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

Market News

The dollar continued its recent rally, rising for the fourth straight session to the highest in three weeks, as strong US private employment data supported the view that the Federal Reserve does not need to cut interest rates aggressively. The Fed’s Thomas Barkin says progress has been made but Fed can’t declare victory yet – he sees two 25bps cuts this year as “a reasonable path” if the economy evolves as expected. The 10-year Treasury yields 3.80%, while gold trades at $2,644 an ounce. US equities were little changed. OpenAI raised $6.6bn in new funding, people familiar said, putting its valuation at $157bn.

In Asia this morning, Japan’s Nikkei 225 (+2.0%) climbed higher amid yen weakness after PM Shigeru Ishiba said the economy isn’t ready for another rate hike. In contrast, the Hang Seng (-1.4%) gave up some of the gains made earlier in the week. China is still on holiday, although a gauge of Hong Kong-listed Chinese companies also fell, halting a 13-day rally that was fueled by optimism over measures to stimulate the world’s second-biggest economy.

The FTSE 100 is currently little changed at 8,314. Companies trading ex-dividend today include Centrica (1.29%), Hargreaves Lansdown (2.70%), Smith & Nephew (0.93%), and Weir Group (0.84%).

Bank of England Governor Andrew Bailey sees a chance of more aggressive rate cuts, provided that news on inflation continues to be good. Sterling slipped to $1.3140 and €1.1911.

Brent Crude ($76 a barrel) rose for a third day amid tensions in the Middle East. Traders are wagering Brent will hit $100 on the risk of supply disruptions. President Biden ratcheted up pressure on US port employers and shipping lines to restart talks with dockworkers, saying the strike may turn into a “man-made disaster.”

Source: Bloomberg

Property News

Last night Vonovia announced the completion of three transactions with a liquidity inflow of €1.8bn. This means the company has secured €3.3bn so far this year, exceeding its €3bn target. It has now raised its full-year expectation to €4bn. Although the nature of the deals isn’t as ‘clean’ as some investors might have liked, and there is no comment on valuation relative to book value, the transactions will continue to ease the pressure on the group’s financial metrics at a time when asset values appear to be close to the bottom of the cycle. The shares have recovered well this year but are still trading on a 25% discount to H1 NAV.

Vonovia is Europe’s largest residential real estate company. The group owns around 543k units worth around €82.5bn across Germany (c. 84%), Sweden, and Austria. The group also manages a further 72k 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. Following its 2021 acquisition, Vonovia also owns industry peer Deutsche Wohnen.

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. In addition to reducing its borrowing, 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.

Last night, the company disclosed three new transactions with a total inflow of €1.8bn expected at the end of 2024 / first half of 2025.

Firstly, Vonovia is selling 11 development projects for €500m to a new fund that was launched in August by HIH Invest Real Estate, one of Europe’s leading real estate investment managers, and Vonovia. In addition, further project developments worth around €150m were sold to the fund by Quarterback Immobilien. The purpose of the fund is to acquire and manage development projects in German metropolitan regions. HIH Invest is the majority owner; Vonovia continues to hold an equity stake and will benefit from the management, which HIH Invest and Vonovia are jointly undertaking.

Secondly, as part of their long-term partnership, Vonovia and Apollo have agreed to establish a company that will hold 20% of the shares in Deutsche Wohnen and in which Vonovia and long-term investors advised by Apollo will be invested. The liquidity inflow for Vonovia will amount to just over €1bn.

Finally, Deutsche Wohnen is selling 27 care facilities, mainly located in the greater Berlin area, for more than €300m. The buyer of the properties is a fund managed by Civitas Investment Management, a company with many years of experience in the care sector; the Alloheim Group, a leader in the care sector, is taking over operations and all employees.

This means the inflow of liquidity since the beginning of the year now amounts to more than €3.3bn. For 2024, the company has now raised its target and now expects a total inflow of liquidity of around €4bn, which is on a par with the previous year.

There is no comment on the value of the transactions relative to the latest NAV. In addition, the transactions don’t represent a ‘clean’ disposal, although they will clearly help to reduce the stress on the company’s balance sheet. The group’s pro-forma loan-to-value (LTV) was 47.3% at the half-year stage, above its 40%-45% target range. No comment has been made regarding the impact of the latest transactions on financial gearing.

They come at a time when valuations in the sector appear to be bottoming out. In the first half of the year, the market value of the group’s portfolio only fell by 1.7% to €82.5bn. At the time the company said it believed the market had bottomed out, and that stabilisation was “now on the home straight”, although we will have to wait for further commentary with the group’s Q3 results in November.

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 or so, however, they have recovered somewhat but still trade at a 25% 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 ongoing substantial mismatch between Vonovia’s equity value (€2,269/sqm), the valuation in the direct real estate market (€3,360/sqm, as evidenced by recent market transactions), and the cost of newly constructed properties (€5,300/sqm, which are rising due to input price inflation).

Source: Bloomberg