Viewed from post-Thatcherite Britain, the popularity of the German housing stocks is something of a paradox. Companies like Deutsche Wohnen (ETR:DWN) and TAG Immobilien (ETR:TEG) operate in one of the most regulated lettings markets in the Western world, with the kind of rent controls and life tenancy agreements that have long been blamed for destroying Britain’s post-war private rented sector. Yet the initial public offering of GSW Immobilien (ETR:GIB), a specialist Berlin player, in April 2011 confirmed the remarkable strength of investor interest in German residential real-estate investment trusts (Reits). Mirroring gains in the wider market, GSW’s stock is up 37 per cent since debut.
Perhaps the biggest reason is the upward trend in German apartment rents. Like-for-like rental growth is one of the most important metrics by which to appraise landlords, because it drives not just profits and dividends but also capital values and share prices. It is also a rare commodity in the current macro-economic climate. Businesses are reluctant to take on more space until an economic recovery is entrenched, and households in most countries face tight budgets.
Not so in Germany. While disposable income is stagnant or shrinking in most of the European Union, it has been growing in Germany by about 2 per cent a year. This has allowed rents to grow without compromising affordability. This is all the more true because German renters are not, like in Britain, almost exclusively concentrated among the poorer sections of society, who might see lower growth in disposable income. The German home-ownership rate is only 44 per cent (compared to 65 per cent in Britain) and there is no social stigma attached to renting.
Moreover, rents are already more affordable in German cities than elsewhere in Europe. According to CBRE, rent accounts for just 24 per cent of households’ disposable income in Berlin and Cologne. Even in the more commercial cities of Hamburg and Frankfurt, the proportion is no more than 30 per cent. The equivalent for London is estimated at 35-40 per cent.
1990 and all that
This is partly a result of Germany’s unusual history. The reunification of the former East and West Germanies in 1990 sparked a government-sponsored house building boom, particularly in the East, that by the mid 1990s had flooded the market with supply. House prices peaked in 1994 and then started falling, scarring a generation of developers and lenders alike. The problem was exacerbated by a soft economy in the late 1990s and early 2000s – also usually blamed on reunification – and, from 2003, a falling population. Germany became the ‘sick man of Europe’.
Convalescence spread to the housing market in about 2009. That was the trough in home building and also in real house prices. For the last two years nominal house price inflation has been running at over 5 per cent in the top 125 German cities, according to the Bundesbank. But that has only marginally reversed the declines of the previous 15 years, so average prices remain about 40 per cent below even the lowest estimates of construction costs, reports Kai Klose at brokerage Berenberg Bank. Little wonder that house completions – which are mainly focused on the top end of the market – remain well below the rate of household formation.
There is one major obstacle to a cyclical upswing in German rents and house prices – regulation. The tenant lobby in Germany is strong, and price stability has long been an all-important tenet of the nation’s economic policy. Both run counter to landlords’ hopes for rental growth. Local authorities cap private rents through a complex system called the Mietspiegel (literally the ‘rental mirror’).
Yet authorities seem to realise that rents need to rise to justify construction. The council of Münster in North Rhine-Westphalia last week passed a Mietspiegel review that paves the way for rental growth of 6.5 per cent over a two year period. GSW’s like-for-like annual rental growth since 2006 is 3.1 per cent; the equivalent figure for Deutsche Wohnen is 2.6 per cent. It shouldn’t be challenging to maintain these growth rates.
| Ticker | Share price | Market cap | Discount to 2013 NAV | Adjusted earnings yield | Dividend yield | Loan to value ratio | 2012 rental growth | Cost of debt | |
|---|---|---|---|---|---|---|---|---|---|
| Deutsche Wohnen | ETR:DWN | € 13.92 | € 2.03bn | 10% | 5.1% | 2.2% | 57% | 2.4% | 3.7% |
| GAGFAH | ETR:GFJ | € 9.11 | € 1.82bn | -23% | 7.7% | nil | 58% | 0.8% | 4.4% |
| GSW Immobilien | ETR:GIB | € 29.45 | € 1.49bn | -3% | 4.7% | 3.0% | 56% | 2.4% | 3.6% |
| LEG Immobilien | ETR:LEG | € 41 | € 2.17bn | -3% | 6.6% | 4.3% | 48% | 2.4%** | 3.3% |
| TAG Immobilien | ETR:TEG | € 8.75 | € 1.14bn | -6% | 4.6% | 3.4% | 58% | 3.2% | 4.2% |
| Patrizia Immobilien | ETR:P1Z | € 7.56 | € 433m | 15% | 4.2% | nil | 65% | na | 5.3% |
| Taliesin Property Fund | LON:TPF | £13.17 | £48m | -13%* | n.a. | nil | 58% | na | 4.2% |
Source: Berenberg Bank, IC research *based on 2012 NAV **2011 data | |||||||||
Cheap debt
It’s easy to forget that property companies consist of liabilities – mainly debts – as well as assets. Fortunately, this side of the German residential sector’s balance sheet is reasonably healthy, too. Loan-to-value ratios look high relative to the UK real-estate investment trusts (see table), but stable valuations and low interest rates – 3.6 per cent on average for GSW, for example – make them affordable.
The substantial spread between net rental yields of roughly 5 per cent and cheap funding costs is a key reason to own the sector, says Marcus Phayre-Mudge of TR Property (TRY), a property investment trust, because it means the companies can boost their profits meaningfully through acquisitions. The market place remains extremely fragmented, with the entire listed sector still owning less than 1 per cent of the nation’s housing stock. Residential property is very management-intensive, so landlords can also generate operational economies of scale by owning more flats in a single area. The brokers at JP Morgan take this logic a step further and predict a wave of mergers among the Reits themselves. All six speakers at a recent sector conference agreed it was “unlikely all the listed entities today would be around in five years time”, they report.
One of the sector’s weaknesses is its dividends, which look modest even by the fairly low-yielding standards of the big UK Reits. Deutsche Wohnen only pays out half its rental profits, giving a yield of 2.2 per cent on the current share price. The low yields also reflect the bull run in the sector last spring and summer, which brought share prices in line with book values for the first time since 2007.
Interest has ebbed away in the past six months. That probably reflects profit taking as well as Goldman Sachs’ long-awaited €1.3bn flotation of LEG Immobilien (ETR:LEG) in February, which may have temporarily sated fund managers’ appetite for German housing Reits. The risk-on mood of markets this year may also have distracted investors’ attention from what is widely viewed as a safe-haven story.
IC VIEW:
The momentum may have gone, but the weak spell has also left valuations looking a little less stretched than they did six months ago. With the exception of Deutsche Wohnen, all the German residential Reits now trade at discounts to forecast book value, albeit slim ones. The sector’s performance won’t be as eye-catching as it was last year. But the rare prospect of sustainable growth in rents and valuations nonetheless makes it an excellent long-term store of value. Buy.
