Phoenix Spree Deutschland — Rent cap decision will determine strategy

Phoenix Spree Deutschland (LSE: PSDL)

Currency in GBP

Last close As at 21/09/2023

GBP1.70

4.00 (2.41%)

Market capitalisation

GBP156m

Research: Real Estate

Phoenix Spree Deutschland — Rent cap decision will determine strategy

Phoenix Spree Deutschland (PSD) is a pure play on Berlin residential property, where excess demand drives free market rent growth. H120 financial performance was robust despite the COVID-19 pandemic and the first effects of Berlin rent controls. Recent full implementation of the legislation will significantly reduce FY21 rental income and peg rents for five years, but it remains PSD’s firm view that the legislation will ultimately be ruled unconstitutional and overturned. Our central scenario (shown below) assumes repeal, effective from 1 January 2021. Should this not happen, it has significant condominium optionality and our analysis highlights significant value embedded in the portfolio in either case.

Martyn King

Written by

Martyn King

Director, Financials

Real Estate

Phoenix Spree Deutschland

Rent cap decision will determine strategy

Initiation of coverage

Real estate

4 December 2020

Price

318p

Market cap

£306m

€1.11/£

Net debt (€m) at 30 June 2020

246.3

Net LTV at 30 June 2020

33.0%

Shares in issue

96.3m

Free float

100%

Code

PSDL

Primary exchange

LSE

Secondary exchange

N/A

Share price performance

%

1m

3m

12m

Abs

0.0

2.4

(2.0)

Rel (local)

(11.4)

(8.5)

6.0

52-week high/low

332p

212p

Business description

Phoenix Spree Deutschland is a long-term investor in mid-market residential property in Berlin targeting reliable income and capital growth. Its core strategy is to acquire unmodernised apartment blocks that may be improved to the benefit of tenants, generating attractive returns for shareholders based on improved rents and capital values.

Next events

FY20 year-end

31 December 2020

Analyst

Martyn King

+44 (0)20 3077 5745

Phoenix Spree Deutschland is a research client of Edison Investment Research Limited

Phoenix Spree Deutschland (PSD) is a pure play on Berlin residential property, where excess demand drives free market rent growth. H120 financial performance was robust despite the COVID-19 pandemic and the first effects of Berlin rent controls. Recent full implementation of the legislation will significantly reduce FY21 rental income and peg rents for five years, but it remains PSD’s firm view that the legislation will ultimately be ruled unconstitutional and overturned. Our central scenario (shown below) assumes repeal, effective from 1 January 2021. Should this not happen, it has significant condominium optionality and our analysis highlights significant value embedded in the portfolio in either case.

Year end

Gross profit** (€m)

EPS
(c)

EPRA NAV/
share (€)

DPS
(c)

P/E
(x)

P/NAV
(x)

Yield
(%)

12/19

8.4

22

4.9

7.5

7.7

0.77

2.1

12/20e

8.8

19

5.1

7.5

16.2

0.72

2.1

12/21s*

9.6

33

5.5

7.5

18.4

0.69

2.1

Note: *12/21s is our ‘no Mietendeckel’ scenario. This note also includes a ‘continuing Mietendeckel’ scenario. **Revenues less total property expenses (including property management expenses, repairs and maintenance, direct property costs, and investment adviser fees.

Rent cap uncertainty

PSD has traditionally focused on acquiring under-rented apartment blocks at low valuations and actively managing them to capture reversionary rent potential and drive income and capital growth, supplemented by the division and subsequent resale of selected apartment blocks as private units (condominiums) at market valuations. NAV total returns have comfortably exceeded the company’s 8–10% pa return target in recent years with a bias towards capital growth reflecting the low current asset yield (2.9%) and the costs of active management. The Berlin rent cap (the ‘Mietendeckel’) has frozen rents since February 2020 and management estimates that the statutory cap on rents introduced on 23 November 2020 will reduce FY21 income by up to 17% if not repealed or suspended.

Outcome will determine strategy for realising value

The rent cap seems destined to exacerbate the fundamental supply-demand imbalance that has driven free market rent growth and property values, and that underpins the value embedded in the portfolio. The outcome of the rent cap legal challenge will determine PSD’s strategy for extracting this value. The FY21 scenario shown above assumes rent cap repeal, avoiding rent reductions, a return to rental growth and a total return in line with target. If not repealed, we expect a significant reduction in recurring income and a focus on accelerated condominium sales and increased disposal gains to realise embedded value.

Valuation: Well above average P/NAV discount

A c 30% discount to FY20e EPRA NAV per share compares with a five-year average of 8% since IPO. The discount is a larger c 40% to our estimated ‘condominium’ valuation that we would expect to be in focus should the rent cap not be repealed.

Investment summary

Significant rent cap uncertainty despite strong fundamentals

PSD has a strong track record of creating value by acquiring under-rented apartment blocks at low valuations and actively managing them to capture reversionary rent potential and drive income and capital growth, supplemented by the division and subsequent resale of selected apartment blocks as private units (condominiums) at market valuations. The average annualised EPRA net asset value (NAV) total return over the five years to end-FY19 of 20.4% pa was well ahead of the 8–10% pa target. PSD estimates the average free market value of rents for the portfolio at €12–12.5 per sqm per month, well ahead of the current contracted €9.1, and local demand for accommodation significantly outstrips supply. If not repealed, the Mietendeckel rent cap seems likely to limit investment in the sector, aggravate the housing shortage, and support further growth in free market rents and capital values, but will require a change in PSD’s strategy to realise this value.

Alternative scenarios for realising value

While we share management’s strongly held view that repeal of the rent cap is the most likely outcome, the timing is difficult to predict and is by no means certain, making the financial impacts impossible to predict. When the outcome is known the strategy will adapt, but we do not know when this may happen. Rather than forecasting the FY21 financial performance, we present alternative scenarios that illustrate the potential outcomes on a full-year basis, assumed to be in FY21. Our central FY21 scenario thus assumes rent cap repeal, reversing the recent rent reductions with effect from 1 January 2021. If the rent cap is not repealed, rental income will significantly reduce with little growth for five years. In our non-repeal scenario, realised gains from stepped-up condominium sales partly offset the impact of rent reductions (PSD estimates a reduction in FY21 rental income of up to 17%). We expect reported profitability to be relatively modest and for investors to focus more on the value embedded in the portfolio, represented expected condominium sales values. On this basis we estimate the underlying discount to NAV to be c 40% with sales proceeds supporting continuing accretive share repurchases.

Robust H120 results

Despite COVID-19 and first effects of the Berlin rent cap from February 2020, H120 performance was robust. More than 99% of rents due in H120 were collected, broadly in line with the prior year, and there was no direct impact on the external property valuation, which showed a 2.6% like-for-like increase in H120 despite first-time inclusion of the rent cap measures in the valuation for an assumed five-year period. Refurbishment and letting activity slowed slightly, with vacancy increasing from 6.7% at end-FY19 to 8.0% at end-H120, but the delay should be positive for medium-term value creation in the event that the Mietendeckel is repealed, allowing future re-letting at uncapped market rents. The H120 EPRA NAV total return per share, including an unchanged DPS, was 3.9%.

Sensitivities: Mietendeckel uncertainty

Aside from the crucial uncertainty surrounding the legal challenge to the Mietendeckel, we see the main fundamental sensitivities as being economic and market driven, although residential property has historically been much less cyclical than is the case for commercial property, and the current market supply-demand position continues to be positive with supportive demographic trends predicted to continue. Political risks, reflected in changes to the legal and regulatory structure, as the Mietendeckel highlights, are tangible and require vigilance and flexibility on the part of management, as has been the case since the company was formed c 13 years ago.

Berlin residential property

Phoenix Spree Deutschland (PSD) is a Jersey-based closed ended investment company that was founded in 2007. It was initially listed on the Channel Islands Stock Exchange in 2007 and after a period of strong growth moved to a Main Market listing on the London Stock Exchange (LSE) in June 2015. It targets an attractive total return from investment in Berlin residential property and is externally managed by QSix (formerly PMM Residential). QSix is an independent and owner-managed alternative asset manager with an experienced team of property and investment professionals and established track record in the German residential property market. It has offices in London and Berlin.

Corresponding to its asset and liability base, the company reports its results in euros. Dividends are also declared in euros but are paid in sterling.

Berlin is the most populous city in Germany and represents the largest rental housing market in the country. With strong housing demand driven by net migration and a relative lack of supply, rents and capital values have steadily increased. This has allowed PSD to comfortably exceed its target 8–10% pa NAV return over several years and in the five years to end-FY19 the NAV total return (change in EPRA NAV with dividends paid added back but not reinvested) was 153.0% or an average annual compound return of 20.4%. Returns have been biased towards capital (c 90% of the five-year return) rather than dividend income and we expect this to remain the case, reflecting the low current yield on the assets and the cost of actively managing these to unlock the value embedded in the portfolio.

The Berlin rent cap (the ‘Mietendeckel’) that began to take effect from February 2020 reflects concern at the pace of rent growth over recent years and a desire by local authorities to maintain Berlin as a city of affordable rented accommodation. However, while Berlin rents have grown strongly in recent years, they remain affordable on both a national and international basis; by dis-incentivising investment in the sector, the cap seems destined to exacerbate the fundamental supply-demand imbalance that has been the driver of free market rent growth and property values.

