Deutsche Wohnen SE

XETRA:DWNI

Earnings Call Transcript 2020-Q1

[Operator]

Good morning, and welcome to the earnings call of Deutsche Wohnen SE regarding the publication of the Q1 results 2020, hosted by Mr. Michael Zahn, CEO; and Mr. Philip Grosse, CFO.The presentation of the call is available on Deutsche Wohnen's website in the Investor Relations section. [Operator Instructions]I am now handing you over to Michael Zahn, CEO, to begin today's conference. Please go ahead.

[Michael Zahn, Chairman of Management Board & CEO]

Thank you. Good morning, ladies and gentlemen, and welcome to our call on Deutsche Wohnen's Q1 results. As always, let me give you a summary of the quarter and give you some background on some of the key factors that influence our performance before handing over to Philip, who will provide you with detailed insights into the Q1 results.Again, this has been a strong and successful quarter for Deutsche Wohnen, but let me explain the quarter also against the backdrop of the 2 overriding topics that are on people's minds: the COVID-19 situation and the developments around the rent cap in Berlin. It is times like these that validate our strategy in terms of portfolio growth, operations and capital structure, and it makes me proud to see that we have taken the right strategic decisions in the past to deliver strong results even in adverse times like currently. And even more, as a very strong organization with resilient business model, we are able to benefit of opportunities that arise and also extend a helping hand to those in need in times like these.First of all, and most importantly, with regard to the COVID-19 crisis, our company runs uninterrupted, especially also on the development and on the nursing home side. We are doing everything possible that it stays this way. We managed to implement all necessary workplace safety measures and work-from-home options for our employees. So far, there have only been very few tenants who were not able to pay rent on time. In relation to the residential sector, only 930 tenants inquired about deferral possibilities. This reflects significantly less than 1% of our tenants.Regarding the commercial side, 350 or 13% of our commercial tenants have registered for deferral possibilities. These figures are more than manageable for us in view of the low economic impact. If there is no government-sponsored support available, we find individual solutions, and if necessary, we also offer our tenants unbureaucratic assistance with our EUR 30 million relief fund. Given the strength and the stability of our business, we are in a position to offer help where help is needed to mitigate the effects of the COVID crisis.It is too early to draw up a balance sheet at this point as we do not have a clear view of how the economic situation of our tenants will develop in the foreseeable future. However, it is already becoming apparent that for Deutsche Wohnen, this will be economically manageable and that the fund we set up is sufficiently big.Secondly, as I've said, our business performance was strong. If you turn to Page 2 of the presentation, you can see the numbers. Across our entire portfolio, like-for-like rent growth was at 2.4% in Q1. Despite the fact that March was the first month where the rental cap came into force, the rental growth in Berlin was still at 2.3%. Without this distorting effect of the rent cap, the like-for-like rental growth for our Berlin portfolio was at 3.4%. This is in line with our expectations, which we have communicated during our full year results of about 1% like-for-like rental growth on a cash flow basis for the year.Please bear in mind so that any potential rent reductions or limitations on rent increases are not forgone, but can be reinstated and raised retroactively should the rent cap law be overturned.With an EBITDA margin of 80% and FFO I per share at EUR 0.40, we were able to repeat our strong results from the previous year. Furthermore, we were able to improve our EPRA NAV to around EUR 47.84 per share.Obviously, the rent cap in Berlin is a key factor for us. In our full year call at the end of March and in our Q3 '19 call, we explained the mechanics and impact on rents and cash flow in detail. The rent cap has been put in place effective at the 23rd of February. We have said this many times before and our view is widely shared among legal scholars, lawyers, but also among a wide group of our shareholders: the Berlin rent cap legislation is unconstitutional, and therefore, void.We initially assume that it would take until the summer break, until the CDU and FTP parliamentary groups would initiate legal proceedings against the Berlin rent cap legislation. However, Wednesday, a week ago, they already started the legal proceedings, the so-called Normenkontrollklage, which will accelerate the passing of a final ruling. In view of the fact that the rent cap affects approximately 1.5 million tenancies, we are hoping for a quick clarification by the court.Deutsche Wohnen traded at or above NAV before the rent cap legislation, and now our stock rates at about the 20% discount to NAV, which is more than the implication of the Berlin rent cap on our cash flows would suggest. So the rent cap undoubtedly weighs on our valuation, especially in comparison to other residential real estate companies. We are, therefore, very happy, and there is no -- now a fast path to a court decision.The decision will deliver one of 2 possible outcomes that Deutsche Wohnen should benefit relative to other companies in the market regardless of what the decision ends up being. If, as we expect, the Berlin rent cap is abolished, we will revert back to the old rent legislation, and we should be able to close the valuation gap to our old valuation. We will also be able to catch up on rent increases that had been suspended due to the rent cap.If, however, the Berlin rent cap is, against all odds, upheld by the constitutional court, we will most likely see the rent cap become a legislation across Germany. It is hard to see that state legislators in other German states will resist passing similar laws. Requests in that direction have already been made in Thuringia and in Frankfurt Main. If that happens, Deutsche Wohnen will not be the only company