Fair Value: EUR 8.20 (-)

Transcription

1 TAG AG Recommendation: BUY (Initiating Coverage) Risk: MEDIUM (-) Fair Value: EUR 8.20 (-) 11 th February 2008 TAG deserves a better price Share price vs. SDAX (1 year) TAG made a good start to the year Pre-tax profit tripled to 15.8m for 9M07 compared with the 9M06 figure, which was at a low level. Management has released a pre-tax profit target of 31m for FY2007, which means TAG has to double its 9M07 figure. We believe TAG should meet its target in light of the real-estate business cycle. The fourth quarter has always been the most profitable in a year for both TAG and the sector in general, and TAG sold a development project at the end of December TAG returned to profitability in Its growth strategy has been based on fresh shareholder funds of 180m from two capital increases in We expect positive earnings development from TAG in coming years. The new business strategy to actively unlock the value of its real estate portfolio and to make new acquisitions should deliver enough profit potential. TAG has developed well since 2005 but this has not been reflected in the share price performance since June The current share price represents a discount of 50% on its NAV. Reasons for the rather disappointing development are not company specific but instead clearly lie in the US subprime crisis and its consequences. Investors are quite concerned about the future development of capital markets and especially the international real estate markets, and are likely to remain so for the next few months. But the German real estate market has not deteriorated and it does not look like doing so this year. TAG shares therefore seem rather cheap compared with other real estate companies. We do not expect a short-term turnaround in real estate shares but we do believe it will come in the medium term. Our price target is 8.20 per TAG share. We place a BUY recommendation on the shares of TAG. Internet: Share data: Share Price: Shares outstanding (m): Market capitalisation: Ø daily trading volume: Performance data: High 52 weeks: Low 52 weeks: Absolute performance (12 months): Relative performance (SDAX): 1 month 3 months 6 months 12 months Shareholders: Source: CBS Research AG, Deutsche Börse Sector: Real Estate WKN: ISIN: DE Free float: Taube Hodson Stonex Partners Ltd.: European Asset Value Fund: Investorengruppe Dr. Ristow: Ratio Asset Management LLP: Tudor Group Verwaltungsgesellschaft: EUR EUR 200m 90, % 2.1% -3.7% % 16% 6% 7% 5% 5% Key data EUR m E 2008E 2009E Total Revenues EBITDA EBIT Net profit EPS DPS EBITDA margin 4.0% 14.1% 36.5% 41.1% 43.5% EBIT margin -8.2% 13.7% 35.2% 39.8% 42.2% EV/EBITDA n/a EV/EBIT n/a P/E n/a Source: CBS Research AG, company data Management Board: Supervisory Board: Andreas Ibel (CEO) Erhard Flint (CFO) Dr. Lutz R. Ristow Prof. Dr. Ronald Frohne Rolf Hauschildt Dr. Wolfgang Schnell Close Brothers Seydler Research AG Phone: +49 (0) research@cbseydlerresearch.ag Close Brothers Seydler AG Institutional Sales: Germany: Uwe Gerhardt Phone: +49 (0) France: Bruno de Lencquesaing Phone: +49 (0) Close Brothers Seydler Ltd. Institutional Sales: United Kingdom: Ernie Ferriday Phone: +44 (0) TAG AG has contributed to this report, Information sourced from fairesearch Analyst Dieter Hein Close Brothers Seydler Research AG 1 Please notice the information on the preparation of this document, the disclaimer, the advice regarding possible conflicts of interests, and the mandatory information required by 34b WpHG (Securities Trading Law) at the end of this document. This financial analysis in accordance with 34b WpHG is exclusively intended for distribution to individuals that buy or sell financial instruments at their own account or at the account of others in connection with their trading activities, occupation, or employment.

2 Investment Summary Strengths Focus on German metropolitan regions, especially Berlin, Hamburg, Munich, Leipzig and the Rhine-Main region (Frankfurt) Expanding service segment enables a significant profit contribution with only limited equity capital usage New strategy to unlock value of its real estate portfolio Improved reporting transparency Weaknesses TAG was a restructuring case The company only returned to profit in 2006 and has yet to prove that it can deliver a sustainable profit level over time The commercial real estate segment is ready to go public as a German REIT but the current market discount on NAV is not attractive for the management Opportunities The German real estate market still looks underdeveloped compared with other European markets Over the medium term G-REITs will open the German real estate market to a new kind of investor, and TAG can participate in this development with its commercial real estate model Medium-term recovery of the German economy Threats Rise in interest rates increase funding costs Investors interest in the German real estate market could weaken further As a real estate company, it is exposed to market- and sector-specific risks Capital increase to finance potential acquisitions Close Brothers Seydler Research AG 2

