This week we look at two more REIT’s, this time both EU based. The first is Frankfurt listed, LEG Immobilien (LEG.FWB), while the second is dual-listed, VGP Group NV (VGP.BR).
LEG Immobilien (LEG.FWB)
LEG Immobilien is a pure-play residential REIT. Created in 1970 as part of a push to develop urban areas and increase small-scale settlements in the state of NRW (North-Rhine Westphalia), it continued to grow its mandate to include the development of fallow land in the 80s and was privatised in 2008 (i.e. bought out by a consortium of private equity investors including Goldman Sachs, Whitehall and Perry Luxco). Since privatisation, the business has expanded and diversified geographically across the West German Federal States to now include close to 145,000 properties with and more than 400,000 tenants. The business listed in 2013.
What has been unique about this particular evolution from state-owned enterprise to private has been the businesses ability to use economies of scale to target particular niches, including smaller-scale developments than would otherwise be impossible as well as value-add services including partnerships with Vodafone for multimedia, B&O for maintenance and various other utilities providers.
So, why do we like this proposition and what exactly is attractive about it? After all, it's not every day that Australian investors get pitched residential property plays on the other side of the planet. Let us explain it as simply as we can. If we consider the return of investment in property, there are simply two aspects to it in my view; 1) the headline cash rate, which has the multiple impact of determining capital growth as well as debt servicing costs; and 2) rental growth as well as the ability to service said rents. On both of these aspects Germany ticks the boxes, depending on where you look though main cities such as Berlin do tend to have rent controls.
On the first point, the fantastic thing about having a single bloc currency is the asymmetry that is created. The ECB, by having to cater to a diverse economy, is somewhat curtailed in its ability to normalise rates than would otherwise be the case. For example, the headline interest rate targets would have to take into account inflation and inflation expectations across the EU (as opposed to any single national polity), so should we see a better recovery rate across Germany (as has been the case) especially in comparison to the southern states then we are not likely to see this reflected in the monetary policy (and hence cost of capital). Importantly, Germany is able to maintain a current account surplus due to her exports being more attractive than would otherwise be the case in the absence of a single currency (i.e. a free floating Deutsche Mark would arguably be a lot higher in relation to say the Italian Lira). This helps with regards to the second aspect of what matters to the property investor, rental yields and the ability of tenants to service said rent (given that close to 20% of the workforce is employed in the manufacturing industry and 47% of the nation’s output is export dominated). Germany also remains one of the few outliers among the OECD to pass increases to the minimum wage during the depth of Covid-19, despite push-back. This helps given that residential plays such as LEG Immobilien focuses on the mid-tier and lower socioeconomic stratas for tenants.
With that context out of the way, let's get down to the numbers for LEG. In short, revenue at TTM (Trailing Twelve Months) currently stands at approximately €2.08bn, WALE of 7.5 years, LVR of 37.7% with a market cap of €8.3bn. In terms of medium term catalysts, 75% of the current portfolio, or 25,000 additional units, are set to come off rent control with significant upside when compared with market values. Over the next five years the theoretical upside to this is about 38% of the current base. Importantly for the cynics amongst, the nature of the business ensures that outsized events such as a pandemic don’t materially impact the business with vacancies only slightly increasing (the German social safety net and subsidies ensure that the business gets paid).
Sticking with our reflation thematic, the business has issued €823m in debt to add to its war chest for growth. This was done at an attractive 0.40% p.a. coupon with a duration of 8 years. Importantly, the debt is senior unsecured convertible notes. The strike being €155.25 (or a about 20% premium to the last traded price), this represents about 5% of the float.
My Expectations: A great reflation trade and bond substitute. In the absence of inflation (just in case I’m wrong), there are significant escalations already built in through the expiration of rent-control terms. Significantly, in the absence of inflation, the continued low yields across the EU and the negative yields on the 10-year Bund should see capital growth. If I am right on inflation, then it can act as a hedge given the unique circumstances of the German residential property market and the low fixed debt servicing costs.
Dividend Yield: 3% (historic growth of 11.8% p.a.) and, in our view, there is no reason for this to be at risk. The trust has a payout ratio of 70%.
VGP Group NV (VGP.BR)
VGP Group is another mid-cap REIT we remain quite bullish on given their existing partnerships and the space they operate in. Simply put, it is an owner, developer and operator of prime logistics/light industrial parks. Many of the readership, we feel certain, have at the very least heard of the tremendous strain that has been put across supply chains globally as a result of Covid-19. It has created a clear catalyst for rethinking supply chains and re-localising infrastructure. VGP’s geographic footprint is pan-Europe, including the Baltics, Germany, Spain and Italy. Their clients are almost entirely made up of blue chip companies such as Volkswagen, Amazon, Nagel and DHL with the advent and maturity of online retail acting as a tailwind.
For the more ESG oriented amongst you, the business has a 0-emissions target by 2025 (i.e. this includes both Scope 1 and Scope 2). For those of you not so worried, it should nevertheless make financial sense given the appetite and institutional flows that such a strategy warrants (hence a stronger multiple).
Looking at the numbers quickly, 99.6% occupancy with a WAULT (Weighted Average Unexpired Lease Term) of around 8.3 years (a more apt metric to use with regards to multi-tenant industrial assets). Moreover, what is rather more interesting in our view are the significant catalysts in terms of a 88.6% pre-let development pipeline and a strategy to focus on last-mile delivery (and the additional value add services that would bring to the table). Management certainly seems to be aggressive in its outlook, with the land bank reaching all-time highs at a 21% p.a. CAGR over the past five years and 22.2% p.a. CAGR in gross lettable space. Importantly, the development side of the business remains attractive with the JV model allowing the business, in conjunction with Allianz Real Estate, to develop and manage the assets while de-risking by having the JV partner buy out the assets at market value over a sequential period. To date, the company has spent €1.97bn in Capex with net cash inflow from divestments over the period equating to €1.57bn. To explain this more succinctly, they have the opportunity to grow their own portfolio over the longer term horizon while also taking part in larger scale developments than would otherwise be the case.
Risk wise, net gearing stands at a conservative 25.2% and EBIDTA stands at a stellar €407.33m, an attractive proposition given their market capitalisation of €3.7bn. On the negative side however, operating profit came in at €370m though this represents a substantial upside by about €167m from the corresponding calendar year. It was primarily driven by property revaluations and seemingly hides the increases in administration expenses (something we will certainly keep a keen eye on going forward).
My Expectations: Similar to Digital Realty (as we mentioned last week), this is a growth play more than a traditional REIT play. VGP is trading at a reasonable (in my view) premium given the categories and markets they operate in. Their footprint is predominantly western europe and significant growth is coming from their exposure to e-commerce as well as last mile delivery. A higher risk proposition than the likes of LEG or VICI, which we also wrote about last week, but a well run operation nevertheless.
Dividend Yield: 2.5%
Expecting double digit growth on a nominal basis over a five year time horizon given significant tailwinds both in the overall space and their specific development pipeline.
Disclaimer: Both stocks are held in the G-REIT segment of TAMIM's Listed Property portfolio.
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TAMIM Asset Management provides general information to help you understand our investment approach. Any financial information we provide is not advice, has not considered your personal circumstances and may not be suitable for you.