Morning Note: Market news and a positive update from German property company Vonovia.

Market News

US equity markets nudged higher last night – S&P 500 (+0.3%), Nasdaq (+0.4%) – while this morning in Asia, markets were mixed: Nikkei 225 (+1.2%); Hang Seng (+0.2%); Shanghai Composite (-0.3%). China’s factory output expanded for a second month, the best streak in more than a year. The official manufacturing PMI was 50.4 in April, versus a forecast of 50.3. The Caixin manufacturing PMI beat estimates, but the official non-manufacturing PMI missed. The yen held gains following yesterday’s wild swings. Samsung Electronics rose after its chip business returned to profitability for the first time since 2022.

The FTSE 100 is currently trading 0.3% higher at 8,175, with HSBC up 3% on the back of good Q1 results and a raised share buyback programme.

Treasuries rose, with the 10-year currently yielding 4.63%, while gold slipped to $2,315 an ounce. UK non-food prices fell by 0.6% in the first week of April, the first time this category was deflationary in more than two years, the BRC said. Inflation pressures eased in the services sector, a separate CBI survey showed. Sterling slipped to $1.2535 and €1.1710.

The oil price steadied after yesterday’s fall at $87.30 a barrel. Cocoa tumbled as higher margin calls and uncertainty prompted traders to sell. The market entered a correction as New York futures dropped more than 20% from their April 19 record peak.

Source: Bloomberg

Property News

Vonovia has today released Q1 results which were largely in line with management expectations. Guidance for 2024 earnings has been reiterated, while the group has upped its expectation for rental growth. The group is one third of the way through its 2024 disposal programme and is confident of hitting its €3bn target. Ahead of this afternoon’s analysts’ call, the shares are up 5% in early trading, leaving them on a c. 40% discount to Q1 NAV.

Vonovia is Europe’s largest residential real estate company. The group owns around 543k units worth around €84bn across Germany (c. 84%), Sweden, and Austria. The group also manages a further 70k units owned by others. Despite its size, in Germany Vonovia still only owns 2% of a highly fragmented market. The focus is on multi-family housing for low- and medium- income tenants in metropolitan areas. The aim is to benefit from residential megatrends such as urbanisation, energy efficiency, and demographic change.

In Q1, adjusted earnings before tax – or EBT, the group’s preferred profit metric – fell by 7.3% to €416.5. The key figure for internal financing and thus liquidity management, operating free cash flow (OFCF), rose significantly by 24% to €501m. Full-year guidance for both metrics have been confirmed.

The core residential property management business grew by 2.2%, despite disposals. The vacancy rate remains very low (2.2%) and highlights the ongoing mismatch between supply and demand. The increasing trend towards higher rents continued, while the collection rate was 99.6%. This includes all ancillary and energy costs, which management see as a strong sign of affordability. The organic increase in rent was 3.8%, with new construction accounting for 0.3%. Like-for-like rental growth of 3.5% was driven by market-related factors (2.1%) and investment in existing buildings (1.4%). The monthly rent per square metre increased by 3.2% to €7.78. Going forward, under the regulatory system, rent growth is expected to follow inflation higher over time albeit with a lag. For 2024 full-year, the group has increased its expectations for organic rental growth from 3.4%-3.6% to 3.8%-4.1%. This still includes an additional irrevocable rent increase claim of around 2%. The expected run-rate going forward is around 4%.

Revenue from other business streams came from the development business (+1.3%), recurring sales (+6.9%), and value-add (-5.9%).

Cost savings of €105m from the Deutsche Wohnen merger integration are being realised as planned. They are fully expected by the end of 2024, with a further €35m from 2025. Over the long term, Vonovia has enjoyed increased benefits of increased scale, with its adjusted EBITDA margin up 20 percentage points and cost per unit down by two thirds.

Vonovia continued to sell properties of inferior quality or in non-core regions. The volume of recurring sales was 44% higher (to 407), although the fair value step-up, at 22.4%, was below last year. Outside of the recurring sales segment, 2,409 non-core units were sold, at a 0.1% value step-up.

