LEG Immobilien SE

XETRA:LEG

Earnings Call Transcript 2022-Q3

[Operator]

Ladies and gentlemen, thank you for standing by. Welcome, and thank you for joining the LEG conference call. [Operator Instructions]

I would now like to turn the conference over to Mr. Frank Kopfinger, Head of Investor Relations. Please go ahead.

[Frank Kopfinger, executive]

Thank you, Andre, and good morning, everyone, from Düsseldorf. Welcome to our Q3 2022 results call, and thank you for your participation. As you have seen, we published the core elements of our guidance 2022 as well as our new guidance 2023 yesterday night already. We hope you also took notice after full reporting set, which we published this morning and which you find on our web page. Please note that there is also a disclaimer, which you'll find on Page 3 of our presentation.

We have today in the call our entire management team with our CEO, Lars von Lackum; our CFO, Susanne Schroter; as well as our COO, Volker Wiegel, who will lead you through the presentation.

And without further ado, I hand it now over to you, Lars.

[Lars Von Lackum, executive]

Thank you, Frank. Good morning also from my side. We are very happy to share our strong operational results with you today. However, as you might have already seen, we are also keen to share our view on the market environment and the recalibration of our business model to the current market environment.

The key takeaways for you should be, firstly, we continued our operational strength over the last 9 months so that we confirm our guidance for the full year by narrowing it down to EUR 475 million to EUR 485 million.

Secondly, we are proud of a strong set of financial figures, especially FFO I per share increasing by 11%. At the same time, like-for-like rental growth reached 3.2%, while vacancy rate has been reduced to just 2.1%.

Finally, we are proud to harvest the fruits of our numerous ESG initiatives. Our start-up Renowate, which strives for not less than becoming a market leader for serial refurbishment, kicked off its first project. Some of you took the chance to visit the project in person already. As of today, the project is almost finished, and Renowate even signed the first external audit. Please keep in mind that all this happens just 6 months after founding the joint venture.

We also achieved top schools within the employer survey, Great Place to Work, even improving our strong initial rating. We are among the best employers in Germany.

And lastly, we made a significant improvement within our customer satisfaction survey, which made us gain quite some ground towards our 2024 target. However, there is still a lot of work ahead of us, but we are on track in this marathon.

Thirdly, you should take away from yesterday's announcement and today's disclosure that we draw a realistic picture of the market environment. However, we do not have a crystal ball, and we can only adjust to a scenario we currently consider most realistic. We can take neither tail risks nor chances into account.

For H2, we expect a valuation decline of our asset base of 3% to 5%. Transaction markets are currently in a sit-and-wait mood. Further development is hard to predict. A substantial supply of assets meets an uncertain investment sentiment as further development of interest rates is uncertain.

Fourthly, we adjusted our business model to an even more defensive setup. Cash generation will be in focus during this more challenging environment.

For 2023, we shift to AFFO as our key KPI. We reduce CapEx spending and will also put dividend payment for the financial years 2022 and 2023 subject to the development of the market environment. We will prioritize the strengthening of our capital base over payouts.

Let me now guide you through our analysis of the market and the reasons for recalibrating our business model. I am now on Page 7. We are operating in a market that lacks new supply. Throughout the last decade, the German population grew by almost 4 million people, while new construction only added a little more than 2 million new units. This means that the structural deficit of the market got even worse throughout the last decade, and no government was able to tackle this problem even in a 0 interest rate environment.

We assessed that the structural deficit today in the market is about 2 million units. The situation in the affordable segment is even worse. No new units have been added while simultaneously higher inflation, ongoing immigration and an upcoming recession will even increase the demand and the pressure on the affordable housing market.

In parallel, the current existing pipeline will dry out. New projects will not come to the market due to high financing costs, higher material costs and new building requirements that simply do not allow for the creation of affordable housing.

From 1st January 2025, new buildings need to be built according to the Efficiency House Standard 40. New buildings need to require 60% less energy than a new standard house. As always, the last efficiency gains are the costless ones and require lots of technology.

Same here. I would bet that, if even anybody, only a tiny fraction amongst you live already in these efficient units. However, this will be the minimum legal requirement for new buildings in Germany going forward.

Based on today's prices, the construction cost per square meter amount to EUR 5,000. This is far from being affordable for our tenants and far from being a mass solution. So there is a strong rising demand for affordable products hitting a market which is already completely rented out and no additional supply of new product in sight. Our vacancy rate of 2.1% is a strong proof of that market development.

While the supply-demand imbalance will increase, let me point out another important market driver for us, the interest rate environment, which you find on Slide 8. As you are all aware, the interest rate environment completely changed since the beginning of the year. The German Bund yield saw one of the sharpest increases in its history. Our own 2032 bond issued at the end of last year with a coupon of 1% offers now a yield of around 6%.

The new interest rate environment clearly affects our cost of capital. Our preferred instrument at current conditions would certainly be secured financings. As we always kept the balanced approach between unsecured and secured financings, we have an excellent access to all real estate financing banks in Germany.

The sharp surge of interest rates and a high level of volatility of interest rate markets also put a harsh hold on transaction markets. Most of the bigger institutional investors are sitting on the sidelines, and buyers as well as sellers seem to wait for interest rates to stabilize.

Given all international central banks are in different phases of the tightening cycle and risk to overtighten against the potential upcoming recession, markets are clearly far from being in an equilibrium in which investors have clarity and visibility on the new stable level of interest rates. However, we, as a management team, are convinced that more of the same is not the appropriate answer to the current challenges and, consequently, recalibrated LEG's business model to the new market environment.

Slide 9 summarizes how we react and adapt the business model to the current challenges. We focus on the execution of all operational levers at hand. The main aim is to preserve cash for as long as the current challenging environment persists. Thereby, we increased the resilience of the group and have the opportunity to boost their capitalization.

Specifically, we identified 4 levers. Firstly, we strengthened operations. With respect to cash inflows, we expect to increase rents like-for-like by 3.3% to 3.7%. This will be the strongest rent increase in LEG's history. We have included 60 basis points from the cost rent adjustment for our subsidized units. First calculations indicate that the number seems to be too conservative and holds some upside.

At the same time, we reduced our investment spending next year significantly. We started already this year to reduce our spending by canceling projects. This will continue so that we will have a substantially lower number of projects also going forward. Thereby, we reduced our investments to EUR 42 per square meter for this year and then again to EUR 35 per square meter for 2023. This represents savings of 26% for this year and 41% in real terms against the original 2022 level. Additionally, we implemented a cost-cutting program to take out more than EUR 10 million of our cost base in operational as well as in admin costs.

Secondly, we confirm to run off our new development business. We already withdrew our new development targets in Q1 this year. Even further, we will now simply finish our existing pipeline, benefiting from the fact that most of our own and external projects are realized on fixed prices. Therefore, our pipeline will run off throughout the next 3 years. We have a total of EUR 263 million of remaining investments until 2025 ahead of us. You'll find more details on our development pipeline going forward in the appendix. This flexibility and the small exposure overall of the development business is one of the key difference of LEG versus all other listed peers.

Thirdly, we stopped our acquisitions, and we will become a net seller. All members of our acquisition unit are now busy with working on our disposal pipeline. As of today, we sold around 400 units for a mid-double-digit million euro amount. We are in the marketing process for more than 5,000 units and are still hopeful to sign some more disposals until the end of the year. Currently, we have visibility to reach a disposal volume for the full year of around EUR 100 million to EUR 200 million.

