Phoenix Spree Deutschland — Valuation decline but sales premium continuing

So far in FY23, the economic outlook for Germany has been improving. Inflation is declining at a faster rate than had been expected, driven by a sharp reduction in energy prices, while GDP has been supported by the government’s fiscal support package. The European Commission now expects the German economy to show slight growth in 2022, of 0.2%, compared with its autumn forecast of a negative 0.6%. However, PSD notes that higher medium-term interest rates continue to present a challenge to the property market and that a further fall in values cannot be ruled out.

While real estate valuations remain uncertain, the fundamental demand-supply balance in the Berlin market continues to support rental values. The Berlin housing shortage has been built over many years by demographic trends, including net migration and insufficient new development. If anything, these drivers have recently strengthened, with more than a million Ukrainian refugees entering Germany and higher construction prices, disrupted supply chains and materials shortages adding to the existing drag on development from strict planning laws.

PSD expects these positive demand-supply fundamentals for rented accommodation to continue to support rental values but believes that it is too early to predict a recovery in buyer sentiment in the condominium market accurately, notwithstanding a positive start to 2023.

Despite the near-term headwinds, the company remains confident in the long-term outlook, based on the significant rent reversion that remains embedded in the portfolio, along with unrecognised capital value in the majority of its residential units, which have been designated as condominiums. The cost of all borrowing is fixed, with no loans maturing until 2026, and we forecast sufficient liquidity to maintain dividend payments and continue to invest in the portfolio (to unlock rent reversion).

Differentiating it from listed German peers, approximately 76% of PSD’s Berlin portfolio is legally designated as condominiums, providing a strategic advantage that was highlighted by federal government legislation, which has placed significant restrictions on the ability of landlords to split their properties into condominiums in the future. The measures will inevitably increase the scarcity of condominiums available for sale in the future, further exacerbating the demand-supply imbalance that currently exists.

The division and subsequent resale of selected apartment blocks as private units (condominiums), with vacant possession, at market valuations, supplements PSD’s rental income, increases cash flow and accelerates the release of significant value embedded within the portfolio. Condominium market prices are typically 30–35% higher than rental-based valuations and this is only partly reflected in PSD’s portfolio valuation. Compared with rental property valuations, the process of land registry splitting generally leads to a valuation uplift in the region of 15% (although these continue to operate as rental properties unless identified for sale. Within the portfolio valuation, only six properties, with an aggregate value of €30.1m, are fully valued as condominiums and sales values are typically well ahead of this. The sales premium in any period is specific to the mix of assets (different locations, floor space, etc) but the 22% premium achieved in FY22 was slightly above the three-year average of 20%, albeit on significantly reduced volume.

The premium to book value on PSD’s first condominium notarisation for sale in FY23 was an exceptional 120%. Since then, reservations for a further three units have been received and are pending notarisation. These have a combined value of €0.8m, representing a gross premium of 45% to book value and 22% to PSD’s end-FY22 average Berlin residential portfolio.

Berlin rents have risen strongly in recent years, but federal laws significantly restrict the pace at which market rental growth can be passed through tenancies already in place. This has built up reversionary potential within the portfolio such that even if free market rents were to weaken, rental income should continue to increase. Refurbishment and subsequent re-letting of vacated units at a premium to existing rents, and closer to market rent levels, will remain the key driver of reversionary capture.

FY22 data will become available with the results in March but the re-letting premium continued through H222, when the average rent achieved on all new lettings was €12.7/sqm per month, an 8.5% increase on the prior year, and an average 28.4% above the previous passing rent for those apartments. Excluding assets in Brandenburg acquired in 2020, where rents are lower than those achieved in central Berlin, the reversionary premium to previous passing rents was 33.7%. The premium to previous passing rents varies from period to period, mainly determined by mix, but the average re-letting premium for the whole portfolio in the three years to end-FY21 was c 27%.

During FY22, PSD invested around €16m in property refurbishment and in bringing new residential condominium projects to market. PSD expects this investment to be reflected in 2023 through condominium sales and rental uplifts. FY23 investment is expected to be materially lower as condominium projects complete.

Providing additional capital for recycling into investment since end-H122 [PSD has completed the sale of two non-core properties for an aggregate consideration of €8.6m. These were acquired in 2008 and 2017, for an aggregate purchase price of €3.9m, and were sold with a 30 June 2022 carrying value of €8.9m. Contracts to sell a further property for €3.5m have been exchanged. This building was acquired in 2008 for a purchase price of €1.0m and had a carry value of €3.9m as at 30 June 2022. PSD does not anticipate further acquisitions until market conditions improve and discount to NAV narrows.

We have adjusted our FY22 forecast in line with the data provided in the valuation update, reducing EPRA NTA (NAV) per share to €5.11, within the range expected by management (€5.7 previously). There is little further data at this stage but, pending the publication of full-year results in late March, our preliminary forecast now includes a total gross revaluation loss of c €43m, comprising the negative like-for-like movement of c €25m (reflecting the like-for-like revaluation movement), capex of c €16m (for which the valuers are unlikely to attach a valuation until this begins to generate rental income or property sales) and the movement in properties under development. The negative swing in property revaluation of c €46m, net of deferred tax, explains the reduction in our forecast net attributable loss of c €31m compared with a profit of c €14m. We expect no change in full-year DPS of €7.5.

NAV is an important indicator of valuation but only partially reflects the market value of units designated as condominiums. The dividend yield does not reflect the reversionary rent potential embedded in the portfolio. PSD continues to generate a premium to book value on condominium sales and a premium on re-letting refurbished units.

That said, our forecast of an unchanged FY22 aggregate DPS of 7.5 cents represents a yield of 2.7%. Meanwhile, the shares trade at a more than 50% discount to FY22e EPRA NTA per share. The discount implies that investors continue to anticipate a significant further deterioration in market conditions, to an extent that none of the companies operating in the sector, including PSD, expects to be the case given the fundamental imbalance of demand and supply in the residential market.

In Exhibit 4 we show a price performance and valuation summary for PSD and its main listed peers.

PSD shares have been significantly de-rated in the past year, down by c 36%, but have clearly outperformed peers, down by an average of c 44%. Over three years the outperformance is greater, with PSD shares down 23% versus the peer average of 49%. We believe that the company’s stable, low-cost borrowing, rent reversion potential and high proportion of units designated as condominiums will all have contributed to this outperformance.