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Research: Real Estate
While German macroeconomic conditions are challenging, the fundamental demand-supply balance for Berlin rented residential accommodation remains robust. Phoenix Spree’s (PSD’s) FY22 property values and NAV declined, but condominium sales continue to generate a strong premium to book value. We expect rental growth also when results are released in March, as the company continues to harvest strong rent reversion.
Phoenix Spree Deutschland |
Valuation decline but sales premium continuing |
FY22 valuation report |
Real estate |
20 February 2023 |
Share price performance
Business description
Next events
Analyst
Phoenix Spree Deutschland is a research client of Edison Investment Research Limited |
While German macroeconomic conditions are challenging, the fundamental demand-supply balance for Berlin rented residential accommodation remains robust. Phoenix Spree’s (PSD’s) FY22 property values and NAV declined, but condominium sales continue to generate a strong premium to book value. We expect rental growth also when results are released in March, as the company continues to harvest strong rent reversion.
Year end |
PBT* |
EPS |
NAV**/ |
DPS |
P/E |
P/NAV |
Yield |
12/20 |
37.9 |
30 |
5.28 |
7.5 |
9.3 |
0.53 |
2.7 |
12/21 |
45.3 |
39 |
5.65 |
7.5 |
7.1 |
0.49 |
2.7 |
12/22e |
(37.0) |
(34.0) |
5.10 |
7.5 |
N/A |
0.55 |
2.7 |
12/23e |
1.4 |
1.6 |
5.05 |
7.5 |
178.0 |
0.55 |
2.7 |
Note: *As reported on an IFRS basis including realised and unrealised gains. **Measured as EPRA net tangible assets per share.
Property values weakened in H222
At 31 December 2022 (end-FY22), PSD’s property portfolio, including properties under construction, was externally valued at €775.9m (vs €801.5m at end-FY21), reflecting a gross fully occupied yield of 3.0% (FY21: 2.8%). Net of acquisitions and disposals, the full-year like for like valuation movement was a negative 3.1%, with a 5.2% H2 decline offsetting the 2.1% H1 gain. We wait to see whether German peers will experience a similar trend in their Q422 valuations. As previously indicated by the company, FY22 condominium sales were negatively affected by market conditions. Positively, the premium to book value on condominium notarisations (22.4%) continued, although volumes weakened (€4.7m vs €15.2m in FY21). The company expects to report FY22 EPRA NTA per share within a range of €5.09–5.14 and we have adjusted our forecasts (from €5.7) accordingly.
Durable embedded value remains in place
Free market rents are significantly above in-place rents in the highly regulated German market and well supported by fundamental demand-supply. Refurbishment and re-letting at market rents is PSD’s core strategy for closing this gap, regularly generating strong rent uplifts. Even if market rents were to stall, rental growth would continue. Splitting apartments into selected individual condominiums for sale has made a significant contribution to earnings and cash flow over time. Condominium market values are much higher than the rental-based valuations applied to most of the portfolio, and little of this potential is reflected in NAV. For now, sales volumes are depressed but, unlike peers, 76% of PSD’s Berlin portfolio is legally split (less than 5% is valued as such), while tighter rules on apartment block splitting leave PSD well placed for a recovery in sales.
Discounting a significant market deterioration
Apparently anticipating a material residential market correction, PSD shares have fallen by 35% over 12 months, continuing to outperform peers listed in Germany (by -43% on average). Reflecting this, and its differentiated reversion strategy, PSD’s trailing P/NAV is higher (0.55x vs c 0.40x) and its yield lower (2.7% vs c 7%).
Significant downturn discounted by equity market
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).
The condominium sales premium has continued
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.
Exhibit 1: Condominium notarisations |
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Source: Phoenix Spree data |
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.
Embedded rent reversion
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%.
Exhibit 2: Re-letting premium to H122 |
Source: Phoenix Spree data |
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.
Forecasts and valuation
EPRA NTA forecast reduced in line with guidance
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.
A material deterioration in the residential housing sector has already been discounted in share prices
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.
Exhibit 3: P/NAV history |
Source: Refinitiv data as at 13 February 2023 |
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.