Fourthly, while we bring down our investments, we want to continue to focus on innovation within the group. Front-running innovative developments allows us to position ourselves as the solution provider for the industry and opens up third-party business in the mid- to long term.

By driving innovations, we can also smartly offset some of the lower investment spend and still stick to our CO2 reduction targets. Specifically, we expect that nudging of the customer towards less consumption of heating will realize a substantial part of the CO2 savings which we lose from a lower level of energetic modernizations.

With the new steering towards a cash-driven model, we also shift our steering away from the FFO I to the FFO -- AFFO, excuse me. This will lead to some changes in respect to KPIs. Our new main KPI will be AFFO. We expect AFFO to reach EUR 110 million to EUR 125 million for 2023. This compares in terms of FFO I to a range of EUR 425 million to EUR 440 million. Please note that we will continue to report FFO I, but we will not steer the business accordingly. We consider FFO I to be the wrong steering and reporting figure in the current challenging environment. Volker will later explain the accounting effects, which you should have in mind. In a nutshell, by shifting to AFFO as our core KPI, we give up focusing on accounting-driven FFO I contribution and instead put saving cash in the focus for everyone in the organization.

Let's now move to Slide 10 to give you some more insights into our new steering. Our new steering will come along with several changes, be it in our target setting or on the disclosure of numbers. To align internal steering and external communication, we focus on AFFO as our cash proxy figure. FFO I served as a strong indicator for operational success in a low interest rate environment, which benefited the sector strongly. The current environment, however, requires a more holistic KPI which also reflects cash outflows and the ability to generate cash. We consider AFFO to be a very easy KPI for you to model. Certainly, it will also be reflected within the update for our remuneration system, i.e., being based on an AFFO per share.

With this, we will also set the foundation of the dividend payment on a new and sustainable basis, which reflects the current challenging market environment. We aim to pay out 100% of the AFFO as it reflects much better the free cash generation from our operating business.

Additionally, we aim to pay out a part of the net proceeds from disposals. Given the uncertain environment, we put both under the condition of further market development. To be a bit more precise here, we need to see how the transaction market and interest rates develop from here and where they stand once we need to make a decision. If the picture gets clearer, we are happy to take away that conditionality. We simply want to keep that option for now as we do not want to make uncertain promises or promises that simply depend on the development of transaction markets.

And with this, I hand it over to Volker.

[Volker Wiegel, executive]

Thank you, Lars, and good morning, everybody, also from my side.

Let me start with Slide #12 and a quick look at our portfolio. Overall, the total number of units has hardly changed compared to Q2. We added 177 units while disposing of 47. These numbers don't include the successful signing of 2 transactions that help to further optimize our asset base. In September, we signed an acquisition of around 370 attractive units located in Düsseldorf and Cologne. Transfer is scheduled for January 2023. At the same time, we succeeded in selling around 340 units with some structural issues. A part came to us from the Adler acquisition and was earmarked for disposal. The sale will free up some internal capacity and helps to focus on the successful integration of the core Adler portfolio. We can confirm that the 405 units have been sold at around book value.

Coming back to the standing portfolio, I'm now on Slide 13 to give you an overview on the rent development. In comparison to September '21, the in-place rent in our portfolio grew strongly by 3.2% to EUR 6.32 on a like-for-like basis. Rent table adjustments contributed 2% while modernization and reletting added another 1.2%.

Looking only at the free financed part of our assets, we see an impressive increase of the in-place rent by 3.9% to EUR 6.73. Let me highlight that all 3 market segments contributed to this and with similar growth rates. Just to mention, the locations in the free financed portfolio was the strongest improvement year-on-year. These were born in the high-growth market with 6.6%; Bielefeld, a stable market with 6.3%; and Duisburg representing the higher-yielding segment with plus 5.5%. Therefore, we are well on track to reach our 3% rent growth target for the full year. This will be almost exclusively driven by the free financed units. The contribution from the subsidized units will remain low given that the next cost rent adjustment will take place in January 2023.

The regulation on the cost rent adjustment is quite complex. In a nutshell, there are 2 components of the rent, i.e., administration costs as well as maintenance costs that are linked to the 3-year CPI development from October 2019 to October 2022. The final CPI figure is to be released tomorrow by the Federal Statistical Office. Based on preliminary figures, CPI development was around 15%. In the guidance, we have calculated with the contribution of circa 60 basis points to the next year's rental growth on a portfolio basis. However, first calculations indicate some upside to that number, as Lars pointed out.

Speaking of rents, we also -- we may also have a look at the ancillary costs that are not included in the code rent. Against the backdrop of the extreme rise in energy costs, we have been supporting our customers in the last month through a comprehensive set of measures. Our approach is twofold. On the one hand, we focus on the reduction of energy consumption through an optimal adjustment of the heating systems and to a wide-spanning information campaign for our tenants. On the other hand, we advise on financial support like applying for housing subsidies or offering installment payments.

The largest support in financial terms, however, comes from the German government. We are certainly aware of the relief packages that have been presented in the past months. They include a gas price break as well as an electricity price break. The total volume of support adds up to more than EUR 200 billion. We are very confident that state aid but also the general positive trend in incomes and pensions and the responsible behavior of our tenants will largely minimize payment defaults.

Let me now move on to Slide 14. Our low vacancy rate, calculated by EPRA standards, already dropped further to 2.1% on a like-for-like basis. We are virtually fully let with regards to the units that have been part of our portfolio since at least 12 months. Looking at the portfolio as a whole, EPRA vacancy stood at 2.9%, a slight increase by 20 basis points, which reflects the portfolio bought from Adler. I'm convinced that we can increase the occupancy rate in this sub-portfolio over the coming months as we have an unmatched track record in managing higher yielding assets.

In the last 12 months, we were particularly successful in reducing the vacancy rate in large locations. In Düsseldorf, vacancy rate dropped by 18 basis points to 0.9%. And all of the top 5 locations in the stable markets increased their occupancy rates by 15 basis points or even more. In the higher-yielding markets, we achieved record-low vacancy of 2.3% in Duisburg or 1.9% in Hamm. All these figures are on a like-for-like basis. All this underpins our very good operational position. The huge demand in the affordable sector helps keeping vacancies at record-low level and underpins what Lars said at the beginning about the severe supply-demand imbalance.

Coming to Slide 15 and our investment approach. Overall, investments increased by 14.9% to around EUR 354 million year-on-year. This is well in line with the number of units in our portfolio that grew by 14.5%. However, looking at the investment per square meter, which is adjusted for new construction on own land, acquisition backlog and capitalized own services, the number decreased by 2.7%, reflecting of actions taken to deliver the slowdown in spending against the backdrop of cost inflation and interest rate increases.

In absolute numbers, investment per square meter was EUR 28.82 for the first 9 months. We already reduced our investment guidance to less than EUR 46 per square meter with the Q2 results. In view of high capital efficiency, we are about to further reduce our spending. As Lars already mentioned, we are now guiding for around EUR 42 per square meter for the full year 2022.

However, when it comes to our ESG commitment for 2022, we are not going to cut any projects at the expense of our ESG KPIs. However, there is potential to do so.

It is incredibly helpful that we run a flexible organization. Most of the modernization projects are being realized by external craftsmen. At the same time, we are not bound by contracted minimum volumes, so we can counsel as well as renegotiate prices and contracts quickly a high option value in uncertain times.