PSD and its legal advisers remain firmly of the view that the Mietendeckel legislation will ultimately be ruled unconstitutional and overturned, although the timing of this process remains uncertain. The company notes that in Bavaria, a similar move to introduce a six-year rent freeze was blocked by the Bavarian Constitutional Court in July. In this note we start by examining the strategic and financial implications of the cap on PSD.

Maintaining strategic flexibility while Mietendeckel outcome decided

PSD’s core strategy has traditionally focused on acquiring under-rented apartment blocks at low valuations and actively managing the assets to realise reversionary rent potential, driving growth in rental income and capital values. This has been supplemented by the division and subsequent resale of selected apartment blocks as private units at market level valuations. The significant opportunity that this strategy seeks to exploit results from strict rent controls in Berlin, which means that many tenants pay rents that are well below market levels, which have increased materially in recent years. In addition to modest permissible rent indexation, reversionary rent capture has been driven by the refurbishment of vacated apartments and re-letting at market level rents.

However, in June 2019 the Berlin municipal government announced its intention to freeze local rents for five years and the law (the Mietendeckel) came into force on 23 February 2020. The key components of the legislation include a freeze on rents (at least until January 2022, with modest increases thereafter), rent ceilings, rent reductions in certain circumstances, and a limit on the ability of landlords to recapture modernisation costs through higher rents. If not repealed, the rent cap and rent reductions will have a material financial impact in FY21 and will ultimately require a significant adaptation of strategy to release the value embedded in the portfolio. In the current year, while legal challenges to the cap are in process, the company has sought to mitigate its effects while maintaining its ability to benefit from the repeal that it expects.

As a result of the new law, since February 2020 there has been an upper limit on the new rent that may be charged on first time lettings and re-lettings, while existing leases have been subject to a rent freeze that lasts until January 2022, with limited increases possible thereafter for the remainder of the five-year period. In some cases, the limit on new rent levels could result in landlords having to lower the rent compared with that paid by the previous tenant. The second phase, which came into effect from 23 November 2020, goes further and imposes automatic reductions in existing rents in certain circumstances. Where rents exceed a local limit by more than 20%, the landlord must reduce the rent to no more than 120% of the limit or face a fine of up to €0.5m for each breach.

The potential impact of Mietendeckel on rental income is significant

The company has guided to a relatively modest impact from the first phase of the Mietendeckel, introduced in February 2020, and this is supported by the H120 results. Based on a similar level of tenant churn to FY19 it has estimated the negative impact of FY20 annualised rental income of the new rent limit on first time letting and reletting at c 1.5% and, assuming no mitigating action (see below), the negative impact of the rent freeze at around 1%.

However, the automatic rent reductions that were recently introduced will have a significantly larger impact and assuming no mitigating action (see below) PSD has estimated the negative impact on FY20 annualised net rental income at c 1.5%, but increasing to a c 17% on a full year basis in FY21.

The actual financial impact on PSD and its strategy, both in the short and longer term, is significantly dependent on the timing and eventual outcomes of the legal challenges to the rent cap. Given the ongoing legal challenge, there had been hopes of a voluntary (by the state authorities) or legal injunction, pending final determination, thereby avoiding the potential for chaos and confusion among renters and landlords alike of rents being reduced and then possibly restored. However, this has not been the case and although PSD expects the Mietendeckel will ultimately be judged illegal and repealed, at least in the short term until determination is reached, some adaptions to the business model are inevitable. If the legal challenge to the Mietendeckel fails, more significant strategic changes to the business model will be required.

Uncertainty renders forecasting difficult

Although we incline to the company’s view that eventual repeal is the most likely outcome, the uncertain timing of this, and the reduction of certain existing rents from 23 November 2020, render an accurate prediction for the next 12 months impossible. Nevertheless, we have embedded the potential strategic responses and financial impacts into two scenarios, intended to illustrate the alternative strategic paths that the company may take and the financial implications of these on an annualised basis: the first scenario assumes that the Mietendeckel is repealed, fully effective throughout FY21, such that strategy returns to ‘normal’ throughout FY21; and the second scenario assumes no repeal and captures the likely strategic response and financial implications of accelerated condominium sales to realise value embedded in the portfolio.

In the following section we discuss the strategic features of these scenarios and in subsequent sections we review their financial implications.

Strategic responses

Mietendeckel repeal: Return to traditional reversionary capture

As we discuss below, during the current year, as the legal challenges to the Mietendeckel are being considered, there has been a noticeable slowdown in discretionary refurbishment and re-letting activity and for the full year we expect an acceleration in sales of individual apartments (condominiums). In part this reflects the impact of COVID-19, but also the company’s efforts to mitigate the impacts of the rent freeze and maintain its strategic flexibility. Assuming that the rent cap is ultimately repealed, we expect the company to continue the strategy that it has successfully followed since it was founded.

Prior to the introduction of the rent cap, which is intended to be in place for five years, existing legislation has acted to slow the increase in the rents that can be applied to existing tenancies. Under the existing legislation, rents increases have been limited to a maximum of 15% over a three-year period, with a minimum of 15 months between increases. The increases have been pegged to local market levels as determined by a local government rent table (the Mietspiegel), which calculates a reference rate every two years and is based on rent data collected over the preceding four years, and which therefore typically lags free market levels. Once a tenant vacates a property, the landlord has been able to increase rents up to a maximum 110% of the reference rate unless the property has been comprehensively modernised.

PSD estimates the average market rent per square metre per month for its portfolio at €12–12.5 per sqm/month, a more than 30% premium to the average in-place rent of €9.1, and its active management strategy has focused on capturing this reversionary rent potential to lift rental income, dividend capacity, capital values and total return. The company indicates that in the absence of the rent cap, c 25% of its tenancies would be governed by the Mietspiegel, allowing for rental growth of c 1.5% pa. However, for more recent tenancies (c 75%), the company has included annual indexation (the Staffel) of c 3.5% for a period of 10 years. Although the regulatory drag on rent increases acts as a disincentive for tenants to vacate, some tenant turnover is inevitable, and it has typically been at a level of c 10% pa. Around half of the vacated units will generally be modernised, at a cost of €20,000–30,000 each, prior to re-letting at market rates. In the five years to end-FY19, new lettings were at an average premium of 40% to the portfolio average in-place rents.

Reflecting an overall shortage of Berlin housing, the market sales values per square metre for individual apartments/condominiums is at a significant premium to the value of tenanted apartment blocks. As a result, PSD has been able to selectively crystallise the value embedded in the portfolio by dividing and selling blocks of apartments as individual condominiums. The process is subject to full regulatory approval and involves the legal splitting of the freeholds in properties that have been identified as being suitable for condominium conversion. PSD estimates that the uplift in market valuation from a pure rental property to that of a fully permissioned, fully separated condominium is c 35%. To date, PSD has limited condominium sales (an average of c €9.0m pa over the five years to end-FY19) as its preference has been to extract the full value embedded in the portfolio through reversionary capture. However, sales have been a useful way to demonstrate the value inherent in the portfolio while generating free cash flow for distributions.

No Mietendeckel repeal: Greater focus on sales

Given the company’s firm belief that the Mietendeckel will eventually be repealed, the current year focus has been on mitigating the initial effects. However, should repeal not occur PSD has provided guidance on how its strategy is likely to adapt, including:

An acceleration in condominium conversion and condominium sales activities. To maximise its strategic flexibility, PSD has sought to split as many properties as possible into condominium units at the land registry, a pre-requisite for selling each apartment separately. As at 30 June 2020, 66% of portfolio assets had been legally split into condominium units (up from 58% at the end of FY19) and a further 19% are in application, more than half of which are in the final stages of the process.

A reduction in discretionary capital expenditure is an inevitable result of the reduction in allowable rent recovery. The new maximum €1/sqm (typically €600–700 pa across the portfolio) no longer justifies the previous levels of investment (typically €20,000–30,000 per apartment) when reletting at market rents was possible. PSD expects capex to be c €3.5m pa lower while the Mietendeckel remains in place.

Share repurchases. The share buy-back programme, introduced in FY19, was suspended in March 2020 as a result of COVID-19 uncertainty but was reinstated in September 2020. PSD said that under the programme it would consider repurchasing up to 10% of the issued share capital and from mid-October 2019 to date has repurchased c 4.4m shares (c 4% of the outstanding number at the commencement of the programme) at a discount of c 25% to prevailing EPRA NAV.

Reinvestment outside of the City of Berlin area. Although an acceleration of condominium sales would provide an alternative route to realising the value embedded in the portfolio, it would also shrink the income generating asset base and would not on its own represent a long-term continuation strategy. In addition to accretive share repurchases, we would expect the company to seek asset purchases outside of the City of Berlin, in the wider Berlin area, unaffected by the rent cap, similar to the December 2019 acquisition of an apartment complex in Brandenburg (see below).

Accentro distribution agreement

PSD has historically focused on selling relatively small numbers of vacant condominiums, for which QSix has in-house capability. Occupied condominium units are usually acquired by investors seeking income and less frequently by individual buyers who are prepared to wait before taking possession. A 2019 agreement with Accentro Real Estate, one of Germany’s leading condominium sales platforms, provides scope for a significant acceleration of condominium sales if required, including tenanted condominiums, without need for volume discounts. The agreement allows PSD to offer properties to Accentro to market, receiving an agreed minimum value for the assets and continuing to benefit from the rental income while they are marketed and sold.

