LEG Immobilien SE

XETRA:LEG

Earnings Call Transcript 2021-Q3

[Operator]

Ladies and gentlemen, thank you for standing by. My name is Emma, your Chorus Call operator. Welcome, and thank you for joining the LEG conference call. [Operator Instructions] And I would now like to turn the conference over to Mr. Frank Kopfinger, Head of Investor Relations. Please go ahead.

[Frank Kopfinger, Head of Investor Relations]

Thank you, Emma, and good morning, everyone, from Düsseldorf. Welcome to our 9 months results call, and thank you for your participation. We have on the call today our entire management team with our CEO, Lars von Lackum; our CFO, Susanne Schroter; as well as our COO, Volker Wiegel. You'll find the presentation document as well as the quarterly report within the IR section of our homepage. Please note that there is also a disclaimer, which you'll find on Page 3 of our presentation. And without further ado, I hand it now over to you, Lars.

[Lars von Lackum, CEO & Chairman of the Management Board]

Thank you, Frank. Good morning, everyone, from my side, and thank you for joining our call today. The first 9 months of this year have been, again, a very strong period for our company. Let me just highlight the most important points upfront. First, we are well on track for a record result in 2021 and about to reach the upper end of our FFO I guidance level of EUR 410 million to EUR 420 million. Today's strong set of results makes us even more confident to reach that target. Second, we deliver consistently on our promises. We continued our growth path organically by reaching a solid 3.3% rental growth and low 2.6% like-for-like vacancy rate externally by achieving our 7,000 units acquisition target for 2021 already as of today. Third, we can offer you more growth with our FFO I guidance for 2022 as we expect to reach EUR 450 million to EUR 460 million next year. This represents another increase of around 8%, taking the midpoint of the new range into account. Fourth, we also increased our new construction targets. We doubled our target from 500 units to 1,000 units per annum as of 2026. Growth will be driven by a new cooperation with Goldbeck, one of the leading serial modular construction companies in Europe. Fifth, we operate in a very attractive market with increasing demand from national as well as international investors. Therefore, we expect another valuation uplift of our gross asset value of 4% to 5% for the second half of this year. Page 6 of our presentation summarizes the results of the first 9 months of 2021. As Volker and Susanne will run you through the details of our operational and financial success story later, I would like to point out our latest ESG achievement. End of last week, we proudly announced an upgrade by Sustainalytics. With our new rating score of 7.8, we are now comfortably within the negligible risk category and among the top 1% of companies within the Sustainalytics coverage of more than 14,000 companies worldwide. We are in place among their global real estate coverage of more than 1,000 companies. This highlights the successful implementation of our ESG strategy and motivates us to keep the momentum high. Let me now give you a brief overview and share some insights into our acquisitions as those will certainly be a key driver for our continued growth in 2022. I move now to Slide 7. We achieved our goal of adding 7,000 units this year already as of today. Additionally, we have further opportunities in our acquisition pipeline, a bigger deal with around 15,000 units, which you are all aware of, but also some smaller portfolios, which fit well into our growth strategy. The acquired 6,900 units follow our strategy to expand outside North Rhine-Westphalia with market entries via high-growth and stable markets. They allow us to open new locations with Kiel in Schleswig-Holstein with 2,300 units and to improve significantly our footprint in the Rhine-Neckar region and in the region around Hanover and Brunswick in Lower Saxony.The purchase price for those assets amounted to in total around EUR 900 million. The assets come with a rent multiple 26, which compares well against our own valuation for those markets. In the first year, we expect an FFO I contribution from the acquired assets of around EUR 20 million. Please note that transfer of ownership for the majority of the 6,900 units will take place in Q4 for most, even as of December 31. With those acquisitions, we laid the foundation to tap the full market potential outside North Rhine-Westphalia. As you know, we are currently in negotiations with a peer to acquire a portfolio of 15,000 units. This would allow us to expand outside NRW and significantly improve our footprint in our target markets, Schleswig-Holstein, lower Saxony and Bremen. At the same time, we would diversify our portfolio into the higher-yielding market cluster. We are currently undertaking a full-fledged due diligence, i.e., a technical due diligence on the assets as well as a detailed financial, tax and legal due diligence. As always, major findings of the due diligence will be either reflected in the contractual agreement or the acquisition price for the portfolio. We currently expect to finalize the due diligence within the coming weeks. Assuming a successful agreement with the seller, transfer of ownership for the assets should take place by the end of the year. As the due diligence is still ongoing, I would ask you for your understanding that we cannot provide more details to the potential transactions at this point in time. However, I can assure you that we will update you once we conclude the negotiations. Therefore, I cannot answer questions to this topic today. Only one closing remark with regards to the potential transaction. The management team has waived the transaction bonus for that deal unanimously. Certainly, it is the responsibility of management to engage with potential sellers and explore such opportunities. However, this transaction, if it proceeds, is not motivated by any personal financial incentive. Therefore, we also entered into discussions with the Supervisory Board to generally amend the management's compensation scheme in this respect and plan to propose to the next AGM in May 2022 to vote on such amended compensation scheme. Page 8 illustrates our increased growth ambitions for our development activities. As promised in 2019, we are happy to announce that we have been successful in securing 500 newly constructed units annually from 2023. Those come either from redensification projects on own land or from turnkey projects, which we bought from different developers. Due to the strong progress made by our development unit within the last 2 years, we have the confidence to double the number of new built units and increase our target to 1,000 units annually by 2026. An increase of our development activities now is more than logical. Firstly, the political focus on new built activities has risen substantially. We expect the new government to increase their new built targets to 400,000 units per year, of which 100,000 units annually will be social housing. Additionally, the supply gap will widen even further. To make up for Germany's demographic challenges, immigration needs to speed up substantially. Current expert estimates see the need for an additional immigration of 400,000 per annum. Finally, we expect the focus on energy-efficient buildings to bring additional momentum into the development market. To address the substantial supply gap, the new government has already indicated to streamline building permission processes and promote serial modular construction as a key building block for further supply. Having built the skills over the course of the last years and recognizing the increasing supply gap, we have decided to increase our development activities. Therefore, we entered into a cooperation with Goldbeck, the European champion in the field of serial modular construction. The cooperation allows us to provide another 500 units per year from 2026 onwards. Those units will be built with low construction costs and target our core market of affordable living. With this, I come to the end of my presentation. I hand over to Volker, who will give you an overview of our portfolio and the operational successes achieved within the first 9 months of this year.