Following the update on the 9-month number, let me provide you with an outlook for the future. Before we go further into detail, I would like to highlight one accounting effect, which you can find on Slide 16. As we shift from FFO I view towards a cash view being measured in AFFO, we will bring down our investment spending. This comes with cash savings, but it comes with a lower capitalization rate overall. Due to our lower spending, we expect that less investments qualify for capitalization. And as a result, the maintenance spend will increase. From an AFFO perspective, this shift of euro spend from CapEx to maintenance is neutral and has no effect, while the FFO I is negatively impacted by the higher maintenance figure. We illustrated this for our expected spending budgets for 2022 and 2023. The lower spending level leads to save cash of EUR 77 million but, at the same time, to around EUR 15 million higher maintenance costs.

And with this short explanation, let me walk you through our 2023 investment budget on the next slide. On Slide 17, you see our investment program. In the past, we focused on adjusted CapEx and adjusted maintenance. This was the basis for our communication. We wanted to present the part that was really used for the refurbishment and improvement of our buildings. On that basis, we reduced our investment spending from EUR 42 per square meter to EUR 35 per square.

And on the AFFO view, we take our entire investment spending into account and expect investments financed by subsidized loans or received subsidies. This includes new development and other items especially from capitalization of own services. This is pretty much in line with the reported AFFO in the past, i.e., from this perspective, not much has changed. I just wanted to flag from cash outflow, i.e., an AFFO perspective, you need to take into account the entire CapEx spend. The new development part will run off, as Lars highlighted, and as you can see in the event.

So for 2023, we expect on the basis of EUR 35 per square meter total investments in the existing stock of EUR 455 million to EUR 475 million, which are AFFO relevant. As maintenance is already reflected in the FFO I, the EUR 315 million to EUR 325 million of CapEx should bridge the gap towards the AFFO.

I hope this gives you some more insight into our consideration. And with this, I hand it over to Susanne.

[Susanne Schroter-Crossan, executive]

Many thanks, Volker.

I will proceed with Slide 19 and the development of the key P&L items. In the first 9 months of the fiscal year 2022, net cold rent rose strongly by 17% or EUR 86.9 million to EUR 596.6 million. Our net acquisitions contributed more than 80% to the increase in our net cold rent.

The adjusted net rental and lease income increased by 14% or EUR 57 million to EUR 477 million. The increase was once again driven by higher net cold rent but also by the continuous growth in our services business.

The adjusted net rental and lease income margin declined from 82.4% to 79.9%. The margin decline year-to-date was, as already explained in previous calls, driven by the acquisition of the Adler portfolio, which is currently generating a lower margin. We are going to increase the FFO I of the Adler portfolio by over 30% until 2026, as we communicated at the time, and accordingly expect an improvement of the margin. Besides, the higher provisioning for not-yet-invoiced operating costs impacted the margins as well.

In the 9-month period, the adjusted net rental and lease income margin was 140 basis points above the level of the first half year. The positive margin development from H1 to the 9-month period was driven by a better maintenance cost ratio as well as an increased positive contribution from what is shown in the FFO table as others. The line item others includes positive contributions from our services and here in particular from our biomass power station due to the high energy costs.

On the negative side, in absolute terms, the provisions are not yet invoiced. Operating costs increased further during Q3 by another EUR 3.9 million and now amounts to EUR 12.4 million. As explained in the Q2 call, one reason is that our tenants will face significantly higher additional payments, in particular, from energy than in previous years.

As was also explained during our call in August, due to higher interest rates, a regular impairment test in Q2 led to a goodwill amortization of a total EUR 100 million, of which EUR 59 million were attributable to operations impacting net rental and lease income and EUR 41 million increase in admin expenses.

We continue to expect to also write-off the goodwill related to the portfolio acquisition from Adler and completed at the end of last year. As the purchase price allocation and, thus, the allocation of the goodwill to the cash-generating units is only completed during this year, a corresponding impairment test can take place for the first time at the end of this year. The write-down has nothing to do with the performance of the portfolio but is solely the result of a significant increase in interest rates and, hence, increased capital costs.

The adjusted EBITDA increased by 14.5% to EUR 458.7 million in the 9-month period. The adjusted EBITDA margin declined from 78.6% to 76.9%. But again, the margin improved by 210 basis points in comparison to the margin realized in the first half of this year. And ongoing strict cost discipline in the administrative functions supported the positive drivers I just explained in connection with the adjusted net rental and lease income margin. With a positive development in the third quarter, we are fully on track for our financial year target of circa 75%.

The FFO I reached EUR 374.3 million, which matches an increase of 12%. On a per-share basis, the FFO I increased by 10.6%. For the detailed drivers of the FFO I development, let us now move to the next slide on the FFO bridge.

In the 9-month period, acquisitions contributed with EUR 49.9 million, most to the increase in FFO I. The second highest positive impact came from rent increases in the standing portfolio with EUR 14.4 million. The block others contributed EUR 4.3 million driven by our biomass heating plant. Finally, lower maintenance costs had a positive impact of EUR 2.5 million.

Negative effects on the FFO development came in particular from rising cash interest cost of EUR 18.3 million. These higher costs are mainly directly linked to the increased financing volume driven by our acquisitions from 2021 and the issuance of corporate bonds. The higher like-for-like operating costs are driven by the portfolio growth but also by higher provisions for not-yet-invoiced operating costs.

On Slide 21, we provide an overview of the valuation of our portfolio. As we did not revaluate the portfolio in the third quarter and as the number of units is basically unchanged versus H1, there are no major changes in comparison to our H1 reporting. For the first 6 months, we reported a revaluation uplift of 6.1%. The gross yield stood at 4.1% at the end of Q3, and the total gross asset value amounted to EUR 20.1 million. Including leasehold land value and assets under construction, the IAS 40 gross asset value is EUR 20.8 billion. The gross value per square meter is at EUR 1,839 on average, ranging from EUR 1,241 per square meter in the high-yielding market to EUR 2,591 per square meter in the high-growth market.

Let's move to Slide 22. On the left-hand side, you see that we have no significant maturities until fiscal year 2024. However, assuming no further disposals in our 2023 budget, we will need to raise further debt in 2023 to finance some of our obligations, for example, to finance some new construction projects which we can't stop. Of course, our disposal program bears the potential to generate funds and to offset this financing need.

The average debt maturity is now 6.8 years. Our average interest cost of 1.26% are basically unchanged from a year ago. Overall, roughly 94% of our financial debt is fixed with regards to the interest rates we have to pay. Our net debt to EBITDA stood at 15.2x at the end of Q3 and the LTV at 42.3%.

I would like to highlight that we are in a comfortable position with regards to our bond covenants. We can digest a drop in valuations of more than 30% before we hit our tightest bond covenant. Besides our cash on hand of around EUR 450 million, we have undrawn credit lines with a volume of EUR 600 million as well as our commercial paper program with a volume of another EUR 600 million in place.

And with this, I would like to hand back to Lars for the guidance of 2022 and 2023.

[Lars Von Lackum, executive]

Thank you, Susanne. I am now on Slide 24 with our guidance for 2022. Based on the business performance in the first 9 months, we can confirm and specify our earnings targets for the financial year 2022. We narrowed the forecast for the FFO I from previously EUR 475 million to EUR 490 million to EUR 475 million to EUR 485 million. Our goals for the like-for-like rent growth and the EBITDA margin remained at around 3% and roughly 75%, respectively. With our half year figures, we already reduced the guidance for the investments per square meter from initially EUR 46 to EUR 48 per square meter to be low EUR 46 per square meter. Due to our spending discipline, we can specify this now and expect a level of roughly EUR 42 per square meter.

