Phoenix Spree Deutschland — Well positioned for market turbulence

Phoenix Spree Deutschland (LSE: PSDL)

Currency in GBP

Last close As at 04/02/2023

GBP2.48

4.00 (1.64%)

Market capitalisation

GBP224m

Phoenix Spree Deutschland — Well positioned for market turbulence

In a challenging environment, we expect Phoenix Spree Deutschland (PSD) to show continuing rental growth but weaker capital returns from slower condominium sales and market-wide yield widening. Demographic trends remain positive, and reversionary rent potential embedded within the portfolio remains strong. Gearing is modest and debt costs are fixed.

Martyn King

Written by

Martyn King

Director, Financials

Phoenix Spree Deutschland

Well positioned for market turbulence

Post H122 results update

Real estate

28 October 2022

Price

252p

Market cap

£232m

€1.16/£

Net debt (€m) at 30 June 2022

295.6

Net LTV at 30 June 2022

36.0%

Shares in issue

91,9m

Free float

100%

Code

PSDL

Primary exchange

LSE

Secondary exchange

N/A

Share price performance

%

1m

3m

12m

Abs

(7.7)

(22.5)

(37.8)

Rel (local)

(9.2)

(18.8)

(33.5)

52-week high/low

406p

252p

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

FY22 year-end

31 December 2022

Analyst

Martyn King

+44 (0)20 3077 5722

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

In a challenging environment, we expect Phoenix Spree Deutschland (PSD) to show continuing rental growth but weaker capital returns from slower condominium sales and market-wide yield widening. Demographic trends remain positive, and reversionary rent potential embedded within the portfolio remains strong. Gearing is modest and debt costs are fixed.

Year end

PBT*
(€m)

EPS
(c)

NAV**/
share (€)

DPS
(c)

P/E
(x)

P/NAV
(x)

Yield
(%)

12/20

37.9

30.0

5.28

7.5

9.7

55.4

2.6

12/21

45.3

39.0

5.65

7.5

7.4

51.8

2.6

12/22e

17.1

15

5.70

7.5

19.2

51.3

2.6

12/23e

9.4

9

5.72

7.5

33.6

51.1

2.6

Note: *As reported on an IFRS basis including realised and unrealised gains. **Measured as EPRA net tangible assets per share.

Conservative balance sheet and liquidity

H122 performance was robust. Rents, property values and NAV all increased. NAV total return was 2.2% and DPS declared was unchanged. PBT was lower (€17.0m versus €20.4m in H121), but the continuing Berlin re-letting premium (33.7%) and premium to book value on condominium notarisations (19.2%) highlight the considerable value embedded in PSD’s portfolio even though volumes weakened (€3m versus €4.3m in H121). We expect continuing growth in rents and rental income, but condominium sales are likely to remain muted and reduce cash flow. The rise in German bond yields is likely to see property yields widen. The reduction in our forecast PBT (by c €25m in FY22 and €35m in FY23) are driven by lower realised and unrealised property gains. With moderate gearing (36% LTV) and interest costs fixed at 2.1% until 2026, we forecast sufficient liquidity to maintain DPS and investment, unlike peers that are divesting to de-gear.

Durable embedded value

Free market rents are significantly above in-place rents in the highly regulated German market. Permissible investment in refurbishment and re-letting at market rents is PSD’s core strategy for closing this gap, regularly generating Berlin rent uplifts of 30% or more. With the acute Berlin housing shortage, we expect this to continue. The splitting of apartments into selected individual condominiums has further supported recognition of the value embedded in the portfolio, with selected sales making a significant contribution to cash flow. Condominium market values are typically 30–35% higher than the rental-based valuations applied to most of the portfolio and, unlike peers, 76% of PSD’s Berlin portfolio has been legally split, yet less than 5% has been fully valued as such. Tighter rules on apartment block splitting leave PSD well-place for a recovery in sales.

Valuation: Disconnect with current market conditions

Apparently anticipating a material residential market correction, PSD shares have fallen by 38% over 12 months, a significant outperformance of Germany-listed peers (-53% on average). Reflecting this, and its differentiated reversion strategy, PSD’s trailing P/NAV is higher (0.5x vs c 0.35x) and its yield lower (2.6% vs c 7%).

Well-positioned for market turbulence

Given the significant changes in economic and market conditions, this note provides a detailed update on our May outlook note, which provides greater detail on PSD’s strategy and the market in which it operates.