[Volker Wiegel, COO & Member of Management Board]

Thank you, Lars, and good morning, everybody, from my side. Let me start with an overview of our portfolio on Slide 10. At the end of the reporting period, our portfolio consisted of 145,700 units. With 32% in the high-growth markets, 39% of our units are located in the stable markets and 29% in the higher-yielding markets, our footprint is well balanced. In Q3 2021, we could slightly increase our share of units outside of North Rhine-Westphalia to around 12,800 units or 9%. By the end of the year, and thanks to our acquisitions so far, this number will grow to over 10%. For further details on acquisitions, let us move to the next slide. As you can see, we are now heading above the 150,000 units level with the integration of two larger portfolios in Q4. Both are located outside of North Rhine-Westphalia, around 2,200 units in the Rhine-Neckar region or from Deutsche Wohnen and around 2,250 units in the northern German city of Kiel. The figures on this slide refer exclusively to the date of transfer of ownership. As most transfers are planned for the end of Q4, you should not expect any material impact on the full year 2021 numbers. To allow you to reconcile our geographical expansion over the course of the last 1.5 years, we provide some more details on the locations of our acquisitions in the box on the right-hand side of the slide. Disposals remain at a very low level. As of Q3, we disposed of around 300 units of transfer of ownership within this year. Coming to Slide #12 and to the rent development. In the last 12 months, rents on a like-for-like basis grew by 3.3%. Please keep in mind that the baseline in the previous year was comparatively low. From end of March 2020, we suspended rent increases on a voluntary basis to support our tenants during the first lockdown. First rent increases took effect in 2020, not before Q4. Therefore, the Q3 rent development cannot be extrapolated to the full year as it refers to an artificially low rent in the previous year. Instead, for 2021, we stick to our target offer like-for-like rent increase of 3%. From the slide, you can see that the free-financed units, which account for 76% of the portfolio, were up 4.1% on a like-for-like basis. The strongest increase was in the stable markets. With plus 4.3%, they even outperformed the high-growth markets by 10 basis points, reflecting the dynamic situation in the commutable areas. The free-financed units in the higher-yielding market as well showed a strong increase of the like-for-like rent of 3.6%. The average in-place rent for our free-financed units was EUR 6.52 per square meter and month at the end of September '21. This underlines our focus on an affordable product even more so when looking at our subsidized units that represent 24% of the portfolio. In this rent-restricted part of our properties, the in-place rents were EUR 4.92 on average. Let us now move on to Slide 13. On this page, we presented the EPRA vacancy by market. The strong vacancy decline continues. This holds true for all three market segments and almost all our locations. We realized that the highest momentum again in the higher-yielding market. Our largest location in this market, is Gelsenkirchen, where vacancy came down by 175 basis points. Many other of our locations in the purple markets also showed an improvement of the occupancy rate, reflecting the new target operating model implemented in 2019. The strong demand for affordable housing and our exposure to attractive regions certainly help keeping vacancies low. Another driver is keeping a constant eye on customer satisfaction. Our services also paid to this. Coming to Slide #14 and our investments. Overall, our investments increased by more than 17% to EUR 308.5 million and in line with our planning. Adjusted for new construction, acquisition, backlog and safety measures and capitalized own services, total investments were EUR 309 million or EUR 29.36 per square meter. As usual, the bulk of investment relates to CapEx, which account for EUR 209 million. The other half of the column shows the modernization. This mainly represents our spending for energy-efficient modernization. In the first 9 months, we completed energy and strategic measures for about 2,500 units and are well on track to reach our 2021 target to refurbish 3% of our units. The lower half of the column represents turn costs for renovating bathrooms, floors or technical installations before reletting an apartment. These measures allow for rent increases and improve the satisfaction of the future customers. A thorough renovation also saves us many small repairs in the future. Overall, we are broadly in line with our EUR 40 to EUR 42 square meter guidance -- investment guidance for 2021. And with this, I hand it over to Susanne.

