Globalworth Real Estate Investments — Dynamic growth continuing

In the relatively short time since listing in 2013, GWI has become the leading institutional office landlord in the CEE region. Its dynamic development has continued during 2019, with the group taking advantage of favourable economic and market conditions to consolidate its position and expand its investment property platform in both Poland and Romania. The growth has been supported by two equity capital raisings (€501m gross in April 2019 and €264m gross in October 2019) and access to debt capital, attractively priced at a cost that remains well below asset yields. The April equity increase included the issue of c €153m worth of shares to fund the acquisition of minorities in the Polish subsidiary, which following completion of the minority buy-out was de-listed in September, marking a welcome simplification of the group structure.

In this note we update on the continued progress of the group, review the interim results that were released in September and provide an update on our forecasts and valuation.

We estimate that adjusting the 30 June 2019 gross asset value of the portfolio for the two Polish standing asset purchases completed since and for the two recently agreed forward purchase agreements in Poland, the value of GWI’s portfolio is now above €3bn (end FY18: c €2.5bn). The near-term investment pipeline includes three additional Polish assets (one standing and two under construction) with a value of €135m and the group continues to perform due diligence on further investment opportunities with an aggregate consideration of more than €300m.

During H119, GWI announced the acquisition of four new Polish investments, of which two completed before 30 June 2019 (Rondo Business Park and Warsaw Trade Tower) at an aggregate cost of €169.9m and two have completed since (Retro Office House and Silesia Star) at an aggregate cost of €113.2m.

With its most recent capital raise in October 2019, GWI provided details of a near-term Polish acquisition pipeline amounting to an expected €320m in aggregate, comprising one standing asset and four development assets at various stages of completion. In November it signed a preliminary agreement to acquire, on their completion (expected in Q120), two of the development assets with the maximum transaction consideration set at €185m.The final consideration is to be determined on their leasing status at completion and after customary deductions. The annual contracted rent of the two assets is expected to be c €12m. Assuming a successful conclusion to negations, we would expect a relatively fast conclusion of the standing asset purchase with remaining two development assets following in H220. The investment in these three assets is expected to be €135m and are forecast to contribute annual contracted rent of c €10m. Regardless of a successful conclusion, GWI indicates additional strong opportunities and has continued to invest in and build on its Romanian development pipeline (see the next section).

The existing development pipeline in Romania has continued to make progress and in H119 the first facility of the second phase of the Timisoara Industrial Park (TIP, formerly TAP) was completed. It was 67% let at 30 June. Globalworth Campus Tower 3 is on course for completion by the end of this year and with the interim results GWI announced that the commercial space was 56% let (70% including expansion options) for a term of 10 years. Major leases have been signed with Allianz and Unicredit. Globalworth Square is due for completion in mid-2020.

Against a favourable market backdrop GWI continues to build its activities in the logistics/light industrial sector, forming a joint venture partnership with Global Vison, a leading construction and property management company in Romania, for the development of new high-quality facilities in Constanta and Chitila, near Bucharest. Marking an increased emphasis on the sector, GWI has rebranded its activities under the ‘Globalworth Industrial’ banner.

The first phases of the Constanta and Chitila developments are included in the near-term development projects shown in Exhibit 3. More substantial further phases are planned in the coming years (Exhibit 4).

Romania and Poland have the largest populations in the CEE region and are the two fastest-growing economies in Europe with a consistent record of high, above European-average growth rates since the global financial crisis. IMF forecasts look for GDP growth to moderate slightly from c 4% in both countries in 2019 but to remain well above the EU average. Both Romania and Poland have been major beneficiaries of multinational companies looking to take advantage of high-quality infrastructure, a skilled workforce, lower overall operating costs and proximity to Western Europe to expand in the region, often using it as a base from which to service parts of their European or global operations.

Expanding economies have created increasing demand for commercial real estate and especially for high-quality space to meet the needs of expanding multinationals. A tightening labour force also makes it increasingly important for employers to be able to offer an attractive working environment, to attract and retain staff but this could also begin to act as a drag on employment growth and office demand.

Both Romania and Poland have seen increasing levels of take up of office space, sufficient to absorb growth in the property stock and the growing access to quality properties has in turn supported rising investment volumes.

The Polish market (2018 investment volume of c €7bn) is much larger than the Romanian market although Poland has seen a welcome increase in liquidity with several years of investment volumes not far off €1bn.

