knowledge on how to navigate Europe’s hottest and tightest logistics market with PERE’s Stuart Watson.

What is the best way for investors to access the German logistics market right now?

Christopher Garbe
Christopher Garbe

Investors that want minimal risk, and are willing to pay high prices because they believe logistics assets are inexpensive compared with offices, can pursue a core strategy and buy direct together with a good advisor. For all strategies with higher risk profiles from core-plus upward, we would strongly recommend that investors team up with an experienced specialist manager via funds or other means of indirect investment like club deals and separate accounts. If an investor wants to take development risk then they should probably form a joint venture with a manager that is taking a considerable equity share to ensure their interests are aligned. This is a time when many investors are focused on active asset management and development because they are aware that pricing is way above its previous peak and they cannot rely on further capital growth.

Will the keen investor appetite for the sector continue?

While prices are quite steep, the positive factor with logistics is that, so far, we have not seen a lot of rental growth. Rents have only really begun to increase over the last 12 to 18 months. Vacancy in the sector in Germany stands at around 2 percent while e-commerce is continuing to drive activity. That gives me confidence that investors are not overpaying because there is still potential for considerable rental growth. By contrast, the office market has already seen a lot of rental growth and yield compression, so I would be more worried about what will happen in that sector if there is a downturn in the market.

The yield gap between the office and logistics market used to stand at about 200 basis points. That has closed to around 100 basis points. The difference in build cost and underlying site value between office and logistics buildings explains why office rents and capital values are higher, but not why there is a difference in the yield. In the past, the argument was there was no real rental growth to be had in logistics, but due to the unsatisfied demand generated by e-commerce, that is no longer true. Many logistics buildings also form part of an integrated supply chain, which means occupiers are very unlikely to move out, and gives the assets infrastructure-like characteristics that make them a more robust investment. By acquiring logistics and industrial assets, investors are not only buying real estate, but also investing in megatrends like e-commerce, digitalization and automation.

There are also German-specific factors that make the country a potent logistics hub. The Deutsche Mittelstand provides the economy with a really strong backbone of medium-sized companies focused on light industrial and manufacturing, and those always require a substantial supply of space. Then because the country is in the middle of Europe you can conduct logistics activity across national borders from a base in Germany. Germany also has a good supply of skilled labor, and it benefits tremendously from being in the euro. If the country had its own currency then it would be valued very highly, which would be a show-stopper for exports. I think we will continue to see further rental growth and demand for space remaining stable. The period of yield compression will come to an end. Right now, the cost of capital in Germany is extremely cheap, but in future the banking market may become slightly less favorable to real estate, bringing an end to the exponential growth in investor demand we have seen in recent years. Instead, the market will become more stable.

What challenges do investors face in current market conditions?

There is a lot of competition in the German market with many local and international investors looking for investment-grade product while supply is limited by a lack of available land. The German government’s sustainability agenda 2020 aims to reduce the take up of greenfield land from 130 hectares per day to 30 hectares per day by 2020. That target will be missed, but the land take has been reduced to around 60 hectares per day and will fall further. Because of that, municipalities are unwilling to allocate their limited supply of development sites to logistics use, which tends to consume a lot of land while generating traffic and CO2 emissions, and provides few skilled jobs and sometimes little tax revenue.

Therefore, it makes sense to buy existing sheds, even older ones, and brownfield sites can be converted to industrial use. Those assets have a great risk/return profile, but to access them you need a good manager that knows the sector and has people on the ground. The rising prices paid for industrial space help to pay for the added expense of redevelopment. However, sometimes we buy a building with the intention of demolishing it and find that there are potential tenants that will pay almost as much as they would for a new shed, so long as it is in a good location.

Technology, artificial intelligence and automation are disrupting the logistics space, as they are all real estate sectors. How can portfolios be future-proofed to respond to tenant demand?

Contract logistics and general forwarding still require about the same type of building as they have for the last two decades, with automation driving up the need for more electric power and better internet access. Sheds have also tended to get bigger – footprints of up to 1 million square feet (100,000 square meters) are not unusual anymore, and buildings are also higher. However, demand will continue for standard buildings with some details adapted for local markets.

E-commerce is a true game changer, with volumes growing exponentially and vast amounts of money being invested in research into technology and fulfillment processes. These buildings have undergone a much more rapid evolution. Only a short time ago, e-commerce sheds were basically large boxes housing relatively simple processes with a low level of automation and requiring large numbers of unskilled manual workers, but in a matter of years most human labor in pick and pack-processes will be replaced by robots. The true value of the real estate in this segment does not lie in the building or its versatility, as e-commerce is profitable enough for operators to invest in adapting buildings out of their own pockets. The true future value of a plot of land lies in the permission to handle intensive traffic and build relatively high.

That poses a particular challenge in many urban areas in Germany, and our answer to that was to design a multi-level hybrid building, the GARBE Cube. In order to convince city councils to permit some logistics space, the two or three-level building is masked by building light industrial and office space on two or three sides and on top. This drives up the number of jobs and also the municipality’s tax revenue per square meter while keeping rents payable for logistics tenants.

Emissions of all sorts are key to the future value of property. We try to buy land and assets with permits allowing plenty of traffic and always make sure not to endanger the permits when tenants or their processes change. We also use every opportunity to beef up electricity supply and internet access. Even in a country with comparatively well-developed digital infrastructure like Germany the quality of internet access – or lack of it – sometimes cools down the interest of potential tenants in a property. It is also essential not to design sheds, multi-level or single-story alike, with too many specific features. Despite all of the technology in use nowadays, industrial buildings will remain a shell to house constantly changing processes.

Garbe data centerCommitting to memory

GARBE enters data center market

In October, GARBE launched a joint venture with Munich-headquartered data center specialist NDC Data Centers to provide a replicable data center model for the European market. NDC-GARBE Data Centers Europe aims to attract custom from hyperscalers such as Amazon, Google and Facebook, as well as co-locators, wholesalers and large corporations. It will develop buildings using NDC’s technology, which can produce energy savings from cooling of 90 percent and cut CO2 emissions by up to 30 percent.

Christopher Garbe says: “Increasing demand for IT capacity is in conflict with dwindling natural resources. Based on GARBE’s project development experience and access to land on the one hand, and NDC’s patented and verified technology concept, which reduces construction time and energy consumption, on the other, we anticipate great development potential.”

The joint venture has secured sites near Frankfurt, Munich and Berlin, as well as in northern Sweden. “The investment commitment for a data center is a lot higher than for a logistics building, so to develop them we need investment partners from more or less day one onward, but when completed they are an attractive asset with a 10 to 15-year contract, often to a blue-chip company like Google or Amazon,” adds Garbe. “To begin with, we are likely to look for investment partners on a project-by-project basis, and then when we have built up that side of the business, we may look for a strategic partner.”