The portfolio and performance

As at 30 June 2020 (H120) PSD’s portfolio was externally valued by Jones Lang LaSalle (JLL) at €746.7m (end-FY19: €730.2m). The like-for-like increase during the period was 2.6%, reflecting the combined impact of active asset management and modest yield compression supported by the decline in interest rates. The valuation reflects an average value per square metre of €3,839 (end-FY19: €3,741), a gross fully occupied yield of 2.8% (31 December 2019: 2.9%) and a net yield, using EPRA methodology, of 2.4% (31 December 2019: 2.3%).

Exhibit 1: Portfolio summary

H120

H119

FY19

Valuation (€m)

746.7

665.2

730.2

Total area ('000 sqm)

194.5

179.4

195.2

Valuation per sqm (€)

3,389

3,716

3,741

Gross contracted rent roll (€m)

19.5

18.0

19.7

Average contracted rent per sqm/month (€)*

9.1

8.7

9.0

Fully occupied gross yield

2.8%

2.9%

2.9%

Vacancy

8.0%

4.2%

6.7%

EPRA vacancy**

4.3%

2.5%

2.8%

Number of buildings

98

96

98

Residential units

2,571

2,378

2,537

Commercial units

141

143

142

Total number of units

2,712

2,521

2,679

Source: Phoenix Spree data. Note: *On a collected basis as currently determined by the Mietendeckel the average collected rent is €8.9 per sqm/month. **EPRA occupancy adjusts for units that are undergoing development/refurbishment and made available for sale.

The portfolio comprises 98 buildings, providing 2,571 residential units and 141 commercial units. The properties are mainly classic ‘Altbau’, built before 1914, and typically five-storey buildings, each containing 20–40 units, made up of one- to three-bedroom apartments, often with shops or other commercial units on the ground floor. Structural alterations to buildings of this age and design are often easier than would be the case for some more modern post-war buildings and environment risks such as asbestos are far less likely. Around 90% of the portfolio units are located within City of Berlin and 6% in the surrounding State of Brandenburg, where PSD acquired an apartment complex in December 2019 for c €40.6m (excluding costs but including €16.4m of debt assumed and subsequently refinanced), reflecting a prospective gross yield of 4.1%. The property is a former army barracks, comprising 259 residential units, one commercial unit and parking, with significant asset management potential from the completion of refurbishment and development, leasing and reversion.

H120 external portfolio valuation already assumes the rent cap

Despite the introduction of the rent cap, the Berlin residential property market has remained stable in the first half of the financial year and, although transaction volume has reduced, investment demand observed by JLL continues to support current pricing. JLL conducted a full RICS Red Book property-by-property analysis for H120 and the portfolio valuation provided to PSD included no matters of concern or material uncertainty. The fair value of investment properties is determined using discounted forecast cash flows, cross checked against comparable market transactions where they are available. JLL has assumed that the Mietendeckel is fully implemented by PSD and is in place for its five-year lifespan; this was not the case for the 31 December 2019 valuation as the Mietendeckel was not in force at that time. This does not mean that market values will not change, particularly as the legal challenges to the rent cap are decided. However, many market participants, including PSD’s investment adviser, believe that even if the rent cap is not repealed, condominium values are likely to increase as existing tenants remain in place and fewer rental apartments become available, while investment in new supply is choked off.

As at 14 September 2020, 66% of the portfolio had been registered as condominiums, providing opportunities for the implementation of further projects where appropriate. A further 19% are in application, over half of which are in the final stages of the process. Although the majority of units within the portfolio are now officially registered as condominiums, this has not generally been reflected in portfolio values and in most cases their valuations reflect an expectation that they will be held for long-term rental income. Included within the portfolio are six properties valued as condominiums, with an aggregate value of €33.0m (end-FY19: five properties with an aggregate value €26.5m). The properties concerned benefit from both the potential (eg necessary structural adjustments) and all relevant permissions to be sold as individual apartments/condominiums. Where a sale is expected in the coming year these assets are considered held for sale and when notarised for sale, the sale value is reflected.

Capturing reversionary potential

Against the positive backdrop of consistently rising market rents over many years, the achieved average contracted rents for PSD’s Berlin portfolio have also increased steadily (Exhibit 2). The restricted indexation of rents on existing tenancies allowed by the regulations has been significantly enhanced by the refurbishment and subsequent reletting of vacated units at a premium and closer to market rent levels (Exhibit 3).

During H120, PSD continued to sign new leases but at a slower pace following the rent cap introduction and including the impact of COVID-19. To avoid uncertainty among tenants as to their contractual rental obligations during the period when the legality of Mietendeckel remains unresolved, PSD has amended its tenancy agreements to specify clearly rents currently payable as prescribed by the Mietendeckel while it is in place and the higher free market rents that would have been permissible under the German Civil Code, and which will become payable if the Mietendeckel or any part thereof is voided, suspended, repealed or otherwise abolished. As a result, there is currently a small difference between contracted rents and the lower collected rents on new lettings. Tenants have been advised by the Berlin government to set aside appropriate reserves to cover this possibility. 

The 88 new leases signed represented a half-year letting rate of c 3.7% of occupied units, with most (78) signed prior to the commencement of the rent cap. The average contracted rent achieved on new lettings was €10.7 per sqm (12% lower than in H119) and the average premium to passing rents also showed a reduction to 18.6%. The average collected rent of the 88 new leases was €10.5 per sqm, a 17.7% re-letting premium to passing rents. PSD says that the decline in reversionary premium mainly reflects the inclusion of the re-lettings from the recent acquisition in Brandenburg, where rents are lower than those achieved in central Berlin. It says that the reversionary premium achieved on the Berlin portfolio was 37.0%, down from 39.9% in H119. The company has noted some tenants in higher rented accommodation cancelling leases to look for apartments that have lower collected rents due to the Mietendeckel, but expects this to be only a temporary factor.

The slowdown in H120 letting activity was also reflected in increased vacancy (8.0% compared with 6.7% at end-FY19), while the increase from 4.2% at end-H119 significantly reflects the Brandenburg acquisition in late 2019. On an EPRA basis, which adjusts for units that are undergoing development/refurbishment and made available for sale, the vacancy rate was 4.3% (end-FY19: 2.8%.

Exhibit 2: Average Berlin portfolio rents and like-for-like rent growth

Exhibit 3: Average reletting rents and reletting premium

Source: Phoenix Spree data

Source: Phoenix Spree data

Exhibit 2: Average Berlin portfolio rents and like-for-like rent growth

Source: Phoenix Spree data

Exhibit 3: Average reletting rents and reletting premium

Source: Phoenix Spree data

Condominium sales at a premium to book value

From listing through to 3 April 2020, 116 units had been notarised (contracted for sale), representing an aggregate sales value of €38.4m, an average uplift to book value of 16%. Sales in the three years to end-FY19 average c €9m pa. The uplift to book value does not capture the full value creation from redesignation, but only the realised gain to the carried book value at the point of notarisation/contracted sale.

Exhibit 4: Condominium notarisation (2015 to 3 April 2020)

Condominium project

Units notarised

Sales value (€m)

Premium to book value

Riemannstrasse

22

5.3

19%

Mittenwalderstrasse

25

5.2

17%

Boxhagenerstrasse

55

22.7

15%

Bergengruenstrasse

3

0.8

18%

Glienickerstrasse

2

1.0

15%

Herrenhausstrasse

2

1.0

31%

Ebertystrasse

7

2.4

21%

Total

116

38.4

16%

Source: Phoenix Spree FY19 results presentation

PSD typically expects to achieve a 30–35% overall valuation uplift compared with the rental based valuation of much of the portfolio and an alternative way to demonstrate this is to analyse the sales data on an annualised basis. We are unable to compare the sales values with the rental valuation of the actual assets sold, but the sale valuation premium to the portfolio average values appears supportive, although it was lower in H120 as we discuss below. Continuing condominium sales highlight the value embedded in the portfolio and represent a complementary way to realise this value alongside reversionary rent capture. As we discuss in the forecast section below, assuming no repeal of the Mietendeckel we expect overall reported profits to be lower and for realised gains on sale to represent a larger share of these. Under these circumstances we would expect investors to increasingly focus on the potential realisable value of the portfolio. Estimating this value with accuracy is difficult, but as we show in the valuation section below, applying a value of c €4,500 per sqm to the 75% of the portfolio that will soon be designated as condominiums would imply an underlying P/NAV at the current share price of c 40%.

Exhibit 5: Annual notarisation data

FY15

FY16

FY17

FY18

FY19

H120

Sales value of notarisations (€m)*

4.7

5.5

9.1

9.9

8.8

3.0

Average notarised value per sqm (€)

3,899

4,427

4,352

4,566

4,711**

4,392

Portfolio average value per sqm (€)

1,639

1,965

2,854

3,527

3,741

3,839

Berlin rental portfolio value per sqm (€)

1,982

2,150

3,220

3,576

3,854

N/A

Premium to portfolio average

137.9%

125.3%

52.5%

29.5%

25.9%

14.4%

Premium to Berlin portfolio average

96.7%

105.9%

35.2%

27.7%

22.2%

N/A

Source: Phoenix Spree data. Note: *includes a small amount of commercial. **Residential notarisations only

Despite the COVID-19 lockdown for part of the period, 10 condominiums units were notarised in H120, representing total sales proceeds of €3.0m (H119: €2.5m). The average achieved notarised value per square metre for the residential units was €4,392, representing a 15.7% premium to book value and a 14.4% premium to the average residential portfolio value as at 30 June 2020. We understand that the lower average selling price in H120 predominantly reflects mix effects, and in particular sales of remaining, lower value units at Boxhagenerstrasse, marketed under the sales agreement with Accentro and to be completed by the year end. Accentro is contracted to purchase any unsold units from the fund for a cash consideration, guaranteeing revenues of €4.5m in the second half of this financial year. Including the Accentro contract and a positive impact from relaxation of the lockdown restrictions (and assuming they are not re-imposed), PSD anticipates that condominium sales will accelerate in the second half of the financial year and that the full year total will materially exceed the €8.8m recorded in FY19. As at 14 September 2020, additional H220 condominium notarisations amounted to €3.3m and new reservations were also showing a significant improvement.

