Deutsche Wohnen SE (OTCPK:DWHHF) Q3 2020 Results Conference Call November 13, 2020 5:00 AM ET
Michael Zahn – Chief Executive Officer
Philip Grosse – Chief Financial Officer
Conference Call Participants
Jaap Kuin – Kempen
Marc Mozzi – Bank of America
Andres Toome – Green Street Advisors
Simon Stippig – Warburg Research
Kaveh Sheibani – Lexcor
Good morning and welcome to the publication of our nine month results. As Corona pandemic continues to occupy us and in light of the growing number of infection cases, uncertainty about the further development of the crisis is increasing, we have come through the pandemic relatively well in Germany so far, but the situation is unchanged areas.
However, both the residential segment and we as a company so far have still only marginally affected by the crisis. Compared to the publication of our half year results, the number of tenants who contacted us in connection with payment difficulties due to the corona pandemic has increased only slightly. Furthermore, we continue to have the situation in our nursing homes under control.
Belong to all of us, here the economic effects caused by the crisis depends on how long it will last. So far, only a fraction of our 30% corona relief fund has been used. We are therefore well prepared for the situation getting gross. We will take individual cases of hardship into account and assume responsibility for our tenants. Despite the uncertainties due to corona, we can look back with great pride on what we have already achieved this year.
We have significantly expanded our involvement in new construction by acquiring and anticipating in project development platforms. We continue by our portfolio in a way, which significantly improved its quality. And despite the difficult environment on the capital markets, we were able to successfully place two bonds to address our upcoming maturities until 2023. We have not left into crisis mode, but have actively set the course for a successful future for Deutsche Wohnen.
Everything we do is dominated by conviction that quality makes the difference. So, we believe in our long-term market strategy, we investing year-by-year, a lot of money for to improve the quality of our housing stock. Today, we have the most attractive most energy efficient housing offer compared to the competition. Our tenants’ customers and partners benefit from a good offer that remains affordable. 9 out from 10 tenants already gives us good marks for our range of apartments and our service.
So, I’m very optimistic about the future prospects. Our sector, and especially our company, as a recently published survey of Price Waterhouse, and Urban Land Institute shows investors are favoring markets that offer defensive low risk characteristics. And the safe haven markets are mainly located in Germany, with Berlin taking once again the top of the city rankings. The fact that the residential sector is benefiting from the uncertainties caused by the corona pandemic is also demonstrated by development on the transaction market, which Phillip will discuss in detail in a moment.
But let me say briefly that there is still an incredible amount of liquidity in the market and transactions are being executed at record prices. We will continue to deal with the macroeconomic appeals and related issues for a long time. Our sector will benefit from this in the long-term. Pressure of demand will continue for yields housing rolls in my view continue to become more expenses.
Against this background, the valuation of our portfolio seems to me very cheap. As you can see on Page 4 of the presentation, in the third quarter, we have been working very intensively on the biggest challenge facing our industry, achieving our climate targets. We presented our concept for socially responsible climate protection at the hybrid event in Berlin and discussed with experts from fine politics business.
To achieve an almost climate neutral folding stock by 2050, the rate of refurbishment must be. But this can only succeed if the state landlords and tenants pull together. However, the letter often rejects energy efficient renovations, because they fear rent increases. We therefore propose that tenants the relief partly of the burden of the modernization shots. The money for this should come from funds from the Energy and Climate Fund, which brought from the CO2 pricing for among other things heating will flow.
In addition to the necessary renovations, however, we must also make full use of the technological possibilities for CO2 reduction and offer our tenants the opportunity is less sustainable. This is why we have agreed to cooperate with GETEC in the field of green power generation and electromobility and will install thousand new photovoltaic systems and 2000 charging points in our Berlin neighborhood.
This is the next step towards climate neutral living and working. We will invest around €75 million here over the next 10 years. Only if we tackle this challenge together and above all in a timely manner, we will be able to achieve our ambitious goals, want to and we will our contribution to this.
And with that I hand you over to Philip.
Yes. Thank you, Michael and a warm welcome to our earnings call also from my side. And all-in-all, the first nine months of 2020 have been very successful and the numbers contain little surprises in my view.
So let’s start with Page 5, the portfolio overview. As you can see, the monthly average in place rent of our portfolio is broadly stable compared to year-end 2019. And as mentioned in our last earnings call, this development is because of the Berlin rent freeze law, which continues to have a negative impact on the rent development of our Berlin stock for the time being.