Robust H122 performance

Only partly reflecting the significantly changed environment, interim results to 30 June 2022 were robust. During the period, gross in-place rents per sqm increased by 1.9% and were the driver of 2.2% like-for-like portfolio valuation growth (H121: 2.5%). NAV increased by 1.2% to €5.72 and, including DPS paid, the total return was 2.2%. H122 DPS was unchanged at €2.35. The Berlin re-letting premium was 33.7% and including the assets in Brandenburg, where in-place rents are higher, the all-portfolio re-letting premium was 28.4%. Although condominium notarisations for sale were lower than in H121 (€3m versus €4.3m), the premium to book value was maintained (19.2%). PBT was €17.0m (H121: €20.4m), affected by lower valuation gains and higher property costs. Although the factors that drive rental income growth remain in place, the key drivers of lower condominium sales are unlikely to quickly reverse, and PSD expects that condominium sales for the full year will be materially lower than in FY21. Period-end borrowings were €305.1m, including unamortised loan arrangement fees, and cash balances were €9.6m, giving net debt of €295.6m (FY21: €278.0m). The increase in net debt reflected acquisitions and portfolio investments as well share repurchases and payment of the FY21 final DPS. LTV was 36.0% (FY21: 34.7%).

The equity market appears to be anticipating a very sharp downturn in the German residential sector

The Berlin housing shortage has been built over many years by demographic trends, including net migration and insufficient new development. If anything, these drivers seem likely to strengthen, with almost a million Ukrainian refugees entering Germany1 and higher construction prices, disrupted supply chains and materials shortages adding to the existing drag on development from strict planning laws. Nonetheless, the equity market appears to be anticipating a very sharp downturn in the German residential property sector.

  Source: The German Federal Statistical Office (Destatis).

We expect positive demand-supply fundamentals for rented accommodation to continue to support rental values but a material deterioration in buyer sentiment since the beginning of the year is evident, for PSD reflected in its lower condominium sales. The flip side of this is that with higher interest rates increasing the cost of home ownership, potential buyers are likely to remain within the rental system for longer, placing further pressure on the significant shortage of housing that already exists. For renters, Federal support initiatives have been introduced to mitigate the financial impact of rising fuel costs. PSD notes that year-to-date rent collection levels have remained stable and is hopeful that this will remain the case

At the institutional investor level, driven by an increased cost of funding, the appetite for real assets has weakened. This includes German residential real estate, where demand for larger portfolio transactions has significantly slowed. A number of larger market participants, including PSD’s larger listed German peers, are now net sellers of assets as they seek to reduce leverage from levels that are currently significantly higher than at PSD. Although transactional evidence is yet sparce, the company notes sufficient anecdotal evidence to suggest that pricing has weakened.

Despite the near-term headwinds presented by the current economic backdrop, the company remains confident in the long-term outlook for PSD, based on the significant rent reversion that remains embedded in the portfolio, along with unrecognised capital value in the majority of its residential units that have been designated as condominiums. Meanwhile, the balance sheet remains robust, and starting with a moderate LTV, PSD is in a good position to manage the impact of a decline in asset values. With the cost of all borrowing fixed until 2026, we forecast sufficient liquidity to maintain dividend payments and continue to invest in the portfolio (to unlock rent reversion) despite the negative impact of lower condominium sales on cash flow.

Continuing positive demand-supply supports rent growth and reversionary capture

Federal laws significantly restrict the pace at which market rental growth can be passed through tenancies already in place. We expect this to gradually accelerate as the rent growth of recent years is increasingly reflected in permissible uplifts, but the process is complex and the timing is difficult to predict. In any case, 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.

Exhibit 1: Portfolio summary

Valuation
(€m)

Valuation
(%)

Value per sqm (€)

Annualised fully occupied cold rent (€m)

Net contracted rent per sqm (€)

Fully occupied
net yield (%)

Vacancy by
area (%)

EPRA vacancy (%)

Berlin rental

726.3

89

4,422

19.8

9.9

2.7

5.6

2.2

Brandenburg

53.2

7

3,271

2.0

9.8

3.8

21.2

5.8

Berlin Cond.

32.8

4

4,304

0.9

9.0

2.6

8.0

N/A

Total

812.3

100

4,318

22.1

9.8

2.8

7.0

2.5

Source: Phoenix Spree Deutschland

Across the portfolio, average gross in-place rents were €9.8 per sqm per month at end-H122, up 3.5% versus H121 and 1.9% versus end-FY21. On a like-for-like basis, adjusted for the impact of acquisitions and disposals, H122 rents were 3.7% above the H121 level.

Exhibit 2: Trend in whole portfolio rent levels and like-for-like growth

Source: Phoenix Spree Deutschland data

In H122, 174 new leases were signed, representing a letting rate of c 7.3% of occupied units. The average rent achieved on all net lettings was €12.7 per sqm per month, a level that was 8.5% higher than in the prior year, and an average 28.4% above the previous passing rent for those apartments (H121: 23.5%). 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% (H121: 35.8%). The premium to previous passing rents varies from period to period, mainly determined by mix. The average re-letting premium for the whole portfolio in the three years to end-FY21 is c 27%.

