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

Market News

US equity markets moved higher last night – S&P 500 (+1.9%); Nasdaq (+1.8%) – although Apple fell 3% in after hours trade after it warned revenue in the holiday quarter will be about the same as last year, while Wall Street had projected around 5% growth. This morning in Asia, markets were also firm: Nikkei 225 (closed); Hang Seng (+2.5%); Shanghai Composite (+0.7%). The FTSE 100 is currently trading 0.4% higher at 7,468.

US jobless claims hits a 7-week high as the labour market remains resilient. The figure of 217K in the week ending 28 October was pretty much in line with market expectations. 10-year Treasury yields continued to move lower (4.66%).

As expected, the Bank of England held UK interest rates at 5.25%. The decision was a 6-3 majority, with the dissenters seeking a further 25 basis points increase. The bank has left the door open for future rate hikes. However, Gilts rallied – the 10-year yields are currently 4.38% – following comments from Governor Andrew Bailey that rates should not be kept restrictive for too long. The Bank also said it expects inflation to fall from 6.7% in September to below 5% in October, and 1.9% in two years’ time. Sterling trades at $1.2190 and €1.1470.

Oil headed for a second weekly loss – Brent is $87 a barrel – while refining margins rebounded to their highest level in about a month. Gold is set for its first weekly decline in four, and currently trades at $1,989 an ounce.

Source: Bloomberg

Property News

Vonovia has today released results covering the first nine months of 2023 and reiterated its full-year guidance. The company has now achieved its target for disposals and reduced financial gearing back into its target range. Ahead of this afternoon’s analysts’ call, the shares are up 4% in early trading, leaving them on a c. 53% discount to end September NAV.

Vonovia is Europe’s largest residential real estate company. The group owns around 548k units worth around €88.7bn across Germany (c. 86%), Sweden, and Austria. The group also manages a further 71k 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. The population of Germany increased in 2022 driven by an influx of Ukrainian refugees which drove further demand for housing. Increased inflation, particularly in energy prices as well as shortages of materials used in construction, has put pressure on construction costs and increased replacement costs to higher levels. Furthermore, the current market environment is discouraging new developments, exacerbating the supply/demand imbalance. 

During the nine months to 30 September, funds from operations (FFO1) – effectively the group’s operating result – fell by 8.4% to €1,446m. Total segment revenue fell by 8.1% to €4.2bn mainly due to lower volume-related revenue from the development business (-77%) and from recurring sales (-54%). The core residential property management business developed positively (+7.0%). The vacancy rate remains very low (2.1%) and highlights the ongoing mismatch between supply and demand.

The increasing trend towards higher rents continued, while the collection rate was 99.9%. The organic increase in rent was 3.8%, of which new construction accounted for 0.7%. Like-for-like rental growth of 3.1% was driven by market-related factors (+2.0%) and investment in existing buildings (+1.1%). The monthly rent per square metre increased by 2.7% to €7.67. Going forward, under the regulatory system, rent growth is expected to follow inflation over time albeit with a lag. For the 2023 full year, growth of 3.7%-3.8% is expected.

Cost savings of €105m from the Deutsche Wohnen merger integration are being realised as planned. They are fully expected by 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 64%.

Vonovia continued to sell properties that are of inferior quality or in non-core regions. However, the volume of recurring sales was 48% lower, although the fair value step-up remains above expectations, at 43%. Outside of the recurring sales segment, 755 non-core units were sold (-95%) with a fair-value step-up of 7.3%. In total, Vonovia has already generated €3.7bn in proceeds for debt reduction this year through sales and joint venture capital, already significantly exceeding its goal of achieving €2bn in sales this year. This includes €1.7bn since August including the sale of new construction projects for €357m to CBRE and a second joint venture.

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 the year to date, the group spent €1,022m (-41%), with spend on maintenance down 17%, modernisation down 43%, and new construction spend down 67%. Despite the high construction costs, Vonovia completed 1,800 new buildings between January and September, 72% to hold to rent and 28% for sale.

In the year to date, the group’s loan-to-value (LTV) has increased from 45.1% to 46.8%, just above the 40%-45% target range. 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 (6.7 years); average cost of debt (1.7% vs. 1.5% at the end of 2022); fixed/hedged (98%); and no more than 12% of debt maturing annually. Overall, the group has said that that marginal debt costs have come in lower than feared.

So far this year, the group has rolled over €0.8bn of secured loans and taken out €2.0bn of new loans (€0.6bn secured and €1.4bn unsecured). During Q3, Vonovia completed a cash tender of €1bn of its bonds for a consideration of €892m, an 11% discount. Unsecured financing is now covered until Q1 2025.

Disposal to date reduces pro-form LTV to 45.0%, back into the target corridor. Following 11% value decline recorded in the portfolio since the June 2022 peak values, 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.

The group has reiterated its full-year guidance: funds from operations are expected to decline to €1.75bn-€1.95bn (-9% at the mid-point), although the guidance is now to be at the mid-point. The group has also provided guidance for 2024: flat rental revenue despite further planned sales; FFO to be moderately below 2023 levels due to higher taxes and interest. The group is also targetting €3bn+ of gross proceeds from further disposals.

Since the end of 2022, the market value of the portfolio has fallen by 6.3% to €88.7bn. The net asset value (known as EPRA NTA) is down 10% to €41.1bn. On a per share basis, the value has fallen by 12.1% to €50.61, but is a touch higher than at the end of the last quarter (€49.67).

The shares, which are listed in Germany, have fallen heavily over the last year and currently trade at a 53% discount to EPRA NTA. The main driver has been the close negative correlation with government bond yields which moved sharply higher – the 10-year bund is currently 2.7%, having been negative at the beginning of 2022. Similarly, higher interest rates and the resulting capital market fears of a knock-on effect on earnings and property values has impacted the shares.

Although greater visibility over the outlook for interest rates 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 (c. €2,415/sqm for the German portfolio), the valuation in the direct real estate market (as evidenced by recent market transactions, c. €3,500), and the cost of newly constructed properties (which are rising due to input price inflation, c. €5,300).

Source: Bloomberg