LEG Immobilien SE

XETRA:LEG

Earnings Call Transcript 2019-Q2

[Operator]

Ladies and gentlemen, thank you for standing by. I am Haley, your Chorus Call operator. Welcome and thank you for joining the LEG conference call. [Operator Instructions] I would now like to turn the conference over to Mr. Burkhard Sawazki, Head of Investor Relations. Please go ahead.

[Burkhard Sawazki]

Thank you. Good morning, everyone. This is Burkhard Sawazki. I'm glad you could join us today for our H1 earnings call. Our management board members Lars Von Lackum and Eckhard Schultz will guide you through our presentation and give you more insights on our half year numbers and our business outlook. As usual, this will be followed by a Q&A session. With this, I'll hand over to Lars Von Lackum.

[Lars Von Lackum, CEO & Member of the Management Board]

Thanks, Burkhard. Good morning, ladies and gentlemen, and welcome to our H1 earnings call. The management team and I are very pleased with the set of results we released this morning. Therefore, also on the back of the Q2 results, we see ourselves on track to reach our full year earnings targets. An important pillar of the value generation of our business model is also attractive capital growth. As guided in May, we posted a valuation uplift of our portfolio of plus 5.1% with our interim valuation in Q2. To put this into perspective, in a generally more volatile macro environment, LEG's defensive growth characteristics are paying off. The German residential sector faced some more headwinds over the last couple of months from the intense political discussions and latest decisions in the state of Berlin. LEG, with its focus on the NRW market and its adjacencies, is the safe-haven stock. Within the German political landscape, especially, the NRW government stands out with its commitment to safeguard an investor-friendly environment. This is, of course, something we are very glad about and which we can, once again, confirm based on our regular exchange with NRW government representatives. Internally, we had a focus on portfolio optimization in the last quarter. In our strategic disposal program, we sold around 2,700 noncore units to an international investor, which were the weakest part of our portfolio. The transaction was executed at around our book value. We are very happy about this result. At the same time, our acquisition pipeline is filling up. We have a high visibility on acquisition volume of at least 3,000 units this year. This comprises deals which have already been signed or where we have a high likelihood of signing within the next couple of months. Therefore, I have good reasons to be optimistic that we will remain a net buyer this year. Let me now briefly summarize the operating and financial highlights of the first 6 months. Our like-for-like rents grew for the complete portfolio by plus 2.9%, with a like-for-like growth of the free financed units of plus 3.5%, which is a better proxy of the underlying dynamics. The occupancy level is nearly flat. The like-for-like vacancy increased marginally by 10 basis points year-on-year, which is rather a temporary effect also due to modernization measures. We stick to our forecast, and we expect a slight decrease of the like-for-like vacancy by the end of the fiscal year. Our investments into the quality of our portfolio rose significantly by some 15% to around EUR 13.12 per square meter in the first 6 months. Coming to the financials. Our FFO I increased by plus 9.3% year-on-year, also on a per share basis, and was driven by sound rental growth and margin