Growth in contracted rents and a tightening of valuation yields have driven strong like-for-like valuation growth in recent years and this has driven the upwards trend in EPRA NAV per share.

Exhibit 6: Portfolio value and like-for-like valuation increase

Exhibit 7: EPRA NAV per share growth

Source: Phoenix Spree data

Source: Phoenix Spree data

Exhibit 6: Portfolio value and like-for-like valuation increase

Source: Phoenix Spree data

Exhibit 7: EPRA NAV per share growth

Source: Phoenix Spree data

Strong NAV growth and total return performance

EPRA NAV per share has increased steadily, driven by strong realised and unrealised portfolio valuation growth resulting from asset management driven rental growth, yield compression and strategic disposals. The 50.5% increase in NAV per share in 2017 included a significantly positive impact from the disposal of the group’s non-Berlin assets.

Although returns are biased towards capital, PSD has targeted a progressive dividend since listing, although FY19 was held flat due to the uncertainty created by the Mietendeckel rent cap proposals, subsequently adopted. Dividends have not been, and are unlikely to be, covered by recurring earnings (excluding realised and unrealised property gains) and distributions are supplemented by condominium disposal proceeds.

PSD has an NAV target of 8–10% pa, which it has comfortably exceeded since IPO. Returns have been biased towards capital rather than dividend income and we expect this to remain the case, reflecting the low yield on the assets and the cost of actively managing these to unlock the value embedded in the portfolio. Assuming repeal of the Mietendeckel, we expect returns to continue within the target range, but if it is not repealed this would be unlikely and we would expect management to review the target. Our FY21 scenario, assuming no repeal, generates a broadly break-even result.

In the five years to end-FY19 the NAV total return (change in EPRA NAV with dividends paid added back but not reinvested) was 153.0% or an average annual compound return of 20.4%. Capital returns accounted for slightly more than 90% of the total return during the five-year period and dividends for the balance.

Exhibit 8: Five-year EPRA NAV total return history

FY15

FY16

FY17

FY18

FY19

Cumulative FY15–19

Opening EPRA NAV per share (€)

2.06

2.28

2.73

4.11

4.58

2.06

Closing EPRA NAV per share (€)

2.28

2.73

4.11

4.58

4.92

4.92

Dividends paid (€ cents)

1.80

5.80

6.20

7.35

7.50

28.65

EPRA NAV total return

11.8%

22.2%

52.6%

13.1%

9.3%

153.0%

Compound annual average return

20.4%

Source: Phoenix Spree data, Edison Investment Research

Berlin remains affordable with market rental growth driven by excess demand

The Berlin rent cap is a political response to the city’s housing shortage, which has seen rents increase sharply in recent years. Aside from the constitutional argument being waged against the rent cap, many in the industry argue that on top of existing bureaucratic obstacles and land shortages, it will only have a negative impact on investment in the sector, further aggravating the housing shortage.

Berlin, the most populous city in Germany, represents the largest rental housing market in Germany (almost 2m units according to the Berlin-Brandenburg Statistical Office, BBSO). The city’s population has grown in recent years, primarily due to inward migration, which would have been encouraged by relatively low rent levels and a strong a strong job market. The number of people with their main residence in the city had reached c 3.8 million by the end of 2019 (although growth was slower than in previous years and below 1%).

Housing demand is being driven by the growing population, an increasing number of single and two-person households, and a rising number of employed persons (even though unemployment remains above the national average). Meanwhile, although the supply of new homes has increased in recent years it has remained well below the level needed to satisfy this growing demand. Berlin faces a housing shortage and it is estimated that to meet this demand c 20,000 new apartments are need for several years in a row. The decision to cap rents, on top of other bureaucratic obstacles and land shortages, has seen building permit applications decline and seems certain to have a negative impact on investment in the sector, further aggravating the housing shortage.

Exhibit 9: Average Berlin residential rental values
(€ per sqm/month)

Exhibit 10: Average Berlin residential prices (€ per sqm)

Source: Phoenix Spree data, Edison Investment Research analysis

Source: Phoenix Spree data, Edison Investment Research analysis

Exhibit 9: Average Berlin residential rental values
(€ per sqm/month)

Source: Phoenix Spree data, Edison Investment Research analysis

Exhibit 10: Average Berlin residential prices (€ per sqm)

Source: Phoenix Spree data, Edison Investment Research analysis

Berlin rents have grown strongly from a relatively low level over a number of years, although the rate of increase has recently slowed. Company data and our analysis indicates that in the five years to end-2019, average rents per square metre per month increased by c 13%. More recently, rents have continued to increase at the top end of the market while stagnating at the lower end.

Berlin residential property has attracted significant investment, and this has been reflected in declining yields despite rising rents. Company data and our analysis indicates that average market prices for condominiums have increased by c 45% to around €5,000 per sqm in the past five years. JLL estimates an 8.4% increase in 2019, down from 12.9% growth in 2018, with the strongest increases noted at the lower end of the market.

Having started from a relatively low level, Berlin rents and condominium prices remain relatively affordable in both a national and international context. Combined with continuing positive demographic trends and the current housing shortage, this is a positive indicator for the continuing performance of PSD’s portfolio.

Exhibit 11: Average monthly rents by European city (€ per sqm)

Source: Phoenix Spree

Exhibit 12: European property prices by European city (€ per sqm)

Source: Phoenix Spree

Management and governance

PSD is overseen by a non-executive board of directors, with overall responsibility for the company’s activities including determination of the company’s investment objective and investment policy. Having no direct employees, the company has appointed as external property adviser QSix (formerly PMM Residential), an independent and owner-managed alternative asset manager with and experienced team of property and investment professionals and an established track record in the German residential property market. It has offices in London and Berlin.

PSD has an experienced board with a diverse range of non-executive directors who bring a wealth of experience in real estate, corporate finance, investment funds and capital markets. The board is chaired by Robert Hingley, appointed in June 2015, with over 30 years’ experience as a corporate finance adviser. The other current board members are Jonathan Thompson, appointed in January 2018, a chartered accountant and honorary fellow of the Royal Institute of Chartered Surveyors, with extensive real estate and board experience; Monique O’Keefe, appointed in April 2018, a Jersey resident with investment banking and extensive board experience; Greg Branch, appointed in September 2020, a Jersey resident with more than 30 years’ experience in the financial service and real estate sectors, including working with complex business structures; Antonia Burgess, appointed in August 2020, a Jersey resident with more than 25 years’ experience working in the legal and financial services sectors with leading real estate fund managers and investment companies; and Quentin Spicer, appointed in April 2007, a Guernsey resident and lawyer experienced in commercial property transactions including funding for non-UK residents and associated low tax jurisdiction. The company considers all the directors to be independent other than Quentin Spicer due to his length of service on the board. The recent appointments of Antonia Burgess and Greg Branch allow for the retirement of Charlotte Valeur at the last (2020) AGM and the expected retirement of Quentin Spicer at the next AGM. Full biographies can be found on the company’s website.

QSix

Founded in 2006, QSix originates and manages real estate and real estate debt investment on behalf of leading institutional investors. It consists of a team of experienced real estate investment professionals with a recognised track record of advising on fund origination, structuring, acquisitions and disposals, due diligence and asset management in Germany. QSix advises the company of property acquisitions and disposals, supervises the renovation of properties, provides oversight of the property managers and reviews tenant selection. It also advises on the initiation of bank finance and the preparation of business plans. These functions are split between offices in London and Berlin, where the asset management functions are based.

Investment adviser fees

The property adviser receives a portfolio and asset management fee calculated annually as:

1.2% of EPRA NAV on EPRA net assets of less than €500m.

1.0% of EPRA NAV on EPRA net assets of €500m or more.

The property adviser is also entitled to fees relating to property transactions and debt financings, lettings and investor relations activities. In FY19 investment adviser fees of €6,098k comprised €5,944k of management fees and €154k of other fees. A capex monitoring fee (7% of capex) is also payable to the investment adviser and this is reported in the financial statements within capital expenditure and written off.

The property adviser performance fee is based on the excess by which annual EPRA NAV total return exceeds 8%, measured over consecutive three-year periods, and payable and settled in shares. For three-year performance periods ending before 31 December 2020 the investment adviser is entitled to 16% of the excess, falling to 15% for subsequent periods, and is subject to a high watermark.

The FY19 performance fee charge was €2.8m (FY18: €4.0m) but in H120 a reduction in the cumulative accrual resulting from slower NAV total return growth resulted in a €1.9m credit.