Our LTV will be influenced by factors which we have actually not in our hands, in particular, valuation effects and portfolio disposals. In general, we stick to our target of maximum 43%. However, we cannot rule out to exceed that level depending on the market development. On a medium-term basis, we confirm our ambition of a maximum level of 43%.

For the dividend 2022, we confirm the 70% payout ratio but subject to further market development. In case the market deteriorates further, we regard the dividend payout as a potential capital buffer within our framework. We are convinced not to be well advised to pay out a record-high dividend for the price of weakening the capital base of the group.

With regards to acquisitions, we stated with our half year report that we are highly selective. As of October 1, we have stopped our acquisition activity completely. Finally, we confirm all our ESG targets for the current fiscal year.

Coming to the guidance for the next financial year on Slide 25. We expect like-for-like rent growth to pick up even further, also driven by the cost rent adjustment and subsidized portfolio, and to reach between 3.3% and 3.7% at year-end 2023. For the AFFO, which will become the most important key figures, we forecast a range between EUR 110 million to EUR 125 million for 2023. For information purposes, this compares to an FFO I of EUR 425 million to EUR 440 million.

FFO I is below market expectations due to several factors. One, the shift towards a cash view leads to higher maintenance expenses following a lower capitalization rate. Two, the conservative assumption of no further sales increases the financing volume at higher interest rates, which at the same time are being reflected in the non-fixed part of our financing. Three, the higher inflation drives higher costs from wages and materials. And four, the excess profit tax for power producers strongly impacts profitability of the biomass power plant. We will certainly continue to report FFO I, but we will no longer provide our official guidance as AFFO will be our leading KPI. You will find an FFO I bridge in the appendix of the presentation.

On profitability, we forecast an adjusted EBITDA margin of 78%. Please be aware that we adjust the EBITDA differently than in the past to align it with our internal steering of our operations. This number is adjusted for maintenance, internally procured and capitalized services and nonrecurring special effects.

As already mentioned, we are going to scale down our investments. Nevertheless, we will still spend around EUR 35 per square meter to maintain and improve the quality of our portfolio.

Concerning gearing, we stick to an LTV of 43% as a medium-term target level. As dividend proposal for business year 2023, we intend to propose to pay out 100% of the AFFO plus a part of net proceeds from disposals. Like our 2022 dividend, we put it under the condition of the market environment for the time being. Once we face clearer skies, we are happy to remove this condition.

Finally, new KPIs will be reflected in these -- in the remuneration system. This will be proposed to the AGM 2024 together with the new ESG targets for STI and LTI.

With this, I conclude our presentation, and we are happy to take your questions.

[Frank Kopfinger, executive]

Thank you, Lars. And with this, we begin the Q&A session, and we hand it over to you, Andre, to guide us through the Q&A.

[Operator]

[Operator Instructions] The first question comes from the line of Rob Jones from BNP Paribas Exane.

[Robert Jones, analyst]

Just before I start, would you like all the questions at once or would you like them one by one?

[Frank Kopfinger, executive]

Just one by one. And Rob, you're very muted at our end. Maybe you can speak up a little bit.

[Robert Jones, analyst]

Okay. Is that better, Frank?

[Frank Kopfinger, executive]

Yes, that's better. Thanks, Rob.

[Robert Jones, analyst]

Fine. Okay. So we'll do them one by one. So firstly, on dividends, '22 divi I appreciate you say subject to kind of further market condition development. When I look at your guide of minus 3% to minus 5% for capital values, doesn't that result in a scenario where aside from any material disposal in the next few weeks, which is going to be challenging, your LTV is going to be above that 43%? And if that's the case, then why not just cut the dividend today rather than waiting another 3 months and then cutting it? That's my first question.

[Lars Von Lackum, executive]

Thanks a lot, Rob, for the question. So with regards to the LTV, you're rightly assuming that if we are really going to see a decline of valuations of 4 to -- 3% to 5%, then certainly, we would end up with an LTV above 45%.

Still, we are very much uncertain with regards to further market development. Volatility and uncertainty has been not as high as during the last weeks, I think, within the last decade. So therefore, it is very difficult to say what's going to happen over the course of the next weeks, so therefore, we just want to take that into consideration of how the valuations are developing but also take into consideration of how the transaction markets are behaving. And there, once again, we also want to see how much of transactions are going really to happen and whether we can also benefit from perhaps a bit better situation. Currently, the situation is, as described, very, very silent, so not much is going on there and only very small portfolios being traded.

[Robert Jones, analyst]

Okay. That's very clear. And I've just got 3 more questions. One is in terms of the dividend policy from FY '23 onwards, which, by the way, I think from a sustainability perspective is very good in terms of your free cash flow. But my query around it was, obviously, not only do we not know what disposals you might execute on any given year, but even if I forecast that correctly, we then don't know for the element that isn't the AFFO payout of how much of that disposals proceeds that you are going to pay out as part of that overall dividend distribution because, obviously, it depends on how much you want to continue to delever the business, et cetera.

So obviously, that -- I think potentially that leads to a scenario where we have less visibility on the dividend in magnitude, albeit the policy is very clear. Could we get a policy clarification, do you think, at some point in the future in terms of the elements of the distribution that isn't linked to AFFO? Or do we -- do you think we'll have some uncertainty around that absolute level of distribution in future years?

[Lars Von Lackum, executive]

Yes. Thanks for the second question, Rob. So with regards to dividend 2023, you've seen it. So there is stable element. So we already said we want to be prepared and are prepared to propose to really pay 100% of the AFFO. Unfortunately, due to the high uncertainty in the market, and we do not even have visibility over the next 8 weeks as we normally had and were able to give you really precise answer, it is very difficult to predict the next 12 months. So therefore, we did not feel comfortable to say we are really dedicating ourselves to a certain share of the net proceeds. But certainly, if we get more visibility over the course of next year and there is more transparency on that, we are also very happy to give you more transparency from our end of how much we would be willing to really share of the net proceeds we are realizing from transactions in the market.

[Robert Jones, analyst]

Okay. That's very clear. And then I'll do the final 2 questions at once because they're relatively short. In terms of incremental secured borrowing capacity, obviously, you've got a figure in there on one of the slides. But when I look at your '24 unsecured and your -- I think, early '25, it comes to about EUR 900 million, which pretty much eats up the majority of that capacity of incremental security if we see no decline in capital values. And I'm just wondering if -- how you are thinking about that or to what extent, obviously, therefore, as a result, we either need the unsecured market to open up again or maybe asset disposals.

And then the final question, and this perhaps a more personal one. And so if it causes offense, then I apologize. But it doesn't, I don't mean to, which is in the appendix on Page 44, obviously, as a result of your change in kind of key targets and obviously moving towards an AFFO-based model rather than FFO, you're updating your compensation kind of KPIs for '23 to '26. I wonder if on this call you could commit to saying that if I was to back test whatever the new policy is based on previous years, that management compensation under the new model, if you were, say, looking at FY '20 or FY '19 or whatever it might be that, that compensation won't go up as a result of the new policy, if that makes sense.

[Susanne Schroter-Crossan, executive]

Yes. Thanks, Rob. I'll take question 3. Yes, so you've asked firstly for the incremental debt capacity, right? It's around EUR 1.4 billion if we look at current asset values. If we have a valuation decrease of, let's say, 10%, which we are not forecasting, it lasted for this half year. But just to give you some perspective there, it goes down to around EUR 1 billion.