expansion across all lines. The pro forma NAV per share, the NAV, including a simulated executed conversion of the 2014/2021 convertible, increased by 6.6% year-to-date to EUR 99.57 per share. Taking into account the dividend payout, the NAV-based total return amounted to 10.4% over the first 2 quarters, reflecting sound value generation for our shareholders. Coming to Slide 6, where we provide an overview of our operating performance. Overall, the in-place rent in the LEG portfolio rose by 2.9% on a like-for-like basis. The free financed units, which currently account for 74% of our portfolio, grew by as much as 3.5% like-for-like, continuing the positive growth trend. We realized the strongest increase in the high-growth segment with a plus of 3.1%. The stable markets are only 20 basis points behind, with plus 2.9% rent growth. It is obvious that those segments also benefited from the modernization program. In the purple market, where our modernization activities are less pronounced, rents rose still by 2.2%. The EPRA vacancy on a like-for-like basis was nearly flat, up 10 basis points compared to the previous year. Our modernization measures triggered some higher tenant turnover in one or other asset as a natural part of the business. There is some larger increase in our higher-yielding segment as you can see. We also consider this to be a temporary effect. The increase is attributable mostly to Duisburg, our second largest higher-yielding market. As explained already in Q2 -- Q1, sorry, we made some adjustments to our structure there as we named a new regional lead and further improvements to the organizational setup and its processes. Our forecast for the full fiscal year 2019 regarding our portfolio as a whole is unchanged. We expect a slightly rising like-for-like occupancy rate year-on-year. The positive rent development in our markets is based on the strong performance of important locations, which you can see on Page 7. In the high-growth markets, Monheim continues to be the top performer with a year-on-year rent increase of 7% like-for-like. You probably know that Monheim is located between Cologne and Düsseldorf and therefore benefits from the strong dynamics in its surroundings. At the same time, it is the most important location within our CapEx program. Additionally, Cologne showed a decent growth with plus 3.9% like-for-like, although more [ than ] 1/3 of the units there are rent restricted. The free financed units alone were up plus 5.6% in Cologne. For Düsseldorf, there is more to come with a new Mietspiegel that is expected to be released in the second half of this year. There is additional rent potential from the new Mietspiegel for Leverkusen, a city bordering Cologne, which is up by 3.7%; as well as from Münster, which is up by 4%. Still, the outcome of these Mietspiegel are not really a reflection of the actual underlying dynamics in those markets and which gives us reason to believe that we will see additional growth in the future. In the stable markets, our largest location, Dortmund, was a beneficiary from both the CapEx program and the new Mietspiegel released in the first quarter with a rent growth of plus 3.4%. Mönchengladbach, as well, continued its positive development with a like-for-like rent growth of 3.3%. In the purple markets, we still saw the strongest growth in Duisburg with an increase of 3.7% like-for-like. In Hagen, where we own around 1,200 units, we have also realized a rent growth of 3.7%. This concludes my remarks on the operating key figures. And with that, I'm happy to hand over to Eckhard.

