Digitization and increasing international competition are going to generate an enormous structural change in the production industry in Germany over the coming years. This will have an effect on companies’ real estate requirements. In their article, university professors Tobias Just and Andreas Pfnür describe how the management of production-related real estate will change, and why investors underestimate this asset class.
Economic structures are subject to constant change. However, there are phases in which this change accelerates, either because a new cross-sectional technology has been developed or because the institutional framework for doing business has changed. The last three decades have been shaped by two parallel and mutually reinforcing trends: firstly, the costs of data processing and data transmission have reduced rapidly, leading to entirely new industries emerging and new stages of value creation forming within companies. The internet, and subsequently the interlinking of production processes (Industry 4.0), are essentially just two more recent stages of this development. At the same time, enormous markets have opened up to global economic exchange. China has become the world’s workbench; India, its software factory. And the associated economic success has created large sales markets for consumer and industrial goods.
International competition and digitization are forcing change
German industry is both a winner and loser in this: on the one hand, millions of jobs for low-skilled workers have been relocated from Germany to what are known as “low-wage countries.” On the other hand, millions of new jobs have been created in the service sector and in higher-level roles within industry. This development is not yet complete, as the two key trends – economic opening and digitization of value creation processes – have not yet let up. This is important for manufacturing companies and the real estate industry because these changes will have a considerable impact on operational procedures, as well as on the processing industry’s concrete need for real estate. At first glance, both trends would appear to lead to increased cost competition. It forces companies to put their cost parameters under the microscope. However, this is just one facet, as digitization is open-ended, and many companies in emerging markets are pushing ahead in higher stages of value creation – and therefore becoming competitors for German firms in knowledge-intensive sectors. This means that, for many industrial firms, cost leadership is not the best strategy; what counts is innovative leadership under strict cost control. Creativity is, by definition, difficult to plan, meaning that innovative leadership demands openness in terms of process and result. Real estate in the manufacturing industry – particularly the less capital-intensive light industry – needs to meet these requirements.
Flexibility is more important than reducing costs
What does this mean? There is a cost-optimized solution amidst pure cost competition: economies of scale in production lead to bigger operational units; wage cost competition leads to relocation of operating sites. If this logic lasts, very specific buildings will emerge, some of which will be designed for decades of use. However, flexibility becomes more important in the competition to become innovation leader, because the perfect process has not yet been found; ultimately, there are numerous markets still to be discovered. In such a competitive environment, flexibility is often more important than short-term cost reduction. A study that we recently conducted for Aurelis among large SMEs in production-related sectors (> 3,000 employees) displays this shift in an impressive way: two thirds of those surveyed are expecting increasing demand for flexible spaces within their own company, and almost 70 % of those surveyed see flexibility of real estate portfolios as one of the core challenges in the management of production-related real estate – purely economic (cost) aspects were specified most frequently after that. The distance between these two core challenges is, however, very great. Encouraging flexibility is easy; implementing it is no walk in the park. Three things are key:
- In-house production processes must not be too specific, because the more particular the requirements for production in a building are, the more specific the building has to be and the more difficult it becomes to use the building for other internal or external purposes.
- Alongside this property-related flexibility, flexibility in the portfolio is important. What is needed is a liquid investment market, or a liquid rental market as a minimum, as only then can additional space be taken up at short notice or space that is no longer required be offloaded. Alongside the ability for the building to be used by third parties, a well-informed and active real estate capital market that also considers production-related real estate is important.
- Professional real estate management is essential, as it is more or less the glue between existing property holders on the one hand, and the capital market – or future users – on the other.
The underrated EUR 600 bil. asset class
Our study provides valuable findings on these three aspects:
- Production-related real estate used to be considered very specific. However, the results of our survey now suggest that this specificity could be overestimated in many cases. The majority of companies work by very similar locational parameters: good transportation links and access to qualified workers are by far the most important factors. Added to this is the fact that two out of three companies believe that they would be able to obtain necessary real estate “within the market stock” and, vice-versa, that their own real estate would be able to be used by others. Existing production-related real estate could therefore already be more suitable for third-party use than is often assumed.
- At the same time, despite increasing interest from investors, a large, individual asset class of production-related real estate has not yet managed to establish itself. This is significant because we estimate the stock of production-related real estate at some 600 billion euros. According to our results, the extensive presence of niches is primarily due to insufficient transparency on the market, as well as a lack of expertise. The availability of sufficient market data for capital investment decision-making and the controlling thereof are important for institutional investors. They have to inform their investors in order to justify decisions, and in many cases they have to compensate for a lack of specific real estate market data with assessments of general national and regional economic information. The more flexible the existing production-related real estate is, the more suitable it is for third-party use, the easier it will be to build up a robust database of real estate data.
- Such data does not necessarily have to be simple market data; individual pieces of information about buildings or portfolios are interesting for investors if they facilitate interpretation. The important thing is that the interest among institutional investors for this new asset class is not generated through higher market transparency alone. Rather, what is required in the case of these comparatively management-intensive properties is an experienced asset manager that makes the specific market, locational, and usage concept risks manageable for end investors. This expertise exists on the German market, but the range of services in the management of production-related real estate is relatively small. Asset managers’ most important task is therefore to bring flexibility to real estate use by means of standardization of location and building concepts. The halls that are used to produce solar panels must be able to produce wine glasses tomorrow.
Plenty of potential for investors
These considerations and the results of the survey make it possible to derive key conclusions for the coming years: demand for flexible buildings that can be used by others will increase. So that this demand can be met, a liquid market for such properties needs to be created. This market will only be able to emerge if institutional investors are able to resolve their uncertainties regarding the investment class. The value of professional advice and management is clearly increasing in view of dramatically dropping rental returns in traditional core investment markets. We suspect that there are economies of scale to be found in this young market segment because the existing production-related real estate is not distributed evenly across Germany, but rather pooled in a few centers. In this case, the advantage of regional expertise will quickly be compensated for with expertise about how an asset class works.
Dr. Tobias Just is the scientific coordinator/director and chair of real estate management at the University of Regensburg and IREBS International Real Estate Business School. Dr. Andreas Pfnür is the director of studies for real estate and construction management at Technische Universität Darmstadt.