, , , , , , , , , , , , , , , , , , ,

It’s a year now since I completed my German residential property series (Parts I, II, III, IV & V, and the first part of this post offers a brief recap) so it’s a good time to take another look. With winter drawing in fast, why not whip up a plate of sauerbraten & pour a (very) large stein of beer, and we’ll begin:

I’m ignoring companies with non-English IR websites. This may be a personal prejudice, but sometimes it can be hard enough to decipher a company’s communications & (underlying) performance without suffering a language barrier too! For practical reasons, I’m also ignoring sub-10 million market caps, plus companies with a relatively minor German property allocation. [But here’s a fairly comprehensive list of these companies]. I’m kicking out Youniq (YOU:GR) (see comments below), plus Speymill (SYG:LN) which has disposed of its German property to Jim Mellon. However, I’ve added two big IPOs from earlier this year (Deutsche Annington & LEG), plus Adler who ramped up its residential portfolio this year (& added an English IR website). Finally, I’ll still treat Deutsche Wohnen & GSW as separate companies, even though the takeover of GSW’s now a done deal. [GSW may well remain a separately listed company]. This leaves us with 13 companies, a baker’s dozenthe vast majority of which are residential pure plays. They should serve as a good proxy for the entire sector:

Adler Real Estate (ADL:GR)

Conwert Immobilien Invest (CWI:AV)

Deutsche Annington Immobilien (ANN:GR)

Deutsche Wohnen (DWNI:GR)

Estavis (E7S:GR)

Gagfah (GFJ:GR)

Grand City Properties (GYC:GR)

GSW Immobilien (GIB:GR)

KWG Kommunale Wohnen (BIW:GR)

LEG Immobilien (LEG:GR)

Patrizia Immobilien (P1Z:GR)

TAG Immobilien (TEG:GR)

Taliesin Property Fund (TPF:LN)

[Note Conwert & Estavis have nearly a third of their portfolios invested in commercial property – this allocation will likely continue to decrease. Note also, nearly a quarter of Conwert’s portfolio is invested in Austria].

[NB: If you’re seeking (greater) exposure to Berlin/E German property, these are probably the best companies to focus on:  Conwert, Taliesin, GSW, Deutsche Wohnen, Estavis & TAG Immobilien].

The specific focus on residential property is no accident – it’s increasingly common in the past number of years, as companies bid on large municipal portfolios & bulked up to achieve increasing economies of scale. This trend’s acquired additional momentum in the past year or two, as large-cap/pure play residential companies have increasingly traded at a premium to NAV. And judging by far higher US REIT valuations (on average, despite recent setbacks), there could be a lot more mileage to be enjoyed by investors. Meanwhile, German companies remain (understandably) focused on a continued land grab for cheap property – but when they eventually re-focus on FFO, tax efficiency & dividends, it may well usher in a fresh revaluation phase.

Of course, when it comes to property everybody’s looking for something different… It’s far better for me to come up with a selection of rankings, which should provide a good feel for the sector & perhaps suggest a few research candidates. [NB: All ratios are based on Nov-20th eod share prices. I’ve confirmed/calculated & double-checked all figures, but please do your own research & confirmation if you’re considering a particular company. I’ve also derived certain figures, and/or made adjustments, as appropriate – email me if you wish to clarify any details]. To change it up a bit, in each category I’ll generally provide a Top 5 plus some sector stats – let’s start with:

EUR Value per Sqm:

German Resi Value

Values are cheapest in E Germany, begin to increase as you head West, and then jump substantially as you go down South. Surveying the table, value’s actually less about location & more about access to large-scale/cheap portfolio purchases – North Rhine-Westphalia (NRW) has provided the best opportunities to date. [Though I suspect we’ll see increasing activity & focus on Berlin/E Germany going forward]. The sector average is EUR 959 per sqm, while a EUR 900 per sqm market cap weighted average reflects the purchase discounts & economies of scale larger companies can achieve. On a relative or even absolute basis, I hardly need to remind you how cheap these values are..!

