Attractive, secure and growing yield with LEG

Most Germans rent rather than own their home. That means a company such as LEG, which owns about 91,000 homes in the state of North Rhine-Westphalia, receives its revenues from a very broad spread of German consumers. These could easily afford to spend more on housing - for two reasons.

First, housing costs are low after an extended property slump. While most other western countries were enjoying a housing and consumer boom in the decade running up to 2007, Germany was absorbing the enormous costs of its reunification in 1990. One of these was a housebuilding frenzy that flooded the property market with supply. Even now that rents have started growing again, they account for well under 30 per cent of disposable income in most cities, which is low by European standards.

Second, German wages - which fell in real terms for much of the last decade - have since 2010 been growing by more than consumer prices. With unemployment at its lowest rate for over two decades, further real wage growth is highly likely. Rents can therefore grow by at least the inflation rate without compromising affordability.

This is important in what remains a highly regulated sector. The German rented sector resembles its UK equivalent before Margaret Thatcher's reforms. Tenants have complete security of tenure - landlords have no right to evict them as long as they pay the rent - and rents for sitting tenants cannot be raised by more than a percentage set according to a bureaucratic procedure by the local authority.

The extent of these regulations for many years cast a pall over the German residential real-estate investment trusts. It still means rents are unlikely to rocket, however strong the market fundamentals. Yet wage growth should allow councils to let rents rise without provoking too much opposition. The city of Münster this month adjusted its so-called Mietspiegel ('rental mirror') so that rents can increase by 6.5 per cent over a two-year period.

Perhaps local bureaucrats recognise that housing costs need to rise in real terms if more homes are to be built. It's estimated that LEG's portfolio is currently worth anywhere between 48 and 59 per cent less than replacement cost. Volume housebuilding makes no economic sense in such an environment, which is good news for landlords.

Since 2008 LEG has delivered rental growth of 2.3 per cent a year. That's a slightly lower number than peers such as GSW Immobilien and Deutsche Wohnen have achieved. With the post-industrial problems of the Ruhr Valley, North-Rhine Westphalia has less favourable demographics than, say, Berlin or Hamburg. Overlaying LEG's portfolio with official population growth forecasts, brokers at JPMorgan Cazenove calculate that the company is exposed to an average population decline of 2.9 per cent over the period to 2025.

But the difference in rental growth between LEG and its peers is slight, while its balance sheet leaves more room for growth by acquisition. The company's loan-to-value ratio of 48 per cent may look high compared with UK commercial landlords, but in light of the resilience of the German housing sector and the company's robust debt profile - it pays just 3.3 per cent to service its debts despite an average length to maturity of 12 years - it can easily take on more borrowing. Management wants to buy 10,000 units over the next two years. Given the wide spread between LEG's cost of debt and the net rental yield on its portfolio (roughly 5 per cent), these acquisitions will boost earnings meaningfully.