Money finds safe, no-thrills home in German listed resi


Sector offers rising share prices and solid, if unspectacular returns, writes Virginia Blackburn

As the crisis in the eurozone calms down and investors show tentative signs of being prepared to up the risk content of their portfolio, one safe and slightly less exciting area continues to curry favour: the listed German real estate sector.

Share prices in listed property companies have been rising since 2008, sparking some fears of a bubble, but most investors continue to regard the market as a safe haven.

p18Deutsche Bank and JP Morgan Cazenove forecast further growth. The former points out that in real terms, Germany’s price rises are at the lower end of the scale compared to similar phases in other OECD countries, and should be seen as a normalisation of pricing.

JP Morgan Cazenove, meanwhile, says values will grow for another five to 10 years, driven by strong tenant demand, limited supply, the volume of capital seeking stable returns, affordability and the current differential to replacement cost. However, there are differences between the commercial and residential sectors.

“Over the past year or two, residential property has been most attractive,” says James Wilkinson, European chief investment officer at BlackRock’s new global real estate securities business. There has been a flurry of initial public offerings as Deutsche Annington, LEG Immobilien and GSW Immobilien have all floated.

Wilkinson: “We expect annual rental growth of around 2-2.5%, which is not very high, but the source of it is highly granular”
Wilkinson: “We expect annual rental growth of around 2-2.5%, which is not very high, but the source of it is highly granular”

“We see good rental and capital growth prospects and the risk/return balance is right. We expect annual rental growth of around 2-2.5%, which is not very high, but the source of this income is highly granular.”

Many market players expect more IPO’s. Peter Nieuwland, manager of the Schroders Global Properties Securities Fund’s European portfolio, says: “In April, Austria’s Immofinanz bought almost 2,000 Berlin flats through its BUWOG subsidiary, with a view to floating the latter; this has been postponed, but is still expected to happen.

“Cerberus Capital Management is considering an IPO for its retail assets, which is expected to be in the region of €2bn. US giants Equity Residential and AvalonBay Communities are preparing to sell their unit DeWAG, through a private buyer or an IPO valued at about €1.3bn. More portfolios are coming to the market and publicly listed companies are interested.”

At the same time, established players are making acquisitions as and when appropriate: for
example, Deutsche Wohnen has launched a €1.7bn bid for GSW Immobilien. The deal would boost its portfolio of flats by around 63% to more than 147,000 and put it second in the market behind Deutsche Annington, which has 179,000 apartments.

The company plans to publish full offer documents after its extraordinary shareholder meeting on 30 September.

Bid for GSW gains support

The takeover target itself has expressed some support for the deal. “A combination of GSW and Deutsche Wohnen could make sense from an operational and industry viewpoint,” says a spokesman, confirming that Goldman Sachs, Citigroup and Kempen & Co have been appointed to advise on the offer.
Market players approve of the proposed deal: “It makes sense on an operational level,” says Boris Schran, founding partner of European real estate private equity firm Peakside Capital.

GSW has also appointed Jörg Schwagen-scheidt and Andreas Segal as joint CEOs after shareholder pressure led predecessor Bernd Kottmann to resign in June less than three months after his appointment.

On the down side, the market was shocked when IVG Immobilien, co-owner of London’s Gherkin office building in the City as well as The Squaire in Frankfurt, said it was seeking protection from creditors after failing to reach an agreement over the restructuring of its €3.2bn debt (see panel).

Altogether, it has been a year of seismic activity in what is still a very small market. Ali Zaidi,
analyst at the European Real Estate Association (EPRA), puts the total value of German real estate at €1.16trn, while listed real estate is a comparatively minor €13.68bn.

There are 13 German property stocks, worth a total of €10.4bn, in EPRA’s property index (the figure is smaller than Zaidi’s €13.68bn estimate as not all companies are included in the index) and it comprises just 1.18% of the total stock market, as compared with 3.47% on the continent as a whole.

Even the most seasoned market insiders are mystified as to why the German market stays so small, but no one expects it to grow rapidly any time soon.

While the market is small, the players have distinct identities. Geographical exposure is one relevant criteria when deciding where to invest, Wilkinson says. GSW and LEG have strong holdings in North Rhine-West- phalia and, in the case of the former, booming Berlin; Deutsche Wohnen and GAGFAH are more geographically diverse.

“Berlin, western and southern Germany, which are economically most active, have greater potential for rental growth,” says Wilkinson. “They also lack stock, so there’s a supply and demand imbalance. What gives greater scope in rental value growth is that German rents and capital values are still so low it is not economical to develop housing. There will continue to be that imbalance for some time to come.”