[Eckhard Schultz, CFO & Member of Management Board]

Thank you, Lars, and good morning, everyone, also from my side. Let me start with Slide #8 for more details on our investments. Overall, the investments into our portfolio rose by around 15% to EUR 13.12 per square meter. This development was driven mainly by higher value-enhancing measures. Therefore, the capitalization ratio rose by 300 basis points year-on-year to 66.9%. For the second half of 2019, we have planned a somewhat higher investment and share of CapEx measures, which should result into a capitalization ratio of around 70% for the full year. Our guidance remains unchanged. We still expect total investments of EUR 30 to EUR 32 per square meter for 2019. The change in regulations had no serious impact on our investment plans as they were not based on overly aggressive assumptions. We are still striving for a yield on cost of some 5.5% to 6%. Actually, we are currently thinking about an extension of our CapEx program in the years to come. An additional area for growth investments in the coming years will be new construction, although it will not change our overall business profile. Currently, our pipeline for the coming years comprises 1,000 units to be built on owned land. Through the first 6 months, we spent slightly more than EUR 2 million on a smaller development project in Dortmund with around 40 units [ to go ]. And now let me give you some more insight into the financials. First, let us have a look at the financial highlights on Slide #10. The numbers clearly demonstrate that LEG's margin expansion story is well underway with further noticeable improvement across all P&L lines. We were able to cope with a slightly dampening effect from the regulatory side and with cost inflation. The adjusted net rental and lease income rose by 8.9% and therefore considerably stronger than the net cold rent. This results in an adjusted NOI margin of 79.2%, which clearly reflects our ongoing efficiency gains, so does the EBITDA margin, which is supported by recurring admin costs that were below the previous year's level despite wage inflation. For 2019, I can confirm our EBITDA margin target of around 73% despite some higher expected maintenance and admin costs in the second half as part of the natural seasonality of our business. Our ongoing process optimization will drive the EBITDA margin further, clearly underlying our leading position in terms of cash flow, profitability. On Slide 11, you'll find the calculation of the FFO, our key performance indicator. It increased considerably by 9.3% to EUR 171 million driven by the mentioned positive development of the recurring NOI and the EBITDA. In addition to this, we could keep cash interest expenses nearly flat despite the increase in debt volume due to further decreasing average cost of debt. Consequently, our interest coverage ratio, that is adjusted EBITDA to cash interest expenses, further improved, reaching a high level of 560%. Looking at the cash tax expenses. There's a small negative effect from a higher cash tax rate in H1, but this cannot be extrapolated. Also due to rising investments, the tax rate is expected to decrease again in H2. On Slide 14, we prepared the calculation of the pro forma NAV according to the scheme that we introduced at year-end 2018 to reflect the potential effect from the 2014/2021 convertible. The pro forma NAV climbed by 6.6% to EUR 99.57 at the end of Q2. Adjusted for the dividend payment, which amounted to EUR 3.53 per share, the NAV-based total return amounted to 10.4% year-to-date. This was, of course, strongly driven by the positive impact from our interim portfolio revaluation. For more details on the valuation, let's move now to Slides 16 and 17. In the first half of the current year, the revaluation gains amounted to EUR 550 million, an uplift of 5.1% year-to-date. The most important driver was the adjustment of the discount rate from 5.2% to 4.9% as the ongoing yield compression in our market is feeding through to the appraisal values. However, there was also, again, a significant positive effect from our strong letting performance. The strongest value momentum was in our high-growth markets with an average revaluation gain of 5.9%. There are 2 important value drivers. The scarcity of the product, especially in A locations, and the unchanged high-demand situation is clearly the most relevant one. However, there is also a technical component. Some price developments in growth markets which we have witnessed in the past have become part of the dataset for the committee of valuation experts simply with somewhat a longer time lag. In our orange markets, the large cities Düsseldorf and Bonn were up 6.6% each. Cologne was up 5.9%. And smaller towns in the direct catchment areas of Cologne, like Hürth, Frechen or Pulheim, are strongly catching up with a value uplift north of 6%. There's also very strong momentum in many big cities, especially in those which are commuting distance to A markets. An extremely positive example for this development is Dortmund, our largest single market, which has seen an impressive value appreciation. After a very strong uplift of nearly 14% in 2018, our values rose by another 7.5% in Q2. For the LEG portfolio as a whole, the rental yield stood at a still attractive 5.2% at the end of Q2. The value per square meter now reaches EUR 1,287, which still suggests upside in my view. Prices in our markets continue to rise albeit at a somewhat slower pace. I believe that there is still a valuation gap of a mid-single percentage number between our IFRS values and current transaction prices, and therefore, I anticipate a further valuation uplift in Q4. Coming to Slides 19 and 20. Because of our portfolio revaluation, our LTV as of June stood at a low level of 40%. Our intention is not to gear up with yield compression. Accordingly, we have slightly adjusted our LTV target downwards from 40% to 45% to a maximum level of 43%. We are currently well positioned in this respect, and therefore, we consider ourselves to be well prepared to take advantage of upcoming growth opportunities. Coming to our financing structure on Page 21. No major changes. At the end of Q2, our average cost of debt stood at 1.6%, with an average remaining maturity of 7.3 years. The overall debt volume amounted to nearly EUR 4.8 billion, of which, 25% relates to capital market financing. The market environment is, as you can see, very volatile. There's not only the decline in interest rates but, at the same time, the credit spreads in the unsecured market have tightened again since the beginning of the year. For terms of 5 to 7 years, the margin for unsecured financing are priced again at similar levels to secured mortgage financing. However, there is still a decent gap for longer maturities. With a preference for longer maturities, we feel comfortable that this lion's share of our debt consists of traditional mortgage financing, which should clearly provide the lowest cost of capital over the cycle. An important element of the financing of our future growth is our 2014/2021 convertible. We will provide you later on with a bit more insight into our thinking. With this, I hand back to Lars for the business update.