Although prime office yields in Bucharest have declined over the past three years, the tightening has not kept pace with that seen in Warsaw, Budapest and Prague (1.0–1.5pp) and they remain noticeably higher and remain well above the c 6.0% seen at the 2007 pre-financial crisis market peak. GWI management continues to anticipate the gap with other CEE centres will narrow, which would have a positive impact on our EPRA NAV and total return forecasts. Management notes that transaction yields appear to have tightened but this is yet to be fully reflected in external valuations. Although the terms have not been publicly disclosed, it estimates that one recent Bucharest office transaction was agreed at 6.5–6.75% and more widely, latest bids in Bucharest for prime office buildings are being negotiated at below 7%.

The gross leasable space of the GWI investment portfolio was 1,139k sqm at 30 June 2019, increasing to 1,190k sqm including the July acquisitions of Retro Office House and Silesia Star. The H119 portfolio gross asset valuation adjusted for the July acquisitions at cost is €2.858m and splits c 46:54 between Romania and Poland. On the same basis, the contracted rent roll of €184.1m splits c 44:56. The weighted average lease length (WALL) was 5.0 years. Portfolio income is well spread across 36 standing investments comprising 59 standing properties let to established, blue chip, mostly international tenants. The office sector represents 81% of portfolio value and mixed office/retail a further 10%. The logistics/light industrial weighting of 4% is likely to increase as the expanded development pipeline is delivered. The land and development assets represent the 5% balance of the portfolio.

Favourable market conditions support strong leasing progress and H119 was the most active half-year in the group’s history. During the period GWI negotiated the take up (including expansions) or extensions of just over 100k sqm of commercial space let in Romania and Poland at a WALL of 7.3 years. New leases were signed at a WALL of 8.1 years, accounting for 82% of the take up and included tenants such as Allianz, UniCredit and NDB Logistics Romania as well as 37 other corporates. Leases were renewed or extended for 65 tenants including AXA (which signed a 10-year lease extension at Warsaw Trade Tower post acquisition), International Paper, Scheider Electric and Airbus Defence.

Occupancy of the commercial standing portfolio was 93.9% at H119 (94.8% including tenant options), down slightly from 95.1%/96.3% at end-FY18, mainly reflecting the effect of acquisitions and deliveries. On a like-for-like basis there was a small 0.5% decrease in H119 occupancy of the standing commercial assets, which was driven by movements of certain tenants within the Romanian portfolio, but the group is confident of the near-term scope for occupancy to increase.

Including the July acquisitions, commercial standing occupancy was 95.1% or 96.3% including tenant options.

Since our last published forecasts, Globalworth has reported interim results (in September) and completed a €264m (gross) capital raising while continuing to grow its standing income-generating investment portfolio and substantially adding to its pipeline of development projects. Below we briefly review the interim results then provide an update on our revised forecasts.

The interim results showed strong growth, reflecting the expansion of the investment portfolio and underlying progress with the existing portfolio, including development completions, rental growth, and operational efficiency. H119 net operating income increased 31.5% on the prior-year period to €68.0m from €51.1m and EPRA earnings increased 38.0% to €37.3m or 23.0 cents per share (+14.6%). An increased dividend per share of 30.0 cents (H118: 27.0 cents) has been paid. EPRA NAV increased 46.1% to €1.75bn, including €348m of shares issued for cash at €9.10 per share to support its ongoing portfolio growth and benefitting from a 2.2% like-for-like increase in the value of the standing asset portfolio. Reflecting the 44% growth in share count, EPRA NAV per share was flat at €9.1.

Our updated forecasts include:

Not included in our forecasts but shown as a sensitivity below is the potential for additional capital growth that would result from a convergence of Bucharest office yields towards the lower levels seen in markets elsewhere in the CEE region.