Limited upside in residential sector

But the upside remains limited. “Residential property companies are at or above net asset value,” Nieuwland warns. “They trade at a price-to-earnings ratio of 20 to 22, but do provide secure, albeit limited, growth, making these defensive stocks.”

“Residential property companies are at or above net asset value. They trade at a price-to-earnings ratio of 20 to 22, but provide secure, albeit limited, growth, making hese defensive stocks” Peter Nieuwland, Schroders
“Residential property companies are at or above net asset value. They trade at a price-to-earnings ratio of 20 to 22, but provide secure, albeit limited, growth, making hese defensive stocks”
Peter Nieuwland, Schroders

The companies vary greatly in size. The biggest in terms of apartments is Deutsche Annington, with just under 180,000; then GAGFAH, with 150,000; Deutsche Wohnen and LEG Immobilien, with 90,000 each; TAG Immobilien and GSW Immobilien, with 50,000; and Grand City, with 15,000.

The commercial sector is less popular with investors than the multi-family rented housing sector, not least because of the rocky economic conditions of recent years, but even here good returns can be made.

“Prime rents in Germany have risen 3%,” Wilkinson says. “If we take that and assume per annum for the next few years a 5.5% yield, you are seeing an 8-8.5% ungeared internal rate of return.”

With Germany still one of the relative shining lights of Europe, thanks to wage growth, reasonable economic strength, increasing consumer confidence and a resilient economy, that is unlikely to change.

The fundamentals are also working in favour of the commercial sector. “Vacancy rates are falling in major cities, from 9.2% to 8.4%, and in Frankfurt from 14.7% to 12.4% in the past six months,” Nieuwland says. “The reasons are that there is little new construction and Germany is a pretty good economy, which is helping demand.”

But one continuing bugbear for investors is the status of REITs, which were introduced in 2007 and, after a shaky start, are now popular investment vehicles that are not taxed on their income and capital gains.

However, in what some suspect is a politically motivated attempt to keep German residential
property out of foreign ownership, only commercial property companies, and residential property companies with assets built after 2006, can be REITs.

There is growing pressure to force the German regulators to think again. “REITs are still
popular,” says Dr Herbert Harrer, a capital markets partner at Linklaters. “German REITs offer
attractive investment opportunities for investors, providing for full exemption from corporate and trade tax. The German REIT must be a German stock corporation having its seat and place of management in Germany and its shares must be traded on an organised market in the EU or the European Economic Area.

“Additional requirements apply with regard to free float, equity capital, distribution of profits and revenue generation.”

The fact that property is a politically sensitive asset class manifests itself in other ways. Rising rents, while good for individual companies, are unpopular with the German public.

There are also fears of increased residential sector regulation (see p20).

“The authorities are holding back,” says one market insider who did not wish to be named. “However, as it is, properties are subject to a variety of rent controls and now a stricter set is
being proposed.

Growing risks and disappointing returns

“The increased supply of paper, the risk of increased regulation and rising bond yields suggest long-term capital costs could rise, negatively affecting German residential businesses. On top of that, some high-quality names haven’t delivered the returns people were looking for.”

Deutsche Wohnen, for example, is only 2.4% up on the year. IVG has collapsed (see panel) and GAGFAH produced a relatively modest 6.9% rise. But other players did post stronger gains, with TAG Immobilien up an impressive 20.4% on the year.

The financing side is also opening up: banks are more willing to lend and more sources of debt are becoming available on favourable terms, including CMBS. The market looks set to continue as before: unexciting but fairly safe.

Frankfurt airport scheme helps land IVG in debt crisis

Once Germany’s biggest listed property company, IVG’s fortunes declined after it was caught with high gearing in the wake of the financial crisis and huge cost overruns on what was supposed to be its flagship project, The Squaire at Frankfurt airport.

At its 2007 peak, the stock market valued IVG, co-owner of London’s Gherkin, at about €35 per share, its portfolio having been built up in a rapid, debt-fuelled expansion spree. Now burdened with €3.2bn of borrowings, the company said in May that it had to cut its liabilities by up to €1.75bn and completely restructure the rest.

A preliminary deal with IVG’s creditors to swap debt for equity, which would have all but wiped out shareholders, fell through. On August 20, the company sought protection
from its creditors; under German law it has up to three months to find a solution.

According to CoStar, around a third of a €1.3bn loan syndicated to about 10 banks was acquired at around a 20% discount in July, by Apollo Global Management, TPG, Cerberus and Varde Partners, while US hedge funds Aurelius Capital Management and Third Avenue Management own stakes in a €400m convertible bond.

“Despite weeks of intensive mediations and negotiation efforts on the part of IVG, the creditor groups were unable to agree on a consensual solution taking into account all stakeholder interests,” conceded chief executive Wolfgang Schaefers.

It was the culmination of a terrible year for investors in the company.