Edited Transcript of DWNG.DE earnings conference call or presentation 25-Mar-20 10:00am GMT

I have the big belief that our shareholders will support our proposal and send a strong sign of solidarity in these challenging times. We will inform about the structure of the relief fund in the coming days.

Despite the corona crisis, we are continuing to focus on our operational issues. One topic I will discuss in depth later is our plan for the current housing shortage in our big cities. We do not want to wait, but to act strongly. This is why we decided to invest even more in new project development. I will tell you about in a few minutes.

Firstly, I would like to give you a short update on our handling of the rental cap, which came into effect in Berlin on February 23. We are currently in the middle of implementing the relevant regulation. In this context, we have revised the rent for approximately 25,000 tenants, which we had increased after the announcement of the introduction of the rental cap on 18 June 2019. Please note that we do not have to repay the increased rent that we have received since the rent increase until the rental cap came into force. It was, therefore, the right decision and in accordance with the law to continue to implement rent increases after the 18 June 2019.

At the same time, as required by law, we will inform more than 100,000 tenants in the next few days by registered mail about the rental cap and the circumstances relevant for the calculation of the individual rental cap rent.

Even if we comply with the new billing regulation, we remain fundamentally convinced that it is unconstitutional. Initial court rulings confirm our view. We very much welcome the fact that one chamber of the district court in Berlin formally asked the Federal Constitutional Court to undertake a constitutional review of the rental cap. At the same time, we appreciate the announcement by delegates of the Christian democrats and the liberal party to file a lawsuit against the rental caps as well. We hope also for the benefit of our tenants that we will receive a clarification of this matter from the highest court as soon as possible. In the event that the law violates the constitution, we have reserved the claims to make up for the loss of rent.

Before I will focus on our business results, I would like to comment briefly on the current economic situation. In addition to the effects of the corona crisis on the economy and, in particular, on the stock markets, we observe developments that are more and more relevant to our industry.

Tuesday last week, the bond market collapsed. Despite federal activities, it will be increasingly difficult to raise the necessary capital. During the next month, refinancing will become more and more challenging. Following the sharp fall in share price for many involved, it will be almost impossible to implement equity measures. At the same time, borrowing costs are rising due to the higher risk of default. Against this background, I expect that we will see more and more M&A activity. Debt market is still working, but even here only for large liquid structures.

In the current market environment, large platforms with strong balance sheets are in greater demand than ever. We feel well prepared for this situation based on our conservative capital structure and excellent balance sheet. We are not dependent on the bond market. For us, financing from banks is much more important. We have taken precautions here and maintained long-term relationships with banks, which give us comfort, especially in the current situation, that we will not have any problems or on the financing side.

A large part of our properties’ assets is unsecured, as you know, which gives us further headroom for growth and security in the current situation.

Let me now turn to the results of the past fiscal year, which, again, was a very successful one, as you can see on Page 3.

Our FFO I rose by 11% to EUR 538 million due to acquisitions and thanks to operational improvements. The EPRA NAV also improved by 11% to around EUR 47 per share. We were able to grow in all segments and, at the same time, keep our cost structure stable.

Particularly worth highlighting is the very good sales result. Here, we took advantage of the momentum in the market and disposed of nonstrategic assets at very attractive prices. In addition, we were able to acquire new assets for almost EUR 1 billion. We have also increased our spending on CapEx. Altogether, our residential and our nursing portfolio has been further improved in terms of both location and quality.

If you turn to Page 4, you can see that our portfolio has benefited from the megatrends urbanization, demographic change and a persistent low interest period in the past, and is ideally suited to continue benefiting from these megatrends in the future.

One of the most important accelerators of our growth will continue to be urbanization and the excess demand. The decision to focus our portfolio on metropolitan regions and growing markets has paid off. This trend will continue. By the year 2050, 84% of the population in Germany were living in cities. Our portfolio puts us in a very good position to benefit from these developments. Mid to long term, we expect, therefore, further value growth in these markets.