As discussed previously, we have structured our rental contract and that’s pretty much in line with most market participants. It’s such that you can retro actively charge the higher rent according to the civil code, once our highest court has concerned the unconstitutionality of the Berlin rent freeze law. The possibility of claiming that’s a difference has been concerned just recently then the constitutional court dismissed emergency appeal on the lowering of rents that will come through from the end of November onwards.
Our relating rents based on the civil code are stable compared to the levels of last year, so slightly north of €9 per square meter per month. If you have not revalued our portfolio, as of the end of September, the average value per square meter remained almost unchanged at around €2,400 per square meter translating into a gross yield of 3.4%.
On the next page, we will have a closer look at the development of the Berlin residential markets. As you can see, since the implementation of the Berlin rent freeze law, the number of rental offers declined significantly by almost 40%, if demand for rental apartments remains very high, it is more difficult than ever for tenants to find a new apartment. This was the predominant driver for prices for condominiums, with almost €5,000 per square meter, an impressive increase of another 7% year-on-year driven by further good compression.
The transaction market for multifamily homes remains active, we have observed the stable pricing environment, that average price is north of €3,000 per square meter. After having started the year-end valuation process for our portfolio, considering market evidence and following discussions with our appraiser, Jones Lang LaSalle, we see a very comfortable to guide for a valuation uplift of around 6% at year-end that is excluding capitalized investments.
This is predominantly driven by an increase once again of the value of our Berlin stock round €2,800 per square meter. And further to add with a final ruling of our supreme court which we expect next year, there will be a further positive stimulus for the Berlin transaction market.
On Page 7, some quick remarks on our like-for-like rent development which is obviously distorted and will be distorted for as long as the Berlin rent freeze law is in place. Consequently, like-for-like rental growth has come down to 0.9% for the total portfolio. Adjusted for the negative impact of the rent freeze law like-for-like rental growth would have been around 2.4% for the entire portfolio when 6% for Berlin.
So far catch up potential in case the Berlin rent freeze law is ruled unconstitutional amounts to around €5 million. It’s the Berlin rent keep law is forcing landlords to reduce some rents for existing tenants starting November 23. This year, we will see a third drop around 6% in Q4 on the rent per square meter basis for our Berlin stock market.
As you can see on Page 8, the lifting business is running very stable. Income from rents increased by 2% year on year to around €634 million, NOI came out at €514 billion so slightly above last year’s level. NOI margin of 81% slightly declined by one percentage point compared to last year, adjusted for maintenance the NOI margin remained broadly stable, despite the current regulatory pressure on the top-line growth.
Moving to Page 9. Our disposal business, no big change here. Our prioritization business continues to deliver average gross margins of around 30%. For the institutional disposal business, the gross margin is at 15% for the first nine months of 2020. And this as previously explained, is to a large extent driven by clean up disposes of 13 nursing facilities, its book value.
Please keep in mind that the only reflect transactions which had already transferred title in that overview, which is why the time disposals of around 2400 units are not yet included. performer for these disposals our gross margin was significantly improved to around 30% for the full year of 2020.
Let’s moved to our nursing assisted living business on Page 10. Despite the challenging environment that regards to the pandemic, our nursing business continues to perform as solid as before. Increased spending for safety and hygiene measures have been fully compensated by Long Term Care Insurance. Both EBITDA contributions are slightly down by 5%, which is due to the mentioned cleanup disposal in May this year. Annual rent associated with the sold assets is around €12 million per year. So part of that in the numbers we have shown on the page.
Moving to Page 11.You can see our adjusted EBITDA excluding disposals, which amounted to €547 million with an attractive EBITDAR margin of around 80% proving once again the efficiency of our business model. The one-off mainly transaction related the biggest part of €20 million is from real estate transfer tax in relation to the ISARIA transaction. We have slightly adjusted the definition of our cost ratio, which is now in addition to the rental income, also accounting for the lease revenues from our nursing business in the numerator, and came out at around 11%.
The slight increase in our cost ratio is partially driven by the provisioning for the long-term incentive component of our compensation due to relative outperformance of our shares. And just as a reminder, the negative contribution from our disposal business is because it excludes €47 million book gains, which have already been accounted for as disposed of related valuation gains of our investment properties. So by that you can see that remains a highly profitable business.