3 Valuation TAG is a real estate investor. In our view the best evaluation of its fair value is therefore its net asset value (NAV). The current share prices of TAG and other real estate companies are well below their NAVs. A peer group comparison, together with some other fairesearch valuation models, should give a good overview regarding the performance potential of TAG shares: multiple comparisons, an earnings discount model, NAV and book value. The company focuses on residential and commercial real estate in Germany and the asset management of real estate with a local emphasis on big cities. The peer group compiled by fairesearch therefore consists of six real estate companies that also focus on residential or commercial real estate in Germany. However, the business mix within the peer group is of course not identical, so the peer group comparison is somewhat limited in our view. fairesearch has calculated a per-share NAV for the real estate portfolio of TAG. The calculated figure is a NNNAV (ie market value minus deferred taxes on capital gains). We estimate the market value of TAG s real estate portfolio to be around 10% above the book value. We deducted a tax rate of 30% for deferred tax liabilities on the forecast capital gains as well as some sales commissions and other costs. The service segment is included at its present value. The NAV valuation is a good tool for pure real estate portfolio management and a buy-and-hold strategy. Hidden reserves NAV comparison ( E) NAV E 2008E 2009E P/NAV 2008E Colonia Real Estate Deutsche Wohnen GAGFAH PATRIZIA Immobilien Alstria Office n.a DIC Asset average TAG based on average 8.96 Source: CBS Research AG, fairesearch, HSH NORDBANK A historic data comparison shows that investors have assessed real estate companies quite differently on a P/NAV valuation over time. European and German real estate companies were valued with a discount of up to 40% to NAV in On the other hand, investors were ready to pay a premium of up to 40% to the NAV of these real estate companies in Amid the current market turmoil, the market values our peer group at a discount of 30% to the estimated NAV for TAG is currently valued with a discount of around 50% on its estimated 2008 NAV. As a result of profit problems TAG hit a low of a discount of up to 75% on the NAV in But the earnings potential seems much better today. Based on fairesearch s 2008 NAV estimates the potential target price for TAG is 8.96 per share based on the average valuation of the peer group and this is likely to be Close Brothers Seydler Research AG 3

4 on the low side. The book value per TAG share (shareholder funds per share) is around 8.20 for 2007, and we think that is at least a fair price level for TAG shares. We calculated an average book value of 8.60 per share for the 2007e-2009e period. The peer group comparison shows that the companies multiples differ considerably. This could be due to differences in their business mix, strategy, prospects, free float and market confidence in management s skills. We therefore compared TAG s figures with the peer group average. The forecasts for TAG are fairesearch estimates, while the peer group forecasts are based on consensus and market figures. Our P/E-based multiples valuation suggests that TAG is not undervalued. The target share price ranges from 5.35 for 2008e to 5.19 for 2009e based on the peer group average. The average target price for the 2007e-2009e period would be 5.30 per share, which does not make much sense in our view, because the extremely low P/E ratios of two peers distort the average multiple. Multiples comparison of major competitors (2007E 2009E) Company Price in Market cap. m EPS`07 EPS`08 EPS`09 P/E`07 P/E`08 P/E`09 Colonia Real Estate Deutsche Wohnen GAGFAH , PATRIZIA Immobilien Alstria Office DIC Asset average TAG based on average Source: CBS Research, fairesearch, Börsenzeitung The EV/EBITDA valuation indicates that TAG is overvalued. The potential target price ranges from 5.37 per share for 2007e to 3.55 for 2009e. The average target price for the 2007e-2009e period would be 4.28 per share. TAG is currently in an investment phase and the figures of the peer group have a wide range. The EV/EBITDA comparison seems therefore currently not appropriate for TAG evaluation. Close Brothers Seydler Research AG 4

5 EV/EBITDA comparison (2007E-2009E) EV/EBITDA 2007E 2008E 2009E Colonia Real Estate Deutsche Wohnen GAGFAH PATRIZIA Immobilien Alstria Office DIC Asset average TAG based on average Source: CBS Research AG, fairesearch, HSH NORDBANK fairesearch also valued TAG using our shareholder profit model, which is an earnings discount model. We decided to opt for this rather than a DCF model because the cash flow of a real estate company is often strongly influenced by inventory investments and disposals. Such cash flows are particularly hard to forecast. In fairesearch s view, the earnings discount model is a more reliable means of valuing that business. We calculate a fair value of 9.11 per TAG share. TAG looks undervalued according to our NAV and book value analysis as well as on our shareholder profit model. The different valuation methods we used yielded fair values that ranged from 3.55 to 9.11 per share for 2007e to 2009e. The average target prices is 7.26 per share, which is clearly above the current share price of TAG. TAG price per share by different valuation methods P/E valuation 5.3 EV/EBITDA 4.3 NAV (2008E) 9.0 Book value 8.6 Shareholder profit model 9.1 Average price per share 7.26 Source: CBS Research AG, fairesearch TAG shares do not look expensive compared with other real estate companies. However, the whole sector has underperformed in 2007 and 2008 to date after a strong performance in The weakness of some real estate markets, such as the US, UK and Spain, seems to be taking its toll on institutional investors interest in the real estate market as a whole. The global financial turmoil caused by the so-called US subprime crisis has been a disaster for real estate companies. But the German real estate market has not deteriorated and it does not look like it will do so in current year. TAG shares seem therefore rather cheap compared with other real estate companies. The book value per TAG share (shareholder funds per share) is around 8.20 for We believe that is at least a fair price level for TAG shares. This represents upside potential of 34% from the current price per share. Price target of 8.20 per share represents 34% upside potential Close Brothers Seydler Research AG 5

