RealCap Portfolios
RealCap German Residential Real Estate
RealFin Capital Partners “REALCAP” Proprietary Limited
Sep 2017
RealCap Portfolios
RealCap Residential Real Estate | Germany
Introduction to Property Investing
Most investors are personally familiar with property investing in that they have bought a house, or
An allocation to property investing plays a key role in
apartment at some point in their careers. The purchase
global investment portfolios. Within the typical
of the house in which we live conveys basic utility and
institutional global portfolio, the allocation to real
shouldn’t strictly be thought of as “an investment”.
estate assets is about 8.5% of AUM with an intended
But, having entered into the process, we have some
target of 9.8% of portfolio assets.
degree of familiarity with property transacting and what elements ensure ultimate property investing
Investors Current & Target Allocations to Real Estate by Investor Type
success. Location is important, the blend of equity to debt is
Current Allocation
Target Allocation
10% 9% 8% 7% 6% 5% 4% 3% 2% 1% 0%
important, the monthly financing requirements are important and the key features of the property itself are important.
Beyond Residential Investing While we may be personally familiar with the residential property market, this is just one facet of real estate investing. The real estate market is typically broken into three high-level categories:
Source: Prequin, 2015
There are multiple reasons for this dedicated allocation. “Finance 101” clearly encourages us to diversify across asset classes in order to ensure the sources of our return, and the associated risks, are not concentrated on a single asset class. This means we are not overly dependent on any one segment of our portfolio for our return. The “spread” also enables smoother portfolio returns over the medium to longterm investment horizon. A more diversified portfolio
»
Residential
»
Commercial
»
Industrial
And increasingly, exposure to infrastructural projects is intruding into the real estate category. As individual investors, it is difficult to accumulate sufficient capital (and associated leverage) to gain access to a basket of properties. Such a basket, potentially spanning the real estate categories, would be required for broader real estate exposure within the context of a portfolio.
tends to exhibit lower overall portfolio volatility.
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RealCap Residential Real Estate | Germany When we scale up property investing, across
The European Political Landscape was irrevocably
residential, commercial and industrial sectors, all of
altered when the United Kingdom voted in June 2016
those same transactional components need to be
to leave the European Union.
evaluated – property features and usage, the degree of leverage, financing costs, and availability – to ensure
The Effect of Brexit
that the property portfolio as a whole delivers investment returns to investors in two ways.
By invoking Article 50 of the Treaty of the European Union, the UK is on course to leave by March 2019. This
Real estate investments generate a combination of
decision and the negotiations which follow will have
capital appreciation and yield. Properties are income
material consequences for the British economy and for
generative because of rents paid and when rental
that of the remaining EU members.
income covers the cost of financing, can provide investors with steady and enviable cash flow. Under
United Kingdom EU Referendum Results
positive economic growth situations, properties also
Blue = Leave, Yellow = Remain
appreciate in price and can contribute capital returns in addition to the income generation. So, finding a geographic location with strong economic growth, which in turn generates strong property demand and the ability to pay rent, coupled with attractive financing opportunities makes for an ideal property investing opportunity. We believe key areas of the European property market present just such an attractive opportunity.
European Political Landscape The political landscape dictates to a large degree the economic landscape which is why both politics and economics must be assessed, particularly when forming a medium-term outlook.
Source: Wikipedia
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Sep 2017
RealCap Portfolios
RealCap Residential Real Estate | Germany From a financial services perspective, the key “game
EU Refugees
changer” is the loss of passporting. A financial passport is essentially a system of common financial
Citizens of 143 countries sought asylum for the first
rules which all countries of the passport network sign
time in the EU in the first quarter of 2017. Syrians,
up to. For example, a bank from the US or Japan could
Afghans, and Nigerians were the top 3 citizenships of
set up a subsidiary in London and from that hub
asylum seekers and of the 22 500 Syrians who applied
provide services across the EU. Without the passport,
for the first time for asylum in the EU in 1Q17, more
London no longer is the natural banking hub, which
than 40% were registered in Germany. Similarly,
runs counter to the business model of many firms who
around 40% of Afghans applied for asylum in Germany
provide financial services to EU customers via this UK
while about 70% of Nigerians applied for asylum in
financial hub. The UK exported £20 billion of services
Italy.
inside the single market and provided hundreds of
Despite these large numbers in 1Q17, in Germany, the
billions of euros in finance in 2014 according to the
number of asylum seekers has dropped significantly
British Bankers Association.