One Page 12, you can see that we are straight on the way to reach our FFO I guidance. FFO I amounted €422 million and €1.21 on a per share basis. So comparable to last year, the increased importance of our development business, we decided to make use of the accounting option to capitalize interest expenses for our developed towed projects. By that, we make sure that FFO I episode one is not distorted during the period of construction. The amount of capitalized interest by the way was around €6 million for the nine months.
Page 13, EPRA NAV came out at €47.89 and 2% higher than year-end. Moving to Page 14, our traditional slide on capital structure, broadly unchanged. Average interest rates at 1.2%, average maturity, seven years, first bigger upcoming maturities in 2023. The LTV came out just try off 41%, however, pro forma or the cash proceeds from the signed, but most yet close disposal as well as the expected year end valuation uplift. However, our LTV will come out at the relative midpoint of our 35 to 40 target range.
Last on Page 15, outlook confirm our 2020 guidance as it relates to FFO I to comparable to last year, and further as already mentioned, 6% valuation uplift at year end, positively impacting at per EPRA NAV per share, which would come out at the 20% 20% premium versus our.
Next, I conclude the presentation and hand it back to the operator to open the floor for Q&A.
[Operator Instructions] Our first question is coming from the line of Jaap Kuin from Kempen. Please go ahead.
Good morning. Three questions if I may. Could you maybe explain on the valuations? Maybe addressed it in the call, but I didn’t catch it, the catch up nature of the re-evaluations. How should I see that? The second one is the like-for-like guidance is stable until year end for just 0.9 now and rent reductions coming up in November. How should I square those two items? And then on the 2021 outlook you you’ve refrained from giving a 2021 outlook but we understandable given limited medical discussions and legal case, but you perhaps provide a range for the case that it does hold up, versus maybe the case that it doesn’t hold up? Thanks.
Thank you for your questions. Let me start with the first one on valuation. What we have observed in the current year is that despite the corona pandemic, and despite all the noise around the Berlin rent freeze law, pricing has remained very stable in the institutionalized transaction market, and has even seen further pressure in the market for condominiums. That is why we have re-valued our portfolio in particular in Berlin.
I look at the valuation uplift. We have guided 4% or 6% numbers that is translating to approximately €1.5 million slightly above what he has achieved last year. And 80% of that is actually coming from Berlin, resulting in prices per square meter of around €2800. That’s pretty much catching-up to the levels we are seeing in the balance sheet of other listed peers the Berlin exposure.
On your second question like-for-like, here, the story is somewhat unchanged from a cash flow perspective, we do expect by year end an increase in rents of 1% that having said our definition of like-for-like is comparing the respective rent levels as of the cut-off days with the rent reduction we will see as of November 23 in Berlin stock.
We will see a drop in rents of around 6% which based on that definition will translate in a negative like-for-like rental growth for the entire portfolio with year-end numbers, assuming, obviously, rent levels according to the Berlin rent freeze law, very different picture as we have explained if we assume rent levels according to the civil code, which we can claw back once unconstitutionality has been has been concerned.
Last on outlook, yes, as you rightly pointed out, there is sort of uncertainty as of now. Given that our profitability will very much depend on the timing and the outcome of the legal challenge of the Berlin rent freeze law. Against that backdrop, we will await more visibility and also timing wise on that process to give guidance on profitability key KPIs. Our earnings call for yearend numbers 2019, which will happen in March or May.
Next question is coming from the line of Marc Mozzi from Bank of America. Please go ahead.
Thank you, very good morning all. I have two questions on my side, the first one even on your capital rotation. Can we have a view on when the acquisition of ISARIA and of QUARTERBACK will effectively impact your cash flow statement or your LTV? Because it seems like relatively stable at 39%, which tells me that ISARIA is not discounted in your, as an acquisition yet. Just to confirm this? That’s my number one. And my number two question is back on your like-for-like rental growth for this year. If I understand correctly, I’m a bit confused, is it 1% what you expect for the year or minus 6%? Can you just clarify what should we expect on that year?
Just to start on the latter point. If you look at the rental income and you will see an increase of around 1% for the year 2020. If you simply compare the in-place rent level of our Berlin stock as of the 31st of December 2020 in comparison to the 31st of December 2019, you will see a drop of around 6%. Is that the clear?
