German public real estate funds in brief

For as long as we can remember, German housewives have cooked a dish called “Rotkohl”, or red cabbage mixed with apples, vinegar, cloves, cinnamon, sugar, onions , fruit jams, caraway seeds, garlic, wine, raisins and any number of spices, making it both sour and sweet alike.

I think the characteristics of this nationally acclaimed meal can be a good metaphor to describe the historic performance of German FPIs, which have gone from sour to sweet and vice versa several times over the past 18 years, as you can see see on the FTSE EPRA Analysis of the NAREIT Germany index below. Therefore, I want to determine whether sourness or sweetness prevails in the German REIT market today.

Starting our analysis of German REITs (or so-called G-REITs), I must say that German and international investors have benefited from REIT legislation since 2007, when the country introduced the following basic rules:

• At least 75% of the G-REIT’s total assets must be real estate and at least 75% of its gross income must come from renting, leasing, renting and disposing of real estate.

• The G-REIT must distribute at least 90% of its net income, calculated according to German GAAP, to its shareholders until the end of the following fiscal year

• All current income is tax exempt and capital gains are tax exempt

• In general, the investor must pay a withholding tax of 25% plus a solidarity surcharge of 5.5% on the withholding tax, i.e. a total of 26.375%

Having defined the legislative requirements for G-REITs, I should mention that the G-REIT universe on the local Deutsche Boerse stock exchange is presented by 12 public funds, divided into four main sectors:

• Multifamily: Vonovia (OTCPK:VNNVF), Grand City Properties (OTC:GRNNF), TAG Immobilien (OTC:TAGOF), LEG Immobilien (OTCPK:LEGIF), Adler (OTC:ADPPF)

• Mixed use: Hamborner (OTC: HANBF), Deutsche Wohnen (OTCPK: DWHHF), Aroundtown (OTCPK: AANNF), Patrizia (OTC: PTZIF)

• Office: DIC Asset (OTCPK:DDCCF), Office in Alstrie (OTC:ALSRF)

• Retail: Deutsche EuroShop (OTC: DUSCF)

In terms of public valuation, the multi-family sector occupies more than 60% of the total capitalization cake of around 62 billion euros in May 2022. (see infographic below).

Investment Analysis of German REITs

I’ll walk you through the 3-step process of how I assess the investment attractiveness of German REITs in the current market environment:

1. General Index Analysis

2. Analysis of the strength of the regional economy

3. Analysis of valuation metrics

General Index Analysis

From a macroeconomic point of view, the current total capitalization of the 12 REITs corresponds to almost the lowest value of the iSTOXX® Germany Real Estate Capped 20 index of the last five years, which gives me the first impression of the right time to enter the general market.

Analysis of land economic forces

As you may know, the Federal Republic of Germany consists of Lands (in fact, sixteen partially sovereign federal states), each with its unique cultural environment and economic power. Therefore, I thought it would be interesting to create an analytical framework to see the potential of each land and match it to the REIT portfolio allocation, based on the highest percentage of investments in a land particular. By superimposing two dimensions, we were able to identify REITs investing in the most attractive areas. For this analysis, I decided to use three indicators:

• purchasing power

• Highest GRP (Gross Regional Product)

• Highest level of HDI (Human Development Index)

Below you can see the result:

Two main results:

1. Three states – North Rhine-Westphalia, Baden-Württemberg and Bavaria – are at the top of this assessment

2. Hamborner is the only REIT with significant portfolio allocations (>15%) in these three countries

Thus, Hamborner could be an excellent long-term investment, given its unusually high free float (~77% of outstanding shares) for those who are valuation independent and looking for other ways to screen potential targets for their REIT portfolio.

Also, I would like to lightly touch TAG Immobilien. Despite its highest portfolio allocations outside the scope of the first 3 plots, it will invest (and has already invested) heavily in Polish assets, including the acquisition of local developer ROBYG – the main player in the Polish residential market.

I fully agree with TAG’s investment logic because in a context of macroeconomic strength and population growth, Poland is experiencing a structural mismatch between supply and demand in the multi-family segment for historical reasons. Therefore, it deserves the attention of individual and institutional investors.

I fully agree with TAG’s investment logic because in a context of macroeconomic strength and population growth, Poland is experiencing a structural mismatch between supply and demand in the multi-family segment for historical reasons. Therefore, it deserves the attention of individual and institutional investors.

Analysis of valuation metrics

Just like in my previous articles on the local REIT landscape in different countries, I have prepared some data tables to take a snapshot of the current valuation of 11 REITs and calculate the metrics needed for different investment strategies. (I excluded Adler due to alleged manipulation of financial reports and apparent fraud by management. For those interested in learning more about this story, which could be a great addition to the collection of short sales by David Einhorn, please see a fascinating report by the research group Viceroy Research).

Ultimately, among 11 REITs:

1. Deutsche Wohnen and DIC Asset have the lowest P/NAV ratio

2. Deutsche EuroShop and DIC Asset have the lowest 2021 P/FFO multiple

3. Patrizia has the highest cap rate spread

4. TAG Immobilien and DIC Asset have the highest dividend yield

Keeping in mind the results of my 3-step analysis, I would like to highlight one of my favorite German REITs, which a) seems undervalued to me and b) has an exciting and evolving business model.

Patrizia – my top choice in the German REIT market

Speaking of a mixed-use REIT Patrizia, I have to say that it has a unique business model for Germany and other European REITs. I better identify this company as PREIM or public real estate investment manager instead of REIT because its operations are almost entirely fee-based, managing real estate investments for institutional, semi-professional and private investors. Looking at the balance sheet:

I have to say this is one of the strongest I have seen in the REIT space.

1) The net equity ratio is above 70%

Equity (excluding non-controlling interests) divided by total net assets (total assets less loans covered by cash on hand)

2) Interest-bearing debt/total assets is 17.5%

3) Two-fifths of the assets on the balance sheet are a very liquid part of the assets (cash + deposits + current receivables)

Overall, Patrizia, which is still a founder-led company (CEO Wolfgang Egger founded it in 1984!), has four main activities:

• Place and manage fund assets in core and core+ strategies for clients via its platforms

• Co-invest with clients in value-added and opportunistic segments

• Acting as a fund of funds, investing clients’ money in the world‘s best RE funds

• Speculative investment from its balance

Generate five types of cash flow:

• Management fees based on AUM

• Transaction fees based on the volume of purchases or sales

• Performance fees for hitting investment hurdles

• Net sales and co-investment income as return on capital employed

Also, unexpectedly for me, but given the six years, Patrizia found her way to the top 3 negotiators in Europe.

Patrizia’s investment logic is supported by the business model based on blended fees and a strong AUM, which is reflected in the decisions of the analyst community. Eight out of eight analysts covering this REIT confirmed their BUY opinion in Q1 2022 with a price target of EUR 26.8 (> 65% upside):

Conclusion

To sum up, I would like to tell my readers that in my opinion, the German REIT market is worth spending more time examining using different analytical frameworks. Also, I hope my article will help you get a first impression of the state of the market these days or make you think about adding one of them to your portfolios. And I am ready to discuss your thoughts and ideas in the comments to the article.