Exhibit 4: Peer valuation and price performance comparison |
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Source: Phoenix Spree Deutschland data, Refinitiv. Note: Prices as at 17 February 2023. |
Exhibit 5: Financial summary
Year ending 31 December, €m unless stated otherwise |
2018 |
2019 |
2020 |
2021 |
2022e |
2023e |
INCOME STATEMENT |
||||||
Revenue |
22.7 |
22.6 |
23.9 |
25.8 |
26.5 |
28.2 |
Total property expenses |
(15.8) |
(14.2) |
(16.4) |
(16.1) |
(17.0) |
(16.5) |
Gross profit |
6.9 |
8.4 |
7.5 |
9.7 |
9.6 |
11.6 |
Administrative expenses |
(3.2) |
(3.1) |
(3.3) |
(3.4) |
(2.7) |
(3.0) |
Gain on disposal of investment property |
1.0 |
0.9 |
2.2 |
1.5 |
0.1 |
0.6 |
Fair value movement on investment property |
66.1 |
41.5 |
41.5 |
38.0 |
(42.7) |
0.0 |
Property advisor performance fee |
(4.0) |
(2.8) |
0.4 |
(0.3) |
0.3 |
0.0 |
Separately disclosed items |
(1.0) |
(0.3) |
0.0 |
0.0 |
0.0 |
0.0 |
Operating profit |
65.9 |
44.6 |
48.3 |
45.4 |
(35.4) |
9.2 |
Net finance charge |
(9.5) |
(16.0) |
(8.2) |
(7.5) |
(7.7) |
(7.7) |
Gain on financial asset |
0.0 |
0.0 |
(2.2) |
7.3 |
6.1 |
0.0 |
Profit before tax |
56.4 |
28.6 |
37.9 |
45.3 |
(37.0) |
1.4 |
Tax |
(11.1) |
(5.8) |
(7.6) |
(7.9) |
5.6 |
0.0 |
Profit after tax |
45.4 |
22.7 |
30.3 |
37.4 |
(31.5) |
1.4 |
Non-controlling interest |
(0.3) |
(0.5) |
(0.5) |
(0.1) |
0.1 |
(0.0) |
Attributable profit after tax |
45.1 |
22.3 |
29.8 |
37.3 |
(31.3) |
1.4 |
Closing basic number of shares (m) |
100.8 |
97.8 |
96.1 |
92.8 |
91.9 |
91.9 |
Average diluted number of shares (m) |
99.0 |
102.1 |
98.9 |
95.0 |
92.2 |
91.9 |
IFRS EPS, diluted (€ cents) |
46 |
22 |
30 |
39 |
(34) |
2 |
DPS declared (€ cents) |
7.5 |
7.5 |
7.5 |
7.5 |
7.5 |
7.5 |
EPRA NTA total return |
13.1% |
9.3% |
8.8% |
8.4% |
-8.2% |
0.3% |
BALANCE SHEET |
||||||
Investment properties |
632.9 |
719.5 |
749.0 |
759.8 |
732.1 |
740.8 |
Other non-current assets |
3.4 |
3.5 |
3.8 |
2.7 |
1.7 |
1.7 |
Total non-current assets |
636.4 |
723.0 |
752.8 |
762.5 |
733.8 |
742.5 |
Investment properties held for sale |
12.7 |
10.6 |
19.3 |
41.6 |
43.8 |
29.3 |
Cash & equivalents |
26.9 |
42.4 |
37.0 |
10.4 |
9.5 |
11.0 |
Other current assets |
7.5 |
9.5 |
8.4 |
11.7 |
9.8 |
10.2 |
Total current assets |
47.1 |
62.6 |
64.7 |
63.8 |
63.1 |
50.5 |
Borrowings |
(3.6) |
(17.8) |
(1.0) |
(0.9) |
0.0 |
0.0 |
Other current liabilities |
(13.2) |
(15.6) |
(9.6) |
(12.4) |
(11.6) |
(12.1) |
Total current liabilities |
(16.8) |
(33.4) |
(10.6) |
(13.3) |
(11.6) |
(12.1) |
Borrowings |