I think when you look at our upcoming maturities in 2024 you have to differentiate. There was EUR 500 million of unsecured debt, which, of course, we could consider refinancing with secured debt. The other half is already secured debt. So by refinancing that with new secured debt, we are not changing the capacity, right, because it's already secured as of today. So therefore, it doesn't eat into that capacity. And therefore, we feel very comfortable that we have sufficient capacity on the secured debt side to address the upcoming redemptions.

[Lars Von Lackum, executive]

And with regards to the second question, Rob, so certainly, we are not in the position as a Management Board to define our own compensation. So it's in the hand of the Supervisory Board. Discussions in the Supervisory Board are certainly in the way that, they are very much interested to have a strong alignment between the development of the company and the management compensation.

So just changing the numbers from -- and the key KPI from FFO to AFFO will have no impact on the amount of money being paid to Management Board. Therefore, during the presentation, we pointed out one of the KPIs definitely will be the AFFO per share. But that certainly will be added by ESG criteria, as you are used to, but also the Supervisory Board. And we'll make sure that management is equally focusing on growth of the company as well as ensuring that we are running a high-quality asset base.

[Operator]

The next question comes from the line of Bart Gysens from Morgan Stanley.

[Bart Gysens, analyst]

One follow-up question on the dividend questions that Rob just asked. Why do you wait till beginning of '23 to change the dividend policy? Why not -- I appreciate you've added some kind of clause that gives you a bit of leeway, and maybe you'll go to 0 when you actually announce the '22 dividend early '23, but why not change the dividend policy already for '22?

[Lars Von Lackum, executive]

Thanks a lot for the question, Bart. Because once again the uncertainty in the market is really something we have not seen over the last decade, so therefore, we just want to see how the market is going to develop over the course also of the first months in 2023 before we then come out with the final dividend proposal for the AGM in 2024. Currently, we felt that would be too early in that very uncertain market situation.

[Bart Gysens, analyst]

But you come up with a very detailed statement. You clearly had the confidence to come up with a very detailed statement, so you've clearly thought long and hard about it. Why not cut everything to 0 now if you're cutting the dividend really to shore up the balance sheet? Why not go all the way? And then you can always come back on that commitment.

[Lars Von Lackum, executive]

Yes, because so much is currently happening in the market. Uncertainty is high. We do not know how investors' behavior will be after year-end. So our assessment is that we are not going to see opening up the transaction market over the course of the next 8 weeks, so number of transactions remains low. And that already makes uncertainty with regards to valuation of the assets much more difficult -- much higher than in the last years. So therefore, from our perspective, we are well advised to not rush into that decision now while we have all the time to take the decision in April when we send out the dividend proposal to the AGM.

[Operator]

The next question comes from the line of Thomas Rothaeusler from Deutsche Bank.

[Thomas Rothaeusler, analyst]

One question on financing, actually. I mean it seems like everybody is going for secured financing now. What would you say is the appetite and also maybe the capacity of mortgage banks to do all that volumes? Maybe we can get some view from you.

[Susanne Schroter-Crossan, executive]

Yes. So I think that I can obviously comment best on the discussions we are having with banks and their appetite for LEG. And I can confirm that appetite to do business with LEG in the secured space continues to be strong. We have ongoing dialogue with banks, of course, and I have the strong understanding that nothing has changed in their view on the company and, generally speaking, on the attractiveness of financing also German residential portfolios, especially if they are well managed.

[Thomas Rothaeusler, analyst]

Okay. Maybe another question on rental growth. I mean if I look at your guidance for next year and adjust for cost rent impact, it is like, I think, roughly 2.9%, which is, yes, roughly in line with the level you expect for this year. So it seems like you're not that upbeat on market rental growth than one of -- or some of your competitors. Maybe you can comment on that.

[Volker Wiegel, executive]

Sure. Happy to take this question. I think there are several factors that more significant growth. You know that the tenants have a high burden of energy costs and inflation to bear. So -- and tables adjust quite slowly on new market developments. And I think we should also take our -- take this into consideration not to be too bullish on the rent growth with regards to the share that can be borne by the tenants and then to have more payment defaults at the other end. So that wouldn't make sense in the balance sheet.

And on the other side, you also see that we decreased our investments for modernizations and for turn costs, which also might have a slowing impact on rent growth for our new lettings.

[Thomas Rothaeusler, analyst]

Okay. And do I get it right that, I mean, if we consider reduced investment, then rental growth for beyond 2023, let's say starting from '24, should get another hit from lower returns from investments? Is that right?

[Volker Wiegel, executive]

Well, Thomas, we are now talking about 2023. And I think Lars pointed clearly out the difficulty to see over the last 8 weeks -- the next 8 weeks, and so I don't want to talk anything about 2024. But we see a very high demand in the market for a product which is very limited. And I think in all economic sense, this should have an impact on prices if availability of product is low and demand is high.

[Thomas Rothaeusler, analyst]

Okay. Maybe last one on AFFO focus and also remuneration. I mean isn't there a conflict? I mean you are incentivized for lower investments to increase AFFO at the end of the day, but at the same time, you have to stick to the climate path targets.

[Lars Von Lackum, executive]

Yes. So therefore, we make sure that we are being incentivized on both sites. And Thomas, it's absolutely the right question. So certainly, the Supervisory Board will make sure in its proposal to the AGM that both sides are being taken into account, that on the one hand side, we are sticking committed to the CO2 neutrality to be reached by 2045, the quality of the assets being run by the company, but also by maximizing AFFO per share via growth but also via strict cost management.

[Operator]

The next question comes from the line of Andres Toome from Green Street.

[Andres Toome, analyst]

I have a few questions. Starting with the FFO I bridge into 2023 and particularly on the interest expense component, just gauging that chart and measuring it feels like the interest expenses are going up about EUR 30 million next year. And obviously, I do appreciate the fact that there's 6% variable debt, which is heading higher. And as you mentioned, you would have for some part of the year higher just debt to refinance that January 2024 bond as well.

But I'm just wondering how much in there is also the fact that you have 5% of derivatives and any sort of rehedging cost impact in 2023 and, in addition, how much capitalized interest are you losing in FFO I interest expenses in next year given you're cutting back on both modernization and new development.

[Susanne Schroter-Crossan, executive]

Yes. So let me start with the additional interest next year. So about half of that amount, that you rightly pointed out, is coming from additional incremental debt. So if we are, of course, financing less because we make progress on disposals, then that portion will go down. And the other half is about 50-50 between variable debt that you pointed out and the full year effect of financing that we did this year because that will also, of course, then apply for full year for the first time and have an impact there as well.

[Andres Toome, analyst]

So there is no impact from capitalized interest or anything of the sort?

[Susanne Schroter-Crossan, executive]

No. That is what I just said about half comes from incremental debt, and then the other half is split 50-50 between the variable debt portion and the full year effect of 2022 refinancing and new financing.

[Andres Toome, analyst]

Understood. And then maybe turning to disposals, just trying to understand your sort of viewpoint of the transaction market today. Obviously, it's difficult, but we felt like you were pretty confident about closing some disposals just a month ago. And I think one of your peers very recently also seem very confident about closing a very large amount of disposals into the next year. I'm just trying to maybe put these pieces together.

[Lars Von Lackum, executive]

Yes, Andres. So with regards to what we have disclosed in August was that already we were under the impression that bigger transactions are not working in the current market, and that has proven right. So we already needed to resize to 100 to 500 units per portfolio. Unfortunately, even those portfolios have proven to be too big for the market. We are now really down to selling of single multifamily houses. Single multifamily houses, this is what is currently the sweet spot for the market.

