Deutsche Annington gets set for ascent from Terra Firma

Analysts see an IPO as eventual conclusion to housing giant’s refinancing, writes Doug Morrison

The dust is some way from settling on Terra Firma’s proposed €4.3bn debt refinancing of Deutsche Annington – the largest deal of its kind attempted in Europe – but already there is fevered anticipation of a stock market flotation as the end game.

Analysts and commentators seem to have been waiting for Terra Firma’s exit from the moment Guy Hands’ private equity group bought into German housing in 2000.

The scale, complexity and contentiousness of the GRAND refinancing plan, announced in July, for the CMBS debt securing its €8.4bn German multi-family housing portfolio raised expectations of an initial public offering sooner rather than later.

But in a rare interview, Terra Firma financial managing director Arjan Breure cautions: “We’re not done yet.” Terra Firma wants to invest €1bn in the 231,300-home portfolio (or network, as he calls it) before thoughts turn to flotation.

Aside from “accretive” acquisitions, the investment would involve modernisation of Deutsche Annington’s portfolio as well as exploiting its clout as landlord to more than 500,000 people by instigating joint ventures with major utility providers.

It is an exhaustive asset management programme, designed to extract more value at a time when German residential rental property is performing strongly and Deutsche Annington’s particularly so. Nearly half of its portfolio is in the North Rhine- Westphalia region, which has shown the highest rental growth and lowest vacancies.

Robust residential opportunities

“We identified residential as an attractive sector in 1999 and made our first investment in DAIG in 2000,” he says. “We’ve always believed the sector is an extremely robust investment opportunity in terms of security of cash flow and its total return profile between cash flow and growth. You have got upside potential, implicit inflation protection and growth.”

Overall the company is achieving 8-9% total returns. In these days of lower expectations, Breure says this is more than satisfactory for investors in Terra Firma’s 83% equity holding, as well as the Citigroup Property Investors consortium that acquired a 17% stake in 2006.

“It’s very sustainable. On a total return basis, residential still looks very attractive. It has got low volatility and the assets backing it are at a significant discount to replacement value, which is very rare,” says Breure.

“But international institutions own the company, so eventually we will exit, at the right time, when we feel the value has been maximised. Because of the size of the business it is very likely to be an IPO.”

For now, the focus is understandably on the GRAND CMBS, which covers the bulk of Deutsche Annington’s assets. With its loans due to mature in 2013, the refinanc-ing proposal to its noteholders involves extending the debt by five years and paying it off in instalments (see July/August issue).

GRAND is potentially fraught because Terra Firma and six bondholders representing 32% of the debt initially excluded subordinated noteholders when they hammered out the agreement. But Breure says GRAND  “speaks towards how well this company is run” and is confident that the required 75% of bondholders will rubber-stamp the proposal by its November completion date.

All of this is manna from heaven for the flotation wish-fulfilment brigade. Though IPOs are now almost as rare as hens’ teeth, shares in Germany’s leading listed residential property companies have risen 50% this year, reflecting the sector’s strength. Deutsche Annington would be a welcome addition.

Yet such sharp share price rises always raise suspicions of a bubble. Last month Morgan Stanley reported that while the fundamentals for well-located, well- financed housing remained stronger than for offices, listed companies such as Deutsche Wohnen and GSW were “fully priced”.

Institutional interest growing

Breure admits that brokers will press some investors to take profits now, but suggests  plenty of other institutions want to buy into German housing. He believes the stock market is “rebasing the valuation of German residential assets. It’s not a temporary cycle.”

Breure adds: “I don’t feel we need to float as soon as possible in case the market falls away. I think this market is sustainable for the type of return it now provides. Investors  will look at this not as another 50% stock price appreciation, but as a long-term, sustainable return level with low volatility.

“It is an emerging institutional asset class with five to 10 large players in the near future. I’m not a jealous person; if other people do well, that’s all good for the sector.”

Meanwhile, Deutsche Annington ticks along nicely. In 2011 its earnings before interest, tax, depreciation and amortisation were €510m, up from €502m in 2010 and €480m in 2009. The group will seek to boost earnings by buying portfolios that come onto the market – a likely byproduct of other companies’ refinancing deals.

Breure will continue to stress Terra Firma’s long-term track record. He points out that the firm has been in the residential sector since 1996, when it bought Annington in the UK, which it still owns Asked if there could be more UK as well as German acquistions, he adds: “Absolutely. We’re looking for long-term, attractive investments that can generate stable returns for investors. We are the longest-standing residential investor in two of Europe’s largest markets. Once you know something about a sector, you always expect to look for other opportunities in other markets.”