[Susanne Schroter-Crossan]

Thank you, Volker. Before I start with the financials, I wanted to continue on the investments and give you a brief overview of our 2022 investment program. Next year's investment program represents the first time that we structurally reflect our ESG strategy. That means a shift from a pure rent increase focus to an optimization of both rental as well as carbon years, i.e., the effect we generate on the efficiency improvements and on the carbon reduction. However, to be clear, the majority of the CapEx projects, which will be completed in 2022, have been planned in 2020 and in the first half of this year prior to the implementation of our ESG strategy. That means that they were selected and planned under the old regime. The first full effect of the changes to our planning process will, therefore, only be visible from 2023 onwards. With this, let me guide you through the numbers. For 2022, we expect to spend EUR 430 million to EUR 455 million in total of EUR 44 to EUR 46 per square meter in CapEx and maintenance. Like in 2021, we expect again to invest around EUR 110 million into energy efficiency improvement, for example refurbishment projects but also heating system improvement. This is in line with what we showed you in the context of our ESG agenda. We have given you also an example around the effect of BEG subsidies. This is the real-world example from a specific project, which we are going to undertake in Osnabrück. The project was aimed at energy improvement from the start. The numbers show that only a small increase in total investment is needed to meet the technical requirements for receiving BEG subsidies. The receipt of the subsidies not only increases the profitability of the investment but also generates additional carbon savings of around 5 tonnes per year. We, therefore, aim to apply for subsidies whenever they help us to improve the financial or carbon yield of a project. For 2022, we only expect BEG subsidies in the order of EUR 1 million to EUR 2 million. This is due to the fact that I mentioned earlier, that those projects, which complete in 2022 have been initiated by the investment programs of the previous year. This will change going forward, and based on projects already planned now, we expect about EUR 18 million of subsidies for 2023. And with this, let me now move to the 9-month financials on Slide 17. This slide shows the development of our key P&L items. Our good performance continued into Q3. Accordingly, we have been able to improve our KPIs and expand our margins across all P&L lines. Our net cold rent increased by 9.7% to close to EUR 510 million. Roughly 2/3 of the increase is related to portfolio growth and 1/3 to organic growth. The recurring net rental and lease income outpaced the top line growth and rose by 11.6% to EUR 420 million. As a result, the margin increased to 82.4%, driven by scale effects due to a high -- bigger portfolio and due to the strong performance of our services business. Our EBITDA grew by 11.2% to EUR 401 million, and we could improve our EBITDA margin by 110 basis points to 78.6%. For the full year, we continue to expect an EBITDA margin of around 75%. Like last year, the margin in our fourth quarter will be weaker than in the previous quarters. Traditionally, there is a catch-up effect in several cost positions at year-end, including higher maintenance, seasonality from our energy business, as well as some cost effects due to a normalizing personnel and other cost position following the reopening after the lockdown situation. Our FFO I grew strongly 12.6% to EUR 334 million, which puts us well on track for achieving the upper end of our financial year guidance. For detailed drivers of our FFO I expansion, please turn to the next slide. The biggest driver of our FFO I increase compared to the 9-month period in 2020 is a contribution from acquisitions with EUR 21.4 million. The second biggest driver were rent increases, which contributed to EUR 16.8 million. The third biggest positive driver were lower operating costs, which contributed EUR 6.9 million. Higher admin costs and higher net cash interest had the opposite effect. Both effects on the cost side are directly linked to our growth as well as the aforementioned normalizing of some admin cost positions as we could better fill open job positions following the end of the lockdown. On Slide 19, we have, as usual, put together the key valuation metrics broken down by our three market segments. Following the revaluation of our entire portfolio at the end of H1 '22, we will complete the next full revaluation at financial year-end 2021. As Lars pointed out at the beginning, we would expect a valuation uplift of 4% to 5% of our gross asset value for the second half of 2021. Our assets still offer an attractive growth yield of 4.4% on average in a negative interest rate environment. This compares to an in-place rent multiple of 22.9x. The gross value per square meter amounts to EUR 1,655 at the end of the third quarter. As you have seen earlier on our acquisition chart, we have recently acquired mostly in the orange market, which reflects our expansion outside North Rhine-Westphalia that focuses on high growth in stable markets as a first step as well as opportunity. We would like to reiterate, though, that we continue to feel very comfortable with all our three market segments and the respective asset profile. I'm now coming to Slide 20 with an update on our financial profile. As at the end of Q3, our LTV stood at 38% and is slightly higher in comparison to the end of Q2 and a year ago given our acquisition activity. On a pro forma basis, taking the acquisitions into account, which will transfer in Q4, the pro forma LTV stands at around 41.5%. Net debt to EBITDA at the end of the reporting period was at 12.2x. With the two corporate bond issues and the early redemption of the EUR 200 million mortgage loan in H1, we have reduced our interest cost to an average 1.23% from 1.35% a year ago. The average debt maturity stands at 7.4 years. When it comes to potentially larger portfolio acquisitions and the corresponding financing, we will aim at maintaining our defensive capital structure in order to keep flexibility for further growth while taking into account the market environment for different products. And now back to Lars for our outlook.