The megatrend urbanization is accelerated by the fact that due to the persistent low interest rate period, there’s really no alternative to investing in real estate. Classic and popular investment instruments for Germans are losing importance today due to negative and falling yields. The only alternative for the general public is to invest in real estate. In this context, it is no surprise that mutual funds are collecting more and more money and are increasingly dominating the real estate market. We have now seen 14 years of ongoing positive price development on the real estate market. I’m strongly convinced that this chapter will be continued.

Furthermore, we benefit from the aging society. By 2025, we need around 190,000 additional nursing home places. At the same time, we are observing a growing demand for assisted living. Currently, there is an unmet need for approximately 550,000 units. With our 2 brands in Berlin and Hamburg, we are in an excellent position to benefit from these developments. We are responding to the growing demand with the targeted expansion of these areas.

We have just launched our new construction offensive in Hamburg. There, we built new facilities with modern equipment and new offers such as service living. These new facilities also provide attractive workplaces for our employees and, above all, enabled better nursing care for our residents. At the same time, we will further increase the value of our nursing portfolio from a regional perspective. This is why last year, we signed the disposal of 13 nursing care properties.

Focusing our residential and nursing portfolio on growing metropolitan regions has proven to be spot on considering past developments, but also in future prospects. All the described developments bring also significant challenges. The strong movement of people into cities has led to rising rents and not everyone is able to pay them. Here, we have developed our own philosophy and made our tenants a fair offer.

Our offer is accepted by the tenants. Last year, our promise led to rent concessions being made to tenants in approximately 700 hardship cases. We are still the only private company in Germany to make such far-reaching hardship provisions for the benefit of its tenant. Recent survey shows us that we are on the right track. The absolute maturity of our employees and tenants are satisfied with Deutsche Wohnen as their employer and landlord. These results are a motivation as well as an incentive for us. We will take customer and employee satisfaction even more into account, frequently holding appropriate surveys and using the results as a basis for the remuneration of our executives.

The greatest long-term challenge for all of us will be to achieve the climate targets. The green deal proposal from the EU commission has clearly shown energy-efficient renovation in the building sector has reached top of the agenda in Europe. The housing sector is responsible for around 30% of CO2 emissions. At the same time, however, only less than 1% of the buildings are being renovated to improve their energy efficiency. If we want to achieve our climate targets, we need more new construction and energy-efficient refurbishment of existing stock.

Last year, we spent almost EUR 500 million on maintenance and refurbishment, an increase of around 30% to the previous year. Energy efficiency is one key element of our investments. The success of these measures is illustrated by the fact that the energy efficiency of our buildings has been reduced continuously.

Summarized, around 64% of our portfolio today has a better energy balance than the average residential building in Germany. Yes, we have not yet reached our goal here, but we are well on track to make our contribution to climate protection.

Come back on the topic I raised at the beginning of my speech. The movement of people into cities will not stop, the population will grow older and climate protection will remain a top priority. Therefore, we need an investment offensive to develop the neighborhoods of the future. Deutsche Wohnen has reached an agreement with the Munich-based project developer, Isaria Wohnbau AG, on the acquisition of a project development platform, including major real estate projects.

On Page 5, you can see that the expansion into project developments enables us to significantly strengthen our expertise in the field of new construction. Combined with our own new building business, we will create one of the major German platforms for project development in German hotspots. This move makes us less dependent on inorganic growth and gives us the opportunity to expand our business to other attractive cities in Germany such as Stuttgart or Munich.

The combined pipeline has a volume of around EUR 3 billion for the construction and development of residential and commercial properties. I have already described that the market environment is becoming increasingly challenging, especially for smaller structures with high refinancing requirements. Depending on the market situation, we see further opportunities in this area.

To be clear, we remain committed to our long term and very successful strategy and our focus on residential priority and attractive growth region. Our core market will remain in Berlin, where 70% of our apartments are located.

If you turn to Page 6, you can see that our joint project pipeline reaches from Hamburg to Munich. Our 3 platforms, residential, nursing and project development, enable us to benefit from the growth strengths in the major metropolitan regions.

