Research Update: German Residential Real Estate Company Deutsche Wohnen Assigned 'BBB+' Rating; Outlook Primary Credit Analyst: Marie-Aude Vialle, London (44) 20-7176-3655; marie-aude.vialle@standardandpoors.com Secondary Contact: Nicole Reinhardt, London (44) 20-7176-3587; nicole.reinhardt@standardandpoors.com Table Of Contents Overview Rating Action Rationale Outlook Ratings Score Snapshot Related Criteria And Research Ratings List WWW.STANDARDANDPOORS.COM/RATINGSDIRECT NOVEMBER 25, 2014 1
Research Update: German Residential Real Estate Company Deutsche Wohnen Assigned 'BBB+' Rating; Outlook Overview German residential real estate company Deutsche Wohnen AG owns and manages a portfolio of about 150,000 units, mostly residential apartments in German metropolitan areas. We assess Deutsche Wohnen's business risk profile as "strong" and its financial risk profile as "significant." We are assigning our 'BBB+' long-term corporate credit rating to the company. The stable outlook reflects our view that the high demand for midsize residential apartments in Deutsche Wohnen's key regions should continue to support moderate rental income growth and a gradual improvement in credit metrics over the next 12 to 24 months. Rating Action On Nov. 25, 2014, Standard & Poor's Ratings Services assigned its 'BBB+' long-term corporate credit ratings to the German residential real estate company Deutsche Wohnen AG (Deutsche Wohnen). The outlook is stable. Rationale The rating on Deutsche Wohnen reflects our assessment of the company's good scale and its focus on residential properties in German metropolitan areas with favorable market dynamics, such as Berlin, the Rhine-Main area (including Frankfurt/Main), and the Rhineland (notably Düsseldorf). Deutsche Wohnen is the second largest residential property company in Germany, managing a portfolio of about 150,000 units valued at about 9 billion. As of Sept. 30, 2014, the portfolio comprised about 147,000 residential units with an average unit size of 60.8 square meters, and about 2,000 commercial units included within the residential buildings. In addition, the company operates around 2,200 nursing homes and assisted living apartments under the Katharinenhof brand name. About 73% of the portfolio is concentrated in the Berlin metropolitan area, which is characterized by an undersupply of residential flats, as the population is growing and construction activity remains low. Demand for small to midsize flats is especially high, as the number of households with one or two persons is increasing. We consider that the high concentration in one geographical area with weaker economic fundamentals in terms of the employment WWW.STANDARDANDPOORS.COM/RATINGSDIRECT NOVEMBER 25, 2014 2
rate and GDP than the average in Germany is partly mitigated by the higher growth potential for rent and property valuation, as prices in Berlin remain lower than those in other major cities in Germany. Deutsche Wohnen has been able to increase its like-for-like rent at a compound annual growth rate of 2.7% in its overall portfolio over the past five years, and by 2.9% in Berlin only, and we expect the company to achieve growth of nearly these levels in the next two years. In addition, its large presence in Berlin allows Deutsche Wohnen to benefit from some economies of scale. Our business risk assessment is also supported by the high and stable occupancy rate of about 97%-98% and the low tenant turnover of around 8% per year. This is driven by a long average tenancy stay of about 10.8 years, which is close to the German average of about 12 years. We consider the tenant diversity to be very good, with about 150,000 units owned and managed, and we positively view the company's diversification into nursing homes and assisted living apartments, which also benefits from positive demographic trends. This segment, however, is relatively small and only represents about 4% of Deutsche Wohnen's gross profit under our calculation. Deutsche Wohnen mainly owns small to midsize apartments located in affordable residential buildings. We consider the asset quality to be low to average, given the buildings are on average 50 years old and therefore require maintenance expenses and capital expenditure (capex) for renovation and modernization. We consider, however, that management has a good track record of increasing rent levels following renovation work, which should, to some extent, compensate higher capex spending forecast in the future. Our assessment of Deutsche Wohnen's financial risk profile as "significant" mainly reflects the relatively high level of debt on the balance sheet, with a Standard & Poor's-adjusted debt-to-debt-plus-equity ratio of about 55.7% as of Sept. 30, 2014. While we forecast this ratio to improve closer to 50% over the next two years as a result of debt amortization, debt repayment, and positive assets revaluation, this is still higher than peers that we rate within the "intermediate" category. On the other hand, we expect a strong improvement of the adjusted EBITDA interest coverage to close to 3.0x over the next two years from about 2.2x as of Sept. 