Of course, ultimately one might argue price equates to location, but I probably stopped listening… Yes, there’s some truth to the equation, but it’s mostly a crock – dreamed up by real estate agents wanting you to pay up & fatten their commissions. [Don’t get me wrong – I’m certainly not implying every word out of their mouths is a lie…I mean, they have to sleep occasionally, don’t they?!] Trouble is, people are tremendously insecure about property, which means they’re suckers for this kind of shite – so it tends to become a self-fulfilling prophecy. Personally, I believe the cheaper a property, the safer it is & the more upside potential it presents – particularly true of German residential property, I believe, especially at this point in the cycle. Anyway, yield is the great equalizer – one property might be a multiple of another in terms of value, but I’ll happily bet their yields are pretty similar. Let’s take another look:

Property Yield:

German Resi Yield

Again, we’re looking at a real bargain here – the sector enjoys a 6.8% portfolio yield, while the weighted average yield edges up to 7.0% – presumably assisted by the purchase discounts larger companies manage to capture. Hmmm, now which would you prefer: Managing large blocks of German apartments, or the latest US property craze – i.e. trying to assemble & manage thousands of individual rental homes?! [Then again, I’m asking the wrong question – US REIT investors will pretty much buy anything you shove down their throats. But God forbid you offer them German property… ;-)] Of course, these portfolio values & yields aren’t necessarily what an investor gets – it all depends on what they pay:

Price/Book Value:

German Resi PB

[NB: I prefer to calculate NAV based on an average of IFRS & EPRA NAVs].

I’ve included a Top 6 here, as KWG & Conwert essentially overlap. [Note also: Two companies end up unfairly ranked from a P/B perspective: i) Patrizia has an external EUR 10 billion of Assets under Management (AUM), which isn’t reflected in its NAV, and ii) Grand City has an 8.4% yield – presuming convergence with the sector average, it would be much more reasonably priced]. The sector itself continues to trade ’round book value, with the large-caps mostly priced between 1.0-1.2 times book. Considering large-cap property company valuations in other developed markets, plus the relative gap in property yields & (particularly) valuations, an increased premium to NAV (say, of 20-30%) would appear to be warranted (& sustainable) for the market leaders. Of course, no property company’s cheap if it’s over-leveraged:

German Resi LTV

[Note: I prefer to calculate Net Loan-to-Value (LTV) as follows (& see my related comments here):

(Borrowings + Financial Derivative Liabilities + (Convertible/Preference Liabilities + Pension/Employee Liabilities + Government Loans/Repayable Grants etc.) * 50% – Cash/Marketable Securities – Derivative Financial Assets) / (Current/Non-Current/Held-for-Sale Property)]

Clearly it’s good news across the board (in fact, only Adler has a Net LTV in excess of 65%). Equity issuance, debt amortization, re-financing & property revaluations have left the sector in an enviable position – with a cap weighted average of only 55%. Admittedly, the average is flattered by Deutsche Annington & LEG, which IPOed with surprisingly low leverage. Noting the banks are clearly comfortable financing 60-65% LTVs, I’d expect the sector average to creep back up over time. Considering current German residential property valuations, and its price history, I’m pretty confident that kind of leverage doesn’t present a significant financial risk for investors.

So, what’s worth buying?! Well, some like to focus on the market leaders:

German Resi Gains

The Top 5 might all be outliers here – benefiting from positive deal & news flow, and/or a revaluation from undeserved valuations. What’s more revealing is the 11% cap weighted average gain – wow, the sector’s actually been a global laggard this year! Now, I don’t think for a second that this undermines my investment thesis – it simply reflects the return of risk-on in the markets. Too many investors have short memories & even shorter attention spans, plus there’s a multitude of far sexier investments beckoning right now… Personally, I’m perfectly happy to keep/add to my German property exposure as a core low-risk (& potential high-reward) portfolio holding. After all, we could wake up any day to a fresh wave of revulsion, risk-off, European sovereign debt crisis, bank asset write-downs, call it what you will…German residential property’s still a great place to hide.