The company is targetting €3bn in gross disposals in 2024 as it looks to offload care homes and commercial properties, while holding on to residential properties where the outlook for rental growth is positive. So far, the group has achieved €1.1bn of its target. Last week, the group announced the sale of 4,500 apartments and a piece of land in Berlin to two state-owned housing associations. The €700m price is in line with the market value at the end of 2023 and down 14.4% from the June 2023 peak. The consideration equates to an (encouraging) gross return of 3.5%. In addition, proceeds of €363m have come from other disposals in various transactions and across different sales channels. This includes three care home properties and the group expects to complete the sale of the division by the end of the year. Overall, management has high confidence of achieving its €3bn target and is also reviewing opportunistic disposals from the remaining portfolio.

Capital is being partly re-allocated toward the construction of new properties and the improvement of the existing portfolio to comply with environmental demands which can drive higher rents. In Q1, the group spent €316.6m (-8.2%), with spend on maintenance down 4.7%, modernisation down 11.6%, and new construction spend down 11.5%. Despite the high construction costs, Vonovia completed 845 new buildings in Q1 (up 8.5%), 18% to hold to rent and 82% for sale. Due to current conditions, for now the focus remains on completing existing projects rather than constructing new projects. Clearly this exacerbates the current supply/demand imbalance. 

The group’s loan-to-value (LTV) fell from 47.3% to 46.9%, above the 40%-45% target range. Including potential proceeds from announced transactions, the pro-forma LTV is 45.9%. As a result of monetary tightening, the cost of issuing new debt has increased substantially. However, the group’s long-term and well-balanced debt maturity profile provides a hedge against increasing financing costs: weighted average maturity (6.9 years); average cost of debt (1.8% vs. 1.7% at the end of 2023); fixed/hedged (99%); and no more than 12% of debt maturing annually. Overall, the group has said that marginal debt costs have come in lower than feared.

The strategy is to roll over secured debt and repay unsecured bonds with disposal proceeds. This year, the group has issued its first bond on the UK market (€400m 12-year unsecured at 4.5%) and in Switzerland (€159m, 5-year, unsecured at 4.2%). In addition, it has launched a euro social bond (€850m, 10-year, 4.25%). Vonovia has now covered all unsecured liabilities up to the end of Q3 2025. Fitch rated Vonovia for the first time in March, giving the company a BBB+ rating with stable outlook.

The group is proposing a dividend of €0.90 per share, 6% higher than last year, equal to a yield of 3.5%. Looking forward, the group has changed its dividend policy – the plan is to pay out 50% of earnings plus surplus liquidity from operating free cash flow.

The market value of the portfolio remained stable at €83.7bn. The group expects real estate valuations to bottom in 2024, with a ‘return to growth path in sight’. The group now believes organic value growth of around €3bn p.a. is possible from 2025 to take advantage of the housing shortage and high demand for living space in major cities.

At the end of the first quarter, the net asset value (known as EPRA NTA) per share was little changed at €46.72. The standing portfolio is now valued at 24x in-place rent equalling 4.1% on a gross basis and 3.3% on a net initial yield basis.

Following a 21% gross value decline in the portfolio since the June 2022 peak, the company estimates that fair values would have to drop a further 26% for the LTV to cross 60% covenant threshold. This excludes any positive impact from further rent growth and deleveraging from disposals. The company believes it doesn’t need to raise new equity for deleveraging and will only do so to fund growth.

Guidance for full-year adjusted earnings before tax has been confirmed in a range of €1.7bn-€1.8bn, a 6.2% decline at the mid-point versus 2023. As highlighted above the group has increased its expectations for organic rental growth.

The shares, which are listed in Germany, fell heavily in 2021 and 2022 on the back of rising government bund yields, to which they are negatively correlated, and the knock-on effect on earnings and property values. Over the last year, however, the shares have recovered somewhat but still trade at a 40% discount to EPRA NTA.

Greater visibility over the outlook for interest rates (and the marginal cost of new debt), the extent of further valuation declines, and progress on disposals will be required for the shares to move substantially higher. In the meantime, we are comforted by the substantial mismatch between Vonovia’s equity value, the valuation in the direct real estate market (as evidenced by recent market transaction), and the cost of newly constructed properties (which are rising due to input price inflation.

Source: Bloomberg