[Lars Von Lackum, CEO & Member of the Management Board]

Thank you, Eckhard. At this point, I would like to add a few more words on the disposal program. We are actively managing and optimizing our portfolio. We sold assets in peripheral areas, in weaker micro locations and with substantial technical CapEx challenges. As already pointed out, we were able to sell the weakest part of our portfolio. For those assets, we have seen no option to develop the assets according to our internal risk/return requirement. The selling price for the portfolio was close to our last stated book values and amounted to EUR 148 million. The average vacancy of this portfolio stood at around 12%. Please take note that we are facing some short-term drag on our group FFO from this divestment. The current annualized FFO contribution is some EUR 6 million to EUR 6.5 million. According to our assessment, this number, however, is misleading as it is not a sustainable run rate. There is, from our perspective, a need for higher CapEx and maintenance spending in the coming years with a respective negative impact on earnings. We are going to recycle the cash into growth investments. While there was a very calm start to the year for our external growth strategy, we see some encouraging pickup of supply since spring. We have bought more than 1,000 residential units year-to-date, and we are currently in advanced stages for the additional acquisition of more than 2,000 units. Accordingly, we believe that we now have a high visibility for a total acquisition volume of more than 3,000 units this year. Additionally, as we still have another 5 months to go until year-end, we hope that there is more to come. Maybe there is even a chance that a single larger or some more midsized portfolios might come to the market in the coming months. The properties which we have bought are mainly located in our core region NRW. For the first time, these portfolios also contain some assets in the neighboring region of Lower Saxony. The average FFO yield of the portfolio, assuming an LTV of 50%, which we use as the basis for our calculation, is around 6% and therefore accretive to the overall FFO yield of our portfolio. A key success factor for LEG over the past year was the strong regional network and the unique access to off-market deals. This still holds true. We again gained exclusivity on most of the portfolios at quite an early stage. According to this development, I have good reasons to be optimistic that we will remain a net buyer this year in a tough environment and despite the larger portfolio cleanup. Nevertheless, some minor short-term FFO dilution appears likely, mainly due to timing differences between acquisitions and disposals. We have the clear ambition to leverage our know-how and to further expand our platform. You know that we have the intention to broaden our regional scope and to grow outside of NRW, predominantly in the attractive B and C cities benefiting from expected spillover effects. We have now taken a smaller step with the acquisition of a few hundred units in Lower Saxony. As already pointed out by Eckhard , we consider ourselves to be well financed according to our new LTV target of maximum 43%. For further growth investments beyond our short-term firepower, we could, among others, deploy the capital from the 2014/2021 convertible, at least partially. With an improving visibility on the acquisition side, the full conversion of the convertible into new shares might become a valid option in the coming months. We are still looking at the whole spectrum of alternatives for this instrument, i.e., a partial cash settlement and potential issuance of shares is still among the likely scenarios. We have not taken a final decision yet. We'll have to see depending on the growth outlook. As usual, I would like to conclude our presentation with the financial outlook. We reiterate our earnings growth targets for 2019 and 2020 despite the short-term drag from the disposal of higher-yielding noncore assets. Except for timing differences, we believe that this negative effect can be compensated by new acquisitions in 2020. Let me quickly repeat the ballpark figures for our forecast period. We expect an FFO in the range of EUR 338 million to EUR 344 million for 2019. If you asked me as of today, due to the mentioned disposals, it appears to be more likely to expect a result at the lower end of this range. For the year 2020, as of now, we can confirm the range from EUR 356 million to EUR 364 million. As you know, except for the discussed 3 deals, our guidance conceptually does not contain any impact from future acquisitions or disposals. Ladies and gentlemen, thank you for your attention. With that, I would like to open up the call for your questions.

[Operator]

[Operator Instructions] First question comes from the line of Kai Klose of Berenberg.

[Kai Malte Klose, Analyst]

It's Kai Klose at Berenberg. I've got 2 quick questions. First one on the portfolio structure. Back on the piece on the recent portfolio appraisal, are you considering to, let's say, reallocate some regions from the stable markets into the high-growth markets or vice versa? And second question would be on Page 12 of the report, where we had EUR 6.4 million nonrecurring project costs and extraordinary and prior-period expenses. Could you maybe give a split on that and how we can expect this to evolve in the second half?