I think it is also a reflection that bigger institutional investors have left the market. They are really at the sidelines. Uncertainty with regards to the right interest rate level and then also with regards to the pricing of transactions is incredibly high, so therefore, our assumption is that doing that, we will be able to add additional transactions to what we have already been able to execute over the course of the last weeks and hopefully ending up in the range of EUR 100 million to EUR 200 million. But we do not think that we will be able to do more because the market is just too silent on bigger portfolios.

[Andres Toome, analyst]

Understood. And my final question comes to the investments you are planning. And obviously, in recent years, it's been ramping up at a really rapid pace if you just think about your total CapEx envelope. Just wondering, where do you see the sort of long-term sustainable CapEx expenditure per square meter in your portfolio?

[Lars Von Lackum, executive]

Yes. So that's very difficult to answer, Andres. So with regards to now the cost of capital being taken into consideration, we felt well advised to cut it down to EUR 35 per square meter. At the same time, and that's of huge importance, we will invest into innovative solutions. That is an absolute necessity, from our perspective, if you want to make sure to drive down the euro per ton cost of CO2 reduction. Therefore, we will strongly work on cooperations like the one we founded with Renowate.

And that certainly has a direct implication of how much money we really need to invest into modernization. So I think carving out the modernization part, we feel very comfortable that with regards to the maintenance part, which is being impacted now by a different capitalization right, we are at a sustainable level. With regards to modernization, that will highly depend on the progress we are able to make on innovative solutions being driven forward and then, hopefully, scaling up over the next years.

[Operator]

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

[Jonathan Kownator, analyst]

Just first question, I just want to go back to this AFFO and this long-term investment question. I mean obviously, as you're highlighting, this is a very uncertain environment, you don't have visibility over 8 weeks, yet you're changing the way you want to steer the business, the AFFO. And obviously, in the short to midterm, I'd say the surest way to drive AFFO up is to cut investments. So why don't you cut investment more? Or how do we understand how you steer that uncertain element of investments going forward given that you're now looking at a KPI that is very easy to just improve whilst not investing at all, right? So that is really my first question. I think it brings a lot of uncertainty into the investments outlook. Should we start by this one, and I'll go read the others afterwards?

[Lars Von Lackum, executive]

Yes. Very happy to take that one, Jonathan. So certainly, you can improve the AFFO by saving. But as you know, and we have already included that in our guidance, we are planning to spend EUR 35 per square meter. Looking back into the history of LEG, you will see that the first years of LEG's history we have started with payments of around EUR 12 to EUR 13 per square meter, which is barely the maintenance amount needed back at that time. So I think we have done the right steps into the right direction to really increase quality of the portfolio and also generate additional value for our shareholders.

At the same time, we are dedicated to walk along the CO2 reduction path, and we will make sure that we are going to reach those targets. One of it, and you know that, is the nudging part. So we spent money on a project already during the last winter. And this will now strongly contribute to CO2 reduction because people will just make less use of heating, and that helps us to then walk along the CO2 reduction path.

But in order to be able to do so, drive down the efficiency -- drive down the cost per ton of CO2 being reduced, we need more innovation. And that is exactly what we are going to do. And therefore, you will be able to see the progress we are making on the quality of the portfolio directly in the CO2 reduction path.

[Jonathan Kownator, analyst]

Can I bounce back on that? I mean, obviously, we visited a site on Renowate and appreciate all the innovation efforts. I mean right now, you're renovating a site for EUR 1,700 a square meter, which needs a lot of scaling-up and a lot of investment to drive that cost down. And right now, you're actually doing the opposite. You're cutting down investments. So the ability to achieve the synergies needed to get there, somehow I struggle to see how you're going to achieve that. So again, how do you achieve these ESG targets, right, if you're not investing? Yes, can you help us understand better how you, in details, proposed to achieve that?

[Lars Von Lackum, executive]

Yes, very happy. So for the next 3 years, a strong contribution will come from the nudging of consumers. Certainly, the current price environment with regards to higher energy prices will do a substantial part of it, but also the information of tenants on a monthly basis with regards to peer consumption and many more information will also help. So therefore, we are quite confident generate a reduction of around 15% of CO2 reduction via that nudging part.

With regards to Renowate and the EUR 1,700 you are rightly stating asset per square meter cost, I think the strongest proof that we are moving in the right direction is that already and even with the current cost situation, we found a third party which was willing to contract with us on the first project. I think that is proof that even at the current cost situation, you are able to find third parties being willing to go that route together with us.

And certainly, that will be not the final number we are striving for. We are still striving for EUR 1,000 per square meter. And I hope you did have the chance to talk to Andreas, who, from our perspective, can very detailed -- in detail describe how we will make that progress towards the EUR 1,000.

[Volker Wiegel, executive]

Maybe, Jonathan, to add from my side, we will not cut down on the Renowate project for next year. So as you learned on the side, we have there a 14 pilot project program, and we are commencing this. And we see the significant cost improvements from project to project, maybe even allowing to beat our cost reduction targets.

[Jonathan Kownator, analyst]

So just to be clear, you're trying to effectively reduce traditional modernization, right? And then you're hoping that your tenants achieve your green targets by reducing just their consumption, right?

[Lars Von Lackum, executive]

Yes. So for the next 3 years, the 15% consumption reduction will be -- the 15% CO2 reduction will very much been driven by reduced consumption. But at the same time, certainly, we are working on those additional innovative solutions. One of it is Renowate, but we are quite confident to give you more insight into new approaches we are also working on during next year.

[Jonathan Kownator, analyst]

Sure. One final question for us in the interest of timing. What -- you're describing an environment which is obviously very constrained in terms of capacity, you're saying. Obviously, you're saying cost of capital is much higher, and therefore, you have to reduce investments, all of that perfectly understandable.

What do you think the government should do? Because clearly, everyone is describing a full system where everyone is pretty much stopping to invest because of cost of capital. But then at the federal level, there seems to be a clear issue, right? What do you think the government does and react -- how do you think they react to the current situation?

[Lars Von Lackum, executive]

Yes. Thanks a lot for the question, Jonathan. If I would have wished for a question, then it would have been certainly that one because, from my perspective, the government is already prioritizing the modernization of the existing stock strongly over subsidies for new buildings. And I think that is absolutely the right way of doing it because in a situation where you need hundreds of billions to make up for increased energy costs, it becomes very visible that if you want to drive down that number, the only option you are having is helping people to work on the existing asset stock. So therefore, I think we are pretty much in favor of what current government has done, increased subsidies to help people to work on the existing asset base to drive down CO2 emissions there.

[Jonathan Kownator, analyst]

And so you're expecting new subsidies for next year. I think that you had guided to that potentially or you had said that, that would be the possibility.

[Lars Von Lackum, executive]

Yes. So let's wait and see how the new situation will look like in the new subsidization regime. We are very confident that the number for new buildings will remain at the EUR 1 billion, but it will be a much, much higher number for the existing stock. And looking at the current discussions on the government level, we are quite confident that there is a subsidization regime being decided, which will help us work on our asset stock substantially.

[Operator]

The next question comes from the line of Paul May from Barclays.

[Paul May, analyst]

First one, just a quick one, would you be willing to sell assets at discounts to prior book values, obviously, admitting that private values are probably wrong, historically looking, and they may not reflect current market pricing, so at book value, just maybe a discount to the prior book value? I just wondered how sort of committed you are to the disposals and reducing leverage through disposals. I have a few more after that, please.