6 Company Profile TAG is a listed company which can look back on a history of 125 years. It has therefore a much longer company history than most of its German real estate peers. But TAG switched its business focus to real estate less than 10 years ago. The company was originally a railway company, which was founded in TAG leased its railway business to a third party in The railway business included properties with a total area of around 50,000 sqm on the banks of Lake Tegern, which still belong to TAG. The company switched its business focus to a listed real estate group following the acquisition of subsidiaries and real estate companies. At the end of 2006 TAG joined the German SDAX, which is an index of 50 German small caps, and it belongs to the 10 biggest listed German real estate companies. A long history in a different business TAG acquired 44.4% of Bau-Verein zu Hamburg AG in Bau-Verein zu Hamburg was set up in 1892 as a real estate cooperative in the city of Hamburg. TAG increased its stake on Bau-Verein zu Hamburg to 87.9% at the beginning of 2002 and reduced it to 71% in August 2006 to increase the free-float. Andreas Ibel and Erhard Flint were appointed as members of the board of Bau-Verein zu Hamburg in 2001, and in 2006 also joined the board of TAG. TAG acquired JUS AG at the beginning of 2001 and changed its name to TAG Asset Management at the end of Group structure of TAG (September 2007) 71% Residential real estate Bau-Verein zu Hamburg AG - Listed at the Prime Standard - Total assets 344m - 29% free float Holding company function TAG - Listed at the SDAX - Equity 296m - Market cap 269m - Total assets 800m 90% 10% Commercial real estate TAG Gewerbe AG - Pre-REIT status - Total assets 336m 100% Real estate services TAG Asset Management - Total assets 79m Source: CBS Research AG, fairesearch, TAG Close Brothers Seydler Research AG 6

7 Market value of TAG portfolio by type of use (end-june 2007) 14% 23% 41% 22% Residential investment portfolio Commercial Residential current asset portfolio Undeveloped real estate Source: CBS Research AG, fairesearch, TAG TAG is the holding company of the real estate group and focuses on German metropolitan regions, especially Berlin, Hamburg, Munich, Leipzig and the Rhine-Main region (Frankfurt). The core business of TAG is the management and development of its own portfolio, new construction, portfolio management for third parties, and real estate services. TAG runs both the residential and the commercial real estate businesses via its subsidiaries. The company keeps around 5,000 residential and commercial units in its own portfolio. Another 1,500 units are under construction or in the pipeline. In addition, it manages 7,200 units for third parties. TAG increased its capital three times in 2005 by a total of 28m and twice in 2006 by a total of 180m. The group s shareholder funds were 296.4m at the end of September The number of shares outstanding is currently 32.6m. The free float was 61% at the end of 2007, according to TAG, and 93% according to the definition of Deutsche Börse AG. The shareholder structure is detailed in the chart on the next page. Close Brothers Seydler Research AG 7

8 Shareholder structure of TAG 7% 5% 5% 6% 16% 61% Free float European Asset Value Fund Ratio AM Taube Hodson Stonex Partners Ltd. Investorengruppe Dr. Ristow Tudor group Source: CBS Research AG, fairesearch, TAG The shareholder funds it collected in 2006 will enable the company to increase its total assets to 1.3bn in The budget for acquisitions of real estate is 800m for the years 2006 to Corporate strategy: buy, build and hold TAG s strategy aims to generate long-term value growth. The company wants to realise that target with a combination of real estate portfolio maintenance and the development of the portfolio together with a real estate service provider. It therefore covers the value chain for that real estate business. TAG believes that its longterm view enables the company to use the cyclical moves of the real estate market and to acquire properties at the cyclical bottom. TAG aims to build up a long-term real estate investment portfolio with stable cash flows and high returns. Buy Build Hold Service Major German cities with longterm prospects Modernisation and repairs Long-term portfolio Property and asset management Good residential locations Creation of extra space by extensions and additional storeys Trapping potential for raising rentals Due diligence Attractive rental yields with high cash flows Extensions and new constructions Optimising operating costs Project and construction management Focus on small to mid-size real estate portfolios Improvements to surroundings Controlling Detailed due diligence reviews by expert staff Active value creation by means of portfolio enhancement activities Book keeping Source: CBS Research AG, fairesearch, TAG Close Brothers Seydler Research AG 8