Then on your first question, I mean, first we have for the acquisitions in our increased exposure for new developments, namely ISARIA and QUARTERBACK seen the respective closings. So ISARIA has close, 1st of July and this year, QUARTERBACK has closed end of August this year. So that is all already embedded in our balance sheet. When is it, when we see that significantly impacting our cash flows? That is really, as of next year. The full year in which our new developments are under our ownership, so to speak, in terms of capital spending methods remains unchanged, that we do expect some €400 million to €500 million of capital spending for our developments.
Can I just add a follow-up question on that? Ho9w are you planning to report the income and earnings from this division? Because you’re going to have to I would say areas, one is going to be development to sell and one is going to be development to hold. How are you planning to report those numbers?
Let me start with the letter, developments itself which is predominantly forming part of our minority participation in the QUARTERBACK organization that is going to be accounted for equity and we intend to split the equity contribution as to that portion, which is contributing towards FFO I and that portion which is contributing towards FFO II and the letter is dominantly the contribution we do expect from QUARTERBACK.
For our investments in new developments, which we intend to hold, that over time will be reflected in our rental income. So, here with the 9,000 units, and to develop over the next 10 years 50% over the next five years, is expected to add to our top line €140 million respectively next five years of €70 million. That is how you will see that in the P&L in our disclosure to CapEx, we will obviously going forward that differentiates the investments we undertake into our existing portfolio and those for our newly built projects.
We currently have one more question in the queue. [Operator Instructions] The next question is coming from the line of Andres Toome from Green Street Advisors. Please go ahead.
I wanted to ask about the leverage policy given that we will increase the share of developments, you seek to rotate towards lower quality, sorry, lower yielding assets by going into higher quality. And assuming that the rent cap in Berlin will stick then your income will be impaired from that as well. So how do you think about your leverage on the back of that? And particularly, I mean, you’re debt to EBITDA as you’re going through our lower yielding assets?
Yes, I mean, so, let me reiterate that it is certainly not our base case assumptions that Berlin rent freeze law will possess. We have very high conviction that this noise will disappear in the first half of next year. But in terms of our leverage policy, statement A, we want to keep leverage within the boundaries of 35% to 40%, looking at loan to value ratio.
Second, we would also like to see our method to EBITDA multiple remain inside 15 times. Why 15 times, because this is basically the rental income, restricted net rental income, it requires differently refinance property portfolios in the secured banking market for us the most or the best proxy as to how we manage leverage structure from a cash flow perspective.
Just to follow-up on that that 15 times target, assumes that the rent cap in Berlin will be taken down?
That is correct. But even without that, if I look at EBITDAR numbers, and if I look at the respective multiple, we are inside the 15 times threshold by a good margin by the way.
The next question is coming from the line of Simon Stippig from Warburg Research. Please go ahead
Good morning, I would have two questions. And I would ask them one by one. The first question would be in regard to LTV. And I saw on Page 20, on your report that you added two line items on the side of the value calculation. And its investment in property companies and loans, property companies, so I assume this is actually coming from ISARIA and QUARTERBACK. But could you detail it a little bit more, please.
That is basically our investment in QUARTERBACK. And it’s obviously an investment financed on the loan side, which is why it obviously also be reflected on the valuation side. That is only QUARTERBACK. This is accounted for equity. And for that very reason, not forming part of our investment properties. Different story for ISARIA that is 100% subsidiary and the debt forms fully part of our investment properties.
Okay, great. And just to understand how would that change over let’s say — over the next year, and just what is actually changing the value of it, just to see what’s the forecast, get a better understanding about the future?
I’m not sure. I fully understand your question. I mean, the value side is obviously a reflection as to how property values of our portfolio develop. Here reiterating what Michael also said in his introduction statement, we have in particular, with the view that the rent freeze law will fade away, H1 next year, very positive view, on the further prospering of in particular Berlin market metropolitan areas in general, which serves as key driver to property values.
When it comes more specifically to the new developments, the valuation looks at the so called residual value of the development, which is in the development process. And the more advanced the development is, the higher the share of the embedded development margin, we are capturing. So, in addition to the positive fundamentals of our target markets, there’s an additional element on the partial monetization of the development margin for our development business to be affected in.