Exhibit 3: Trend in whole portfolio re-letting premium

Source: Phoenix Spree Deutschland data

Condominium sales have slowed with inflation, rising interest rates and economic uncertainty

Condominium market prices are typically 30–35% higher than rental-based valuations 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.

Exhibit 4: Trend in condominium notarisations

Source: Phoenix Spree Deutschland data

During H122, nine condominium units were notarised for sale for an aggregate €3.0m, a slowdown from €4.3m in H121. So far during H222, a further two units have been notarised with a total value of €1.0m. H221 notarisations of €10.9m set a high bar, and to the extent that the key drivers of weaker buyer sentiment (higher mortgage rates and a higher cost of living) are unlikely to reverse during the second half of the year, PSD expects that condominium sales for FY22 will be materially lower than FY21.

Exhibit 5: Condominium sales slower in H122 but sales premium maintained

FY17

FY18

FY19

FY20

FY21

H122

Sales value of notarisations

9.1

9.9

8.8

14.6

15.2

3.0

Average notarised value per sqm

4,352

4,566

4,068

4,320

4,988

5,257

Average book value of notarised properties per sqm

3,515

3,676

3,459

3,624

4,216

4,410

Premium to book value

23.8%

24.2%

17.6%

19.2%

18.3%

19.2%

Portfolio average value per sqm at year end

2,854

3,527

3,741

3,977

4,225

4,318

Premium to portfolio average

52.5%

29.5%

8.8%

8.6%

18.1%

21.8%

Source: Phoenix Spree Deutschland data, Edison Investment Research

The average notarised values per sqm in any period are specific to the mix of assets (different locations, floor space, etc) sold in that period, but the sales premium to the book value of the assets sold, 19.2% in H122, has been relatively stable.

The process of splitting and impact on asset valuations is illustrated in Exhibit 6, although actual valuation changes will differ.2 At each stage, the independent external valuation process, based on a discounted cash flow methodology, applies a progressively lower discount rate, capturing some of the potential valuation uplift that is expected to result from eventual sale. The difference between the market sale values of condominium units with vacant possession and their carried values represents additional capital upside embedded in the portfolio that is mostly not reflected in net asset value.

  The illustration points to a final 12.5% uplift at the point of sale (135%/120%), although as Exhibit 6 demonstrates the historically reported uplifts have been consistently higher.

Exhibit 6: Illustrative impact of condominium splitting and sale on valuation

Source: Phoenix Spree Deutschland . Note: As at 31 December 2021.

Differentiating it from listed German peers, approximately 76%3 of PSD’s Berlin portfolio is legally designated as condominiums, although within the portfolio valuation only six properties, with an aggregate value of €32.8m, are valued as such. The carried value of the legally designated condominium units that are not valued as condominiums is broadly consistent to the valuation at the point of ‘land registry split’ in Exhibit 6. This provides opportunities for the implementation of further sales projects where PSD considers this to be appropriate and is a positive indicator for underlying portfolio valuation and NAV. The strategic advantage of having a large share of the portfolio legally designated as condominiums is highlighted by recent federal government legislation, which places 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 supply-demand imbalance that currently exists.

  As at 28 September 2022 it was 75.8%.

The recent legislation is not retrospective and does not affect assets that have already been split into condominiums. It remains uncertain whether PSD will be successful with the additional 9.5% of Berlin units that are in application, over half of which are in the final stages of the process.

Stable, low-cost funding and moderate gearing

At end-H122, PSD had gross borrowings (nominal value, including unamortised loan arrangement fees) of €305.1m and cash balances of €9.6m, resulting in net debt of €295.6m and a net loan to value ratio (LTV) of 36.0% (FY21: 34.7%), well below the long-term target of 50% (with a 60% maximum). Interest costs are mostly fixed through hedging at a blended average effective 2.1%, protecting against further increases in interest rates. The end-H122 average remaining duration was 4.3 years (with no maturities until September 2026).

Compared with some of the larger listed German companies, PSD’s gearing is lower and it continues to be a net investor in its portfolio. LEG Immobilien (H122 LTV of 42.1%) and Vonovia (43.5%) have both said that they expect to be net disinvestors as they seek to reduce gearing.