Corporate structure simplified

The group structure has recently been simplified by the exercise of an option to acquire the remaining 5.2% partnership interest in the Phoenix Spree Property Fund (PSPF), a core component of the group since the ‘effective merger’ of the company and PSPF in 2015, prior to listing on the LSE. In 2015 the company acquired a 94.8% partnership interest in PSPF, a similar investment fund managed by the investment adviser, avoiding the potential adverse tax consequences of an immediate full merger. In economic terms, full merger equivalence was provided by a variable rate loan instrument (VRL) under which all investors in both PSPF and PSD participated in the NAV (gains and losses) of each other’s respective funds as if they were holders together in a single fund. As a result, the company has had an effective 98.3% interest in PSPF, which has now increased to 100%. The value of the put option was reflected in an ‘other financial liability’ of €7.5m at end-H120, which was settled in July net of a €1.6m adjustment in respect of effects.

Robust H120 results

H120 financial performance was robust despite the COVID-19 pandemic and the first effects of the Berlin rent controls. Like-for-like rental income and property values increased, driving a 3.9% EPRA NAV total return including dividends paid.

Exhibit 13: Summary of H120 financials

€m unless stated otherwise

H120

H119

H120/H119

H219

FY19

Revenue

12.0

10.8

11.7%

11.8

22.6

Total property expenses

(8.1)

(7.5)

7.7%

(6.7)

(14.2)

Gross profit

4.0

3.3

20.7%

5.1

8.4

Administrative expenses

(1.9)

(1.5)

29.1%

(1.6)

(3.1)

Property adviser performance fee

1.9

(0.7)

n.m.

(2.1)

(2.8)

Gain on disposal of investment property

0.7

0.2

0.7

0.9

Fair value movement on investment property

17.0

21.6

19.8

41.5

Separately disclosed items

0.0

(0.3)

0.0

(0.3)

Operating profit

21.6

22.7

-4.5%

21.9

44.6

Net finance charge

(6.4)

(10.6)

-40.1%

(5.4)

(16.0)

Profit before tax

15.3

12.0

26.8%

16.5

28.6

Tax

(2.9)

(1.0)

(4.8)

(5.8)

Profit after tax

12.3

11.1

11.4%

11.7

22.7

Non-controlling interest

(0.2)

(0.1)

(0.3)

(0.5)

Attributable profit after tax

12.1

10.9

11.1%

11.4

22.3

IFRS EPS, basic and diluted (€)

0.12

0.11

0.11

0.22

DPS (c)

2.35

2.35

0.0%

2.35

7.50

EPRA NAV (€)

5.06

4.73

4.92

4.92

EPRA NAV total return

3.9%

4.4%

0.0%

9.1%

Investment property

746.7

665.2

730.2

730.2

Net debt

(246.3)

(178.0)

(237.8)

(237.8)

Net LTV

33.0%

26.8%

32.6%

32.6%

Source: Phoenix Spree data

Revenue of €12.0m (comprising rents and service charge payments) was 11.7% ahead of H119 and was also up slightly on H219, despite the first impacts of the rent control legislation from February 2020. The like-for-like increase in rents per square metre (we estimate c 1.8%) in H120 reflected leasing activity before the imposition of the rent cap in February, while EPRA vacancy increased to 4.3% from 2.8% at end-FY19.

After total property expenses (including property management expenses, repairs and maintenance, direct property costs and investment adviser fees), gross profit of €4.0m was 20.7% ahead of H119. Gross profit was lower compared with H219 due to higher property expenses, driven by direct property costs (eg utility charges) that are quite variable from period to period.

The increase in administrative costs to €1.9m included a significant increase in legal and professional fees, substantially driven by the Mietendeckel legal challenge.

Within operating profit, property gains (realised and unrealised) were lower than in H119, but a reduction in the cumulative success fee due to the property adviser of €1.9m had a positive impact. The like-for-like portfolio value, adjusted for acquisitions and disposals, increased by 2.6% in H120.

The net finance charge benefited from a c €5.6m year on year reduction in unrealised losses on interest rate derivatives used to hedge interest rate exposure, while underlying interest expense broadly tracked higher average debt.

Pre-tax profit of €15.3m was 26.8% ahead of H119 and slightly down on H219.

The increased tax charge in H120 relates to deferred tax effects in respect of the movements in property and interest rate derivative valuations. Current tax effects remain negligible due to German tax losses carried forward (€29.0m at end-FY20, and not reflected in the balance sheet). Net attributable profits increased 11.1% to €12.1m and diluted EPS was €0.12.

The interim DPS was unchanged at 2.35 cents (broadly equivalent to 2.1p) and on an EPRA basis (adjusting IFRS net assets for deferred tax, unrealised derivative valuation losses and the share-based payment reserve) NAV per share increased 2.8% compared with end-FY19 to €5.06. In sterling terms, the increase was c 10%. Allowing for payment of the FY19 final DPS of €5.15, the EPRA NAV total return for the six-month period was 3.9%.

The period end net LTV of 33.0% was well below the long-term target of 50% (with a 60% maximum).

Stable, low-cost funding

At end-H120 PSD had gross borrowings (nominal value, including unamortised loan arrangement fees) of €283.6m, slightly increased on end-FY19 (€280.2m) as a result of the refinancing of €16.4m in debt acquired with the acquisition of the apartment building in Brandenburg in December 2019, refinanced over a longer period and at lower cost by €20.3m of drawing on the €50m acquisition facility agreed with Natixis in September 2019. The end-H120 debt facilities comprised:

A seven-year €240m interest-only facility (in two tranches, a €190m refinancing facility and a €50m acquisition facility) with Natixis Pfandbriefbank, maturing in 2026, of which €211.2m had been drawn as at end-H120. The interest cost on drawn debt is the same for both tranches and has been hedged to give an effective fixed rate of 2.0%. The unbalance of the acquisition facility carries a commitment fee of 0.575% pa.

A €72.4m term facility Berliner Sparkasse with a remaining term of c seven years, amortising at c 1% pa. Of the total, €32.1m is fixed rate, €6.8m is freely floating, and the balance has been fixed with an interest rate swap. The blended cost is c 1.8%.

Although the interest cost on the majority of PSD’s debt has been fixed through hedging (at a little under 2.0% on average), because the reference rate on the swaps is currently negative the overall cost of debt is higher (PSD is currently paying both the fixed rate of the debt and negative interest on the swap). We have assumed an average cost of borrowing, including swap costs of 2.25%.

With cash of €37.3m at end-H120, net debt was €246.3m (end-FY19: €237.8m) and the net loan to value ratio was 33.0% (end-FY19: 32.6%) well below the long-term target of 50% (with a 60% maximum).

Forecasting scenarios

Our FY20 forecast reflects the impact of the Mitenendeckel (on the company’s behaviour in terms of capex, lettings, and disposals) in that year. The rent cap measures introduced in February will continue to act as a significant drag on rent growth while the 23 November reductions in 2020 will have their first impact in the closing weeks of the year. More positively, we expect some reduction in vacancy (from 8% by area at end-H120 to 6% at end-FY20) now that COVID-19 lockdown restrictions have been eased. PSD has also indicated it expects condominium sales to accelerate.

Looking ahead, we share the view of the investment adviser that repeal of the Mietendeckel rent cap in some form or another is likely (but not certain), but the timing of this is difficult to predict. From a financial forecasting perspective for FY21 this poses some challenges and we have sought to address this by illustrating two quite different scenarios:

Mietendeckel repeal. The scenario that we expect to most closely match the future course of events assumes that the rent cap legislation is removed and we illustrate FY21 as if this were effective for a full year (ie reversing the November rent cuts) and with a return to the traditional PSD strategy of reversionary rent capture and selective condominium disposals.

Mietendeckel not repealed. Assuming the Mietendeckel is not repealed and remains in force for at least the initial five-year period, we expect PSD’s strategy to materially alter, as described above. For our FY21 illustration this is reflected in significantly reduced rental income and an increased focus on crystallising embedded value through condominium disposals. We also assume reinvestment of sales proceeds outside of the City of Berlin where the rent cap does not apply, although acquisitions will be benchmarked against share repurchases at a discount to NAV. And continuing share repurchases seem likely.

Assuming Mietendeckel repeal

For FY21 our key assumptions include:

The mandated rent reductions effective 23 November are reversed from 1 January 2021.

Average rental like-for-like growth in rents per sqm per month of 6.0%. This comprises:

A contribution from re-letting, assuming 10% lease churn and an average 30% uplift on the new rents.

Indexation (or ‘staffein’) at 3.5% in respect of an assumed 75% of the portfolio.

A 1.5% Mietspiegel uplift in respect of an assumed 25% of the portfolio.

Vacancy (by area) is forecast to reduce further to 4% by end FY21, closer to the 2–3% historical norm.

A gross margin (rental income less property costs, including the investment advisery fees, as a percent of rental income) of 50% (compared with a 2015–19 average of c 51%).

A reduction in administrative expenses compared with FY20 as legal and other expenses related to the Mietendeckel challenge fall away.

Condominium sales of €10m compared with our forecast €12.6m in FY20. We assume a 15% unrealised uplift in valuation as sales are notarised and an additional 15% realised uplift on the then carried book value at completion (30% gain on sales in total).

We have assumed unrealised property valuation uplifts in line with like-for-like rental growth, adjusted for capex, and the unrealised gain on sale properties as notarised. This implies an unchanged full occupancy rental yield at c 2.8%. For FY21 the net unrealised valuation uplift represents 5.3% of the opening value.