Acquisition of a project development platform is not a realignment of our business model, but the consistent further development of our approach to provide living space and offer Nursing and Assisted Living in metropolitan regions in Germany.

Turning to Page 7, you can see that this approach generates value for all our stakeholders. Tenants will benefit because of an increased offer of newly built apartments. Shareholders will benefit because of the organic growth and, therefore, the successful continuation of our equity story. Employees will benefit from the fact that we will continue to be a modern and successful employer that continues to create additional jobs in metropolitan regions. Our society will benefit because of easing conditions in the housing and care markets by building the working, living and care places of the future. And finally, climate neutral new construction will help us all achieving our climate targets.

Please allow me one more note. So we crash and burn money like in these days uncontrolled, and we hope to return. Deutsche Wohnen is well positioned. We see, like others, a lot of risks in the future in the market. But we see on the other side, good entry prices.

And with that, I hand you over to Philip.

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Philip Grosse, Deutsche Wohnen SE – CFO & Member of the Management Board [3]

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Thank you, Michael, and also a warm welcome to our earnings call from my side. We had, once again, a very successful year to which all our business segments contributed. Let me start with Page 8, our portfolio overview for the residential business.

You can see the average in-place rent of our portfolio is EUR 6.94 per square meter. That is some 5% higher compared to last year and the result of, A, organic growth; but, B, equally, our continued improvement of our portfolio towards co-plus and hotspot regions.

The average value per square meter is slightly below EUR 2,400 per square meter, translating into a gross yield of 3.2%. Even after revaluation, we continue to see a significant spread between gross yield and reversionary yield of around 100 basis points or almost 7x multiple spread in Berlin market.

In 2020, our reletting rents will be negatively affected by the newly introduced Berlin rent regulation. Until the final decision of the subject matter by our highest court, I expect a drop in our Berlin rents. Please keep in mind that the average rent ceiling would be around EUR 3.20 per square meter a month for our portfolio or around 10% below the current in-place rents. Our share price, by the way, currently implies the square meter of our portfolio is adequately valued at slightly above EUR 2,000 per square meter. This is more than 50% below replacement costs and offers, in my view, a good investment opportunity in currently uncertain times from a macro perspective. This is also one of the key reasons for our continued share buyback.

Like-for-like rental growth in 2019 was 3.4% overall and 3.7% in Berlin based on the comparison of rents per square meter as of the respective cutoff dates, as you can see on Page 9 of the presentation. For our standing client base, rental increases have been moderate with around 1.5%, more or less in line with inflation. In other words, most of the rental growth came from relettings capturing a huge portion of the reversionary upside.

Vacancy for the total portfolio is at 1.7%, which still includes approximately 60 basis points of CapEx-related vacancy.

Move to Page 10 for the valuation of our portfolio. In 2019, we have had a valuation uplift of EUR 1.4 billion. That corresponds to an increase of 6% on a like-for-like basis, even 7% if you include the capitalized investments of around EUR 400 million. Our total portfolio is now valued with EUR 24.4 billion and excluding our EUR 1.3 billion Nursing and Assisted Living properties. The core plus markets with Berlin were again the main driver for the valuation uplift, and our hotspot and growth locations have seen around 9% to 10% uplift on a per square meter basis in a year-on-year comparison.

As we currently observe less transaction activity, given the current situation, I don’t expect that actually to pick up any time soon. It looks from today’s perspective likely that we will suspend the half-year revaluation and revalue our portfolio next time at year-end 2020.

On Page 11, you see how the Berlin portfolio breaks down in the 3 subclusters of hotspot, growth and stable markets. Around 80% of fair value in Berlin is in the hotspot and growth markets with the most compelling macro fundamentals for further capital growth.