(by more than 146 200 applicants) when compared
Without a passport, UK banks would have to apply for
with 1Q16.
a license in each EU country – some of which do not
Germany’s extensive support for refugees is both a
make such licenses available. Also, the range of
remarkable humanitarian gesture and an example of
licensed banking services is more limited than
economic pragmatism. The integration of refugees is
passport services. Multiple, duplicate licenses per
complex, costly, and controversial up front but longer-
country are simply not economically viable for many
term, the increased population may form part of a
UK-based institutions.
much-needed solution to combat the economic challenges posed by a rapidly ageing native
The result being is that other European cities will find themselves as financial hubs for the servicing of the EU market. Cities like Paris, Berlin, Frankfurt, Dublin, and
population. Projected Changes in GDP due to Refugee Migration to Germany
Amsterdam could see their already core financial services positions elevated. An increased financial services stature will undoubtedly bring a highly skilled workforce and the associated economic activity. Together with economic migration, the other key dynamic in the EU population profile is the influx of refugees. Source: German Institute for Economic Research
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European Economics
From a European perspective, the chart below left shows the 2016 GDP per capita in Nominal US Dollars
We mentioned earlier the importance of evaluating
for the top 20 European countries and the second chart
the political landscape when forming an evaluation of
(right) indicates the change in that metric from 2015 to
the economic outlook, and our previous section shows
2016. We note the fall in UK GDP per Capita and also
just how the currently implemented political approach
note that of the non-Scandinavian Continental
to the German refugee policy is ultimately additive to
European countries, Germany has experienced the
economic growth.
biggest increase in GDP per Capita over the period.
Top 20 European Country per Capita GDP (Nominal) ($) 100 000
Top 20 European Country Change per Capita GDP (Nominal) ($) 2015 to 2016 8 000
90 000 6 000
80 000 70 000
4 000
60 000 50 000
2 000
40 000 0
30 000 20 000
-2 000
10 000 Luxembourg Switzerland Norway Ireland Iceland Denmark Sweden San Marino Netherlands Austria Finland Germany Belgium United Kingdom France Italy Spain Malta Cyprus Slovenia
-4 000 Luxembourg Switzerland Norway Ireland Iceland Denmark Sweden San Marino Netherlands Austria Finland Germany Belgium United Kingdom France Italy Spain Malta Cyprus Slovenia
0
Source: Statistics Times
German Economics
Cumulative German GDP is around €3.1 trillion which is around 30% of the EU’s total annual GDP.
The German economy generates just over 42 thousand US Dollars per person annually and that
The total population is just under 83 million people
amount increased by $1 300 per person from 2015 to
with a seasonally adjusted unemployment rate of
2016. By contrast, South African GDP per capita is $7
3.8%.
500.
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Sep 2017
RealCap Portfolios
RealCap Residential Real Estate | Germany German Population (millions)
Germany demonstrates an average interest rate on corporate loans of just above 1.5%. Such attractive financing levels are undoubtedly a source of economic stimulation – the ability to finance corporate activity at such attractive levels will certainly promote corporate expansion. With corporate expansion and an increasing labour
Source: Trading Economics, Federal Statistics Office
force comes pressure on the real estate sector. Real
The increasing population due to economic and
estate turnover volume in 2016 was made up of the
refugee migration is positive for the German
sectors displayed in the chart below.
economy. Increasing human capital creates increasing demand for goods and services throughout the
German Real Estate Transactional Volume (2016) (€ billions)
economy. Coupled with increasing population growth and low levels of unemployment is an effective zero ECB Bank Rate. The ECB has maintained its Quantitative Easing
Hotel Properties 5,5
Logistics 4,4 Office Properties 23
policy, which has resulted in very low levels of interest on corporate loans in the Euro-area. Average Interest Rates on Corporate Loans
Retail Properties 13
Residential Properties 13,5
Source: BNP Paribas Real Estate
In 2016, prime rents rose by an average of 3.5% with much of that growth coming from Berlin office rentals. However, prime office rents in Germany are still significantly lower than those in London or Paris Source: ECB, Bundesbank
leaving significant upside potential.