Finance expense includes total interest costs (including hedging costs) of 2.25% pa plus c €0.5m of non-cash loan arrangement fee amortisation.

We have applied deferred tax at the basic German rate of 20% to the property gains but do not expect any current tax to be payable in respect of FY21 (negative earnings before property gains) or for the foreseeable future due to off-balance sheet available tax losses.

We have assumed an unchanged dividend, although there is scope for an increase, and EPRA NAV increases with retained earnings (and deferred tax add-backs). The FY21 EPRA NAV total return is 8.2% and would be unaffected by a change in DPS, which would simply adjust the balance between income and capital returns.

Exhibit 14: Repeal scenario summary

€m unless stated otherwise

FY19

FY20e

FY21e

Revenue

22.6

24.1

24.8

Total property expenses

(14.2)

(15.3)

(14.8)

Gross profit

8.4

8.8

9.9

Administrative expenses

(3.1)

(3.7)

(3.3)

Gain on disposal of investment property

0.9

2.0

1.9

Fair value movement on investment property

41.5

24.4

39.1

Property adviser performance fee

(2.8)

1.9

(0.2)

Separately disclosed items

(0.3)

0.0

0.0

Operating profit

44.6

33.4

47.4

Net finance charge

(16.0)

(9.7)

(6.8)

Profit before tax

28.6

23.7

40.7

Tax

(5.8)

(4.4)

(7.8)

Profit after tax

22.7

19.2

32.8

Non-controlling interest

(0.5)

(0.3)

(0.5)

Attributable profit after tax

22.3

18.9

32.3

EPS (cents)

21.8

19.2

33.2

DPS (cents)

7.50

7.50

7.50

EPRA NAV per share (€)

4.92

5.13

5.48

NAV total return

9.3%

5.7%

8.1%

Source: Phoenix Spree historical data, Edison Investment Research

Assuming Mietendeckel not repealed

If the Mietendeckel is not repealed and it becomes likely that it will remain in place for the next five years, PSD’s strategy would change, although in reality this may not be the case immediately, if the legal challenge continues during 2021 with a reasonable expectation of success. However, to better illustrate the impact of any strategy shift we have assumed this becomes effective at the beginning of FY21. We assume the November 2020 reduction in rent per square metre remains in place with no increase in FY21, with a significant negative impact on rental income, partly offset by additional void reduction and increased realised gains from accelerated condominium sales. Our key assumptions for this scenario include:

Average rents decline by 17% (as guided by PSD) in November 2020 and remain unchanged during FY21. Given that the rent freeze is likely to act as a disincentive for tenants to move, we expect a slightly faster reduction in voids, to 3% by end-FY21. Our assumptions for service charge payments (20–25% of revenues) and property costs are unchanged compared with the base case.

Higher condominium disposals compared with the base case (€20m) with a similar 30% gain, split between unrealised gains (when notarised) and realised gains at completion. Adjusting for capex, we assume no net revaluation movement at all. This assumption is based on the lack of rent growth during the rent freeze but may prove conservative if the condominium prices continue to increase. This appears to be the case currently and may continue if the rent freeze restricts new supply and does nothing to limit the demand for housing.

The realised gains partly offset the negative impact of rent reductions and generate significant cash flow, which we assume is partly reinvested in assets outside of the City of Berlin and partly used to repurchase shares.

We assume c €18m of reinvestment (including acquisition costs at an assumed 11%) at a yield of 3.5%.

We would also expect continuing share repurchases with an accretive impact on NAV if completed at a discount.

If condominium sales were to be greater than we assume, it would have a positive impact on profitability. However, our scenario as it stands generates a broadly break-even result, hence the strategic shift towards accelerated condominium sales as a way to crystallise the value embedded in the portfolio. As with the base case scenario, we have assumed an unchanged DPS and although it is well covered by disposal proceeds, we suspect that PSD would consider a rebalancing of returns away from income and towards capital growth if the Mietendeckel were not repealed.

Exhibit 15: Continuing Mietendeckel scenario

€m unless stated otherwise

FY19

FY20e

FY21e

Revenue

22.6

24.1

22.0

Total property expenses

(14.2)

(15.3)

(14.6)

Gross profit

8.4

8.8

7.4

Administrative expenses

(3.1)

(3.7)

(3.0)

Gain on disposal of investment property

0.9

2.0

2.7

Fair value movement on investment property

41.5

24.4

0.0

Property adviser performance fee

(2.8)

1.9

0.0

Separately disclosed items

(0.3)

0.0

0.0

Operating profit

44.6

33.4

7.1

Net finance charge

(16.0)

(9.7)

(6.8)

Profit before tax

28.6

23.7

0.3

Tax

(5.8)

(4.4)

0.0

Profit after tax

22.7

19.2

0.3

Non-controlling interest

(0.5)

(0.3)

(0.0)

Attributable profit after tax

22.3

18.9

0.3

EPS (cents)

21.8

19.2

0.3

DPS (cents)

7.50

7.50

7.50

EPRA NAV per share (€)

4.92

5.13

5.06

NAV total return

9.3%

5.7%

0.1%

Source: Phoenix Spree historical data, Edison Investment Research

Valuation

PSD is the only German residential property investment company listed on the LSE. Other London-listed German property companies, Summit Germany and Sirius RE, are focused on commercial property. German-listed residential property developers with significant Berlin exposure are all much larger and include ADO Properties (49% Berlin following the reverse take-over with Adler), Deutsche Wohnen (94% Berlin), Vonovia (14% Berlin) and Grand City (25% Berlin).

The whole group has de-rated in terms of P/NAV in recent months, but the de-rating of PSD has been somewhat larger, and contrasts with the share price performance and P/NAV rating of the larger and more liquid Deutsche Wohnen, with a similar Berlin focus. The current c 30% discount on PSD shares compares with a five-year average of 8% and our base case scenario indicates that with a repeal of the Mietendeckel, the EPRA NAV total return should continue to at least fall within the targeted 8–10% pa range.

Exhibit 16: Phoenix Spree P/NAV compared with unweighted peer average*

Source: Refinitiv. Note: *Peers include ADO, Deutsche Wohnen, Vonovia, Grand City.

Exhibit 17 shows a valuation and performance summary for PSD and the German listed peers; the PSD P/NAV and trailing yield are both similar to the peer average, although the average is reduced by ADO (which paid no DPS for FY19 ahead of a capital raise).

Exhibit 17: Peer group comparison

Price in local currency

Market cap (€m)

Price/NAV
(x)

Trailing yield (%)

Share price performance

1 month

3 months

12 months

From 12M high

Grand City

19.4

3,314

0.77

4.0

-7.0

-7.7

-7.3

-19.7

ADO*

24.2

2,574

0.53

0.0

8.2

1.6

-19.4

-21.4

Deutsche Wohnen

42.0

15,084

0.88

2.1

-9.4

-3.6

19.5

-10.8

Vonovia

56.2

31,690

0.97

2.8

-5.6

-2.7

21.1

-10.7

Average

0.79

2.2

-3.5

-3.1

3.5

-15.6

Phoenix Spree

318.0

375

0.77

2.1

0.8

3.1

-1.8

-4.8

Source: Company data, Refinitiv. Prices as at 4 December 2020. Note: *ADO P/NAV based on H120 EPRA pro forma EPRA NAV per share of €45.96 provided by the company to reflect subsequent €450m equity raise and acquisition of Consus Real Estate. Ahead of the capital raise ADO paid no DPS in respect of FY19.

Assuming no repeal of the Mietendeckel, PSD would be significantly more dependent on condominium sales to realise the value embedded in the portfolio. In these circumstances we would expect investors to focus on the underlying portfolio value, adjusting the balance sheet property values and NAV to a condominium basis valuation. The average realised values per square metre reflected in Exhibits 4 and 5 above are specific to the assets disposed of in any period. With that caveat, we estimate a value-weighted average sale price of just over €4,500 per sqm from the beginning of FY17 to end-H120. Applying a €4,500 per sqm value to the c 75% of the portfolio that will soon be designated as condominiums suggests a c 20% uplift to the reported H120 EPRA NAV per share, implying an adjusted discount to NAV of c 40%.

Exhibit 18: P/NAV sensitivity to condominium valuation

Average condominium value (€ per sqm)

4,000

4,250

4,500

4,750

5,000

Premium to H120 portfolio average value (€ per sqm)

4%

11%

17%

24%

30%

Implied uplift to H120 NAV

5%

12%

20%

27%

34%

Implied P/NAV based on current price (x)

0.68

0.64

0.60

0.56

0.53

Source: Edison Investment Research

Sensitivities

As noted above, although we believe that a repeal of the Mietendeckel is likely, the timing is uncertain, and it is by no means certain. In this context, the financial impacts on PSD remain difficult to predict and we refer to our modelled outcomes as scenarios. Non-repeal of the Mietendeckel would have a material negative impact on rental income, which the company plans to partly offset with increased condominium sales. We see the main fundamental sensitivities as being economic and market driven, although residential property has historically been much less cyclical than is the case for commercial property, and the current market supply-demand position continues to be positive, with supportive demographic trends predicted to continue. Political risks, reflected in changes to the legal and regulatory structure, as the Mietendeckel highlights, are tangible and require vigilance and flexibility on the part of management, as has been the case since the company was formed c 13 years ago. In particular, we highlight:

A deterioration in the economic environment. This could have an adverse impact on tenant demand and vacancy, especially if severe or prolonged, leading to a reduction in rental and property values.