Exhibit 7: Summary of borrowings as at end-H122

Drawn amount (€)

Yeares to maturity

Interest rate including hedging

Natixis Pfanbrief

243.5

4.2

2.1%

Berliner Sparkasse

61.6

4.9

1.9%

Total/average

305.1

4.3

2.1%

Source: Phoenix Spree Deutschland data

Total debt facilities have increased to c €360m, including a new €60m loan facility agreed with existing lending partner, Natixis Pfandbriefbank (‘Natixis’), announced on 25 January 2022, and the refinancing of an existing debt facility with Berliner Sparkasse adding an additional c €14m. The new Natixis facility comprises a €45m acquisition facility and a €15m capital expenditure facility. The acquisition facility provides additional flexibility to pursue potential future acquisitions if there are suitable opportunities. Since end-H122, PSD has completed/agreed net acquisitions pf c €3m and has a c €13m remaining commitment in respect of the forward funding development at Erkner in Brandenburg. Allowing for disposals and other cash flows, we forecast no material change in net debt or LTV by end-FY23.

Market expectations, reflected in the Euribor forward curve are that policy rates will increase to around 3% by the end of this year and remain broadly at that level through 2026, in line with the bulk of PDS’s debt maturities. Exhibit 8 shows our existing rental income and interest cost forecasts for FY22 and FY23. Forecast rental growth includes disposals impacts and underling growth is c 4% pa. As an illustration, assuming rental income growth accelerates to 5% pa through FY24–26, the change in rental income from end-FY21 (the last fully reported year) to end-FY26 would be c €5.2m. Assuming a full refinancing of debt in FY26, on annualised basis, at a 1.5% margin and 3.0 Euribor rate, FY26 cash interest cost would be €6.9m higher. The net negative impact would be €1.7m but we believe this would be manageable. Meanwhile, assuming free market rents also increase during the period, significant portfolio income reversion upside would remain.

Exhibit 8: Illustrative impact of increased funding costs

€m unless stated otherwise

Actual

Forecast

Illustration

FY21

FY22

FY23

FY24

FY25

FY26

Increase FY21–26

Annualised rental income

21.9

22.6

23.4

24.5

25.7

27.0

5.2

Annualised rental income growth

3.5%

3.2%

5.0%

5.0%

5.0%

Net finance expense

7.5

7.7

7.5

Less amortisation of loan arrangement fees and other non-interest charges

(0.7)

(1.1)

(1.1)

Cash interest costs

6.8

6.5

6.4

6.4

6.4

13.7

6.9

Average borrowing

290.1

300.9

305.1

305.1

305.1

305.1

Average cash borrowing cost

2.3%

2.2%

2.1%

2.1%

2.1%

4.5%

Source: Phoenix Spree Deutschland, Edison Investment Research

Continuing investment and capital recycling to create additional value

By refurbishing selected apartments as they become vacant, PSD can re-let them at or around free market rent levels, capturing reversion potential in the portfolio. In FY21, this accounted for €4.7m from total capex of €9.5m and was €1.8m in H122. This excludes maintenance expenditure reported through the income statement (c €1.6m pa). In addition, PSD’s asset management strategy includes exploiting underutilised space within the footprint of the existing portfolio, which provides an attractive return with relatively low risk. During H221, a project commenced to build out the attic and renovate existing commercial space in one property to create an additional seven residential units at a cost of €3.8m. PSD also has building permits to renovate attics in 19 existing assets to create a further 45 units for sale as condominiums or as rental stock.

PSD continues to acquire assets and in March 2022 announced that it had exchanged contracts to forward fund 17 new-build, semi-detached residential properties (34 units) for a total agreed purchase price of €18.5m. The asset is located in Erkner, in Brandenburg, within the Berlin Beltway, adjacent to the new Tesla Gigafactory, which is being constructed at a cost of €4bn and is expected to employ around 40,000 staff, significantly more than Erkner’s 12,000 population. PSD expects the factory to generate migration from central Berlin, leading to increased rents and property values. Construction is expected to complete in the second half of 2024. PSD estimates a prospective gross yield of 3.5% once the project is fully occupied. In May 2022, it exchanged contracts to acquire four multi-family houses consisting of 24 residential units for a purchase price of €6.3m. These properties are located in Hoppegarten and Neuenhagen, Berlin. Built in 1995 and 1998, they are in good technical condition and offer significant reversionary potential, having benefited from recent positive demographic changes. Since end-H122, the company has exchanged contracts to acquire a multi-family house with 22 residential units and three commercial units for €4.9m. This property is located in Berlin-Neukölln, is well maintained and offers significant reversionary and attic potential.

In addition to the condominium sale programme, PSD continues to consider options for the disposal of buildings deemed to be non-core. Typically, these buildings will have a mature tenant structure with limited scope for further capital expenditure and subsequent reversionary re-letting. Since the half-year end, it has exchanged contracts to sell two such properties for an aggregate consideration of €8.6m, a small discount to the end-H122 external valuation of €8.8m. The buildings were acquired in 2008 and 2017 respectively, for an aggregate purchase price of €3.9m.