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Accessing German Real Estate
Germany, despite having the highest GDP in Europe, has the lowest homeownership rate. The German legal
Having established earlier in this report that investing
system is designed to protect property renters in
in a basket of real estate assets is far preferable to the
favour of property owners and German tenants have
purchase of individual units, the expense of which can
rights that renters from other countries can only
be prohibitive, we now examine the most efficient way
dream of!
in which to access the German Real Estate market. Selected European Homeownership Rates Investing in real estate is best facilitated by a company with a real estate focus. Globally, these are known to us as Real Estate Investment Trusts or REITs. A REIT is a corporate entity that owns, operates, manages, acquires and finances real estate. As a fairly standard global feature, provided the REIT passes on more than 90% of its taxable income to its shareholders, it avoids taxation at the corporate level. In Germany, these REITs are known as G-REITs
Source: Statistica
following an Act introduced in 2007 and while they do
Although the number of Germans living in major cities
not necessarily have to be listed on the German Stock
(Germany has 7 major cities) has been on the rise for
Exchange, they must have their official residence and
many years, residential construction has failed to keep
management in Germany. At least 75% of the G-REITs
pace with the rate of urbanisation. The shortage of
assets have to consist of real estate, and, in
housing together with strong demand is pushing rents
accordance with global standards, at least 90% of
higher (and vacancy rates lowers) and encouraging
profits have to be distributed to shareholders.
property companies to invest in new residential developments.
Residential Property Focus The chart below shows how the number of building While all forms of German property are likely set to benefit from economic growth and a changing population, we believe the residential property sector is the most attractive and are focusing on this property
permits awarded and number of building completions starting to rise post the 2008 stagnation. However, this growth is still not fast enough to satiate residential property demand.
sector rather than other commercial and industrial opportunities.
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RealCap Residential Real Estate | Germany Residential Construction
Of the G-REITs available with focused exposure to the German residential property market, we have selected two potential investment vehicles. Deutsche Wohnen (Xetra: DWNI) is an attractive investment option for gaining exposure to Berlinbased residential property as a Brexit-beneficiary, and Vonovia SE (Xetra: VNA) is a broad-based German residential specialist that stands to benefit from country-wide increasing residential property demand.
Source: Federal Statistical Office
Some may express concern that rising rents will ultimately become unaffordable, diminishing the overall residential demand in key urban centres.
Review of Deutsche Wohnen Deutsche Wohnen is listed on the German Stock Exchange with a head office in Berlin. The company
However, although rents are rising, the rate of rental
strategy is to focus on the residential property market
growth is reasonable. Currently, rents in top locations
in economically sensitive and important hubs within
are growing at about 3% y/y, certainly above inflation,
Germany as well as to undertake strategic and
but not at a rate that will price potential tenants out of
operative sales in the nursing and assisted living
the market. It must also be remembered that new
business segment.
developments are being built to a very high (German) standard which accounts and justifies some of the rental increase. Rate of Rent Growth
Deutsche Wohnen owns around 163,000 units, of which 160,600 are residential units spanning an area of around 9.7 million sqm. The predominant share of the portfolio is concentrated in the core regions of Greater Berlin, Rhine-Main region, the Rhineland, Dresden and in Hanover/Brunswick as well as in other growing German metropolitan regions. There are just under 355 million common shares outstanding and with a current share price of around â‚Ź35 per share, the market capitalisation is over â‚Ź12 billion.
Source: BulwienGesa, DZ Bank AG
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RealCap Portfolios
RealCap Residential Real Estate | Germany Deutsche Wohnen Strategic Focus
In the latest latter to their shareholders from March 2017, the management team writes: “Deutsche Wohnen not only exceeded all expectations; its earnings also reached new record levels. This is hardly surprising because in recent years we have attained a pre-eminent position in the German property market. Our strategy of focusing on conurbations within Germany, and in particular on Berlin, is bearing fruit and is being reinforced by positive developments with regard to rents, vacancy rates and selling prices.” An important metric when assessing a REIT is the Loan-to-Value Ratio (LTV). This essentially divides the
Source: Deutsche Wohnen Investor Relations
MFS Investment Management, a large US-based global investment manager and Blackrock, another large US-based investment manager both own over 8% of Deutsche Wohnen, while the Central Bank of Norway owns just under 7% and Vonovia has just
mortgage or finance amount by the property value. The higher the number, the great the financed portion of the portfolio is relative to the underlying property asset which indicates greater risk. The chart below shows the LTV Ratios for Deutsche Wohnen since 2010.
under 5%. The remaining 70% of shares trade freely on the exchange.