Changes to property and tenant law. German property laws remain under constant review and further changes in the framework of regulation and rent control could affect rental values and property valuations.

A slowdown in the market for condominium sales. Sales of vacant condominiums are an important source of cash flow and earnings to fund the company’s refurbishment programme and dividend payments.

Diversification. PSD is completely focused on the Berlin market, which currently enjoys positive market fundamentals. A repeal of the Mietendeckel would be very beneficial for the company. However, PSD is exposed to any more permanent deterioration in the Berlin market.

Breach of borrowing covenants. A material and unexpected fall in rental values and property valuations could have an adverse impact on PSD’s banking covenants, reducing interest and asset cover ratios.

Exhibit 19: Financial summary

‘Mietendeckel

Year ending 31 December, €m unless stated otherwise

2017

2018

2019

2020e

repealed’ scenario* 2021

INCOME STATEMENT

Revenue

23.7

22.7

22.6

24.1

24.8

Total property expenses

(12.6)

(15.8)

(14.2)

(15.3)

(14.8)

Gross profit

11.1

6.9

8.4

8.8

9.9

Administrative expenses

(3.0)

(3.2)

(3.1)

(3.7)

(3.3)

Gain on disposal of investment property

5.3

1.0

0.9

2.0

1.9

Fair value movement on investment property

157.4

66.1

41.5

24.4

39.1

Property adviser performance fee

(26.3)

(4.0)

(2.8)

1.9

(0.2)

Separately disclosed items

0.0

(1.0)

(0.3)

0.0

0.0

Operating profit

144.5

65.9

44.6

33.4

47.4

Net finance charge

(6.0)

(9.5)

(16.0)

(9.7)

(6.8)

Gain on financial asset

0.0

0.0

0.0

0.0

0.0

Profit before tax

138.5

56.4

28.6

23.7

40.7

Tax

(26.2)

(11.1)

(5.8)

(4.4)

(7.8)

Profit after tax

112.3

45.4

22.7

19.2

32.8

Non-controlling interest

(0.8)

(0.3)

(0.5)

(0.3)

(0.5)

Attributable profit after tax

111.5

45.1

22.3

18.9

32.3

Closing basic number of shares (m)

92.5

100.8

97.8

96.6

96.3

Average diluted number of shares (m)

100.2

99.0

102.1

98.7

97.5

IFRS EPS, diluted (cents)

111.35

45.57

21.83

19.18

33.16

DPS declared (cents)

6.9

7.5

7.5

7.5

7.5

DPS declared (sterling pence equivalent)

6.4

6.7

6.5

6.8

6.8

EPRA NAV total return

52.6%

13.1%

9.3%

5.7%

8.1%

BALANCE SHEET

Investment properties

502.4

632.9

719.5

738.9

771.1

Other non-current assets

2.9

3.4

3.5

3.9

3.9

Total non-current assets

505.3

636.4

723.0

742.8

775.0

Investment properties held for sale

106.9

12.7

10.6

7.5

7.5

Cash & equivalents

27.2

26.9

42.4

35.2

36.2

Other current assets

14.4

7.5

9.5

9.6

10.1

Total current assets

148.5

47.1

62.6

52.3

53.7

Borrowings

(2.6)

(3.6)

(17.8)

0.0

0.0

Other current liabilities

(9.4)

(13.2)

(15.6)

(8.4)

(8.8)

Total current liabilities

(12.1)

(16.8)

(33.4)

(8.4)

(8.8)

Borrowings

(219.6)

(191.6)

(258.5)

(279.9)

(280.4)

Other non-current liabilities

(54.1)

(65.2)

(76.8)

(83.9)

(91.8)

Total non-current liabilities

(273.8)

(256.9)

(335.3)

(363.9)

(372.2)

Net assets

367.9

409.8

416.9

422.8

447.7

Non-controlling interest

(1.7)

(2.0)

(3.0)

(3.3)

(3.8)

Net attributable assets

366.2

407.9

413.9

419.5

443.9

Adjust for:

Deferred tax assets & liabilities

44.6

52.5

58.3

62.8

70.6

Derivative financial instruments

3.3

6.0

16.0

18.3

18.3

Other EPRA adjustments

(34.0)

(5.4)

(6.8)

(4.9)

(5.1)

EPRA net assets

380.2

461.0

481.4

495.6

527.7

IFRS NAV per share (€)

3.96

4.05

4.23

4.34

4.61

EPRA NAV per share (€)

4.11

4.58

4.92

5.13

5.48

CASH-FLOW

Cash flow from operating activity

5.9

13.2

1.5

6.0

6.6

Income tax paid

(0.1)

(4.7)

(0.0)

(1.4)

0.0

Net cash flow from operating activity

5.8

8.5

1.4

4.7

6.6

Property additions

(76.5)

(47.3)

(32.2)

0.0

0.0

Proceeds from disposal of investment property

60.4

86.0

13.5

13.2

15.9

Capital expenditure on investment property

(6.7)

(7.9)

(6.5)

(4.5)

(7.0)

Other cash flow from investing activity

0.0

0.0

0.1

(5.8)

0.0

Cash flow from investing activity

(22.7)

30.8

(25.1)

2.9

8.9

Interest paid

(5.1)

(5.1)

(6.2)

(6.8)

(6.4)

Bank debt drawn/(repaid)

36.7

(27.0)

64.6

3.4

0.0

Share issuance/repurchase

0.0

0.0

(11.5)

(4.3)

0.0

Dividends paid

(6.0)

(7.5)

(7.7)

(7.2)

(7.2)

Other cash flow from financing activity

0.0

0.0

0.0

0.0

0.0

Cash flow from financing activity

25.6

(39.6)

39.2

(14.8)

(13.6)

Change in cash

8.7

(0.3)

15.5

(7.2)

1.9

FX

(0.0)

(0.0)

(0.0)

(0.0)

0.0

Opening cash

18.5

27.2

26.9

42.4

34.3

Closing cash

27.2

26.9

42.4

35.2

36.2

Closing debt

(222.3)

(195.3)

(280.2)

(283.6)

(283.6)

Closing net debt

(195.1)

(168.4)

(237.8)

(248.4)

(247.4)

LTV

32.0%

26.1%

32.6%

33.3%

31.8%

Source: Phoenix Spree historical data, Edison Investment Research forecasts. Note: *As described within this report.

Contact details

Revenue by geography

QSix Residential
Royal Trust House, 54 Jermyn Street
London SW1Y 6LX
UK
+44 20 3937 8760
info@phoenixspree.com
www.pheonixspree.com

Contact details

QSix Residential
Royal Trust House, 54 Jermyn Street
London SW1Y 6LX
UK
+44 20 3937 8760
info@phoenixspree.com
www.pheonixspree.com

Revenue by geography

Leadership team

Non-executive chairman: Robert Hingley

Managing Partner, QSix: Mike Hilton

Robert Hingley had over 30 years’ experience as a corporate finance adviser, retiring as a partner at Ondra Partners LLP in 2017. He joined the Association of British Insurers as director, investment affairs in September 2012 and, following the merger of ABI’s investment affairs with the Investment Management Association, acted as a consultant to the enlarged IMA until the end of 2014. From 2010 until January 2015, he was a managing director, and later senior adviser, at Lazard. He was previously director general of The Takeover Panel from December 2007, on secondment from Lexicon Partners, where he was vice chairman. Prior to joining Lexicon Partners in 2005, he was co-head of the Global Financial Institutions Group and head of German Investment Banking at Citigroup Global Capital Markets, which acquired the investment banking business of Schroders in 2000. He joined Schroders in 1985 after having qualified as a solicitor with Clifford Chance in 1984.

Mike is one of QSix’s founding partners, focused on the firm’s growth strategy and overseeing all aspects of the German residential business and Phoenix Spree Deutschland. Prior to founding QSix, Mike was managing director and European sector head at UBS where he worked closely with Matthew Northover, with whom he founded QSix in 2006. Mike also held roles at Charterhouse Bank and Dresdner Kleinwort Benson as an equity research analyst and LEK Partners within its corporate strategy division. Mike holds an MA in economics from Cambridge University.

Managing Partner, QSix: Mathew Northover

Managing Partner, QSix: Jörg Schwagenscheidt

Matthew is one of QSix’s founding partners and oversees the firm’s growth strategy. He is also a board member of a commercial real estate lending fund for which QSix acts as an investment adviser. After qualifying as a chartered accountant with Ernst & Young, he worked in AstraZenecas strategy department. He then spent 10 years in investment banking, working at ABN, JP Morgan Chase and UBS where he worked closely with Mike Hilton with whom he founded QSix in 2006. Prior to founding QSix, he led the corporate consultancy team at Hargreaves Lansdown, one of the leading financial services providers in the UK. Matthew holds a masters degree in economics from Cambridge University.

Jörg joined QSix in 2015 as managing partner of QSix’s German operations, which lead the asset management of Phoenix Spree Deutschland. Prior to joining QSix, Jörg was co-CEO for GSW Immobilien AG, Berlin’s largest residential property company where he played an integral part in the IPO of GSW in 2011 and its subsequent combination with Deutsche Wohnen in 2013. During his eight years at GSW, Jörg oversaw the growth of the business, including a number of capital raisings and the acquisition of more than 15,000 residential units. Jörg holds an ‘Immobilienökonom’ from the European Business School and is a fellow of The Royal Institute of Chartered Surveyors.