Near-term returns and cash flow will be more dependent on income

PSD has a strong track record of EPRA NTA total return generation, well above its medium-term 8–10% pa target range. This has been substantially driven by capital growth, reflecting the current low running income yield on the portfolio, the capital growth that results from the impact of steady reversionary rent capture on portfolio valuation, valuation upside crystalised by the condominium sale strategy and the broader increase in market valuations of recent years. In current market conditions, we expect significantly lower capital returns as market valuation increases stall (or perhaps weaken), and as lower condominium sales slow the realisation of value embedded within the portfolio. We expect income returns to remain robust, driven by the continuing capture of reversionary income as in-force rents continue to adjust to significantly higher free market rents.

Exhibit 9: Portfolio value and like-for-like valuation growth

Source: Phoenix Spree data

In the period since listing on the Main Market of the London Stock Exchange in June 20154 until end-H122, PSD has generated a total return of 198.8% or an annual average return of 16.9%. Capital returns have represented almost 90% of the total return over this period, although the income return has been increasing, reaching 17% in FY21 and 42% in H122.

  The company was previously listed on the Channel Islands Stock Exchange since being founded in 2007.

Exhibit 10: EPRA NTA total return history (end-2014 to end-H122)

FY15

FY16

FY17

FY18

FY19

FY20

FY21

H122

FY15–H122

Opening NAV per share (€)

2.06

2.28

2.73

4.11

4.58

4.92

5.28

5.65

2.06

Closing NAV per share (€)

2.28

2.73

4.11

4.58

4.92

5.28

5.65

5.72

5.72

Dividends paid (€ cents)

1.80

5.80

6.20

7.35

7.50

7.50

7.50

5.15

43.65

NAV total return

11.8%

22.2%

52.6%

13.1%

9.3%

8.8%

8.3%

2.2%

198.8%

o/w capital return

10.9%

19.7%

50.3%

11.3%

7.6%

7.2%

6.9%

1.3%

177.6%

o/w income

0.9%

2.5%

2.3%

1.8%

1.6%

1.5%

1.4%

0.9%

21.2%

Average annual total return

16.9%

Source: Phoenix Spree Deutschland data, Edison Investment Research

Reflecting the current low running income yield on the portfolio, the condominium sales programme has contributed significantly to cash flow in addition to earnings. Over the three years to end-FY21, operational cash flow broadly matches dividend payments (FY19 operational cash flow was reduced by the payment of investment adviser performance fees accrued in respect of the preceding three years), while disposal proceeds largely fund interest payments and capex. Net borrowing and LTV increased, primarily as a result of discretionary property additions and share repurchases.

Although PSD considers the current level of gearing (H122 LTV of 36.0%) and cash balances to be appropriate at this stage of the cycle, it is not looking to increase its debt capacity5 until market conditions become more stable. We do not forecast FY22 dividends to be covered by net cash flow although this is the case in FY23. However, we do expect significant proceeds from non-core asset sales (a part of which is included in the end-H122 balance of held-for-sale assets of €41.6m, along with condominiums earmarked for sale) during FY22 and FY23. For that reason, we expect unchanged dividends. The board has indicated that further share repurchases will be dependent on the strength of the balance sheet and future condominium sales. Based on our forecasts, we do not expect further repurchases.

  As noted above, we expect existing debt capacity to be utilised to fund committed investment.

Exhibit 11: Cash flow components

2019

2020

2021

2019–21

2022e

2023e

Net cash flow from operations

1.4

6.7

8.0

16.2

2.1

7.6

Interest paid

(6.2)

(7.5)

(7.7)

(21.4)

(6.9)

(6.4)

Proceeds from disposal of investment property

13.5

7.2

13.8

34.5

29.1

21.1

Dividends paid

(7.7)

(7.0)

(7.4)

(22.1)

(7.0)

(6.9)

Capital expenditure on investment property

(6.5)

(4.2)

(9.5)

(20.1)

(9.9)

(7.3)

Sub total

(5.3)

(4.7)

(2.9)

(13.0)

7.4

8.0

Property additions

(32.2)

0.0

0.0

(32.2)

(22.7)

(5.2)

Share repurchases

(11.5)

(6.0)

(20.5)

(38.0)

(4.0)

0.0

Other cash movements

0.1

(5.9)

0.0

(5.8)

0.1

0.0

Net change in cash before debt movements

(49.0)

(16.6)

(23.4)

(89.0)

(19.3)

2.8

Net increase in borrowing/(decrease) in borrowing

64.6

11.2

(3.2)

16.7

0.0

Change in cash

15.5

(5.4)

(26.6)

(2.6)

2.8

Closing cash

42.4

37.0

10.4

7.9

10.7

Closing debt

(280.2)

(291.4)

(288.4)

(305.1)

(305.1)

Closing net debt

(237.8)

(254.4)

(278.0)

(297.2)

(294.4)

LTV

32.6%

33.1%

34.7%

36.6%

36.5%

Source: Phoenix Spree Deutschland data, Edison Investment Research

H122 financial performance in detail

PSD’s results for the six months to 30 June 2022 (H122) were robust, although the headwinds of war in Ukraine, increasing interest rates and a sharp rise in the cost of living were in place for only part of the period. Exhibit 12 provides a detailed summary.