[Eckhard Schultz, CFO & Member of Management Board]

Kai, this is Eckhard speaking. So regarding your first question, portfolio structure, I think it was at 2,700 units we have done a major portfolio cleanup, and you should not expect larger disposals in the foreseeable or the nearer future. So we have not planned significant shifts within our 3 market clusters. Regarding the onetime costs -- or the nonrecurring onetime costs, I think the increase is mainly due to severance payments for the former legal staff of the company. As of June 2019, there was one aspect where we have a larger cost because of a former development project in greater [indiscernible], where we had to make enough provision of around EUR 2 million. And now we are secure that no further requirement for provision will occur in this project. So these are the major components.

[Kai Malte Klose, Analyst]

My first question was more on the portfolio on a like-for-like basis. Referring to Page 17 of the presentation, looking how much the portfolio in Dortmund, for example, has increased. Is this maybe due to this location to become a high-growth market? Or are you going to keep the portfolio -- split the portfolio according to the 3 submarkets more or less stable?

[Eckhard Schultz, CFO & Member of Management Board]

Well, I think, of course, it can be the case that the market development and the market growth from green cluster development will go into a higher-growth market, but we don't do that for the time being for this specific city. And as you know, just to be transparent and comparable, we only update the market clusters every 2 to 3 years in order to make our numbers comparable. So no major changes should be expected, let's say, within the next 12 months.

[Operator]

Your next question is from the line of Georg Kanders of Bankhaus Lampe.

[Georg Kanders, Investment Analyst]

First, regarding the acquisition, you mentioned that 600 were in -- from Lower Saxony. Is this around the area of Osnabrück or close to North Rhine-Westphalia? Or is this something more remote? And could you please also mention where the other acquisitions are -- some of science acquisitions, what locations is that?

[Lars Von Lackum, CEO & Member of the Management Board]

Thank you, Georg. Yes. So happy to give you some more details on the acquisition which we have executed within this 1,000 units. So the 1,000 units, those which we have bought in Lower Saxony are in Hameln, Göttingen and Hannover. So from the perspective that we already had some units there, we had a close eye that we were acquiring assets which can be accessed also from the current platform we are running. With regard to the other acquisitions with it, so this was pretty much across North Rhine-Westphalia, some assets in Düsseldorf but also increases in Krefeld and Bielefeld. So this is where we bought additional assets. So as you can see, it was a broad reach across North Rhine-Westphalia but always close to the assets we are already having in those markets.

[Georg Kanders, Investment Analyst]

And another question I have regarding -- in the results from the rental business, there is a positive contribution from other within Q2. Is this something -- what is behind this? I think it's not sustained but...

[Eckhard Schultz, CFO & Member of Management Board]

We will check that and we'll come back with this question.

[Operator]

[Operator Instructions] The next question comes from the line of Marc Mozzi of Bank of America Merrill Lynch.

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

Regarding your potential acquisitions outside of North Rhine-Westphalia, how do you think your EBITDA margin might evolve in that context if you have to create from scratch a new platform?

[Lars Von Lackum, CEO & Member of the Management Board]

Thanks, Marc, for your question. So what we are planning is that we will closely cooperate with those partners which we are already doing business also in North Rhine-Westphalia, in Lower Saxony or in Rhineland-Palatinate so that we are quite confident that the EBITDA margin which we can also earn on the new acquired assets will be in line with the EBITDA margin which we are currently running in North Rhine-Westphalia. So -- and looking at what we've done now in Lower Saxony, we are quite comfortable to confirm this because we've now concluded some additional contracts with some service providers where we are not willing to do all the services ourselves. And the service providers we are cooperating in North Rhine-Westphalia with are -- a lot of them are operating German-wide so that we were able to get the same prices for assets being serviced in North Rhine-Westphalia as for those which we now newly acquired in Lower Saxony. So therefore, EBITDA margin has not been at risk while we were acquiring now also assets in Lower Saxony.

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

And would you say that would be the case if you have to move in another country?

[Lars Von Lackum, CEO & Member of the Management Board]

In another country? So...

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

I understand for the region in Germany, but if you were to think about moving potentially in Netherlands, typically.