Compared with our previous forecasts EPRA EPS is reduced, primarily as a result of an increase in our assumption for lease incentive costs, a reduction (from 2.0% pa to 1.75% pa) in assumed rent indexation linked to harmonised EU consumer price inflation, and increased administrative expenses as GWI further invests in its property management platform. For the Romanian portfolio the increase in assumed lease incentive costs reflects the recently reported trend and mirrors market-wide developments. For Poland, it further reflects the late 2018 unwinding of master lease and NOI guarantees that had been granted to the Polish subsidiary before GWI acquired it. GWI received a €21.5m one-off cash settlement in FY18 for the unwinding but became responsible for the small amount of vacant space. In H119 lease incentive costs represented 8.9% of gross rental income, up from 5.7% in FY18. Our revised forecasts assume a similar c 9% throughout the forecasting period. Investment in the property management platform is aimed at reinforcing GWI’s commitment to offer best-in-class services for tenants, which in turn should positively impact tenant retention, occupancy and income. By value, c 81% of standing office and mixed-use assets are now managed internally.

Forecast EPRA NAV is also lower than previously forecast reflecting the knock-on effect of the EPS reduction on retained earnings and a feed through to property valuations from reduced indexation (we continue to assume unchanged yields such that valuation gains are directly linked to rent growth) and the spreading of future development profits across an increased number of shares.

We have assumed an increase in full year DPS to 60 cents per share and that this is held flat until FY22, at which point it is fully covered by our forecast EPRA earnings.

Our revised forecasts are shown in Exhibit 12. However, given the continuing pace of development at GWI and the scale of its continuing ambitions we think it very likely these may change materially in the coming months.

Our forecasts also include:

As noted above, current market conditions suggest good potential for prime office yields to tighten in Bucharest in particular, where prime office yields remain well above the levels in other regional markets, valuations remain well below historical highs, and market liquidity has been increasing. GWI also believes that there is scope for revaluation gains on the Polish assets.

The full occupancy yield on the wholly owned Romanian commercial portfolio (i.e. excluding the RBC JV asset and the Upground Towers residential assets) was c 7.4% at end-H119 or 6.7% based on contracted rental income. For the overall wholly owned Romanian portfolio (including the Upground Towers residential assets) the full occupancy yield was 7.1%. The quality and location of the Romanian commercial assets is a positive feature.

At H119, the full occupancy yield on GWI’s Polish assets in Warsaw and a number of other key Polish cities where yields tend to be higher was c 6.7%. Management estimates the Warsaw asset yields are c 150bp above prime and although in part this reflects the smaller lot size of some of the properties, there remains scope for portfolio asset yields to tighten versus prime yields and for regional yields to tighten versus Warsaw.

In Exhibit 13 we show an updated sensitivity of our EPRA NAV forecasts to alternative full occupancy yield assumptions. We have included the potential impact of yield tightening in respect of the JV industrial development assets that are included in our forecasts at an assumed yield on completion of 8.5%, although this has a minimal impact on the overall sensitivity. We estimate that a 50bp tightening in yields across the portfolio would increase FY22 EPRA NAV per share by c €1.5, or c 15%. If confined to Romanian assets only, the same movement in NAV per share would equate to a c 100bp tightening in Romanian yields.

From FY14 (the first full year of operations following IPO) to the end of FY18 (the last full year reported) EPRA NAV total return (the change in EPRA NAV per share adjusted for dividends paid) was an aggregate 75%, an annualised compound return (without reinvesting dividends) of 11.9% pa. Having built a substantial income-generating portfolio over the period, we expect dividends to represent a growing share of future returns and based on our forecasts for the period FY19 to FY22 represent around two-thirds of the implied c 7% annualised return. Although the forecast returns are lower than those historically reported, they assume no Romanian yield convergence versus other CEE markets. Even on this basis we believe the returns are attractive in the context of the continuing low yield environment.

Based on the interim DPS of €0.30 we expect an aggregate DPS for FY19 of €0.60, representing a yield of 6.5%. Although the DPS is not fully covered by recurring earnings (we estimate 72% cover in FY19) we welcome management’s commitment to dividend payments and anticipate an increasing level of dividend cover over the forecast period (fully covered in FY22). Meanwhile the shares trade at around NAV.

Although there are no direct comparators to GWI, in Exhibit 15 we show a summary valuation and share price performance comparison of GWI with a small number of other quoted companies that are also significant investors in the CEE regional commercial property market within more broadly spread portfolios. For comparative purposes the table is based on last reported NAVs and trailing 12-month dividends declared. On this basis, GWI offers a significantly higher yield than the peer group average while trading at a slightly higher P/NAV. Compared with the more widely diversified peer group, Globalworth is focused on the CEE markets, and the strongly performing Romanian and Polish markets in particular.