[Lars von Lackum, CEO & Chairman of the Management Board]

Thank you, Susanne. I am now on Slide 22. We are well on track in every respect. Therefore, we can confirm all our financial targets for 2021. We are still aiming for the upper end of the range of EUR 410 million to EUR 420 million. On a year-on-year basis, this suggests an increase of around 10%. I can also confirm like-for-like rental growth of around 3% and a further increase of the EBITDA margin to roughly 75%. We also remain very focused on our conservative balance sheet structure and maintain our LTV target set at a maximum of 43%. As we have shown, we already achieved our acquisition target of 7,000 units. There is a chance that we will do more as our pipeline is filled with one bigger and some additional smaller deals. For 2022, we expect FFO I to further increase to a range of EUR 450 million to EUR 460 million. This represents an increase of over 8% if I simply take the midpoint of the guidance against the upper end of this year's guidance. Growth will be driven by an ongoing healthy demand for our product, the 3% rent increase expectation, as well as the contributions from the successful acquisitions in 2021. Please note that the guidance does not reflect any pending acquisitions from 2021, i.e., neither the acquisition of this 15,000 unit portfolio nor the acquisition of the smaller portfolios in our pipeline. The guidance also does not include the acquisition of the 7,000 units which we aim for in 2022. We also introduced our new ESG targets, which will be directly linked to Management Board's compensation scheme and which will be reflected also in the incentive schemes of our senior management team. Again, all targets are measurable, quantifiable and auditable with limited assurance by our external auditor. On the environmental side, we continue to aim for a 10% CO2 reduction within the next 4 years and, for 2022, for a reduction of 4,000 tonnes of CO2 from energetic modernization measures. On the social side, we now anchored our customer satisfaction index ambition of 70% until 2025 into our target system. For 2022, we aim to hold our employee feedback at the strong level of 66% for the trust index. On the governance aspect, we, again, link our target to the Sustainalytics rating, which reflects very well the governance aspect of our business. We want to confirm our strong rating with Sustainalytics by remaining in the negligible risk category also for 2022. With this, I come to the end of my presentation, and I would like to open the call for questions and answers. My colleagues and I are happy to take your questions.

[Frank Kopfinger, Head of Investor Relations]

Thanks, Lars. And with this, we begin the Q&A session, and I hand it over to you, Emma.

[Operator]

[Operator Instructions] Your first question comes from the line of Marc Mozzi with Bank of America.

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

I have essentially two questions around your acquisition side. Essentially, on the 7,000 units you've been acquiring this year, what sort of yield should we assess for this portfolio? And as a consequence, what sort of yield should we also expect from the 2022 acquisition? Are there any gap here outside of the natural market yield compression, if there is one? That would be my first question. And number two, in terms of top line of acquisition, can you give us a quantum of how many units you're currently reviewing because you said that you're potentially going to do more than [ 10,000 ] units this year and you'll target [ 20,000 ] next year? I'm just trying to understand if currently as well you're reviewing some portfolio that potentially could be sold by Vonovia and Deutsche Wohnen. And the final one, sorry, again, on acquisition, if that's going to be allowed here, is just to clarify one -- two numbers. From Adler communication, there's two numbers on the street: one which is EUR 1,500 of GAV and then a deal -- a transaction, which is EUR 800 million. I just wanted to clarify what, in your view, is the difference between those two numbers?