[Lars Von Lackum, CEO & Member of the Management Board]

Yes. So I think it always depends on the number of assets you are acquiring. And certainly, those providers which we are working with in Germany are not those which are operating in The Netherlands. So at least those which we have in North Rhine-Westphalia are purely focused in Germany. And perhaps reiterating what we already tried to make clear during the last call. We had a look into the Dutch market, and looking at the differences on the political side, the differences in culture and language, et cetera, if we would enter a foreign market, it would have to be a platform really sizable, giving us the chance to then have an owned foot on the ground there with own people. Currently, we do not see this, and -- but we see additional potential in the German market whether it's 1,000 units which we have already signed or the additional 2,000 units which we plan to sign within the next couple of months.

[Operator]

The next question comes from the line of Jonathan Kownator of Goldman Sachs.

[Jonathan Sacha Kownator, Financial Analyst]

A couple of questions, if I may. The first one, just on your disposal program. So now that you've executed the 2,700 units, is there another tranche to think about either this year or next year? That's the first question. And the second question. You mentioned 1,000 units, I believe, in development currently. I think we discussed already during the last call, but can you please comment perhaps a bit on your efforts in terms of development? Are you trying to source additional land? Are you progressing in discussions with local authorities? Yes, if you can update us on that, that would be great.

[Lars Von Lackum, CEO & Member of the Management Board]

Jonathan, thanks for your question. So with regard to the disposals which we have taken, I think we are very happy to have executed this deal, and it's really -- it has been really the weakest part of our portfolio. And so we made sure to really size it to a level where we feel comfortable we are doing, on regular basis, some privatization but at a very low scale, and we also have some other assets which we put up for sale. So I expect a number of around 3,100 to 3,200 units which we are going to sell in 2019. If you ask me whether we are doing additional sales in 2020, currently, certainly, we talked to different market participants, always screen our portfolio closely, but we do not see anything which is now close to our mind which we wanted to put up for sale in 2020. So you will see only minor adjustments to our portfolio in 2020 to a lower -- much, much lower degree, so more in the range of 500 units but not more currently for 2020. If you look at what we are doing on the development side, I'm happy to give you some more insight there. We are planning this 1,000 units on owned land, so it's all densification program and projects. And we try to reach a stable plateau by 2023 by the completion per year of 250 units. At the same time, we have started to also source new developments, which are close to be finalized. For this acquisition, we have done 50 units in Bielefeld, and we are currently close to a deal in Dortmund of around 100 units. And at the same time, we have also, I can say, intensified our work on the acquisition of land. Honestly, this has been proven to be the slowest ones that we didn't make the progress which I had hoped for within the last months. We are forcing wherever we can, but looking at the prices, we want to stay very reasonable. And we unfortunately have seen markups which are just unreasonable. So therefore, we have not closed a deal on the land side yet. But we are open for it, and we are still looking for some interesting plots of land. And I'm quite sure, by the end of the year, we will also be able to sign one or the other deal.

[Jonathan Sacha Kownator, Financial Analyst]

Okay. Perhaps as a follow-up, so what is the budget for development of these 1,000 units? And what yield on cost are you expecting on that? And generally speaking, how much should we think about, in terms of, again, development costs and yield on cost of these 250 units, let's say, per annum? And the second question is are you having any discussions with local authorities to see if there's any partnerships available to potentially reduce the cost of land?

[Lars Von Lackum, CEO & Member of the Management Board]

Yes. So we are in very close contact with the municipalities with regard to the cost of land and especially the question whether they always need to sell to the highest bidder or whether we can have also agreements with regards to the concepts which we are providing, so offering also part to be then rent restricted. This, unfortunately, is not that easy because some of those municipalities we are talking to just need the money desperately, and therefore, it just proves to be a longer process. But once again, I'm quite comfortable that we are as close as possible to NRW municipalities that we -- hopefully, by the end of the year, we'll also see the one or the other deal being done. Over the complete portfolio, we try to have a yield on cost of 4.5%, which is, in majority, driven the projects which we are doing, are in markets like in Cologne, for example, where we're just having a big project of around 400 units to be built. And therefore -- so 4.5% yield on cost is what we're currently planning.

[Jonathan Sacha Kownator, Financial Analyst]

Is it gross or net ,that 4.5%?

[Eckhard Schultz, CFO & Member of Management Board]

Sorry.