[Lars Von Lackum, executive]

Yes. So thanks for your first question, Paul. I'm happy to take that. So certainly, currently, we have said that the market is a bit weaker. Expectation from our end is 3% to 5% of a value decrease. And certainly, incentivization of the sales team is to GAAP book value. So latest book value, which is the book value, September 30, 2022. But certainly, we give them some leeway in order to be able to be in the market and do transactions. So therefore, we are willing to also include what we are seeing for this year due to the uncertainty with regards to next year and no additional leeways being given.

[Paul May, analyst]

Okay. I see obviously you're reducing CapEx overall, but it appears sort of increasing maintenance CapEx certainly quite materially versus FY '21 levels, which is kind of before this whole sort of transition is happening. So it's about up 30% versus FY '21. Is that simply that FY '21 was too low or that you are having to spend more in maintenance? I'm just trying to get understanding as to whether the shift is 30% more or it's just that FY '21 was artificially too low given the FFO focus.

[Lars Von Lackum, executive]

Paul, that was only being driven by the changes of the capitalization rate. So that is just an accounting effect. It has nothing to do with steering our business.

[Paul May, analyst]

Okay. Next one, on the Renowate business, I appreciate obviously the need to invest and to push the ESG factors forward. But even on a stabilized EUR 1,000 square meter, it doesn't feel like the Renowate business actually makes money. I think yield on cost is still significantly less than valuation yields, so arguably losing money on a capital basis. Is that still the right way to think about it? Or do you feel that you will get additional rental growth to get a higher yield on cost on that EUR 1,000 per square meter?

[Lars Von Lackum, executive]

Yes. Excuse me, we were still discussing who is allowed to answer the question, Paul. It was certainly Volker who is doing the business and volunteering, so I step back. Apologies.

[Volker Wiegel, executive]

Okay. Maybe I'll start, Lars, and finish this then. Well, you should also think about Renowate as first you need to think about is, of course, when we use it for our own stock, but also you should think about that we will offer it to third parties. And we will provide a completely new solution for owners of buildings which we will be able to sell at significant margins. That's what our first indication is from market testings that people we are talking about -- talking to are willing to pay significantly higher prices than we are having costs for producing this kind of solution.

And in terms for using it for our own stock and own properties, you need to think that we have some uncertainties on the subsidy regimes. There are some initiatives going on that there will be an additional subsidy for serial renovations, so to bolster these innovative measures and modernization measures. And we obviously, of course, as we focus on high capital discipline, focus also on value creation and want to make this business in a way to create value when we sell it to third parties by creating significant margins and also when we buy the solution for our own properties by calculating very thoroughly how to use this solution to create value.

[Paul May, analyst]

Sorry, just following up on that, I mean, in terms of the returns, if you're charging in a margin, I suspect the returns to the third parties will be even less. So just wondering what the attraction is for a third party. Just sort of trying to get understanding as to the Renowate business. I appreciate that, as you say, you need to invest, but it seems to be CapEx being spent that's not going to be return generating, though. But hopefully, you can prove me wrong on that, but just trying to understand what would be the attraction to the third party.

[Volker Wiegel, executive]

Well, the attraction to the third party is that we are selling an entirely new product, which you can't really buy in the market. We are selling a part of CO2 reduction, yes. And then you don't need technical experience. You don't need to bother for subsidies. You don't need to talk to your tenants. If you buy the solution, that's all included there. And this is like you're buying -- going to your car dealer and configurating a car, and that's nothing you can buy in the market so far. And that's what we are striving to offer to the market, that you buy part of CO2 reduction and modernization if you own a house like you are going to a car dealer and buying a car.

[Paul May, analyst]

Okay. Cool. And then the final one, I think sort of linked together, sort of a couple linked together. Obviously, the focus is on AFFO moving forward. First question is, do you think that's something that the industry would do? And how do you think you compare to your peers?

And then the second point, sort of linked to the dividend. I think on my calculations, you're currently running at a roughly 2% dividend yield on a sort of base level given the new dividend policy. I appreciate that excludes the proceeds from disposals, and it will be around about a 1% dividend yield if you were trading at NAV. Given financing costs are going to be somewhere -- I think really anywhere between 4% and 6%, inflation may be on a stabilized basis somewhere between 2% and 4%, what I'm sort of trying to get at, does it sort of make sense as a business with a 1% dividend yield at NAV? Or are there other parties out there that may be looking at the space with a lower cost of capital that can probably generate a better return? And is that something you've considered in terms of ultimately putting the business up for sale given those returns?

[Lars Von Lackum, executive]

Thanks a lot for the question, Paul. So first of all, I think we once again need to underline that the AFFO from our perspective is the right KPI for the very uncertain market environment we are operating in. We do not say that this is the KPI we want to run our business according to for the next 20 years. That is definitely not what we want to get across today. Therefore, it is very difficult to say how peers will align their businesses to the very uncertain and difficult and challenging market environment. From our perspective, it is the right KPI to follow. It is the right KPI to steer the business to. And therefore, as we want to align all the people in LEG to be focused on cash reduction, we think that AFFO is the right metric.

With regards to dividend, also there, that is the current thinking we are having on the dividend. We have put the dividend 2022, which is 70% of the FFO I, already subject to market development. The uncertainty for the next 12 months is incredibly high, so therefore, we try to give you at least some indication how we think or how we -- how you should think about the dividend being paid by us. Dividend certainly might be lower if transaction markets are not opening up, but I think we can give you more transparency during 2023. For the time being, yes, if we would really end up with just 100% of AFFO being paid out, that would be a lower dividend yield. On the other hand side, I think it would definitely benefit the company and also shareholders because we would operate on a very sound capitalization.

[Paul May, analyst]

Sorry, just following up on that, I mean, if it's 100% of post-FFO, you're not generating any free cash flow. Is that correct, the way you think about it? So in terms of then bringing down leverage if you're seeing values declining, as you said, mentioned sort of 3% to 5%, potentially, that could be more into next year, who knows. Is it purely on asset disposals? Or are you also looking to, say, do a scrip dividend as part of the AFFO payout? Just trying to get an understanding as to basically how do you reduce leverage when your free cash flow is 0.

[Lars Von Lackum, executive]

Yes, you're absolutely right. So we are paying out 100% of AFFO. That would be a good proxy for the operational cash flow which we are generating. If we are paying that out, that certainly would not be available to reduce leverage. Leverage could then only be reduced by being successful in the sales market, which unfortunately holds quite a lot of uncertainties and certainly would then depend on the net proceeds being paid out versus the net proceeds being used to deleverage. But I think that also became clear from the presentation of Susanne that we are dedicated to then use net proceeds to delever. So that is where we currently stand without understanding there. But once again, we want in the midterm make sure to once again arrive at a 43% LTV for the company.

[Paul May, analyst]

Sorry, I know it's the final one. Sorry, very last one. At what point does equity become either a requirement or an option to reduce leverage? If liquidity is not there to sell assets, asset values are falling, leverage is increasing, at what point does equity become an option? Or is it never an option in your eyes?

[Lars Von Lackum, executive]

Never say never, Paul, so therefore, I certainly will not be able to exclude it forever. But look at the numbers and set of numbers we have presented. Today, we feel comfortable with what we are planning for next year. We feel comfortable with the setup of the company. And by also putting the dividend proposal for 2022 under condition, I think we are well prepared to also weather a more difficult market situation in 2023, especially at the beginning of 2023, if we would get into something like that.