(191.6) |
(258.5) |
(286.5) |
(283.2) |
(311.7) |
(312.8) |
Other non-current liabilities |
(65.2) |
(76.8) |
(86.5) |
(86.1) |
(72.7) |
(72.7) |
Total non-current liabilities |
(256.9) |
(335.3) |
(373.0) |
(369.3) |
(384.3) |
(385.5) |
Net assets |
409.8 |
416.9 |
434.0 |
443.6 |
400.9 |
395.5 |
Non-controlling interest |
(2.0) |
(3.0) |
(3.5) |
(3.6) |
(3.4) |
(3.4) |
Net attributable assets |
407.9 |
413.9 |
430.4 |
440.0 |
397.5 |
392.0 |
Adjust for: |
||||||
Deferred tax assets & liabilities |
52.5 |
58.3 |
65.4 |
73.5 |
67.1 |
67.1 |
Derivative financial instruments |
6.0 |
16.0 |
18.2 |
10.9 |
4.8 |
4.8 |
Other EPRA adjustments |
(5.4) |
(6.8) |
(6.4) |
(0.3) |
0.0 |
0.0 |
EPRA net tangible assets (NTA) |
461.0 |
481.4 |
507.6 |
524.1 |
469.4 |
464.0 |
IFRS NAV per share (€) |
4.05 |
4.23 |
4.48 |
4.74 |
4.33 |
4.27 |
EPRA NTA per share (€) |
4.58 |
4.92 |
5.28 |
5.65 |
5.11 |
5.05 |
CASH-FLOW |
||||||
Cash flow from operating activity |
13.2 |
1.5 |
8.1 |
7.8 |
2.9 |
8.7 |
Income tax paid |
(4.7) |
(0.0) |
(1.3) |
0.2 |
(0.0) |
0.0 |
Net cash flow from operating activity |
8.5 |
1.4 |
6.7 |
8.0 |
2.8 |
8.7 |
Property additions |
(47.3) |
(32.2) |
0.0 |
0.0 |
(7.7) |
(7.4) |
Proceeds from disposal of investment property |
86.0 |
13.5 |
7.2 |
13.8 |
11.2 |
21.1 |
Capital expenditure on investment property |
(7.9) |
(6.5) |
(4.2) |
(9.5) |
(16.1) |
(7.3) |
Other cash flow from investing activity |
0.0 |
0.1 |
(5.9) |
0.0 |
(0.0) |
0.0 |
Cash flow from investing activity |
30.8 |
(25.1) |
(2.9) |
4.3 |
(12.6) |
6.3 |
Interest paid |
(5.1) |
(6.2) |
(7.5) |
(7.7) |
(6.9) |
(6.6) |
Bank debt drawn/(repaid) |
(27.0) |
64.6 |
11.2 |
(3.2) |
26.7 |
0.0 |
Share issuance/repurchase |
0.0 |
(11.5) |
(6.0) |
(20.5) |
(4.0) |
0.0 |
Dividends paid |
(7.5) |
(7.7) |
(7.0) |
(7.4) |
(7.0) |
(6.9) |
Other cash flow from financing activity |
0.0 |
0.0 |
0.0 |
0.0 |
0.1 |
0.0 |
Cash flow from financing activity |
(39.6) |
39.2 |
(9.3) |
(38.8) |
8.8 |
(13.5) |
Change in cash |
(0.3) |
15.5 |
(5.4) |
(26.6) |
(0.9) |
1.5 |
FX |
(0.0) |
(0.0) |
(0.0) |
0.0 |
0.0 |
0.0 |
Opening cash |
27.2 |
26.9 |
42.4 |
37.0 |
10.4 |
9.5 |
Closing cash |
26.9 |
42.4 |
37.0 |
10.4 |
9.5 |
11.0 |
Closing debt |
(195.3) |
(280.2) |
(291.4) |
(288.4) |
(315.1) |
(315.1) |
Closing net debt |
(168.4) |
(237.8) |
(254.4) |
(278.0) |
(305.6) |
(304.1) |
LTV |
26.1% |
32.6% |
33.1% |
34.7% |
39.7% |
40.2% |
Source: Phoenix Spree historical data, Edison investment Research forecast
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