9 Residential real estate Bau-Verein zu Hamburg runs the residential real estate business for the TAG group. Its core business is to develop its residential real estate portfolio as well as to build new dwellings in established locations in German metropolitan regions. Its focus is on Hamburg, Berlin, Munich, Leipzig and the Rhine-Main region. TAG sees markets expanding there due to rising populations. Bau-Verein zu Hamburg sold 90% of its commercial real estate subsidiary to TAG at the end of This subsidiary was renamed TAG Gewerbeimmobilien AG and now runs the commercial real estate of the TAG group. Bau-Verein zu Hamburg wants to strengthen its own residential real estate portfolio sustainably through acquisitions and to enhance the value of its portfolio through active portfolio management. The company keeps around 5,000 residential and commercial units in its own portfolio. Another 1,500 units are under construction or in the pipeline. In addition, it manages 7,200 units for third parties. Bau-Verein zu Hamburg has branches in Berlin, Hamburg, Munich and Leipzig to keep close contact with the regional markets and its own real estate portfolio. Market value of residential portfolio by region (end-june 2007) 9% 10% 27% 10% 44% Source: CBS Research AG, fairesearch, TAG; Hamburg Berlin Munich Leipzig Other Close Brothers Seydler Research AG 9

10 Residential real estate investment portfolio (end-2006) Hamburg Berlin Munich Leipzig Other Total Units 1, ,142 Area in sqm 59,205 10,121 4,092 24,752 40, ,120 Average size in sqm Vacancy for rent in sqm 1, ,707 4,192 Vacancy for rent 2% 4% 5% 3% 4% 3% Net rent in TEUR 4, ,582 8,425 Net rent in /sqm Market rent after development in TEUR 5, ,810 3,327 12,302 Market rent after development in /sqm Planned investment in TEUR 2,443 2, ,277 5,943 24,416 Source: CBS Research AG, fairesearch, TAG; Current assets - residential real estate portfolio (end-2006) Hamburg Berlin Munich Leipzig Other Total Units 308 1, Area in sqm 19, ,866 10,572 1,939 3, ,800 Average size in sqm Vacancy for rent in sqm 146 2, ,338 Vacancy for rent 1% 2% 3% 10% 2% 2% Vacancy for sale in sqm 5,943 14, , ,135 Vacancy for sale 30% 12% 4% 77% 0% 15% Net rent in TEUR 986 4, Net rent in /sqm Planned investment in TEUR 2,443 2, ,277 5,943 24,416 Source: CBS Research AG, fairesearch, TAG Bau-Verein zu Hamburg sold an entire development project in Hamburg in 4Q07. TAG s revenue contribution from that sale should be close to 40m and pre-tax profit share around 12m, booked in 4Q07. It was a joint venture with DESIGN Bau AG. Some 750 apartments as well as commercial units and retail outlets covering a floor area of around 14,000 sqm are being developed and constructed in this project, which abuts directly onto the City Park and is located in the Hamburg suburb of Winterhude. Construction work is expected to commence in the first quarter of TAG will remain involved in the execution of the project. Current assets - Undeveloped real estate portfolio (end-2006) Hamburg Berlin Munich Leipzig Rhine-Main Total Area of land in sqm 128,725 7,940 5,187 10,455 15, ,307 Units planned Area planned 70,185 1,558 12, ,179 91,838 Planned investment in TEUR 103, , , ,215 Source: CBS Research AG, fairesearch, TAG Close Brothers Seydler Research AG 10

11 Prospects TAG s strategy of buying residential properties that have space with further development potential and levels of rent that are not fully developed makes a lot of sense in our view. It can therefore increase the value of its portfolio as well as its profitability after the necessary investments. The average rent per sqm of its investment portfolio was still 46% below the average market rent at the end of 2006 (see the first table on the previous page). The second pillar of TAG s strategy is a right one as well: to focus the real estate portfolio on German metropolitan regions. There has for some years been a clear trend in Germany to move back into major city centres; in addition, the average residential space per capita is forecast to rise by around 20% by We therefore expect demand for housing to increase in areas where the TAG portfolio is located. The value of the investment portfolio and the market rent level should benefit from these trends. The value enhancement growth of TAG s investment portfolio was at least 5% p.a. over the last years. TAG s last published deal in the project development business shows that there are some profitable business opportunities in its underdeveloped real estate portfolio. The construction of new dwellings in established locations in German metropolitan regions should benefit, as the investment portfolio will, from the demand development in this area, described above. The low vacancy rates of the residential real estate portfolios of TAG support this view. We therefore expect a sustainable increase in revenues and EBIT for the real estate business until 2009, driven mainly by the positive trends in the metropolitan regions. The figures for 2007 may be distorted by the sale of the development project at Hamburg in 4Q07. We do not believe that the current financial market turmoil should have a big negative effect on the residential real estate market in German metropolitan regions in the next two years. Residential real estate ( E) m E 2008E 2009E Sales revenues EBIT Source: CBS Research AG, fairesearch Close Brothers Seydler Research AG 11