30, 2014. This reflects the full impact of the company's recent refinancing and fits further improvement in EBITDA. Our calculation of EBITDA only includes rental income in line with our key credit factors for the real estate industry. We therefore do not include any proceeds or income from the privatization business, given we consider the sale of assets to be part of the company's general asset rotation strategy. Following the recent debt refinancing, totaling about 1.7 billion, Deutsche Wohnen has reduced its overall cost of debt to approximately 2.5% from 3.5% as of December 2013, and improved the average maturity of the loans to nine years from 7.5 years. We also positively view the high hedging policy with a target hedge ratio of 85%. WWW.STANDARDANDPOORS.COM/RATINGSDIRECT NOVEMBER 25, 2014 3
Our base case assumes: An increase in like-for-like rental income of about 2.9% in 2014 and 2.5% in 2015. This assumes mostly an increase in rents, while we forecast flat occupancy rate at approximately 98% for the residential business and 96% for the nursing and assisted living segment. Our forecast for 2015 is slightly more conservative than the historical level of like-for-like rental growth for Deutsche Wohnen's portfolio, but it incorporates the potential impact of pending rent cap regulation for new lettings, which is most likely to affect metropolitan areas such as Berlin. Improvement in EBITDA margins to approximately 61%-63% over the next two years (excluding the privatization business, but including the nursing homes and assisted living segment), from 58% in 2013. This improvement is mainly related to further economies of scale and synergies following the integration of GSW Immobilien. Uplift in the asset portfolio valuation of about 4% in both 2014 and 2015, in line with our forecasts for German house prices. We believe that there is some potential for higher uplift, given the fact that Deutsche Wohnen's portfolio is concentrated in regions with above average growth potential. Privatization of about 2,000 units per year in 2015 and 2016, in line with management's guidance, with a similar number of units being acquired. Capex to modernize and renovate the flats of about 65 million per year. Based on these assumptions, we arrive at the following credit measures: Adjusted debt-to-debt-plus-equity ratio of about 55% in December 2014, decreasing toward 50% over the next two years. Adjusted EBITDA interest coverage of 2.8x-3.0x over the next two years. We assess Deutsche Wohnen's financial policy as relatively conservative for the real estate sector, underpinned by its strategy of long-term ownership and rental of real estate residential properties, the absence of development activities, and its moderate dividend payout ratio of 60% of recurring funds from operations (FFO). We also positively view management's aim to reduce leverage toward 50% by the end of 2015 and its commitment to fund future acquisitions with a balanced mix of debt and equity. Liquidity We assess Deutsche Wohnen's liquidity as "adequate" under our criteria, supported by our forecast that the company's liquidity sources will exceed its funding needs by more than 1.2x over the next 12-24 months. We believe that FFO, the cash balance, and recent refinancing of bank debt, will be sufficient to cover Deutsche Wohnen's requirements over the next 12 months. Deutsche Wohnen's principal liquidity sources over the next 12 months to Sept. 30, 2015, are: High cash balance of 620 million pro forma for the convertible bond issuance in September 2014; Cash FFO of about 180 million for the 12 months to Sept. 30, 2015; WWW.STANDARDANDPOORS.COM/RATINGSDIRECT NOVEMBER 25, 2014 4
About 34 million available under the 40 million committed bank lines (we assume that the 100 million unused credit line with Hessische Landesbank will be cancelled shortly, as indicated by management given the high cash balance); and We also include the proceeds of the loans of about 1.36 billion raised in October 2014 with Berlin Hyp and Landesbank Hessen-Thüringen. We have not included in the sources of liquidity expected proceeds of asset sales related to the privatization business (about 165 million forecast), although we understand that management has a good track record of selling properties to individuals and investors. Deutsche Wohnen's principal liquidity uses over the 12 months to Sept. 30, 2015, are: We assume that the proceeds of the recent issuance of bank debt of 1.36 billion will be fully used to repay existing loan facilities. In addition, we assume another 60 million of debt repayment (including amortization payments) in the 12 months to September 2015; Modernization capex of approximately 56 million for the next 12 months ( 65 million per year starting in 2015). About 105 million of committed acquisitions which are expected to be paid in fourth quarter 2014; and Dividend payment of about 110 million based on an estimate for the next 12 months. Although we note that Deutsche Wohnen has no contractual obligation to pay dividends, we have included dividends in the uses of liquidity, given that it is part of the company's