that reflects the rent cap in its valuation.Moving to acquisitions and our development business. Also on this front, the passing of the rental cap had its implication. You might have heard from many sites that the transaction market in Berlin has completely stalled. This is not quite true. There are still transactions ongoing, but the number of transactions definitely has come down but at previously observed price levels. We feel, however, that the implementation of the rent cap has increased the number of owners considering a sale, especially private owners of portfolios who do not want, or in many cases, are not even set up to deal with the administrative burden of the rent cap and are willing sellers.Deutsche Wohnen is considered a quality buyer of portfolio, so we have seen an increased number of attractive buying opportunities in recent months still above the valuation of our portfolio, but lower than what was offered prior to the rent cap discussion.As a side note to our development and other investment activities, a clear negative side effect of the rent cap was that the investment activity in Berlin went down significantly. We are continuing to implement already initiated investments and modernization efforts in Berlin. However, further investments with a volume of around EUR 1 billion are under examination.In construction, with the COVID-19 crisis, the related reduction in construction activity, especially of hotel and office buildings, we have a much wider access to construction companies and craftsmen for modernization and unit turn.As a sizable, reliable organization, we have always been a desired business partner for craftsmen, but this particularly holds true in uncertain time like currently. Deutsche Wohnen benefits and will continue to benefit from the flexible and cost-efficient setup we are running with independent companies for our modernization and development work.On capital structure, as you might have seen, we have continued our share buyback program. By now, our buyback volume amounts to EUR 400 million or 11 million shares, and hence, more than 3% of share capital. This is a relatively straightforward way of creating shareholder value, if we buy back shares at levels of up to 20% discount to NAV.On the funding side, the current volatile markets likely exploited the flight to quality tenancy of investors. In that regard, our funding strategy that we have been pursuing for years for sound mix of mortgage debt, senior bonds and at an LTV range of 35% to 40% continues to pay off. At the end of April, Deutsche Wohnen offered 5- and 10-year bonds at levels substantially below from where other companies ended up funding with similar instruments. The offering, nevertheless, was heavily oversubscribed and we ended up sizing it to EUR 1.2 billion.Finally, let me give you an outlook regarding the development of our portfolio. This year, we will make a major step in connection with our portfolio restructuring and does concentrate even more on growing hotspots in Germany. Due to the COVID-19 crisis and the associated refinancing and liquidity requirements of individual market participants, we see good opportunities to make further purchases at attractive conditions.Let me now say a few words about the topic of valuation. As we have previously announced, we will update our property valuations at the end of 2020. In a peer comparison, we managed the portfolio with the best quality and the most promising prospects from a market perspective. We have the greatest potential for long-term value growth. This is primarily because we are focusing on the right markets, in line with the megatrends, urbanization and have the necessary target sizes here benefit from economies of scale. In the long term, large metropolitan regions will win over structurally weak rural regions. The corona crisis, in particular, will contribute to this. So it is precisely in these rural regions that we might see a sharp economic downturn. Large cities, on the other hand, will be able to make up for the economic setback much quicker and respond dynamically to such developments.Everything we do as a company, including our activities in the multimedia and energy sectors, and above all, in line with our climate strategy, contributes to the long-term performance of our portfolio. As soon as the distortions associated with the COVID-19 crisis are resolved, we firmly believe that the importance of the product housing will become even more important and that prices will continue to rise.It should also be noted that we have taken a very conservative approach to valuation compared to our peers in the past and are, therefore, in a very comfortable position with regard to further appreciations. And these will come, especially in the markets we manage.Finally, let me say something else with regard to our like-for-like rental growth. First of all, we are convinced that we have great potential with the quality we offer and on the basis of our affordable average rents, some of which are even lower than the average rents of our peers with a lower-quality portfolio.Also, we are currently restricted by the rent cap. We expect clarity in this regard by 2021 at the latest when the Federal Constitutional Court makes its decision. Until then, we will build up a significant economic potential with regard to unimplemented rent increases due to rent index adjustments and modernization charges as well as the restrictions imposed by the rent cap. These catch-up effects should become visible by 2021.Against this background, we see no reason to adjust our investments. We will continue to invest in the quality of our portfolio. CapEx measures that have already been initiated are also being completed. Only new investments will take place at a later date, that is when the rent cap falls.So all up, as dramatic the COVID crisis is for the entire world, I feel very proud that we at Deutsche Wohnen can actively help to stabilize things. The strength of this company, the quality of our portfolio and businesses make us a desired employer, landlord and business partner, especially also in these volatile times. And on that basis, we can continue to deliver a very success business performance to our shareholders.So far, I hand over to you, Philip.