12 Commercial real estate TAG set up TAG Gewerbeimmobilien AG to run the group s commercial real estate at the end of The background was the positive legislative development relating to the introduction of Real Estate Investment Trust (REITs) in Germany. TAG therefore converted its commercial real estate subsidiary from the legal status of a German GmbH to a listed company (AG) at the end of It was registered as a pre-reit. The conditions for the establishment of TAG Gewerbeimmobilien AG as a German REIT (G-REIT) have been created and the target is to go public with this segment as a REIT. TAG has said it is investing only in locations in cities including Munich, Hamburg and the Rhine-Main region and in the commercial real estate segment. The focus is there on investments in the best locations of second-best cities or second-best locations in premium cities. It aims to reach a good commercial real estate portfolio mix between investment properties with stable cash flows and undervalued properties with value-added development potential. The buy, build and hold strategy enables rental growth and realise space reserves of its properties. Market value of commercial portfolio by region (end-june 2006) 10% 12% 26% 15% 37% Hamburg Berlin Munich Rhine-Main Other Source: CBS Research AG, fairesearch, TAG TAG has a strong growing commercial real estate portfolio. The value of the portfolio was 105m at the end of The target is total assets of 400m for the commercial real estate portfolio at the end of Close Brothers Seydler Research AG 12

13 Current assets - commercial real estate portfolio (end-2006) Hamburg Munich Rhine-Main Other Total Units Area in sqm 19,811 42,990 26,567 25, ,933 Vacancy for investment in sqm 457 2,692 2,327 1, Vacancy for investment 2% 6% 9% 6% 6% Vacancy for rent in sqm Vacancy for rent 0% 0% 11% 3% 3% Net rent in TEUR 849 3,499 2,315 1, Net rent in /sqm Planned investment in TEUR 1,441 7, ,000 Source: CBS Research AG, fairesearch, TAG Prospects TAG made some relatively large acquisitions in its commercial real estate business last year. It has participated that German big companies prefer to sell its self used properties to potential G-REITs as setting up their own G-REITs. The so-called Exit Tax on German REITs enables commercial real estate sellers to realise part of their capital gains on their sold properties with a 50% reduction in income, corporate income and local payments tax until the end of The companies sell and lease back their properties and can realise part of their disposal gains on the properties with reduced tax. TAG should therefore hit its investment target for its commercial real estate portfolio in the current year. The second target currently seems harder to reach: to go public with this segment as a G-REIT. The valuation of real estate companies and commercial real estate portfolios has changed dramatically since spring The market was ready to pay a premium on the current net asset value of a real estate company one year ago. Now investors only buy with a considerable discount on the NAV. We do not believe that the market s assessment of real estate companies is going to change in the short term. But the management of TAG still intends to sell its commercial real estate portfolio via an IPO as a G-REIT, close or above the NAV. We therefore predict that TAG will not be able to realise its G-REIT plans this year. The plan to reinvest the money from a G-REIT IPO into a new commercial real estate portfolio should be postponed as well. Our estimates for the commercial real estate business do not include any IPO contribution. We predict no G-REIT this year Commercial real estate ( E) m E 2008E 2009E Sales revenues EBIT Source: CBS Research AG, fairesearch Close Brothers Seydler Research AG 13

14 Services TAG has pooled its real estate service activities in a subsidiary, TAG Asset Management. The company carries out all activities related to real estate: acquisition, due diligence, project development and management, construction site supervision, controlling and asset management. TAG Asset Management handles these functions for the group as well as for third parties. It supports national and international investors construction projects. The most frequently used services relate to acquisitions, public relations, data processing and controlling. The group has widened its source of non-capital-tied income with a reliable planning horizon by expanding its range of services related to real estate. TAG is able to offer the entire value chain in the real estate sector together with its residential and commercial real estate activities. As a result it has been possible to extend the service business substantially. New co-operation with HSH Nordbank HSH Real Estate and TAG launched a joint asset management company at the beginning of An agreement establishing the joint venture, with each partner holding a 50% stake, was signed at the end of The headquarters will be in Hamburg. HSH Real Estate is a subsidiary of HSH Nordbank, one of the big public banks in Germany and the biggest local bank in the Hamburg/Schleswig-Holstein region. The new company will manage a portfolio of commercial real estate in Germany with an initial volume of 1.2bn. The portfolio consists of some of TAG and HSH Real Estate s own commercial properties and real estate managed on behalf of third parties. Prospects We consider that TAG s strategy to extend its source of non-capital-tied income with a reliable planning horizon by expanding its range of services related to real estate is a good one. The company is concentrating its resources, improving know-how and improving profitability, without the need for additional capital. The co-operation with the subsidiary of HSH Nordbank should increase its business opportunities. We therefore forecast a strong increase in the segment s revenues and EBIT contribution in the next few years. Services ( E) m E 2008E 2009E Sales revenues EBIT Source: CBS Research AG, fairesearch Close Brothers Seydler Research AG 14