Exhibit 12: H122 financial summary

€m unless stated otherwise

H122

H121

H122/H121

FY21

Revenue

13.0

12.9

0.4%

25.8

Total property expenses

(8.7)

(7.4)

18.2%

(16.1)

Gross profit

4.2

5.5

-23.5%

9.7

Administrative expenses

(1.3)

(1.6)

-17.7%

(3.4)

Gain on disposal of investment property

0.1

0.6

1.5

Fair value movement on investment property

11.4

16.0

38.0

Property advisor performance fee

0.3

0.0

(0.3)

Operating profit

14.8

20.5

-28.1%

45.4

Net finance charge

(3.9)

(3.7)

4.6%

(7.5)

Change in fair value of interest rate derivatives

6.1

3.6

7.3

Profit before tax

17.0

20.4

-17.0%

45.3

Tax

(3.0)

(4.2)

(7.9)

Profit after tax

14.0

16.2

-14.0%

37.4

Non-controlling interest

(0.1)

(0.0)

(0.1)

Attributable profit after tax

13.9

16.2

-14.3%

37.3

EPS (€)

0.15

0.17

-10.8%

39

DPS (€)

2.35

2.35

0.0%

7.5

EPRA NTA per share (€)

5.72

5.42

5.5%

5.65

NAV total return

2.2%

3.6%

8.4%

Gross debt at nominal value

(305.1)

(290.2)

(288.4)

Cash

9.5

28.4

10.4

Net debt

(295.6)

(261.8)

(278.0)

Net LTV

36.0%

33.7%

34.7%

Source: Phoenix Spree Deutschland data, Edison Investment Research

Key highlights from the H122 results include:

Reported revenues (rents plus service charges paid by tenants) of €13.0m were little changed on both H121 and H221. We estimate that H121 had benefited from the recovery of c €0.8m of back-dated rents in respect of the temporary imposition of rent controls during 2020.6

  The H220 back rents were not accounted for as income in FY20 as the Mietendeckel remained in place. Back rents in respect of H121 are included in income following Mietendeckel repeal.

Total property expenses increased c €1.3m to €8.7m compared with H121, driven by higher service charges that were not recoverable from tenants. Compared with H221, there was little change with higher non-recoverable costs offset by a positive c €0.4m swing in provisions (to a c €0.1m recovery) and lower repair and maintenance costs.

Administrative charges fell to €1.3m compared with €1.6m in H121 and €1.8m in H221, primarily driven by lower legal and professional fees and a positive FX impact.

Including a lower level of realised and unrealised property gains (€11.5m versus €16.6m), slightly offset by the (€0.3m) reversal of the performance fee accrual, operating profit was €14.8m compared with €20.5m in H121.

Net finance charges have increased slightly compared with H121 and H221 because of higher average borrowing. The increase in interest rates resulted in a reduction in cash borrowing costs under the company’s hedging strategy (see below) and also generated a €6.1m fair value gain on interest rate derivates.

Compared with H121, profit before tax was €3.4m lower at €17.0m and attributable net profit, after tax and minority interests, was €2.3m lower at €13.9m. The impact on IFRS EPS of €0.15 was softened by accretive share buybacks, which also enhanced EPRA NTA per share. At €5.72, this was up 5.5% compared with H121 and 1.2% compared with end-FY21.

The H122 DPS declared was unchanged at €2.35 and, including payment of the €5.35 H221 DPS, the accounting total return in the period was 2.2%.

Despite cash-funded share buybacks and investments, the balance sheet remained strong with an LTV ratio of 36.0% (end-FY21: 34.7%), well below the long-term target of c 50% (with a maximum of 60%).

Forecast update

Our forecasts are shown in detail in Exhibit 17 and are summarised below. These reflect our expectation of lower property gains, the result of slower condominium sales and a pause in market-wide valuation increases. Our reduced forecasts for realised and unrealised property gains, by €30.9m in FY22 and €34.6m in FY23, account for most of the projected PBT decline.