On Page 12, our investments into the portfolio are summarized. Last year, we have invested in total around EUR 470 million. On average, that was around EUR 45 per square meter or around 11% more than in 2018. Refurbishment investments increased to almost EUR 370 million, up some 17%. Much of that, as Michael said, has been spent for energetic investments and resulted in an average decrease in energy consumption of our entire portfolio of 2.5%. Our capitalized reletting investments, making up around 1/3 of total CapEx, achieved a yield on cost of around 10% on an unlevered basis.

For 2020, we expect total investment of EUR 40 per square meter, of which EUR 10 for maintenance charged to the P&L and EUR 30 for capitalized investments accounted for in the balance sheet. The Berlin rent ceiling is no reason for us to stop reletting investments. We continue to upgrade vacant apartments and aim to secure the rent levels in accordance with the federal regulation once the unconstitutionality of the Berlin rent freeze law has been concerned.

For complex refurbishments, we will allocate more funds if the Berlin rental law is in place outside the Berlin market. The current corona situation is, however, putting these investments from a timing perspective at risk. To what extent, we’re currently unable to evaluate.

Briefly on the financials, which in my view, contain little surprises, starting on Page 13. Income from rents increased by almost 7% year-on-year to EUR 837 million, predominantly driven by like-for-like rental growth and acquisitions. NOI margin significantly increased to almost 81%, which is partially also because of accounting effects for the changed treatment of leases.

Please remember, certain lease items, which has been previously accounted as cost items at NOI level, have been moved below the EBITDA line. However, even without these accounting effects of almost EUR 20 million, the NOI margin still improved by an impressive 150 basis points.

Moving to Page 14, our disposal business, where we have only shown transactions which have had a closing in 2019 and, therefore, contributed to the P&L disposal result. Our privatization business continues to perform well. Average gross margin for privatizations was at 60% or around 40% adjusted for the exceptional disposal of a mixed-use building in Central Berlin early last year.

With respect to our institutional sales, we have successfully sold more than 7,000 units in 2019. We have been able to realize a gross margin of EUR 186 million or 35% above our book values for below average quality from a product and/or regional perspective.

On the following page, we have summarized all larger institutional transactions, which have been signed in 2019. Here, as you can see, we have sold 3 larger portfolios to professional, mainly institutional investors, of which one portfolio already closed at year-end 2019 and the other 2 will have transfer of title mostly in 2020.

For the residential portfolios, we achieved gross margins of 30% — even above 30%. The Berlin portfolio consisting out of 2,175 units was sold to a state-owned housing company. Here, we are talking about really the bottom end of our quality range. These properties are predominantly social housing buildings from the ’70s and ’80s with high investment needs, very challenging tenant structures.

On the nursing part of our portfolio, we have also successfully sold 13 units, which have not fulfilled our quality criteria in terms of location and technical conditions. Here, we have been able to clean up the portfolio more or less at book value, and the closing is expected in Q2 2020.

Also going forward, this year, we will continue our opportunistic disposal strategy and seek to dispose of below average quality from a regional and/or product perspective and in a value-accretive manner. So depending on the demand and liquidity of the transaction market, there’s more to come.

To our Nursing, Assisted Living business on Page 16, as you can see, EBITDA increased by 60% to EUR 88 million, mainly driven by the acquisitions undertaken in 2018, which had the first full year impact in 2019. For 2020, earnings contribution from that segment is expected to be some EUR 10 million lower accounting for the [signed] disposals.

Page 17 shows our adjusted EBITDA, excluding disposals of around EUR 720 million with an increase of 15.5% year-on-year. The efficiency of our business model is evidenced by an increase of our EBITDA margin to 77%, an increase of 2.1 percentage points, excluding the accounting effects due to the first time implementation of IFRS 16 standards.

The increase in other operating expenses is driven by a one-off and due to the ongoing appraisal proceedings in context of the domination agreement with GSW. Here, we have accounted for expected higher compensation payments for minority shareholders of GSW. Adjusted for that, other operating income and expenses were virtually 0.