15 The industry The German residential real estate market has developed differently from those of other European countries. Prices for residential real estate have risen strongly in most European countries since 1998 but not in Germany, where they have remained more or less unchanged over that time. Meanwhile, we have seen the property bubble bursting in some markets, such as in Spain, Great Britain, Hungary or Ireland. The strong expansion in housing output was driven by considerable price increase and has led to overcapacity, resulting in a downturn in the high property prices in former boom markets. In Germany was no real estate pricing bubble and therefore no burst. European housing market price development (1998 = 100) Country Average change per year (%) Hungary Spain France UK Norway Ireland Sweden Netherlands Italy Poland Denmark Finland Switzerland Germany Source: Euroconstruct There are some reasons for this development in Germany. Firstly, the country s poor economic development has led to weak demand in the past years. Secondly, the German government has for decades subsidised the building of new residential properties via tax benefits. Demand for housing was huge in Germany after widespread destruction in World War II. After the war, the trend was supported by growth in the population and GDP. In particular, after German reunification in 1990 the government had to encourage private equity to invest in the ailing East German real estate market by offering tax benefits. The lack of private investors and private owners had left much of east German real estate stock in a disastrous condition and caused a deficit in supply. Government measures to boost the building of new residential properties worked well too well, indeed, as the government cancelled the tax incentives too late, causing a deficit in demand for Germany. Close Brothers Seydler Research AG 15

16 General trends in the German residential real estate market However, we see signs of a turnaround in the German residential real estate market. On the one hand, new builds more than halved from over 500,000 in 1995 to 211,000 for The building licences for new dwellings in Germany fell by 31% yoy to 136,000 for the first nine months of On the other hand, the German Federal Office for the Building Trade and Regional Planning expects that the number of households will continue to increase in Germany as a result of the general reduction in household size. Experts estimate an annual new housing demand of 340,000 units in Germany. The supply of new buildings has not met the high demand in Germany for several years. This deficit should lead to increasing or at least stable housing prices in Germany with strong local differences, of course. The building of new homes more than halved Germany had 39.2 million households in 2005, with approximately 82.7 million household members. This marked an 11% rise in households and 3% growth in the number of household members from 1991 levels. The average household size decreased from 2.27 people in 1991 to only 2.11 in The German Federal Statistical Office forecasts that this trend will continue for more than a decade and will peak at around 41 million households in This should have a positive effect on demand for dwellings even if the population stagnates or decreases. but the number of households will continue to increase in Germany Projection of number of households development in Germany Year in mln Change E E E E E E E E Source: CBS Research AG, fairesearch, The German Federal Statistical Office In addition, we have seen the recovery of German economy. GDP increased by 2.8% in 2006 compared with a growth rate of only 0.9% for 2005, according to the German Federal Statistical Office. GDP growth slowed down somewhat to around 2.5% for In January 2008 the German government reduced its full-year GDP growth forecast to 1.7%, partly as a result of turmoil on the financial markets. Close Brothers Seydler Research AG 16

17 The German residential real estate market has become more attractive to foreign investors. Property prices in other European countries have increased more strongly than rents, causing rental yield to decrease; by contrast, rental yields are stable in Germany and offer relatively high returns on invested capital. Furthermore, prices in the German real estate market appear to offer more upside potential than in the other developed European markets, which have already enjoyed substantial price increases. Foreign opportunity funds acquired around 700,000 housing units in Germany over the last 10 years ie more than 70% of the transactions for this period. But their share should fall in coming years, due to the real estate bubble bursting in some markets and subprime-related turmoil in the financial markets. The real estate business is currently not in favour with international investors. Overall, we believe that general economic developments and the sector outlook in Germany are more cloudy than a year ago but are still favourable for TAG s business. German GDP growth is decreasing unemployment and making the long-term investment environment more reliable. The declining supply of dwellings and increasing number of households in Germany should raise house prices and rents, benefiting TAG s residential real estate business. General trends in the German commercial real estate market The German commercial real estate market has been booming for several years. Investment volume in German commercial real estate reached a record high in 2006, doubling from the previous year s level to 49.4bn. Investment volume increased by another 20% to 59.4bn in 2007, according to Atisreal. The investment volume in German residential real estate increased as well, by around 18% to 15.2bn in The general interest in German real estate continued to be fairly last year, despite the subprime crisis in mid Investment volume reached new peak in 2007 More than half of total turnover (52%) in German commercial real estate was invested in office space last year. It improved its status due to the positive development of the biggest German office space locations. The share of retail properties decreased from 40% in 2006, which included the sale of the Karstadt real estate portfolio of 4.5bn, to around 22% for Logistics properties accounted for 5% in 2007 with a transaction volume of around 2.8bn ( 2.9bn in 2006). Close Brothers Seydler Research AG 17