Exhibit 13: Forecast revisions

Gross profit (€m)

PBT (€m)

EPS (c)

EPRA NTA/share (€)

DPS (c)

EPRA NTA total return

New

Old

Chg (%)

New

Old

Chg (%))

New

Old

Chg (%))

New

Old

Chg (%)

New

Old

Chg (%)

New

Old

Chg (pp)

12/22e

9.1

9.8

(6.9)

17.1

42.0

(59.2)

15

37

(58.5)

5.70

6.03

(5.5)

7.5

7.5

0.0

2.2%

8.1%

(5.9)

12/23e

10.7

10.7

0.6

9.4

43.7

(78.4)

9

38

(77.2)

5.72

6.43

(10.9)

7.5

7.5

0.0

1.8%

7.8%

(6.0)

Source: Edison Investment Research

Our forecasts are based on the following:

We assume average like-for-like growth in rents per square metre per month of 4.0% pa through H222 and FY23, similar to the 3.7% reported in H122. We expect most of this to be generated by portfolio churn and the reletting of refurbished space at free market rent levels.

Vacancy (by area) is forecast to reduce from 7.0% at end-H122 to 4.0% by end-FY23.

We expect a gross margin (rental income less property costs, including the investment advisory fees, as a percentage of rental income) of c 44% in FY22 and c 49% in FY23, in line with the five-year average of c 47%.

Administrative expenses in H122 benefited from a significant decline in legal and professional expenses as apartment splitting approaches maturity. We expect an inflationary pick-up through H222 and FY23.

We expect condominium notarisations to remain subdued in H222, at a similar level to H122 (€3.0m) and to increase relatively modestly to €8m for FY23. Our forecasts reflect cash flows and realised gains in respect of completed condominium sales. We expect completed sales to be a little higher as existing notarisations complete. We assume a 15% realised uplift on the carried book value at completion.

Additionally, we allow for c €25m of non-core asset disposals, half in H222 and the balance in FY23, at book value, adding to cash flow not but to earnings or NAV.

We assume no material additional unrealised gains in H222. For FY23 we forecast like-for-like gains of 2% before adjustment (down) for capex spending. Lower forecast like-for-like growth in valuation compared with rental income implies an increase in the full occupancy portfolio gross yield from 2.8% to 2.9%. Given the increase in bond yields (the German 10-year government bond yield has increased to around 2%, having been slightly negative at the start of the year and recently as high as 2.4%), asset yields may widen further than we have assumed. We estimate that each 0.1% increase in the property yield would decrease FY22 EPRA NTA per share by c €0.3 or c 5%.

Finance expense reflects an average interest cost of 2.1% and includes total interest costs plus c €1.1m pa of non-cash amortisation of loan arrangement fees. We assume no change in the fair value of interest rate derivatives, although the net liability of c €5m at end-H122 may be reduced by further interest rate increases, with a positive impact on IFRS earnings and NAV.

Valuation

PSD shares have been significantly de-rated in the past year, down by c 38%, but have materially outperformed peers, down by an average of c 53%. We believe that the company’s share repurchase programme, relatively lower gearing, rent reversion potential and high proportion of units designated as condominiums will all have contributed to this outperformance.

Exhibit 14: PSD shares have been weak but have significantly outperformed peers in the last year

Source: Refinitiv data

The FY22e yield is 2.6% while the discount to H122 EPRA NTA of c 50% is significantly below the long-term average7 and we estimate that the P/NTA would be lower still if the NTA were adjusted to include all condominium-designated assets at market values.

  Average discount since listing on the LSE in 2015 has been c 11%.

Exhibit 15: Price/NAV history (x)

Source: Refinitiv data

PSD is the only German residential property investment company listed on the London Stock Exchange (LSE). Other London-listed German property companies, Summit Properties and Sirius RE, are focused on commercial property. Germany-listed residential property investors are all much larger, have significantly lower exposure to Berlin, and more diversified portfolios. Unlike PSD, condominium splitting is not a material element of their strategy and they are somewhat less focused on rent reversion. Notwithstanding that, Exhibit 16 shows a valuation and performance summary for PSD and selected Germany-listed peers.

Exhibit 16: Peer valuation and price performance comparison

Price
(local)

Market cap
(€m)

P/NTA
(x)

Yield
(%)

Share price performance

One month

Three months

One year

Three years

Grand City Properties

10.14

165

0.33

8.2

2.9

-22.6

-55.3

-50.5

Deutsche Wohnen

67.84

73

0.42

6.0

11.3

-21.5

-49.7

-33.1

Vonovia

23.13

777

0.37

7.2

6.0

-27.7

-54.4

-47.2

Phoenix Spree Deutschland

252

93

0.52

2.6

-12.2

-24.8

-37.9

-20.8

Average

0.41

6.0

2.0

-24.1

-49.3

-37.9

Source: Phoenix Spree Deutschland data, Refinitiv. Note: Prices as at 27 October 2022.