[Lars von Lackum, CEO & Chairman of the Management Board]

Thanks a lot for your questions. So I will start with the first question with regards to the 7,000 units, which we have acquired this year. So they came at a multiple of 26, so which translates then in a yield of 3.8%. And we just try to give you a bit of a detail on how much of an FFO impact we are expecting in year 1. So year 1, we are expecting around EUR 20 million of FFO. That's a bit less than you would normally expect, which normal -- which is also quite normal because assets which we acquired certainly come with a bit of a backload with regards to maintenance but also with the chance of doing modernization. So therefore, that is what we have acquired this year, and that's pretty much in line if you just compare and the -- where those assets are being situated. So most of that is orange market. That's very much in line with our own book. Second question was how much do we currently have in the pipeline. Pipeline currently looks very strong, so -- and we currently are looking at around 18,000 units and out of which the 15,000 units you are already aware of. So they are, as always, in different stages, but we are also confident to close the one or the other deal in either this year or early next year. Not all of those 3,000 units, but that is still in line with our 7,000 units acquisition target then for next year. Final question was on the two different numbers, which have been communicated. Unfortunately, I'm only able to give you more clarity on the first number. So the portfolio GAV number, which we have pre-agreed is the EUR 1.5 billion. And the EUR 800 million is something which comes from the other side, and you should ask the question there, seems to be the number they are expecting as a cash flow impact on their numbers but, certainly, which we are not able to give you any details on. So the only number we are aware of is the EUR 1.5 billion.

[Operator]

The next question comes from the line of Christopher Fremantle with Morgan Stanley.

[Christopher Richard Fremantle, Executive Director]

I just had two more technical questions on the development and on the subsidies. On the development, can you just talk a little bit about the financials for the development, either the profit on cost that you have been generating and expect to generate or the yield on cost that you are underwriting for those developments, please? Just so we can get a clearer idea of the value creation from that activity. And if you can just explain where that comes in your accounts, please, that would be great. And then similarly on the subsidies, where and how are we likely to see that sort of come through? Is it simply netted off against the CapEx in your accounts? Or is it treated differently?

[Lars von Lackum, CEO & Chairman of the Management Board]

I will kick it off with the answer to your first question with regards to development. So the cooperation, which we have just started with Goldbeck, will come at a yield and cost a bit lower compared to what we currently buy in the market, so the assumption is that we will arrive at around 3.5% in the first project, which we are about to realize. That's a project in Euskirchen, and we are planning to realize around 250 units there, and that will be something which is going on now. So we are kicking off the project now and hopefully closing the project by 2025. Recognition will be amongst our operations. And so all the numbers will be included there. And regardless, whether we talk personnel or material costs, due to the small size of our development unit, we do not see the need to show it in a different segment. And so we will include it in our operational and statements there.

[Susanne Schroter-Crossan]

Okay. Then, Chris, for the -- on the second question on subsidies. So in terms of the investment numbers, we are guiding these indeed on numbers net of subsidies received of all the investment program going forward. The numbers are sort of after a deduction of the subsidies. From a pure accounting perspective, the subsidies will also represent deferred income, but I guess, given at this small magnitude I mentioned of EUR 1 million to EUR 2 million expected for 2022, you don't see any meaningful impact in the guidance as yet. It will become more relevant in the following years only.

[Operator]

Next question comes from the line of [indiscernible] with [indiscernible].

[Unknown Analyst]

Yes, I'd like to start off with another question on acquisitions versus CapEx. So obviously, you had a 3.8% gross yield, and I think you also stated, in the presentation, 4% to 5% yield of CapEx. So could you compare and contrast the expected total return or IRR that you see for acquisitions versus CapEx? And what is actually the ongoing case for doing acquisitions in a further compressing environment?

[Lars von Lackum, CEO & Chairman of the Management Board]

Yes. Thanks a lot for your question, [ Jab ]. Certainly, that is just year 1. So that's not the target yield, which we're having on those acquisitions which we are making. And as already explained, normally, we do modernizations. We see rent potential. We see potential to decrease the vacancy rate. So all of that certainly then translate in a higher rate than the 3.8%, which is just the day 1 acquisition yields, which we have just disclosed with 3.8%. So that is certainly something which gives us all the confidence to buy still into the market because we are matching certainly the CapEx yield, which we are seeing there.

[Unknown Analyst]

Yes. Could I tempt you to put some numbers on that for IRR? So for IRR, what's your target for acquisitions versus CapEx in, let's say, 10-year time frame?

[Lars von Lackum, CEO & Chairman of the Management Board]

We don't do 10 years. We do 5 years. And certainly, the portfolios we are acquiring then grow into the value over the course of the next years and once again meet then the CapEx yields, which you have just mentioned.