18 German real estate investments in bn % 2007 % Commercial real estate % % Residential real estate % % Total real estate % % Source: CBS Research AG, fairesearch, Atisreal Around 61% of the turnover or 36.1bn was made up of portfolio deals in 2007 compared with 62% in Investments in individual properties accounted for 23.3bn or 39%. Around 76% of the investments in German commercial real estate were made by foreign investors in 2006, falling to around 69% in 2007, and we expect their share to fall further in The relationship between interest rates and rental yields in German commercial real estate market still looks attractive relative to international levels. However, rental yields in Germany reached their bottom in 1H07 and have been increased by the subprime crisis since then. Scheduled transactions were delayed or completely cancelled as a result of the distinctly more reluctant stance of banks to lend money in 2H07. In addition, funding costs have increased. After a huge wave of investors driven by the lure of cheap borrowed capital, the buyers now need their own funds to a greater extent. First-rate commercial real estate and properties on long-term leases should remain in demand. The total investments in the top six locations in Germany (Berlin, Cologne, Düsseldorf, Frankfurt, Hamburg and Munich) increased by 44% yoy to 30.7bn for The best location last year was Frankfurt, where turnover jumped by 82% to 7.9bn. Next was Berlin, with an increase of 65% to 6.9bn. Munich was up by 37% to 6.7bn, Hamburg 29% to 5.1bn and Cologne by 25% to 1.8bn for Only Düsseldorf saw a decline in turnover, by 7% to 2.3bn. Strong demand in top six cities Investments in top German Commercial real estate cities in bn % 2007 % Berlin % % Düsseldorf % 2.3-6% Frankfurt % % Hamburg % % Cologne % % Munich % % Source: CBS Research AG, fairesearch, Atisreal In 2008 the changed environment due to the subprime turmoil is likely to result in real estate turnover falling short of the records reached in But turnover could still be at a good level, as Germany is enjoys a relatively favourable pricing level. Rental yields could remain at the current level, with adjustments in different market segments. Take-up volume fell last year in some European urban areas, like London and Paris, compared with 2006; but rose by 14.5% in the nine biggest German office property locations in the same period. The average vacancy rate decreased Close Brothers Seydler Research AG 18

19 by 3.5pp in 2007 for this group. The average prime rent was up by 4.7% in 2007 for the top nine German cities. Munich Take-up volume jumped by 24% yoy to 834,000 sqm in Munich for 2007, the highest growth rate of Germany s nine biggest cities in terms of office properties, according to Atisreal. The vacancy rate increased from 8.8% to 9.6% for The prime rent was up by 5% to 31 per sqm for Frankfurt Take-up volume was up by 1% yoy to 629,000 sqm in Frankfurt for The vacancy rate came down from 14.5% for 2006 to 13.3% for The prime rent increased by 7% to 37.5 per sqm for Berlin Take-up volume declined by 15% to 500,000 sqm in Berlin for 2007 compared with the year before. That was the weakest figure of the nine biggest cities in Germany in The vacancy rate was flat at around 8.2% for The prime rent was up by 7% to 22 per sqm for Hamburg Hamburg reached a new take-up record in 2007 with 564,000 sqm, up by 23% and the second-best growth rate of the nine top cities in The vacancy rate decreased slightly to 6.3% in 2007 and was again the lowest figure of the German peer group. The prime rent was up by 6% to 25 per sqm for German REITs After long discussions and several delays the government approved a German REIT in REITs have already found a foothold on the international capital markets and are well known by real estate companies and global investors. The first REITs were set up in the US in The legal requirements for REITS differ from country to country. The main legal requirements for G-REITs are follows: The REIT AG (German public limited company) must have its stock listed on an organised market. The REIT AG must have its registered office and management in Germany. The minimum nominal share capital is 15m. Shareholder funds may not fall short of 45% of the fair value of its real estate assets booked under IFRS rules. Free float (holdings below 3% are classified as free float) must be: at least 25% at the time of the IPO; and at least 15% on a ongoing basis. Direct holdings of 10% or more are not permitted. Close Brothers Seydler Research AG 19

20 There can be no investment in properties with a share on residential real estate above 50%. At least 75% of the assets must be immovable assets. Up to 50% of the immovable assets can be sold in a five-year period. At least 75% of gross income must be generated from immovable assets. The G-REIT must distribute at least 90% of its profits, calculated under German GAAP (HGB). German REITs are fully exempted from German corporate income tax and German local tax, though the shareholder is liable for tax on the dividends. G-REITs should therefore be especially interesting for foreign investors. In addition the so-called Exit Tax on G-REITs enables commercial real estate sellers to realise part of the capital gains on their sold properties with a 50% reduction in income, corporate income and local tax payments until the end of Most big companies prefer to sell the properties they use themselves to potential G-REITs as to set up their own G-REITs. The companies sale and lease back their properties and can realise part of their disposal gains on the properties with reduced tax. Close Brothers Seydler Research AG 20