Turning to Page 18. FFO I amounted to EUR 538 million or EUR 1.50 per share and, thus, slightly above our guidance. On a per share basis, this is an increase of 10% compared to last year. And on that basis, and accounting for the EUR 30 million relief fund for our affected tenant base as a result of the corona crisis, we will suggest to our shareholders a dividend per share of $0.90 in our upcoming AGM as a cash dividend translating into a payout ratio of around 60%. FFO I margin improved by 1.6 percentage points to around 59%, and that despite all M&A activity of recent years fully debt financed the corresponding increase in interest expenses.

On Page 19, we show EPRA NAV, which came out at around EUR 47 per share, so an increase of 11% year-on-year. Including the dividend payment, we have been able to deliver a total shareholder return of around 13% in 2019, as you can see on the following page.

Moving to Page 21 on our capital structure. As of the end of last year, average interest rate and maturity remained almost unchanged at 1.3% and 7.5 years, respectively. Our financing and liquidity position is very comfortable and allows enough headroom to continue with our share buyback program and selective acquisitions. We continue to have short-term access to EUR 1 billion liquidity through commercial papers as well as revolving credit facilities, which are maturing in 2022.

LTV at year-end came out at around 35% and, baking in the Isaria acquisition, we achieved a pro forma LTV of around 37%. That means we continue to be very much in our comfort zone, which is based on our LTV target range between 35% to 40%.

And as a side note, despite the recent turmoil in debt capital markets, we managed to refinance last week successfully EUR 200 million on an unsecured basis was a short-term financing of 10 months at a 0% yield. This, in my view, is very much a testimonial to the strength of our balance sheet. On top, we currently have unencumbered assets amounting to circa EUR 7 billion we can prepare for bank financing. So by that, you can see we have a lot of options.

On Page 22, we show the latest details of the respective impact of the Berlin rent freeze law, which has seen some last-minute changes end of January. So what does that mean for our rental income in Berlin? The expected rental loss will be around EUR 9 million in 2020, EUR 31 million in 2021. These numbers do not include the unrealized rental growth of roughly EUR 50 million per annum that we have communicated with our 9-month figures but only reflect the rent reduction risk.

There are 3 elements for the rent reduction: one, the 120% rule, which will apply from November 23, and landlords must proactively reduce rent levels to 120% of the respective ceilings; second, rent increases implemented after June 18, 2019, had to be reversed after implementation of the law, but not, as Michael already alluded to, retroactively; and third, as rent ceiling and the respective levels are approximately 10% below average in-place rents, you will see negative rent adjustments for relettings depending on churn.

Please be aware that we continue to be convinced that the new regulation in Berlin is not in line with the constitution. Recent local and district court ruling support very much this view, and they refer to the lack of competency of the Berlin government. The constitutional review, which is in the making and which is expected to be submitted before the summer break, will provide much needed clarity on this subject matter. Until then, we are structuring our rental contracts in a way that will provide for the possibility to reclaim any rental losses.

Moving to the last page, 23. You can see we have delivered on our guidance. FFO I came out slightly above guidance. On like-for-like rental growth, we achieved 3.4%. This is actually above the guided 3%.

While 2019 was another strong year in terms of operational results, 2020 will be somewhat more challenging. The Berlin rent freeze law will impact our rents and, therefore, we forecast FFO I to be stable in 2020. Our guidance excludes, however, the impact of today’s announcement of the Isaria acquisition. It includes the negative impact on rents and leases from our institutional portfolio sales of around 8,500 residential and commercial units as well as nursing homes, 13 nursing homes to that respect. That, in aggregate, will result in an almost EUR 40 million loss in revenues in 2020.

Like-for-like rental growth, based on P&L figures, is expected to be at roughly plus 1%., forecast growth outside of Berlin to remain stable while Berlin rent growth will be significantly affected by the regulation as long as the Berlin rental freeze law will be in place.

With that, I conclude the presentation and open the floor for Q&A. Thank you.

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Questions and Answers

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Operator [1]

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(Operator Instructions) The first question comes from the line of Sander Bunck from Barclays.