[Unknown Analyst]

All right. And then, I guess, my second question is given the strong yield compression in the markets, I think -- and also I think others agree that the relevance of LTV is actually decreasing and the relevance of net debt to EBITDA is increasing. Obviously, you still guide for an LTV target for next year. And no doubt the EUR 1.5 billion or 90% of that EUR 1.5 billion will fit into that 43% upper end. But still, you would probably see meaningful increase in net debt to EBITDA. So could you maybe share your thoughts on that balance and how you treat your equity requirements for potentially funding a, let's say, random EUR 1.5 billion acquisition in light of net debt to EBITDA fix?

[Lars von Lackum, CEO & Chairman of the Management Board]

Yes. So yes, with regards to the LTV, you know our target of 43%. And we are willing to also do whatever gives us the freedom to -- on our balance sheet. So therefore, we have not decreased that number. And with regards to the statement, which Susanne already gave, you've seen that we are well below the upper threshold, which we have given to the market, which is 13.5x with regard to net debt to EBITDA. So also there, we have some headroom. And therefore, as always, if we have a bigger transaction, we will look at the different options we have on the table, and then we make our decision. And for the time being, currently, we see quite a lot of headroom on the debt side, but also other instruments are available. We will make the decision if we get there.

[Operator]

Your next question comes from the line of Andres Toome with Green Street Advisors.

[Andres Toome, Research Analyst]

I guess my question is kind of a follow-up to the previous one as well. I'm just looking at your CapEx spend, and it's been increasing at a pretty brisk pace over the years, and one can only assume it will go higher that there's more need for energetic investments. So I'm just wondering how are you going to finance that? Just looking at your guidance for '22, your CapEx is pretty much in line with your FFO guidance already. And what -- how are you thinking about it? And are you just going to continue to use debt for that? And also, given that you have pretty aggressive, I guess, acquisition development ambitions, coming back to the previous question, do you think you need to raise any equity?

[Susanne Schroter-Crossan]

Yes. I think you're right that we anticipate to grow further in the next year. I think Lars has mentioned that we will look at the combination of LTV and net debt to EBITDA when making our decisions on financing. I think you are aware, we have all authorizations required to be in a position to do equity as and when we think it's needed. But also, in terms of financing, we have all other instruments available. We have a close dialogue with our lending banks for secured bank debt. We also have, of course, access to the debt market with our debt issuance program. We have a commercial paper program. So I think in terms of funding sources, we have all options available. And we will make the decisions on a one-by-one basis, taking into account the acquisitions we will complete and also further growth opportunities we see in the market. But we can't say more on that at this point.

[Andres Toome, Research Analyst]

Fair enough. And I guess looking at how LEG shares are trading in the kind of public market-implied cost of capital, it seems to be weak given the sustained discount. How does that kind of factor into your thinking about external growth and the need to maybe bring in more capital?

[Lars von Lackum, CEO & Chairman of the Management Board]

Yes. So I think Susanne and myself, we have given you all the transparency, but what we currently think about it, I think the share is not traded at a level where it should trade. You see our strong numbers operationally. We are on a very good growth path. So we still have to hope that with your help, the market learns quickly of how strong LEG has performed and so that the share trades up again.

[Andres Toome, Research Analyst]

But don't you think that maybe the public market is signaling that it should be instead maybe pulling back on your external growth ambitions here?

[Lars von Lackum, CEO & Chairman of the Management Board]

No, I don't see that as a sign.

[Operator]

[Operator Instructions] The next question comes from the line of Thomas Rothaeusler with Deutsche Bank.

[Thomas Rothaeusler, Research Analyst]

A couple of questions, one on the 7,000 acquisitions you've signed this year. Is it possible that you provide a bit more color on operational upside, rent reversion, vacancy, maybe what's the portion of subsidized [indiscernible]?

[Lars von Lackum, CEO & Chairman of the Management Board]

Yes, Thomas, so with regards to the assets which we have acquired, you have seen that the two bigger portfolios we have bought was one portfolio in Kiel and with around 2,300 units and one in the Rhine-Neckar region as stated last time, so both portfolios come, and none of those assets have been modernized. So they give us substantial upside with regard to modernization. But at the same time, especially if you look at the Kiel portfolio, and we are quite confident that we are also able because the former owner was not one -- a bigger company but was a private owner that we have substantial upside with regard to vacancy reduction but also rent upside. That is what we can disclose on those. But once again, it is -- if you compare it to the complete portfolio, we are running a smaller part. So it's not moving the needle so that you will see it in a way that we are increasing our like-for-like rent growth brought in by 10 bps or 20 bps, but certainly, it will contribute nicely, and it will bring up the high end -- the yield as already described and quickly into the range, which is very, very attractive from our perspective.

[Thomas Rothaeusler, Research Analyst]

Okay. Maybe one question on ESG and energetic investments, especially with regards to appraisal values. I mean at a certain point, do you expect this to lead to any premium valuation and how to appraise as we look at this currently? Are you in discussions with [indiscernible] beyond the topic?