[Lars Von Lackum, CEO & Member of the Management Board]

What?

[Jonathan Sacha Kownator, Financial Analyst]

Is the 4.5% gross yield or net yield?

[Lars Von Lackum, CEO & Member of the Management Board]

It is gross yield. Sorry, Jonathan, I didn't understand it for the first time. It's gross yield, yes. Thanks.

[Eckhard Schultz, CFO & Member of Management Board]

Yes. Maybe one additional remark. It's the gross yield, but please take into consideration that we will also -- that we do expect a valuation uplift to come. So for example, the project in [indiscernible] so -- where we built on our own land, I think we spent EUR 2,400 construction cost on our own land to [ budget ] price maybe closer to EUR 4,000, EUR 4,500. So on top of the yield on cost, there comes an additional component of the valuation uplift.

[Operator]

Your next question comes from the line of Andre Remke of Baader Bank.

[Andre Remke, Co]

Basically, 2 questions. First question, what are the main criteria for acquisitions? You mentioned the FFO yield of 6%, and I would assume it's also true for the remaining acquisitions of your pipeline. But more in general, what you are trying to acquire, upside potential from rents or vacancy? Are you seeking for scale effect? Or is -- do you want simply buy stable cash flows versus solid quality?

[Eckhard Schultz, CFO & Member of Management Board]

Andre, so I think, as in the past, we have highlighted that the FFO yield is only one component. And I think in the current low interest environment, it's not too difficult to achieve still very attractive FFO yields and to compensate the decreasing gross yields. I think generally speaking, how we look at acquisitions, of course, we want to grow the platform in order to create more scalability. You can see that at the development of our EBITDA margin coming from 64% and we have reiterated our guidance of 73% for 2019. So this -- therefore, external growth is an integral part of our corporate strategy also going forward. What we are doing is -- I think the problem in the current transaction market is not the FFO yield. It's more NAV dilution. And what we are doing, we benchmark every acquisition against our implied valuation, our internal valuation, and we are also taking into consideration the cost of capital and the slight premium we have. And therefore, we have a benchmark for every single asset, for every single market by benchmarking it against our internal valuation. What we are closely looking at, and that's another aspect from the further improvement of profitability, but we are carefully looking that, with the new acquisitions, that we achieve higher EBITDA margins than the average EBITDA margin of the company. And therefore, acquisitions, to cut a long story short, should be more or less NAV neutral, they should be accretive to our FFO, and they should be accretive to our EBITDA margin and thus, to our operating profitability. So that's how we are looking at it. And most importantly, micro locations are key. So I think that's -- I think, due to our in-depth market knowledge, we can -- and that's very visible in the development of the numbers, we can be also very successful in higher-yielding markets, you have to choose the right micro locations.

[Andre Remke, Co]

And in particular for the EBITDA margin, it's say already in place, EBITDA margin should be accretive not only the planned for the next 2 to 3 years?

[Eckhard Schultz, CFO & Member of Management Board]

Well, of course, we are looking -- on our part, we are calculating on a forward-looking basis. And of course, it can be the case that we are buying a portfolio with currently a below-average EBITDA yield. A very good example is the portfolio where we have bought, I think, last year, 1,400 units in Hassels in Düsseldorf. So it's a weaker micro location in Düsseldorf, however, a very attractive market. We bought this portfolio at an initial vacancy of 22%. And of course, at this time, the EBITDA margin was below our 73%. But in the meantime, we could decrease vacancy to 4.4%. So we are far ahead our schedule. And our target is to improve the vacancy further, and then we are well above the average EBITDA. So clearly, our acquisitions are assessed with a forward-looking view.

[Andre Remke, Co]

Okay. And a follow-up on the acquisition side. In the first quarter call and today, you mentioned there was observations that investment markets are picking up. Is this a more general trend in the market, i.e., an increase in transaction activities? Are owners becoming more willing to sell at rich prices?