And speaking of, others (inc. myself, perhaps) are always tempted by the laggards:

German Resi Losses

Or one might argue sticking with the large-caps makes the most sense:

German Resi Mkt Caps

These obviously possess some natural advantages, and brokers, investors & the media will mostly focus on the well-known names. More importantly, the large-caps may be the only practical (listed) investment option for institutions who want to increase sector exposure. [Damn, I really should listen to myself more…especially about simple market realities like this!] Bearing that in mind, let me highlight the companies I find most interesting now. First, we should look back – I was particularly keen on:

Youniq (YOU:GR):  Yes, I was intrigued by student housing, but certainly didn’t suggest buying this loser (down 66% YTD!). I can’t determine the underlying portfolio metrics, the past year’s news flow & write-downs inspire no confidence, cash flow’s problematic & now leverage is threatening to hit dangerous levels. I don’t care how cheap it is (a 0.36 P/B!) – unless there’s a radical change/turn-around here, Youniq’s now off my radar

Grand City Properties (GYC:GR):  A great pick, up 52% YTD…except I didn’t buy it! Judging by their recent (deal) history, I suspect management will continue to rack up superior NAV performance here – but at this point in time, GYC looks rich enough to me.

Conwert Immobilien Invest (CWI:AV):  What can I say… Despite the poor performance YTD, and its perplexing NAV discount, I continue to see attractive upside potential here – I mean, it’s on a bloody 0.63 P/B!

AT this point, I also potentially like:

LEG Immobilien (LEG:GR):  LEG’s down 3% YTD – while its fellow IPO, Deutsche Annington, is up 18%. This divergence in performance looks unwarranted, particularly as LEG’s metrics are (a little) better ‘cross the board.

Gagfah (GFJ:GR):  The WOBA-Dresden lawsuit is now a distant memory, and the company’s completed a very successful re-financing of its 2013 & 2014 debt cliff. Despite this, it trades on a 0.89 P/B which looks like an undeserved discount to its large-cap peers.

TAG Immobilien (TEG:GR):  The TEG share price continues to suffer some after-effects from the recent Rolf Elgeti revelations. Whether these allegations are (finally) determined to be true or false, or simply lax governance, I suspect it’s ultimately irrelevant to the company’s current/future intrinsic value. The impact on NAV should be relatively immaterial, and it obviously won’t be a risk/issue going forward (whether Elgeti stays or goes).

And of course, that just leaves…

KWG Kommunale Wohnen (BIW:GR):  Yes, it’s still nearest & dearest to my heart – and a 5.6% portfolio holding. Its poor (7)% YTD performance is really just a calendar phenomenon, as I’ve enjoyed a 19% gain versus my write-up price a year ago. Let’s first review their progress in the past year.

Actually, I posted a follow-up piece in May, so we only need to focus on their interim report & their recent Q3 release. As you’ll note, the company continues to report steady operational progress & to re-affirm FY-2013 guidance. However, the company will probably remain in digestion mode ’til 2014, as it continues to absorb & renovate its more recent acquisitions. A lot of investors seem to focus & thrive on deal news in the sector, which probably explains some of the waning enthusiasm for KWG this year. Of course, this ignores the progress & potential that’s going on below the surface – in the past year, the vacancy rate on KWG’s Investment portfolio has declined from 33% to 22%. With a Core portfolio vacancy rate of just 2.8%, this puts overall vacancies at close to 13% – which presents another significant opportunity.