[Philip Grosse, CFO & Member of Management Board]

Thank you, Michael, and a warm welcome to our earnings call also from my side. Q1, again, underlines the resilience of our business model and shows robust cash flows and margins once again throughout all business segments. From my perspective, Q1 contains little surprises, which is a good thing these days.Let me start with Page 4, our portfolio overview for the residential business. The average in-place rent of our portfolio is EUR 6.92 per square meter and month, that is EUR 0.02 below the level at year-end 2019. This development is because of the Berlin rent freeze, which has been implemented towards the end of February.As Michael mentioned, we fully comply with the rules of the Berlin rent cap law, but at the same time, have structured our rental contracts as such that we can retroactively charge the higher rent according to the civil court, once our highest court has confirmed the unconstitutionality of the Berlin rent cap law.So far, the catch-up potential is slightly above EUR 500,000. The average value per square meter is unchanged, slightly below EUR 2,400, translating into a gross yield of 3.5%. Our fair value in Berlin is currently at roughly EUR 2,600 per square meter. This is more than 25% below asking prices for multifamily homes, which we continue to see in the transaction market and around 55% of replacement cost.On Page 4, you can see that like-for-like rental growth has slowed down to 2.3% for the total portfolio. This development shouldn't come as a surprise. As the Berlin rent cap law is only partially reflected in the year-on-year comparison, we will continue to see that development throughout this year. We confirm, however, our 1% guidance for like-for-like rental growth for 2020. But please keep in mind that this guidance is based on cash flow figures, that is P&L-based and not on the rents per square meter, which ignore the timing impact.Tenant churn went slightly down in March due to the corona situation. In April, we have even seen tenant churn being some 30% below previous levels, at around 5%.Let's move to Page 6, our letting business. Here, you can see that income from rents increased by 3% year-on-year to around EUR 211 million. This was predominantly driven by organic like-for-like rental growth, which compensated for the loss of rents based on prior year's net disposals.NOI came out at EUR 172 million, so slightly above last year's level. NOI margin just shy of 82%, slightly declined compared to Q1 as a result of higher maintenance and corporate expenses, but still above full year 2019.Moving to Page 7, our disposal business. As you can see, our privatization business continues to perform well. The average gross margin for privatizations is at 30%. And please be reminded that the 90% gross margin for Q1 last year was inflated by the exceptional disposal of a mixed-use building in Central Berlin.For the institutional disposal business, margins have been stable at around 20%. The signed disposal of 2,150 residential units in Berlin at a gross margin of 30% is not yet reflected in the numbers as closing will only occur end of this and beginning of next year.For our Nursing and Assisted Living business on Page 8, EBITDA was relatively stable in the quarterly comparison. We continued to see slight pressure on the EBITDA margin prior to lease revenues for the operational business, though. This is due to some CapEx-related vacancy predominantly in our Hamburg facilities where we need to keep some capacities for relocating the elderly people while construction is going on.Our operational people are doing a great job, and fortunately, so far, we have had very few COVID-19 cases in our facilities, in fact, only 25 out of the 5,400 beds we own and operate ourselves.In terms of profitability, also the nursing business is somewhat benefiting from the well-funded German social and health care system. Additional costs relating to corona will be compensated by long-term care insurance.Page 9 shows our adjusted EBITDA, excluding disposals of EUR 184 million, at prior year's level. EBITDA margin came out at around 80%. In Q1, we have seen some increases in our personnel expenses, predominantly driven by provisioning for the long-term incentives due to relative outperformance of our shares in recent months.If you look at the adjusted EBITDA, including disposals, please note that the negative contribution from our disposal business is because most of the gross margin has already been accounted for as part of the revaluation of our portfolio at year-end 2019.Turning to Page 10. FFO I amounted to EUR 141 million or 26% of our full year guidance. So well on track. On a per-share basis, FFO I amounted to EUR 0.40 and is somewhat stable compared to Q1 2019.On Page 11, we show the adjusted NAV, formerly known as EPRA NAV, which came out at EUR 47.84.Moving to Page 12, our capital structure. As per the end of March, our average interest rate and maturity remained almost unchanged at 1.3% and 7.3 years, respectively.Despite COVID-19 crisis, we managed to successfully place corporate bonds in the amount of almost EUR 1.2 billion, with an interest rate of 1% for a 5-year tenor and 1.5% for a 10-year tenor. The bond placement met very high institutional demand as the order book has been 12x oversubscribed at pricing level. As spreads further tightened in secondary trading, we decided to tap the bonds by EUR 190 million. This transaction, in my view, is a very strong testimonial to our good access to liquidity, even in an adverse market environment.With the bond placement, there are no bigger upcoming maturities until 2023. Our financing and liquidity position remains very comfortable and allows enough headroom to continue with our share buyback program.LTV at the end of March came out at 36.1%. This means, we continue to be in our comfort zone, which is based on our LTV target range between 35% to 40%.Page 13 is a summary of our 2020 guidance, which, as Michael said, we confirm with our Q1 results.With that, I conclude the presentation, and we are happy to take any questions you may have.