Principal shareholders (% voting rights). Source: FY19 Annual Report

(%)

Bracebridge Capital

12.6

Thames River Capital

8.5

Degroof Petercam

6.8

Goldman Sachs

6.1

Invesco

5.6


General disclaimer and copyright

This report has been commissioned by Phoenix Spree Deutschland and prepared and issued by Edison, in consideration of a fee payable by Phoenix Spree Deutschland. Edison Investment Research standard fees are £49,500 pa for the production and broad dissemination of a detailed note (Outlook) following by regular (typically quarterly) update notes. Fees are paid upfront in cash without recourse. Edison may seek additional fees for the provision of roadshows and related IR services for the client but does not get remunerated for any investment banking services. We never take payment in stock, options or warrants for any of our services.

Accuracy of content: All information used in the publication of this report has been compiled from publicly available sources that are believed to be reliable, however we do not guarantee the accuracy or completeness of this report and have not sought for this information to be independently verified. Opinions contained in this report represent those of the research department of Edison at the time of publication. Forward-looking information or statements in this report contain information that is based on assumptions, forecasts of future results, estimates of amounts not yet determinable, and therefore involve known and unknown risks, uncertainties and other factors which may cause the actual results, performance or achievements of their subject matter to be materially different from current expectations.

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Copyright: Copyright 2020 Edison Investment Research Limited (Edison).

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New Zealand

The research in this document is intended for New Zealand resident professional financial advisers or brokers (for use in their roles as financial advisers or brokers) and habitual investors who are ‘wholesale clients’ for the purpose of the Financial Advisers Act 2008 (FAA) (as described in sections 5(c) (1)(a), (b) and (c) of the FAA). This is not a solicitation or inducement to buy, sell, subscribe, or underwrite any securities mentioned or in the topic of this document. For the purpose of the FAA, the content of this report is of a general nature, is intended as a source of general information only and is not intended to constitute a recommendation or opinion in relation to acquiring or disposing (including refraining from acquiring or disposing) of securities. The distribution of this document is not a ‘personalised service’ and, to the extent that it contains any financial advice, is intended only as a ‘class service’ provided by Edison within the meaning of the FAA (i.e. without taking into account the particular financial situation or goals of any person). As such, it should not be relied upon in making an investment decision.

United Kingdom

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Frankfurt +49 (0)69 78 8076 960

Schumannstrasse 34b

60325 Frankfurt

Germany

London +44 (0)20 3077 5700

280 High Holborn

London, WC1V 7EE

United Kingdom

New York +1 646 653 7026

1185 Avenue of the Americas

3rd Floor, New York, NY 10036

United States of America

Sydney +61 (0)2 8249 8342

Level 4, Office 1205

95 Pitt Street, Sydney

NSW 2000, Australia

Frankfurt +49 (0)69 78 8076 960

Schumannstrasse 34b

60325 Frankfurt

Germany

London +44 (0)20 3077 5700

280 High Holborn

London, WC1V 7EE

United Kingdom

New York +1 646 653 7026

1185 Avenue of the Americas

3rd Floor, New York, NY 10036

United States of America

Sydney +61 (0)2 8249 8342

Level 4, Office 1205

95 Pitt Street, Sydney

NSW 2000, Australia

General disclaimer and copyright

This report has been commissioned by Phoenix Spree Deutschland and prepared and issued by Edison, in consideration of a fee payable by Phoenix Spree Deutschland. Edison Investment Research standard fees are £49,500 pa for the production and broad dissemination of a detailed note (Outlook) following by regular (typically quarterly) update notes. Fees are paid upfront in cash without recourse. Edison may seek additional fees for the provision of roadshows and related IR services for the client but does not get remunerated for any investment banking services. We never take payment in stock, options or warrants for any of our services.

Accuracy of content: All information used in the publication of this report has been compiled from publicly available sources that are believed to be reliable, however we do not guarantee the accuracy or completeness of this report and have not sought for this information to be independently verified. Opinions contained in this report represent those of the research department of Edison at the time of publication. Forward-looking information or statements in this report contain information that is based on assumptions, forecasts of future results, estimates of amounts not yet determinable, and therefore involve known and unknown risks, uncertainties and other factors which may cause the actual results, performance or achievements of their subject matter to be materially different from current expectations.

Exclusion of Liability: To the fullest extent allowed by law, Edison shall not be liable for any direct, indirect or consequential losses, loss of profits, damages, costs or expenses incurred or suffered by you arising out or in connection with the access to, use of or reliance on any information contained on this note.

No personalised advice: The information that we provide should not be construed in any manner whatsoever as, personalised advice. Also, the information provided by us should not be construed by any subscriber or prospective subscriber as Edison’s solicitation to effect, or attempt to effect, any transaction in a security. The securities described in the report may not be eligible for sale in all jurisdictions or to certain categories of investors.

Investment in securities mentioned: Edison has a restrictive policy relating to personal dealing and conflicts of interest. Edison Group does not conduct any investment business and, accordingly, does not itself hold any positions in the securities mentioned in this report. However, the respective directors, officers, employees and contractors of Edison may have a position in any or related securities mentioned in this report, subject to Edison's policies on personal dealing and conflicts of interest.

Copyright: Copyright 2020 Edison Investment Research Limited (Edison).

Australia

Edison Investment Research Pty Ltd (Edison AU) is the Australian subsidiary of Edison. Edison AU is a Corporate Authorised Representative (1252501) of Crown Wealth Group Pty Ltd who holds an Australian Financial Services Licence (Number: 494274). This research is issued in Australia by Edison AU and any access to it, is intended only for ‘wholesale clients’ within the meaning of the Corporations Act 2001 of Australia. Any advice given by Edison AU is general advice only and does not take into account your personal circumstances, needs or objectives. You should, before acting on this advice, consider the appropriateness of the advice, having regard to your objectives, financial situation and needs. If our advice relates to the acquisition, or possible acquisition, of a particular financial product you should read any relevant Product Disclosure Statement or like instrument.

New Zealand

The research in this document is intended for New Zealand resident professional financial advisers or brokers (for use in their roles as financial advisers or brokers) and habitual investors who are ‘wholesale clients’ for the purpose of the Financial Advisers Act 2008 (FAA) (as described in sections 5(c) (1)(a), (b) and (c) of the FAA). This is not a solicitation or inducement to buy, sell, subscribe, or underwrite any securities mentioned or in the topic of this document. For the purpose of the FAA, the content of this report is of a general nature, is intended as a source of general information only and is not intended to constitute a recommendation or opinion in relation to acquiring or disposing (including refraining from acquiring or disposing) of securities. The distribution of this document is not a ‘personalised service’ and, to the extent that it contains any financial advice, is intended only as a ‘class service’ provided by Edison within the meaning of the FAA (i.e. without taking into account the particular financial situation or goals of any person). As such, it should not be relied upon in making an investment decision.

United Kingdom

This document is prepared and provided by Edison for information purposes only and should not be construed as an offer or solicitation for investment in any securities mentioned or in the topic of this document. A marketing communication under FCA Rules, this document has not been prepared in accordance with the legal requirements designed to promote the independence of investment research and is not subject to any prohibition on dealing ahead of the dissemination of investment research.

This Communication is being distributed in the United Kingdom and is directed only at (i) persons having professional experience in matters relating to investments, i.e. investment professionals within the meaning of Article 19(5) of the Financial Services and Markets Act 2000 (Financial Promotion) Order 2005, as amended (the ‘FPO’) (ii) high net-worth companies, unincorporated associations or other bodies within the meaning of Article 49 of the FPO and (iii) persons to whom it is otherwise lawful to distribute it. The investment or investment activity to which this document relates is available only to such persons. It is not intended that this document be distributed or passed on, directly or indirectly, to any other class of persons and in any event and under no circumstances should persons of any other description rely on or act upon the contents of this document.

This Communication is being supplied to you solely for your information and may not be reproduced by, further distributed to or published in whole or in part by, any other person.

United States

Edison relies upon the ‘publishers' exclusion’ from the definition of investment adviser under Section 202(a)(11) of the Investment Advisers Act of 1940 and corresponding state securities laws. This report is a bona fide publication of general and regular circulation offering impersonal investment-related advice, not tailored to a specific investment portfolio or the needs of current and/or prospective subscribers. As such, Edison does not offer or provide personal advice and the research provided is for informational purposes only. No mention of a particular security in this report constitutes a recommendation to buy, sell or hold that or any security, or that any particular security, portfolio of securities, transaction or investment strategy is suitable for any specific person.

Frankfurt +49 (0)69 78 8076 960

Schumannstrasse 34b

60325 Frankfurt

Germany

London +44 (0)20 3077 5700

280 High Holborn

London, WC1V 7EE

United Kingdom

New York +1 646 653 7026

1185 Avenue of the Americas

3rd Floor, New York, NY 10036

United States of America

Sydney +61 (0)2 8249 8342

Level 4, Office 1205

95 Pitt Street, Sydney

NSW 2000, Australia

Frankfurt +49 (0)69 78 8076 960

Schumannstrasse 34b

60325 Frankfurt

Germany

London +44 (0)20 3077 5700

280 High Holborn

London, WC1V 7EE

United Kingdom

New York +1 646 653 7026

1185 Avenue of the Americas

3rd Floor, New York, NY 10036

United States of America

Sydney +61 (0)2 8249 8342

Level 4, Office 1205

95 Pitt Street, Sydney

NSW 2000, Australia

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