stated financial targets. Our assessment of liquidity is also supported by Deutsche Wohnen's good track record of accessing the equity and capital markets and their strong relationships with German banks. Most of the company's debt facilities were granted for the purpose of financing real estate assets. Loan agreements are therefore mostly secured by land charges and assignments of rental payments (only 4% of the assets are unencumbered following the refinancing). About 75% of the loan agreements include financial covenants, such as loan-to-value ratios, a debt service coverage ratio, and exit yields or multiples ratios. We understand that the headroom for a significant number of covenants is currently below 10%, as new loans were onboarded recently and it is customary to start loan facilities with a headroom of 3%-5%. However, we expect headroom to improve closer to 10% over time as rent and asset valuation improves. Other modifiers Our rating on Deutsche Wohnen of 'BBB+' is one notch above our initial analytical outcome, or "anchor", due to our positive comparable rating analysis. This reflects our forecasts of credit metrics at the better end of the "significant" category, with EBITDA interest coverage already commensurate with an "intermediate" financial risk profile. It also takes into account the WWW.STANDARDANDPOORS.COM/RATINGSDIRECT NOVEMBER 25, 2014 5
fact that recurring income from the privatization business is not factored into the credit metrics, but provides a source of cash and financial flexibility. Overall, we believe that there is some potential for further strengthening in credit metrics, given the resilience of the German real estate market and the potential upside in rent increase and portfolio valuation in Deutsche Wohnen's main regions. Outlook The stable outlook reflects our expectation of continued high demand for midsize residential apartments in affordable buildings in Deutsche Wohnen's main metropolitan locations. We expect rental income to grow by approximately 2.5% on a like-for-like basis in 2015, while we forecast positive uplift in asset revaluation of 4%. The stable outlook also reflects Deutsche Wohnen's strengthened credit metrics following the recent refinancing. Over the next two years, we forecast the adjusted EBITDA interest coverage ratio to improve to 2.8x-3.0x and the debt-to-debt-plus-equity ratio in the range of 50% to 55%. Upside scenario We could raise the rating if Deutsche Wohnen demonstrates a track record of strong operating performance well above our base-case scenario for 2015-2016. An upgrade would be contingent on Deutsche Wohnen's ability to increase its EBITDA interest coverage ratio to above 3.5x and lower its debt-to-debt-plus-equity ratio to about 40%. This could be possible if the company is able to generate higher rental income growth while keeping strict operating cost discipline, and if it starts deleveraging by repaying debt from its internal cash flow. Downside scenario Conversely, we could lower the rating if Deutsche Wohnen does not manage to improve its EBITDA interest coverage to above 2.4x in the next 12 months or its debt-to-debt-plus-equity ratio below 55%. Such a scenario is not part of our central assumptions and would most likely arise from a large debt-financed acquisition or higher renovation capex than we anticipate. Ratings Score Snapshot Business risk: Strong Country risk: Very Low Industry risk: Low Competitive position: Strong Financial risk: Significant Cash flow/leverage: Significant WWW.STANDARDANDPOORS.COM/RATINGSDIRECT NOVEMBER 25, 2014 6
Anchor: bbb Modifiers Diversification/Portfolio effect: Neutral (No impact) Capital structure: Neutral (No impact) Liquidity: Adequate (No impact) Financial policy: Neutral (No impact) Management and governance: Satisfactory (No impact) Comparable rating analysis: Favorable (+1 notch) Related Criteria And Research Related Criteria Methodology And Assumptions: Liquidity Descriptors For Global Corporate Issuers, Jan. 2, 2014 Corporate Methodology, Nov. 19, 2013 Corporate Methodology: Ratios And Adjustments, Nov. 19, 2013 Key Credit Factors For The Real Estate Industry, Nov. 19, 2013 Methodology: Management And Governance Credit Factors For Corporate Entities And Insurers, Nov. 13, 2012 Ratings List New Rating; CreditWatch/Outlook Action Deutsche Wohnen AG Corporate Credit Rating BBB+//-- Additional Contact: Industrial Ratings Europe; Corporate_Admin_London@standardandpoors.com Complete ratings information is available to subscribers of RatingsDirect at www.globalcreditportal.com and at spcapitaliq.com. All ratings affected by this rating action can be found on Standard & Poor's public Web site at www.standardandpoors.com. Use the Ratings search box located in the left column. Alternatively, call one of the following Standard & Poor's numbers: Client Support Europe (44) 20-7176-7176; London Press Office (44) 20-7176-3605; Paris (33) 1-4420-6708; Frankfurt (49) 69-33-999-225; Stockholm (46) 8-440-5914; or Moscow 7 (495) 783-4009. WWW.STANDARDANDPOORS.COM/RATINGSDIRECT NOVEMBER 25, 2014 7
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