[Operator]

[Operator Instructions] The first question comes from the line of Jonathan Kownator from Goldman Sachs.

[Jonathan Sacha Kownator, Financial Analyst]

I have 3 questions, if I may. The first one on valuations, some of your peers have actually said they would do 1H valuation and were guiding actually to positive results. It seems you think that the Berlin market remains quite strong, even though you indicated prices perhaps came down slightly. Can you perhaps comment on the evolution of your valuations and perhaps why you chose to maintain not to do valuation there?And second question, just on the guidance for the full year. Can you please remind us what you have included in terms of acquisitions and disposals? I mean you've commented that you've made some acquisitions during Q1. So just to check whether those were now included and whether you had more to come in your guidance on both directions?The third question is a bit longer term. It's really about the constitutional decisions and the binary outcome. And the question is, should the rent cap law be overturned constitutionally, what could be the alternative for the city? Do you think they should -- they would rest ineffectively and act on the decision? Or could they come with potentially alternative measures, and what could those be?

[Philip Grosse, CFO & Member of Management Board]

Let me, Jonathan, start with your last question. If the outcome of the constitutional review by our highest court is as expected and this law becomes void, this is actually translating into the final decision as to who has the competency to regulate the rental market. So with the expected outcome, consequently, there are no options any longer for the city of Berlin to create its own regulatory environment. It's then back to nationwide regulation.To your second question, yes, the guidance we have given with our full year results and which we confirm is actually excluding any acquisitions we have done since then. So it's excluding the impact of ISARIA acquisition, the development platform. Predominantly, that is expected to close in the second, more likely third quarter of this year, and we will update once we have a bit more clarity as to the timing on closing if there is any potential effect on full year guidance. For the time being, I do not expect that to be the case.And on your first question on valuation, I mean, it kind of follows the patterns in previous years. A full year revaluation, including our appraiser, Jones Lang LaSalle, we typically do with year-end numbers. As Michael mentioned in his presentation, fundamentally, we are very convinced on the medium-term outlook of our Berlin stock, but also other Core+ areas.But equally, we have to recognize that with the distortion of the rent cap, it has an impact on the transaction market in terms of liquidity, in terms of volumes. So far, we do not see any material impact on pricing, but that essentially led to the decision that we even are not undertaking an internal update of our valuation with half-year numbers.