Cash flow’s positive, and their current Net LTV’s around 54%. Their portfolio continues to be one of the cheapest in the entire sector, with a value of EUR 726 per sqm & a 7.3% yield. Net equity also continues to advance, with EUR 10.63 IFRS EUR 11.56 EPRA NAVs as of end-June. Averaging these, and tweaking for Q3’s EUR 1.2 million net profit, I arrive at a EUR 11.17 (average) NAV – which makes it the cheapest stock in the sector, trading on a 0.55 Price/Book. Of course, the obvious cloud here is Conwert’s 75.7% majority stake in KWG. Predictably, this has prompted a rash of conspiracy theories amongst the company’s private investors… But I think there’s a different & bigger picture to consider here:

Screwing over KWG’s minority shareholders in a takeover, or some other form of market exit, would be a pointless exercise for Conwert. Its current (IFRS) net equity’s almost EUR 1.1 billion, while the value of KWG’s minority interest is a mere EUR 42 million – in fact, the market value of that interest is a tiny EUR 24 million. So any potential gain for Conwert would be immaterial…

What really interests & excites Conwert is the ridiculous 37% discount its share price still suffers. This is somewhat mystifying – I have to wonder if investors still think Conwert’s some kind of pre-crisis Austrian company, up to its tits in E European property & too much debt. Which couldn’t be further from the truth – only 3% of its portfolio is now outside Austria & Germany, and its latest Net LTV is just 58% (plus management continues to cut expenses & improve cash flow). In fact, it’s really not even an Austrian property company any more – how many investors realize 74% of Conwert’s portfolio is now in Germany? And a majority of this allocation’s invested in cheaper E German property? And its higher EUR 1,099 per sqm valuation & lower 6.2% yield (vs. its German peers) simply reflects the more expensive valuation of its 23% Austrian portfolio allocation? [Note a fairly similar differential exists between Berlin & Munich property, for example].

Essentially, Conwert management’s recognized the most promising route to a premium valuation is (ideally) a German-listed/large-cap German residential property portfolio. With that in mind, they’re still targeting an increase in their German property exposure (to at least 80%) in the next two years. They also plan to decrease their commercial exposure from 30% today (to a target of 20%, which I suspect they’ll easily surpass). Their majority stake in KWG’s obviously integral to this whole strategy. And it presented them with an opportunity to bring Stavros Efremidis (KWG’s former CEO) in-house & place him in charge of their German business.

I expect they’ll continue to take a ‘build & wait’ approach in the near-term. But if KWG and/or Conwert continue to be neglected by investors, I’m sure they’ll consider more aggressive measures to close the current valuation gap. Reasonable leverage allows them to consider share repurchases, or a tender – but other strategies might include bulking up KWG, spinning-out Conwert’s German portfolio, reversing some/all of it into KWG, etc. Again, any advantage gained from shafting minorities – for example, by inflating the value of properties sold to KWG – would prove fairly immaterial. And it could easily provoke wider NAV discount(s), which would entirely defeat the purpose! Anyway, I hardly need go on – if a KWG shareholder can’t see past this (real or imagined) risk, there’s a simple solution:

Just switch into Conwert shares!

Frankly, that’s probably the ‘worst-case’ scenario I foresee for KWG shareholders anyway – i.e. they might end up owning Conwert shares. As I’ve outlined, I see no reason to consider that a potentially alarming prospect. Meanwhile, I note KWG’s cheaper P/B ratio, its near 30% divergence in share price performance (vs. Conwert) since the end of June, and most importantly its record of value creation in the past six years:

Dec-07:   EUR 6.47

Dec-08:   EUR 6.53

Dec-09:   EUR 6.59

Dec-10:   EUR 7.23

Dec-11:   EUR 8.41   (EPRA NAV)

Dec-12:   EUR 11.19   (EPRA NAV)

End Q3-13:   EUR 11.64   (EPRA NAV, estimated)

Yup, I’ll happily stick with KWG. 🙂 And I think it deserves a 1.04 P/B valuation (i.e. the sector’s cap weighted average) in the fullness of time – which implies a EUR 11.66 Fair Value per share, for an Upside Potential of 90%. Of course, a potential convergence in KWG’s portfolio yield (to 7.0%) would also offer some incremental upside. Now, all that’s left is for me to repeat this observation – German residential property is (still):

Perhaps one of the safest & most attractive asset classes in Europe, or even the world.

  • Fair Value:   EUR 11.66
  • Upside Potential:   90%