21 Fundamentals Turnaround in 2006 The difficult economic environment in Germany and particularly problems in some German real estate segments (East Germany) led to a net loss of 35.5m for the TAG group in In particular, the restructuring of the subsidiary JUS AG and the company s properties in East Germany placed a considerable burden on TAG s liquidity and earnings. JUS AG used to be active in the refurbishing of historical buildings in the Special-Purpose Property core business segment. The restructuring and realignment of JUS AG led to high impairments with respect to goodwill and a number of properties held by JUS AG in TAG wrote down loans to JUS AG with a volume of 18.8m for 2007 compared with write-downs of 7.5m for JUS AG was restructured and transformed into a real estate service provider. It now runs the service segment for the group as TAG Asset Management. The TAG group restructured its strategy and management after the JUS AG disaster. Its new strategy is a buy, build and hold strategy aimed at unlocking longterm value. TAG used the good market sentiment for real estate companies and acquired fresh shareholder funds of 180m in The reorganisation of TAG led to a net profit of 2.9m and a turnaround in The capital increase provided the group with resources for acquiring real estate in a planned volume of up to 800m, or a total assets increase to 1.3bn. TAG made its first investments of 250m in M07 figures The revenues of the TAG group increased slightly in the first nine months of 2007 to 58.3m, up by 1% compared with the same period in Rental income rose by 50% to 26.4m for 9M07 as new real estate acquisitions led to higher rental income as well. Construction management income more than tripled from 6.2m for 9M06 to 19m for 9M07. This strong increase in management income came from the planned extension of service management for the group and external clients. On the other hand, the revenues of TAG in the first nine months of 2007 suffered from the switch of group strategy from the development business to being a longterm real estate investor. Revenues from the sale of properties dropped from 33.8m for 9M06 to 12.85m for 9M07. The share of sales of properties in total revenues decreased from close to 60% for 9M06 to 22% for 9M07 as a result. Personnel costs rose by 6% to 6.8m for 9M07. TAG said that was due to the establishment of technical and business management units as well as project development, numerous acquisitions and the extension into the service business. Depreciation rose from 0.4m to 1.5m for 9M07. Other operating expenses rose by 34% to 7.95m for 9M07. The reasons for this increase were partly costs related to preparations for TAG Gewerbeimmobilien becoming a German REIT and partly to higher borrowing costs due to higher liabilities to banks arising from new portfolio acquisitions. Close Brothers Seydler Research AG 21

22 Fair-value gains increased by 150% yoy to 23.2m for 9M07. This was a result of ongoing acquisition activities and the related return-oriented purchase prices together with development activities, which aimed at unlocking value in TAG s existing portfolio. The company also benefited from the reclassification of available for sale commercial properties as investment properties. Net interest expenses went up by 38% to 12.35m for 9M07. Liabilities to banks rose to fund new real estate acquisitions and the cash position of TAG therefore declined. In addition, increased interest rates until September Overall, pre-tax profit tripled to 15.8m for 9M07 compared with 9M06. Net profit after minorities was up from 1.75 for 9M06 to 7m for 9M07. Income statement (9M07) m 9M07 9M06 YoY Sales revenues % Change in inventories >100% Other income % Total turnover % Costs of materials % Employment costs % Depreciations >100% Other operating expenses % Total expenses % EBITDA % EBIT % Financial result % Pre-tax profit >100% Taxes >100% Minority interests >100% Net profit (loss) >100% EPS % Source: CBS Research AG, fairesearch, TAG Close Brothers Seydler Research AG 22

23 Segment reporting All segment figures are EBIT in m. Segment 9M07 9M06 YoY Residential real estate % Commercial real estate >100% Services >100% Consolidation adjustments, others >100% Total group % Source: CBS Research AG, fairesearch, TAG Segmental reporting reflected the strategy switch as well as a strong expansion of the commercial real estate portfolio through new acquisitions. The assets of the residential real estate segment were around 425bn at the end of September 2007, almost unchanged on the end of September 2006, while the assets of the commercial real estate segment more than tripled to 361.6bn in the same period. The service segment benefited from an extended product offering to the group and external clients. Targets and forecasts TAG s future growth strategy has been based on the fresh shareholder funds of 180m from the two capital increases in Its target is an equity ratio of around 25%, which would mean total assets of up to 1.2bn- 1.3bn. We believe that TAG can grow at least until 2009 with the current shareholder fund base. Management projected pretax profits of 31m in 2007 The required changes in strategy and management have had quite a positive effect on earnings development. TAG returned to profit in It increased its profits considerable for 9M07 compared with 9M06, which were on a low level. Management released a pre-tax profit target of 31m for FY2007, which means TAG has to double its 9M07 figure. We believe TAG should fulfil its target in light of the real estate business cycle. The fourth quarter has always been the most profitable quarter of the year for both TAG and the sector, and TAG sold one development project at the end of December We expect positive earnings development from TAG in the coming years. The new business strategy to actively unlock value of its real estate portfolio and to make new acquisitions should deliver enough profit potential. Investors are quite concerned about the future development of capital markets and especially the international real estate markets, and are likely to remain so for the next few months. But the German real estate market has not deteriorated yet and it does not look like doing so this year. Our detailed TAG group earnings forecasts are on the next page and the specific segment estimates are in the segment chapter, in the section Company Profile. Close Brothers Seydler Research AG 23

24 Profit and loss account e in m yoy% 2007e yoy% 2008e yoy% 2009e yoy% - Sale of properties Rental income Construction management expenses and other Sales revenues Change in inventories Other income Total revenues Cost of goods and services purchased Employment costs Depreciation/amortisation Other operating expenses Total expenses EBITDA , EBIT Share of profit of assocciates Financial result Pre-tax profit Taxes Tax ratio -9.6% 23.4% % 35.6% 35.6% Net profit Minority interests Net profit after minorities Number of shares in (mln) EPS Dividend per share RoE pre-tax % 3.80% 12.30% 12.00% 12.70% RoE % 1.70% 5.60% 6.30% 6.70% Source: CBS Research AG, fairesearch, TAG Close Brothers Seydler Research AG 24