REITs are relatively new in Germany with the framework only introduced in 2007. Presently, tremendous real estate value is trapped on German corporate balance sheets. 73% of German companies own real estate compared to 25% in the US and 54% in UK. G-REITs as an asset class is expected to grow as German property owners free up capital trapped in real estate by selling property to tax advantaged G-REITs. Given this macro backdrop, corporate activity and property acquisition involving G-REITs should be heightened in the coming years.
The German real estate property management sector has been undergoing consolidation and further consolidation is expected. On June 16, 2015, AOX announced it would acquire PMOX by exchanging 0.381 AOX shares for 1 share of PMOX. A merger of AOX and PMOX would result in the largest German office REIT with a portfolio value of €3.4 billion, which is still relatively small compared to REITs in more mature REIT markets like the US. AOX is active in Hamburg, Stuttgart, and Rhine-Rhur (Dusseldorf & Cologne) while PMOX is active in Rhine-Ruhr, Rhine-Main (Frankfurt), and Berlin. The combined REIT would command a presence in six of the “Big 7” office markets of Germany. Management expects €17.5M of cost synergies that include reduced administrative and financing costs.
Acquiring PMOX shares is a good way to gain exposure to the new G-REIT. On 9/30, PMOX traded at a 1.12% discount to the takeover value and the shares are expected to trade as combined shares by the end of November (6.7% annualized return). This new G-REIT is a play on the strong and improving German office real estate market.
Capital flows are strong into office, particularly from foreign investors
Vacancy in office continues to decline
Rent for office continues to improve
The new REIT would be trading at 1.04 P/B and 19 trailing P/FFO ratios. The average of Bloomberg’s US office REIT comp sheet currently trades at 1.47 P/B and 20.5 trailing P/FFO ratios. A 19 P/FFO can be interpreted as a 5.26% FFO yield, which is higher than the 4.45% average cap rate for office property across the Big 7.
The combined company has significant room to improve FFO without additional acquisitions because its properties have 14.1% vacancy. This likely explains both companies’ currently discounted P/B vs comps. Given that average German office vacancies are significantly lower and supply continues to tighten, it is very possible for the firm to reduce vacancies on existing properties. AOX management has a plan to aggressively lease PMOX vacancies.
Furthermore, roughly 37% of current rent will expire in the next three calendar years. This enables the combined company to negotiate new leases at today’s higher market rents.
The merger will enable a critical mass of properties in six of the Big 7, allowing the firm to open new local offices in Frankfurt and Stuttgart. New local offices and critical mass of properties enable more efficient leasing and property management. The firm will divest PMOX’s non-office and non-Big 6 (excluding Munich) properties to concentrate its leasing and management efforts.
Size and diversification will enable the combined company to tap credit at better terms. The combined G-REIT will have €217 million cash with €1.6 billion debt due between 2018 and 2020. AOX management believes it can refinance PMOX debt with €7.5 million in interest savings and plans to reduce LTV to 40% in the medium term. The firm will maintain its dividend targets, which has been 4.32% for AOX and 3.43% for PMOX. AOX has never missed a dividend, including during the US and European financial crises, while PMOX just recently initiated a dividend (PMOX was formed in 2014 after the merger of two G-REITS).
Based on managements’ forecasts of €205M for 2015 gross rents and assuming vacancy is reduced by 150bps and rents increase by 5% on 1/5 of rent revenue, then 2016 gross rent would be €210.7M. Assuming 2015 expenses of €104M are reduced by half of management’s expected €17.5 million in cost synergies, then 2016 FFO would be €115.4M. Assuming P/FFO can expand to 20, then market cap for the combined company could reach €2.3 billion, representing a 29% appreciation. Assuming shares outstanding for the combined REIT will be 155.9 million shares, the price target would be €14.75, compared to AOX’s €11.67 price today.
|DO Deutsche Office (PMOX)||alstria office (AOX)||Combined|
|Real Estate Portfolio|
|Real estate property value||€1,705M||€1,692M||€3,397M|
|Number of properties||51||74||125|
|Lettable area (sq-m)||866,280||873,000||1,739,280|
|Equity (Balance Sheet)||€805.5M||€922.2M||€1,727.7M|
|REIT Equity Ratio||41.5%||52.9%||47.2%|
|Gross Rental Income, 2014||€94.2M||€89.0M||€183.2M|
|Gross Rental Income, 2015||€107M||€98M||€205M|
|Fund From Operations, 2014||€46.6M||€47.6M||€94.2M|
|Fund From Operations, 2015||€52.0M||€49.0M||€101.0M|
|FFO Growth, 2015||11.59%||2.94%||7.22%|
|P / FFO, 2014||17.09||21.13||19.13|
|P / FFO, 2015||15.32||20.53||17.84|