[Susanne Schroter-Crossan]

Yes, Thomas. So it definitely has a positive impact on valuation. When we do our valuation, we look also -- in addition to the quality of the investment, also at technical scores and things like that. And obviously, if we renovate buildings to a higher standard, that will be reflected positively in the valuation.

[Thomas Rothaeusler, Research Analyst]

And maybe a last question on your dividend capacity and coverage. You're considering increase in CapEx. You just add to your modernization budget for next year by 10%. Maybe you can provide an update on how you look at dividend capacity. Maybe taking cash flow as a starting point and then also taking into account annual debt amortization, et cetera. Just to get a rough picture on how you look at it, that would be helpful.

[Lars von Lackum, CEO & Chairman of the Management Board]

Yes. As you know, Thomas, unfortunately, we are a cash poor industry. I would love to tell you otherwise, but you are just too long into the industry if you don't know that. So our dividend payment -- dividend payment rate, we want to keep stable at 70% of the FFO I, certainly taking into consideration that we are benefiting in the future from a stronger -- benefiting stronger from the BEG law. And you heard the numbers. They are quite small at the beginning, but we are quite confident that we can take advantage of those payments from the state in order to enable more modernization so that we can also smoothen the effect on the cash flow.

[Operator]

Your next question comes from the line of Robert Jones with Exane.

[Robert Alan Jones, Analyst]

Yes. Also three questions or topics from me: one on ESG, another on guidance FY '22 and a third on politics. On the ESG topic on Slide 22, you highlight that obviously you've now got, or will have going forward, those clear ESG targets linked to your compensation scheme. And I just wanted to understand regarding the 10% reduction on a CO2 per square meter basis, how ambitious is that by 2025? And what is the base year? Second, on the customer satisfaction, I think you said you wanted to improve that to 70%. So I just wanted to understand what that was today. And thirdly, on -- from an ESG perspective, what percentage of the comp is linked to the ESG targets? And then on the FFO question and the politics question, if you end up buying the Adler portfolio by the end of this year, obviously, we'll get the full benefit of that in FY '22. Can you give any sort of color in terms of the contribution to overall group FFO that you expect it to make in FY '22. Is, say, EUR 40 million a reasonable expectation? And then finally, on politics question. Obviously, we've got the coalition press conference. I think it's this evening. Any sort of comment from your side in terms of what you expect? Or do we think we could see a positive update? Or is it going to be a follow-up of the initial reaction in terms of how to deal with riding COVID case, et cetera, rather than necessarily a wider update on how those talks are progressing?

[Lars von Lackum, CEO & Chairman of the Management Board]

Hopefully, I got them all. If I miss anything, just please feel free to interrupt. So first one was on ESG and the targets. So the 10% CO2 reduction, which we have promised, certainly is based on this year now until 2025. And it is in line with the ESG strategy and the CO2 reduction path, which we have disclosed in June. So that certainly will help us to be then climate neutral by 2045. So it's exactly with our promises there. And the ESG targets, so which part of it is this 10% reduction target is 20% of the compensation of management. The second question was with regards to guidance and the impact...

[Robert Alan Jones, Analyst]

Just briefly on the customer satisfaction point target, 70%. What is it today?

[Lars von Lackum, CEO & Chairman of the Management Board]

Sorry, the customer satisfaction index is something which we are calculating based on a customer survey, which we are doing on a yearly basis. And that is something which we certainly try to improve over the course of the next years and trying to reach the top level amongst the peers in the industry. Second question was with regard to guidance. Rob, please understand that we are still in the midst of a due diligence. So normally, that's a point in time where we would normally not disclose that we have started to work on a certain project. So therefore, I just ask for your understanding that for the time being, we would not love to share any numbers because otherwise, later on, perhaps we'll learn more about the portfolio, and then we need to revise it. So therefore, please, we really promise to get back to you as soon as we have a result on that.And third, politics. It is really fascinating of how disciplined those people which are involved into the negotiations are. So it is really difficult to get an outside-in view into where current negotiations stand. And you might have heard that some of the points, and we also try to rise those points, which, from our perspective, are more than clear now. So higher ambitions with regards to building targets in Germany. So 400,000 seems to be something the current coalition has already agreed on, out of which 100,000 will be new developments in the social housing sphere. So that is a result, which is being quite transparent. On the other topics, they are very, very silent, so -- of how the evaluation of the current rent regulation will look like, and which measures they are really planning to do, it is difficult to get an outside reading. I doubt that you will get a lot of clarity as of today. Most probably, it will take another 2 to 3 weeks until we get more clarity around rental regulation and the current thoughts of the new coalition on that topic.

[Operator]

Next question comes from the line of Eleanor Frew with Barclays.