[Operator]

The next question comes from the line of Neeraj Kumar from Barclays.

[Neeraj Kumar, analyst]

Yes, Paul already asked some of my questions, but I would like to ask a few more on the similar lines. So you mentioned that you have 30% valuation decline headroom for your covenants. If I may ask what sort of valuation decline headroom you have got for your current IG credit rating from Moody's, like current rating level, what sort of valuation decline you can weather without impacting that.

[Susanne Schroter-Crossan, executive]

Thanks for the question. I think that's extremely difficult to answer, to be honest. You know that Moody's is looking at a number of different parameters when they decide upon a ratings move. We are, of course, in very close discussions with them. On that basis, I'm unable to comment on what room they see in terms of valuation declines. We will have to continue the dialogue with them. I'm sure that they will appreciate our move to preserve cash within the company, and we have a very comfortable liquidity position going into 2023. And I think that's something that they will clearly focus on as well.

[Neeraj Kumar, analyst]

Okay. So we understand that the LTV can go higher with the valuation -- potential valuation decline. At what sort of LTV level do you feel the need to do more than what you have already announced in terms of all your deleveraging plans?

[Susanne Schroter-Crossan, executive]

Look, I think we currently have visibility on valuations at year-end. We have pointed out a number of times that we have very little visibility on the transactional market going into next year. And at this point in time, we have no indication of what we will do when because we have to monitor the market now, and we feel comfortable with the measures taken right now for what we can envisage at this point in time.

[Neeraj Kumar, analyst]

Got it. And probably, sorry, the last question around valuations. In terms of the portfolio flag, which is a bit different from your rest of peers in terms of not having any exposure to Berlin, do you see any difference in how the valuations might develop compared to Berlin? Is it going to be same, similar or different, if you have any thoughts to share on that?

[Susanne Schroter-Crossan, executive]

Look, I think we've given a clear indication on our expectation for valuation towards year-end, minus 3% to minus 5%, that this is relevant for our portfolio. I think I don't have a clear visibility on the Berlin market because, as you rightly pointed out, we are not present in Berlin. I think that our portfolio is a good portfolio here and a good measure for this region, and that's all I can comment on.

[Neeraj Kumar, analyst]

Yes. That's helpful. So probably 2 more questions on my side. The fourth one is on secured LTV, secured debt basically. So do you see any change in the LTV or any of those metrics in your discussion with banks with like probably slight valuation decline? Are there any change in terms on how they are looking towards secured financing?

[Susanne Schroter-Crossan, executive]

Not at this point in time. I think we see a very small increase in the spread that they are applying because they are just a little bit more cautious generally, but we are talking 5 to 10 basis points here, so a very marginal increase. And we haven't seen any other sort of changes with regards to LTV and so on that they are applying at this point in time.

[Neeraj Kumar, analyst]

Got it. And last question from my side. Do you have any developments on BCP to share on how you're thinking about it?

[Lars Von Lackum, executive]

Yes. Thanks a lot for your question, Neeraj. Unfortunately, nothing new from our end. And we are aware that there are discussions on the shareholdings of BCP in the market, but certainly, we are not involved there. We are in constant contact with BCP's management, also with the Board of BCP. We are on the impression that the Board of BCP is really focusing exclusively on maximizing the position of BCP. They are not acting in any way just on behalf of the single shareholder. And so nothing we can comment because we are not doing the day-to-day operations in the business.

[Operator]

The next question comes from the line of Manuel Martin from ODDO BHF.

[Manuel Martin, analyst]

Just 2 or 3 questions from my side. The first one is actually quite a small question. Your like-for-like rent growth guidance for 2022 is at 3.0%. Currently, you're at 3.2%. Maybe you could shed some light on what could be the effect on Q4 to bring down the currently 3.2% to 3.0%? That would be the first question.

[Volker Wiegel, executive]

Sure, Manuel, happy to take this one, what's the effect of the Adler transaction, which we recorded at our books at 31st of December 2021. So in the like-for-like basis of the portfolio increases by the Adler transaction at year-end. And as we have the smaller rent increase growth in the portfolio compared to the core LEG portfolio due to the integration effects, this will bring down the number by this 0.2%.

[Manuel Martin, analyst]

Okay. I see. And second question is, unfortunately, again on valuation. So you're somehow guiding for a valuation loss in the property portfolio of 3% to 5% in H2. Could you elaborate maybe a bit on where -- how -- well, how you reach or how you come to this guidance? Is it based rather on data points that you see in the market? Or does it come from the appraisers having a look at the interest rates and doing some changes in the WACC? That would be a second question.

[Susanne Schroter-Crossan, executive]

Yes. So basically, it's the same as always. It's a mix of different factors. We obviously have a few prints in the transaction market. We have generally the market parameters and reports we are monitoring. And we are in regular discussion with our appraisers on the topic as well. So nothing different from previous valuation cycles.

[Manuel Martin, analyst]

Okay. I see. And the third question is actually a follow-up question on that. The lower valuation that you're going to have by year-end, does that bring LEG closer to potential transactions, so bringing you closer to some price expectations of potential buyers? So would that become more realistic?

[Lars Von Lackum, executive]

Yes. Thanks a lot, Manuel, for the question. So unfortunately, it is not that we are currently marketing at a level which no one wants to look at, but it is just the size which is not attractive to people. So therefore, if you want to do transactions, then you just need to sell single multifamily homes. There you find still buyers being willing to agree to close to the book value or at book value. But certainly, those are not the ones doing big transactions, so therefore, liquidity in the market is quite low. And therefore, we certainly gave indication that overall volume which we expect for this year, hopefully, will reach a level between EUR 100 million to EUR 200 million.

The 3% to 5% of value decline is something we certainly take into consideration now while negotiating. But saying that if we would take that into consideration and would then approach the market with bigger portfolios again, it is not the case that those bigger portfolios would then attract a lot of institutional interest or would then help to really transact bigger volumes.

[Operator]

The last question for today comes from the line of Simon Stippig from Warburg Research.

[Simon Stippig, analyst]

Just 2 short questions left by me. First one is what's your spot rate currently on secured and unsecured financing.

[Susanne Schroter-Crossan, executive]

Yes. So I give you the spread because the interest rate keeps moving. So I think for secured, you can calculate with 90, 95 basis points on 5-year secured debt. And in the unsecured market, it's probably going to be around 250 basis points of spread over swaps.

[Simon Stippig, analyst]

Okay. Great. And then the second question would be your guidance on the incremental debt, the 50% you mentioned before for the full year '23 guidance. What's your assumptions on those 50% incremental refinancing debt of the roughly EUR 1 billion that comes up in regard to financing costs?

[Susanne Schroter-Crossan, executive]

Yes. So I think we've obviously done a simplified approach and have used basically the current spot financing costs that we are seeing in the market with the 5-year maturity. Obviously, when we look at actually refinancing that maturity, we will take a more differentiated approach. We are currently thinking about a number of different instruments to use to combine to refinance that liability, but we are not decided yet.

[Frank Kopfinger, executive]

And with this, we come to the end of the conference call. Thanks for all your questions. And as always, should you have further questions, then please do not hesitate and contact us. Otherwise, we are looking forward to seeing you at the upcoming roadshows or conferences. Please note that our next scheduled reporting event is on March 9 when we report our full year figures.

And with this, we close the call, and we wish you all the best and hope to see you soon. Thank you, and goodbye, everybody.

[Operator]

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