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

Market News

US wholesale inflation rose by more than expected in February, placing pressure on the Federal Reserve to delay monetary easing. The PPI rose by 1.6% year-on-year, above the market forecast of 1.1% and January reading of 1.0%. The 10-year Treasury yield moved back up to 4.28%, while gold trades at $2,168 an ounce. US equity markets nudged lower: S&P 500 (-0.3%), Nasdaq (-0.3%). Adobe fell by 11% post-market after giving a weak sales outlook. Brent Crude slipped back to $84.36 a barrel, while copper climbed past $9,000 a ton, its highest level in 11 months.

This morning in Asia, markets were mixed – Nikkei 225 (-0.3); Hang Seng (-1.4%); Shanghai Composite (+0.5%) – as the China central bank disappointed investors hoping for more stimulus steps, draining cash from the banking system using its MLF tool for the first time since November 2022 and leaving the one-year rate unchanged.

Members of Japan’s largest union group secured annual wage hikes of more than 5%, in what may be the last piece of the puzzle pushing the BOJ into raising rates next week. The central bank is making final arrangements to end its negative rate policy at the meeting, Jiji reported. The yen gained.

Sterling trades at $1.2737 and €1.1703, while the FTSE 100 is currently little changed at 7,740. Swisscom is to buy Vodafone Italia for €8B, with Vodafone planning to return €4bn to shareholders via buybacks. The shares are up 4% this morning.

Source: Bloomberg

Property News

Vonovia has today released its 2023 results. Although the core rental business continued to perform well, the net asset value fell by 18.5%. Guidance for 2024 has been provided and the company sees signs of market stabilisation. Ahead of this afternoon’s analysts’ call, the shares are down 5% in early trading, in part due to rising bund yields, leaving them at a c. 46% discount to end 2023 NAV.

Vonovia is Europe’s largest residential real estate company. The group owns around 546k units worth around €84bn across Germany (c. 84%), 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.

In 2023, funds from operations (FFO1) – effectively the group’s operating result – fell by 9.3% to €1,847m, at the mid-point of the guidance of €1.75bn-€1.95bn. Total segment revenue fell by 7.5% to €5.15bn mainly due to lower volume-related revenue from the development business (-37%) and from recurring sales (-41%). The core residential property management business grew by 2.1%, despite disposals. The vacancy rate remains very low (2.0%) and highlights the ongoing mismatch between supply and demand.

The increasing trend towards higher rents continued, while the collection rate was 99.9%. This includes all ancillary and energy costs, which management sees as a strong sign of affordability. The organic increase in rent was 3.8%, in line with guidance, with new construction accounting for 0.5%. Like-for-like rental growth of 3.3% was driven by market-related factors (2.3%) and investment in existing buildings (+1.0%). The monthly rent per square metre increased by 3.3% to €7.74. Going forward, under the regulatory system, rent growth is expected to follow inflation over time albeit with a lag. For 2024, the group is guiding to rental growth of 3.4%-3.6% plus an additional irrevocable rent increase claim of more than 2%.

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 two thirds.

Vonovia continued to sell properties of inferior quality or in non-core regions. However, the volume of recurring sales was 41% lower (to 1,590), although the fair value step-up remains above expectations, at 33%. Outside of the recurring sales segment, 2,248 non-core units were sold (-87%). In total, Vonovia generated €4bn in proceeds through sales and joint venture capital, significantly exceeding its €2bn goal. The company is targetting a further €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. Management has high confidence of achieving this target given the level of interest both from listed and private investors, however execution takes time.

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 2023, the group spent €1,484m (-35%), with spend on maintenance down 16%, modernisation down 44%, and new construction spend down 49%. Despite the high construction costs, Vonovia completed 2,425 new buildings in 2023, 54% to hold to rent and 46% 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.  

During the year, the group’s loan-to-value (LTV) increased from 45.1% to 47.3%, above the 40%-45% target range. The pro-forma LTV is 46.7%. 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 (1.7% 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 marginal debt costs have come in lower than feared.

The strategy is to roll over secured debt and repay unsecured bonds with disposal proceeds. In 2023, Vonovia rolled over €0.9bn of secured loans and took out €2.5bn of new loans (€1.1bn secured, €0.8bn unsecured, and €0.6bn bridge to capital markets). The group also completed a cash tender of €1bn of its bonds for a consideration of €892m, an 11% discount. 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%). Vonovia has now covered all unsecured liabilities up to the end of Q3 2025.

The group has proposed a dividend of €0.90 per share, 6% higher than last year, equal to a yield of 3.5%.

During 2023, the market value of the portfolio fell by 11.4% to €83.9bn due to market movements and disposals. The valuation trend decreased in the second half (-4.2%) versus the first half (-6.6%). The net asset value (known as EPRA NTA) declined by 16.6% to €38.1bn. On a per share basis, the value fell by 18.5% to €46.82. The standing portfolio is now valued at 24.2x 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 25% 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.

The group is changing its profit measure from FFO to adjusted earnings before tax (EBT). For 2024, the guidance is in the range of €1.7bn-€1.8bn, a 6.2% decline at the mid-point versus 2023. With an eye on liquidity management, the group will also report its operating free cash flow.

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 46% discount to EPRA NTA.

Greater visibility over the outlook for interest rates and further 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 transactions), and the cost of newly constructed properties (which are rising due to input price inflation).

Source: Bloomberg