Deutsche Wohnen LTV %
Equity analysts from large European and US
60%
investment companies and banks tend to have “buy”
50%
or “overweight” recommendations on the stock with
40%
price targets above current trading levels. 30%
Deutsche Wohnen Share Price (1 Year, EUR)
20% 10% 0% 2010
2011
2012
2013
2014
2015
2016
Source: Deutsche Wohnen AFS
Source: Xetra
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Sep 2017
RealCap Portfolios
RealCap Residential Real Estate | Germany While financial liabilities have increased as more
shows the historic annual dividend yield paid to
property has been acquired and financed as part of the
common shareholders.
growing real estate portfolio, these increasing mortgage levels have been conservative when
Deutsche Wohnen Annual Dividend Yield
compared with the underlying property valuation.
3
These two mechanisms working together have
2,5
essentially deleveraged Deutsche Wohnen since 2010.
2
Deutsche
Wohnen
Fair
Value
Residential
1,5 1
Portfolio (€ millions)
0,5 0 2010 2011 2012 2013 2014 2015 2016 2017
Source: Boerse-Stuttgart
When we consider these yields, currently estimated to be 2.3% for 2017, relative to ECB financing rates, or average interest rates on German corporate loans, the Source: Deutsche Wohnen H1 2017 Presentation
yields are incredibly attractive.
As we referred to earlier, from an investor perspective, real estate investing provides two potential sources of portfolio return, capital appreciation and income generation. Given
the
Given the appreciation in underlying property prices, the evidence of economic demand for German property, Berlin in particular, and the conservative leveraging as evidenced by low LTV levels coupled
German
political
and
economic
with consistent and strong dividend yields, Deutsche
environment, we are confident that demand for
Wohnen is an attractive potential investment holding.
residential property will continue to strengthen leading to an appreciation in property prices
Review of Vonovia
particularly in the financial services centres like Berlin.
Vonovia,
When we examine a G-REIT like Deutsch Wohnen, we must also evaluate the income generation capability and contrast that with other yielding opportunities.
our
preferred
residential
property
“generalist”, has been stock exchange listed since 2013 and is headquartered in Bochum. It currently owns and manages around 355 000 residential units, making it one of Germany’s leading residential real estate
As a G-REIT, Deutsche Wohnen is legally obligated to
companies.
distribute profits to shareholders. The chart below
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RealCap Portfolios
RealCap Residential Real Estate | Germany Shares currently trade at a price of about €36 per share
investment into energy-efficient modernisation of
and with 485 million shares outstanding, Vonovia has
their buildings. Without wanting to diminish the
a market capitalisation of just over €17 billion.
environmental benefits of such a strategy, clearly
In a picture that is not dissimilar to the shareholder structure of Deutsche Wohnen, Blackrock holds 8.5%, the Central Bank of Norway has a 7.5% stake and other key international corporate investors, Lansdowne
tenants are going to opt for an energy-efficient building over one that is less efficient, so the corporate benefit of the investment strategy to Vonovia will be tangible.
Partners, Deutsche Bank, and MFS hold 12.4%
While the investment in both the upgrading of their
collectively.
housing stock and the acquisition of new stock is good, we must always assess the degree of leverage within a
Vonovia Share Price (1 Year, EUR)
REIT. The chart below shows that Vonovia’s LTV is also relatively conservative, remaining below 50% since company listing. Vonovia LTV % 52% 50%
Source: Boerse-Stuggart
48%
When we examine Vonovia’s articulated corporate strategy, there is a very clear overlap with our thinking. Management firmly believes that what they title as “megatrends”, are impacting the German residential property market. These they identify, as we do, as being
demographic
change
and
increasing
46% 44% 42% 40% 38% 36% 2013
2014
2015
2016
2017
immigration to Germany. However, they also point to a third “megatrend” which is of interest.