Now, if I look on the loan side, obviously it’s a question as to how we refinance that for our developments old projects. There is certainly not sufficient cash flow post dividend remaining to cover all investments required in new developments, meaning insufficient to cover our invisible investments into an existing stock.
Here, we actually need to free up cash and also balance sheet capacity by our disposal business, and part of the new development is for disposal and be identified a portfolio of around 20,000 units is considered non-strategic, which we will also overtime sell in an opportunistic and price optimized manner. Is that kind of addressing your question?
Yes, it is and most specifically about the line items investment in property companies and also the loans, and property companies. And if I understand you correctly, that’s really about the percentage of completion accounting coming from QUARTERBACK, affecting the investments in property companies.
Part of that is equity. So, that is not affecting that.
Okay. And then thank you for that and the second question would be in regard to your collecting and refurbishment CapEx. If I compare that year-on-year versus nine month ’19, then that’s lacking is that a reasons due to COVID or is it actually caused by the rental fees? And can we expect the catch up because you’re guiding us €40 to square meter?
You’re right. I mean, we have guided €40 per square meter on total investments here. By year-end, my expectation is that, you will fall a bit short on that. The driver or the reason is predominantly because of the corona pandemic. First, in certain months we have seen certain pressure on tenants turn over which decreased approximately by one percentage point and thereby impacting investments we undertake in re-lettings, take setting scenario for a vacant apartment. Second, also in the pandemic, we have observed some slow down in how we manage complex refurbishments that we are likely —
Okay, great. Thank you very much. If I may, I would have one last question, and that’s regarding the market rent in Berlin and what you actually showed in your presentation. In H1 ’20, you showed 751 and market rent, and now you’re showing 715. As I understand that, on the 22nd of November, the rent has to be decreased. But this gap, could you explain it where its coming from?
I mean, this is the average re-letting rent of Berlin based on the Berlin rent freeze law and in practical terms, what it actually means that often in relating scenarios, we cannot even achieve fence — being fined rent levers by you will see that further come down as long rent freeze law is in place, I think what is more important is to focus on the transparency rent, we have agreed meaning on according to the Civil Code and that is broadly unchanged to what we have seen sort of €9 still a bit short of market rent levels observed by the likes of Jones Lang LaSalle, CBRE, Empirica as by legislation also as it effects relating business. We are not able in our relating business capture the full upside, but we mean some euro below that level.
[Operator instructions] The next question is coming from the line of Nicolas Gourdain from Lexcor. Please go ahead.
Yes. Hi. Good morning, it’s actually, Kaveh speaking, I was just wondering, in terms of just sort of capital allocation. Over the past year, you guys have bought back some shares. And that’s obviously been very value accretive looking at where your expected society is going to be and where you purchased those, as the shares continue to be at a meaningful discount to that, in light of the fact that I guess next year is there are some important developments like for example, the missile technology, determination on that on its constitutionality. I was wondering whether you would still be considering potentially doing additional buybacks not intervening period possibly given the meaningful discount at which your shares can be traded to your net assets.
I mean, I agree that approximately 20% discount of our current stock price versus expected the pleasant share buyback advantage of the very good distressed depressed share price levels we have seen, 80 to 200. And at the same time, I do look optimistic into 2021, and expect parity on this legislation on structural discounts in stock price disappearing backdrop let’s wait until we have that clarity. Because other sides with development exposure, we also have to keep an eye on as to how we allocate capital.
Currently, we think its advantages to allocate capital on the longer term pipeline on new developments where we essentially monetize on the embedded margin for the developed to hold project. We see in all inbuilt costs, these are the market value that is for me better allocated capital. And I take here, a kind of medium-term perspective also on share price. It’s hopefully the best guidance, putting that a little bit in context.
Unfortunately, the first half of what you were saying it seemed to get cut off quite a bit. I don’t know if that’s true for other listeners, too. But for us, either whether it was online or via the phone, we, it was just getting cut off. So I was unfortunately not able to understand what you were saying in the beginning.
Shall we discuss it bilaterally?
Yes. Why don’t we do that? Perfect.
Okay, there are no further questions. So I would like to thank everybody for joining today’s conference call. The next earnings call of Deutsche Wohnen will be on the 25th of March 2021.
For any questions in the meantime, please feel free to contact the IR team. Have a good day and good bye. You may now replace your handsets.