Exhibit 17: 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

26.2

27.7

Total property expenses

(15.8)

(14.2)

(16.4)

(16.1)

(17.1)

(17.0)

Gross profit

6.9

8.4

7.5

9.7

9.1

10.7

Administrative expenses

(3.2)

(3.1)

(3.3)

(3.4)

(3.0)

(3.2)

Gain on disposal of investment property

1.0

0.9

2.2

1.5

0.4

0.6

Fair value movement on investment property

66.1

41.5

41.5

38.0

11.8

8.9

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

18.7

17.0

Net finance charge

(9.5)

(16.0)

(8.2)

(7.5)

(7.7)

(7.53)

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

17.1

9.4

Tax

(11.1)

(5.8)

(7.6)

(7.9)

(3.0)

(1.4)

Profit after tax

45.4

22.7

30.3

37.4

14.1

8.0

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

14.0

8.0

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 (€ cents)

46

22

30

39

15

9

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%

2.2%

1.8%

BALANCE SHEET

Investment properties

632.9

719.5

749.0

759.8

795.4

810.8

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

797.1

812.5

Investment properties held for sale

12.7

10.6

19.3

41.6

26.3

11.8

Cash & equivalents

26.9

42.4

37.0

10.4

7.9

10.7

Other current assets

7.5

9.5

8.4

11.7

9.5

10.1

Total current assets

47.1

62.6

64.7

63.8

43.7

32.6

Borrowings

(3.6)

(17.8)

(1.0)

(0.9)

0.0

0.0

Other current liabilities

(13.2)

(15.6)

(9.6)

(12.4)

(11.4)

(11.9)

Total current liabilities

(16.8)

(33.4)

(10.6)

(13.3)

(11.4)

(11.9)

Borrowings

(191.6)

(258.5)

(286.5)

(283.2)

(301.7)

(302.8)

Other non-current liabilities

(65.2)

(76.8)

(86.5)

(86.1)

(81.3)

(82.7)

Total non-current liabilities

(256.9)

(335.3)

(373.0)

(369.3)

(382.9)

(385.5)

Net assets

409.8

416.9

434.0

443.6

446.5

447.7

Non-controlling interest

(2.0)

(3.0)

(3.5)

(3.6)

(3.7)

(3.7)

Net attributable assets

407.9

413.9

430.4

440.0

442.8

444.0

Adjust for:

Deferred tax assets & liabilities

52.5

58.3

65.4

73.5

75.7

77.1

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

523.4

525.9

IFRS NAV per share (€)

4.05

4.23

4.48

4.74

4.82

4.83

EPRA NTA per share (€)

4.58

4.92

5.28

5.65

5.70

5.72

CASH-FLOW

Cash flow from operating activity

13.2

1.5

8.1

7.8

2.1

7.6

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

2.1

7.6

Property additions

(47.3)

(32.2)

0.0

0.0

(22.7)

(5.2)

Proceeds from disposal of investment property

86.0

13.5

7.2

13.8

29.1

21.1

Capital expenditure on investment property

(7.9)

(6.5)

(4.2)

(9.5)

(9.9)

(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

(3.6)

8.6

Interest paid

(5.1)

(6.2)

(7.5)

(7.7)

(6.9)

(6.4)

Bank debt drawn/(repaid)

(27.0)

64.6

11.2

(3.2)

16.7

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)

(1.1)

(13.3)

Change in cash

(0.3)

15.5

(5.4)

(26.6)

(2.6)

2.8

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

7.9

Closing cash

26.9

42.4

37.0

10.4

7.9

10.7

Closing debt

(195.3)

(280.2)

(291.4)

(288.4)

(305.1)

(305.1)

Closing net debt

(168.4)

(237.8)

(254.4)

(278.0)

(297.2)

(294.4)

LTV

26.1%

32.6%

33.1%

34.7%

36.6%

36.5%

Source: Phoenix Spree Deutschland historical data, Edison Investment Research forecasts


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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 £60,000 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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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 2022 Edison Investment Research Limited (Edison).

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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 £60,000 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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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 2022 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

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.

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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

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Research: Financials

Secure Trust Bank — Prudence despite resilience

In its Q322 trading update, Secure Trust Bank (STB) said business has been trading in line with management expectations. Loan demand has remained strong in its consumer finance niches. However, the bank says it is slowing growth, tightening lending criteria and increasing its focus on operational efficiency to reflect macroeconomic uncertainty. Total loans in Q322 grew 21.5% y-o-y to £2,813m; we are forecasting 15.8% increase for FY22. Asset quality has remained good while the net interest margin remained stable at 5.7% in the face of rising interest rates.

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