[Jonathan Sacha Kownator, Financial Analyst]

Okay. And if I can just follow up on the guidance. So you said the acquisition and disposals were not included, but you actually made some acquisitions during H1 in addition to ISARIA of over EUR 300 million, if I believe -- if I remember correctly. So those are now included? Or those are still excluded from the guidance?

[Philip Grosse, CFO & Member of Management Board]

Those are equally excluded in the guidance, but these acquisitions will somewhat compensate for the additional interest expenses as a result of the ISARIA transaction, which obviously, as a development business, will only contribute to our rental income in some years to come.

[Operator]

The next question comes from the line of Peter Papadakos from Green Street Advisors.

[Peter Papadakos, Head of European Research]

I have a couple of questions, Philip. One is on just the nursing business. What are you seeing in terms of move-ins into that business? So viewings obviously must be impaired at the moment as well from families, et cetera. So what are you seeing? And what is the sort of the trajectory for occupancy where you have the operating business till the end of the year? That's question one.And then question 2, just on ISARIA. Obviously, when you did your due diligence, it was a very different world. So is there any room for negotiating final price based on what's been happening today?

[Philip Grosse, CFO & Member of Management Board]

On the nursing side, it's kind of business as usual. In terms of occupancy rates, one of our operating business is KATHARINENHOF. Here, occupancy rate with around 97% remains very high. Occupancy rate in our Hamburg facilities is somewhat lower. It's around 90%. But on purpose, given that, here, we are in preparation for some bigger refurbishments, which is why keep some of the beds vacant in order to move elderly people while construction is still underway. In terms of overall occupancy, I do not expect the figures we have presented in Q1 to materially deviate throughout the year.In terms of ISARIA, I think the price we paid is appropriate. It's translating in Core+ areas to an all-in gross yield we expect of approximately 3.5%. That is market price and is embedding a development margin of approximately 10%. If I compare that to price points we currently observe for newly built stock, this transaction has signed. So against that backdrop, there is -- this is only subject to closing and pricing is not going to be renegotiated.

[Operator]

The next question comes from the line of Marc Mozzi from Bank of America.

[Marc Louis Baptiste Mozzi, MD & Head of the EMEA Real Estate team]

Yes. Gentlemen, I have just one follow-up question on this guidance for the full year. You did mention that it's excluding ISARIA impact. However, in your Q1 number, it seems that you do recognize EUR 20 million of one-off effect from ISARIA. And I'd like to understand if those EUR 20 million are already part of your guidance or excluding of your -- of this guidance?

[Philip Grosse, CFO & Member of Management Board]

What you see in our numbers is a one-off, that is basically real estate transfer tax we had to pay in context of ISARIA, one precondition also for closing, which we expect in Q2, Q3. It was EUR 20 million of real estate transfer tax.

[Marc Louis Baptiste Mozzi, MD & Head of the EMEA Real Estate team]

Is it part of the guidance for the year? Or is it excluded from that guidance?

[Philip Grosse, CFO & Member of Management Board]

It's excluded because it's a one-off. And one-off is not forming part of our FFO I.

[Marc Louis Baptiste Mozzi, MD & Head of the EMEA Real Estate team]

Okay. And then I have another question around this -- the potential ruling of the constitutional court. It seems that everyone now is talking about kind of a shorter time than we already thought about initially. What sort of timing should we expect for the constitutional court to rule this Berlin rent rate according to your view?

[Philip Grosse, CFO & Member of Management Board]

Yes. I think our guidance remains that we do expect for highest court's quick decision on that, latest by next year. The good thing is that there is pressure for legal clarity basically by all parties. So it is not only the conservative and the liberal party who is pushing for legal clarity. It's also the Social Democrats, the left-wing party and the Green party who are equally eager to have legal clarity on that and that hopefully will be acknowledged by our highest court.And second, what we see is that we have a very, very high number of cases, which are brought in front of the court, on local and district level, and it's a tremendous burden for our jurisdictive system and that equally should encourage our highest court, which, however, is acting purely independent, as you all know, to hopefully come to a quick decision on that subject matter.

[Operator]

We currently have no further questions in the queue. [Operator Instructions]Okay. There are no further questions. So I would like to thank everybody for joining today's conference call. The next earnings call of Deutsche Wohnen will be on 13th of August. For any questions in the meantime, please feel free to contact the IR team.Have a good day, and goodbye. You may now replace your headsets.