Source: Vonovia AFS
Another key metric that merits review in a real estate They suggest energy transition in Germany is key.
portfolio is rent and vacancy rates. The chart below
Residential buildings currently account for more than
presents Vonovia’s rent on € per square metre basis
25% of energy consumption and, by reducing the
which has been steadily increasing since 2016 – worth
heating requirements for these buildings, there is an
keeping in mind that given we are evaluating an EU
opportunity for significant energy consumption
country, this is not simply an inflationary effect!
savings. Vonovia, together with German Development Bank subsidies, has significantly expanded their
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RealCap Residential Real Estate | Germany Also, important, vacancy rates have been in decline so
Returning to our previously covered concept of capital
Vonovia does not have residential building stock
and income returns from property, and assessment of
standing empty. This also provides an indirect picture
the Vonovia dividend yield is warranted.
of the clear residential housing demand. Vonovia Rent and Vacancy Rates
Vonovia Annual Dividend Yield 4,5 4,0 3,5 3,0 2,5 2,0 1,5 1,0 0,5
Source: Vonovia September 2017 Presentation
0,0 2013
2014
2015
2016
2017
Vonovia has an ambitious expansion plan for 2017. Across Germany, there is an intention to significantly
Source: Boerse-Stuggart
increase the residential property portfolio. The
The estimated Vonovia annual dividend yield for 2017
diagram below indicates their targeted areas of
is 3.6% which is certainly higher than that of Deutsche
investment.
Wohnen (currently 2.3%) and when reviewed within
Planned Portfolio Investments in 2017
the context of European interest rates, incredibly attractive. The broad residential scope of Vonovia across Germany, together with well thought-through strategic decision-making on their property portfolio, strong rents and low vacancy rates make the company an ideal core holding for German real estate exposure.
Source: Vonovia September 2017 Presentation
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Conclusion
Suggested German Residential Real Estate Allocation
Real estate, or property investing, is a transaction we, as “average” investors often undertake through the
Satellite: Deutsche Wohnen
purchase of a home or apartment. It is typically in an area we know well and intend to live, so we ensure that the features meet our individual requirements and that we can afford the financing demands.
Core: Vonovia
However, we need not constrain ourselves to a utility real estate purchase or even a South African specific purchase. With the formation of REITs globally, international property markets are now more
Source: RealFin Capital Partners
accessible than ever.
By taking a core-satellite approach, investors are
It is important that we assess the economic landscape
assured of a strong dividend yield in Euros as a result
to ensure the selected real estate market is well
of growing rental incomes and low vacancy rates, as a
supported by underlying demand, and that the
well as the low cost of financing.
financing environment in which the REIT operates
The scope for capital appreciation exists in the
does not hamper their ability to finance property
medium to longer-term due to the continuing
transactions. The production of a consistent dividend
demographic shift taking place in Germany and by
yield is supporting evidence of the ability to generate
innovative decision-making on the part of G-REIT
and distribute profits.
management companies – Vonovia’s future-fit
We believe the German residential property market is
energy-efficient buildings as an example.
an attractive offshore investment opportunity. By
We encourage our investors to take advantage of what
combining the two G-REITs evaluated, Vonovia and
we identify as a compelling investment opportunity.
Deutsche Wohnen, investors can construct a broadbased allocation to the German residential market as well as target the Brexit-specific impact and benefit to the Berlin financial centre.
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Steve Doidge Chief Executive Officer Tel: +27 82 773 0173 Email: sdoidge@realcap.co.za
CONTACT US • Email: enquiries@realcap.co.za • Website: www.realcap.co.za Physical Address: Office 303 Third Floor, Pam Golding on Main, Corner of Main and Summerly Road, Cape Town, South Africa, 7700 Postal Address: Suite 762, Private Bag X16, Constantia, Cape Town, South Africa, 7848
DISCLAIMER The author of this publication, RealFin Capital Partners Proprietary Limited (“RealCap”), its Directors and their Associates from time to time may hold shares in the security/securities mentioned in this Research document and therefore may benefit from any increase in the price of those securities. RealCap and its Advisers may earn brokerage, fees, commissions, other benefits or advantages as a result of a transaction arising from any advice mentioned in publications to clients. Any financial product advice contained in this document is unsolicited general information only. Do not act on this advice without first consulting your investment adviser to determine whether the advice is appropriate for your investment objectives, financial situation, and particular needs. RealCap believes that any information contained in this document is accurate when issued. RealCap, however, does not warrant its accuracy or reliability. RealCap, its officers, agents, and employees exclude all liability whatsoever, in negligence or otherwise, for any loss or damage relating to this document to the full extent permitted by law.