[Eleanor Frew, Research Analyst]

Two questions from me: one on compensation and one on BEG subsidies. So first, could you clarify the changes to the transaction-based compensation scheme that you mentioned? And then on BEG, could you explain what criteria for properties be eligible -- what criteria is to eligible? Then give a sense of how much of your portfolio is currently eligible for those schemes and how much you'd expect to spend to make more properties eligible on top of what you already planned to.

[Lars von Lackum, CEO & Chairman of the Management Board]

Yes. So with regards to compensation scheme and for the current transaction with its peer on the bigger portfolio, the Management Board has already decided that there will be no transaction bonus so that you can be absolutely secured that there is no financial interest of the Management Board in doing the transaction. At the same time, we are in current discussion with Supervisory Board of adapting the Management Board's compensation scheme. And that certainly needs to be proposed to the next AGM, which is taking in place in May 2022. And we are currently discussing to just delete the transaction bonus for transactions going forward.

[Susanne Schroter-Crossan]

And coming to your second question on the BEG subsidies, there is a relatively detailed catalog of different criteria that you need to meet to be able to apply for the subsidies. They are categorized into different categories. So there were subsidies of 20% or 40% or 45% depending on what technical criteria you achieve, and that is then sort of translated into an energy efficiency standard. So it sounds quite complicated. I think we had a detailed slide on that in our ESG presentation, which we published in June, which is also on the website where you will find more details on that. I think for the portfolio that is eligible, any sort of part of the portfolio, which is still able to be optimized energetically, and that is a majority of our portfolio. We could conduct measures and projects to -- that would be eligible for the BEG subsidies. So the question is rather more how much of energetic refurbishment we are able and willing to do per annum as a limiting factor rather than the eligibility within the portfolio.

[Operator]

Next question comes from the line of Marios Pastou with Societe Generale.

[Marios Antonios Pastou, Equity Analyst]

Just one left from my side. It's on Slide 8, and it refers to the new construction pipeline. Would it be possible to give a bit more detail on how the corporation agreement with Goldbeck will actually work and then also a bit more detail on the underlying yield on costs you're assuming for both that portion of the new construction pipeline and also the existing 500 units from 2023? Any updated assumptions there would be helpful.

[Lars von Lackum, CEO & Chairman of the Management Board]

Yes, Marios. So the construction cooperation with Goldbeck, we have just signed Goldbeck, the company which has, I think, from our perspective, in Europe, an incredibly -- incredible excellence with regards to serial and modular construction. They are currently being focused more on logistics and other asset classes. They have started first project into residential, but those are very few. So therefore, the joint interest of both cooperation partners is to do more construction, serial modular construction in the residential space. The target is to have 500 units being built as of 2026 on a regular basis. Target rent would be free financed then between EUR 9 to EUR 11. That's a level which you will not be able to reach with the traditional construction. And certainly, this would be then really be affordable living with regards to a new development in the German market. That is what the partners have agreed to strive for. And with regards to the first project, which we have identified, it's the one already being mentioned in Euskirchen, and certainly, that's the first project. And as always, with the serial products, you have ramp-up costs, you have costs of doing the cooperation, et cetera. So our hope, certainly, is that from the level which we reached there, and we will also be able to increase the yield on cost on further projects, which we will then build together. But that's something which is still to be seen and be proven. And we are confident that we can reach that because the partner has a lot of excellence in doing that. With regards to the 500 units, which are existing, and they come in at a slightly lower yield, and so at a rate of 3.3% on a regular basis, and with regards to the margin, which we are paying then from the developers, which we are buying from. And so that's for the turnkey projects we are buying but, certainly, the projects which we are building on our own land, and they certainly come at a much higher margin because certainly, you do not have pay for the land and the building plot.

[Operator]

Your next question is a follow-up question from Mr. Marc Mozzi of Bank of America.

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

Sorry, just a follow-up question on your funding, especially in the context of the Adler deal in regard to your convertible bonds, which are -- actually, one of them in the money. On that, would you just remind us how you're continuing this convertible bonds because you've got two of them for nearly EUR 1 billion into your funding of the Adler transaction?

[Susanne Schroter-Crossan]

So the existing convertibles will remain outstanding. They have no relevance in the context of the funding of the transaction. And as I said before, with regards to financing of potential transactions, we are completing -- we have all options available. We look at all options of financing, and we'll take the decision as and when we have the need to fund.

[Operator]

There are no further questions at this time. I would like to hand back to Frank Kopfinger for closing comments.

[Frank Kopfinger, Head of Investor Relations]

Yes. Thank you, and thanks for your questions. And as always, should you have further questions, then please do not hesitate and contact us. Otherwise, please note that our next scheduled reporting event is on March 10 when we report our full year 2021 result. And with this, we close the call, and we wish you all the best and hope to see you soon. Thank you, and goodbye.

[Operator]

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