[Lars Von Lackum, CEO & Member of the Management Board]

Honestly, Andre, from my perspective, I think we just have a very good acquisition team. So you just need the right team on the ground and the right network. You've been just -- have to be very close to the market. The market is very tough. So once again, to reiterate on what we already stated, so it's not easy deals. And you really need to make sure that you have -- really, in here -- in all conferences, be very close to brokers, be very close to wealth and private persons. And therefore, the deals which we are closing are coming from a diverse range of investors which are selling to very different reasons. And therefore, there is not the one or other investor class which I can name or the one reason for persons selling assets. But it is really the excellence, I think, of the acquisition team, and I'm very happy that those guys are working for us.

[Andre Remke, Co]

Yes. And so in a nutshell, the acquisition market remains as it is for the last, let's say, 12, 18 months and it's more LEG specific?

[Lars Von Lackum, CEO & Member of the Management Board]

Exactly. So that's my reading, Andre. I think it's still tough markets.

[Operator]

We have a follow-up question from the line of Marc Mozzi at Bank of America.

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

Sorry, a follow-up. One question, one question. On what you indicated about potentially refinancing your convertible bond, if I understand correctly, what would be the criteria or the level of the share price into which you would consider issuing equity? I guess, if I understand correctly, it's an arbitrage between your strike of the convertible bond and where the current prices are. So but can you give us a little bit of color on how you plan to monitor the situation?

[Eckhard Schultz, CFO & Member of Management Board]

Well, Marc, I think it does not primarily depend on the share price. I think as we pointed out, we have now, with an LTV of around 40%, a decent firepower of, let's say, 3,000 or 3,500 units. And for further growth, the conversion of the convertible bonds could be a valid option because it's a very efficient way to raise equity. But again, this depends pretty much on the outlook for further -- acquisition for further growth. There's no decision made yet, and we have the full range between an issuer call and liability management exercises. So the most important question is how the outlook for acquisitions develops over the next few months.

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

Yes. But if I understand correctly -- well, maybe I missed a point. You're planning eventually to refinance your current -- one of the 2 convertible bonds. Is that the understanding or maybe I'm wrong?

[Eckhard Schultz, CFO & Member of Management Board]

No, that is one -- among others, that is one valid option here. But as I said, the full spectrum is possible, a full conversion where there is no refinancing required as well as liability management. Or this partial issuance of shares is an option but not efficiently yet, so it's not a question, Marc.

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

Can you remind me what is the strike on your first convertible bond, which is the one at EUR 300 million? I think it's a very low strike price, no?

[Eckhard Schultz, CFO & Member of Management Board]

It's around EUR 51, EUR 52, but it's now out of my head.

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

Okay. So if I understand correctly things, it would be worse issuing new equity at EUR 100 and whatever and -- compared to issuing equity at EUR 52.

[Eckhard Schultz, CFO & Member of Management Board]

I'm not 100% sure if I understood what you mean.

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

Okay. That's fine. Okay. Well, that will just create less shares. That's basically what I implicitly mean by this.

[Eckhard Schultz, CFO & Member of Management Board]

Yes, yes. But then...

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

If you raise EUR 300 million of equity at EUR 100 instead of raising EUR 300 million of equity at EUR 51, EUR 52, we should have at least roughly half the number of shares.

[Eckhard Schultz, CFO & Member of Management Board]

Well, we'll come back to you, Marc, after the call. So I think there's no further questions. I promised Georg to answer his question. So I think the question, if I remember rightly, was, the NOI, if there is a non-sustainable component of the increase in NOI. I think there's one component from the IFRS 16 adjustment. So there was a new standard. We have explained that already in 2017. But this is only a minor number of EUR 2.5 million, which is included in the NOI in our H1 numbers, but this is also sustainable going forward. So this number will be also reflected in the future. Hope that answers the question.

[Operator]

[Operator Instructions] And there are no further questions at this time. I hand back to Burkhard Sawazki for closing comments.

[Burkhard Sawazki]

Ladies and gentlemen, this concludes our earnings call. Thanks for your participation. As you know, we are available also after the call to answer your questions, so please feel free to give us a call or send us an email. Thank you. Goodbye.

[Operator]

Ladies and gentlemen, the conference has now concluded, and you may disconnect your telephone. Thank you for joining, and have a pleasant day. Goodbye.