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Sander Bunck, Barclays Bank PLC, Research Division – VP of Real Estate Equity Research [2]

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Three questions for me, please. First one is on the guidance. Can you just confirm whether the FFO guidance for 2020, does it include the EUR 30 million worth of rent relief? Or this is being excluded, i.e., is it being capitalized from the P&L and effectively taken into account as a one-off?

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Philip Grosse, Deutsche Wohnen SE – CFO & Member of the Management Board [3]

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The answer is it is excluded, and it’s most likely to be considered as a one-off.

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Sander Bunck, Barclays Bank PLC, Research Division – VP of Real Estate Equity Research [4]

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Great. And the second question I had is on the health care activities, not only for the properties that you own, but also for the KATHARINENHOF joint venture that you have. What are you seeing in terms of when you talk to your operators? And what — as an operator yourself, what are you currently experiencing on the ground in terms of impact from the coronavirus? Are you seeing any impact in terms of delay of people arriving? Are operators seeing margin pressures? And are you taking any of these uncertainties into your guidance for next year as well?

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Philip Grosse, Deutsche Wohnen SE – CFO & Member of the Management Board [5]

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On that point, it’s less a cost risk, it’s an operational risk. And here, in nursing, we are part of the national pandemic plans like it is the case for hospitals. From an operational perspective, we have taken various measures to minimize risk on the operations on the ground. In that we have, for instance, isolated clients with the highest risk that no or hardly any visits are possible any longer, and most importantly, that we have put the required infrastructure in place for child care to ensure that our workforce can do their respective job. But again, the risks here are very much on the operational side. I don’t see any elevated risk on the revenue side.

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Sander Bunck, Barclays Bank PLC, Research Division – VP of Real Estate Equity Research [6]

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Okay. So no, you would not expect to see any impact on margins?

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Philip Grosse, Deutsche Wohnen SE – CFO & Member of the Management Board [7]

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For the time being, no.

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Sander Bunck, Barclays Bank PLC, Research Division – VP of Real Estate Equity Research [8]

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Okay. And then the last question is a slightly broader question, but it includes part of the Isaria acquisition as well as the comments you’re making during the conference call as well about seeing good entry prices in terms of potential acquisitions amidst the current market uncertainty. Can you just help us understand a bit about how you’re thinking about this? Because, obviously, some of these prices probably have come down because there is just more uncertainty in the wider financing market, and there is a lot of uncertainty in deals and M&A more generally. All of those are, in the current environment, kind of being postponed and because people want to have more certainty at financing terms, et cetera. Yet you seem to kind of go ahead full steam, not only with the Isaria acquisition, but also hinting that potentially, there is actually further to go. How are you — so how can you underwrite effectively acquisitions in the current environment? And how can you — and how do you underwrite financing conditions at this stage?

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Philip Grosse, Deutsche Wohnen SE – CFO & Member of the Management Board [9]

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I mean in principle, the current situation also presents chances in our view. And what we, in particular, see is that smaller developers are coming under pressure because risk in the financing market is differently priced than even a couple of weeks ago. And that, in our view, presents opportunities. And with our own platform and the platform we have recently acquired, we want to benefit from these opportunities.

That having said, that has always to be seen in the context of us sticking to our conservative capital structure philosophy. So we have financing capacity. We have, as I have alluded to, good access to financing markets. Many options here, but we will obviously not stress test our balance sheet and deviate from our 35% to 40% LTV target range.

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Sander Bunck, Barclays Bank PLC, Research Division – VP of Real Estate Equity Research [10]

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Sure, understood. So 2 things to take away from that is, one, you’re saying it’s predominantly involved developers that are currently coming under pressure. So you’re mainly seeing the opportunity for some of the smaller developers that have high financing requirements. That is — at the moment, that’s where you see most of the opportunities is kind of [how I] understand.

But the other bit, and maybe some pushback on that, probably from an LTV point of view, you are correct and say you continue to sit within the 35% to 40% range, but it can also not be ignored that the wider bond market for most listed real estate companies has moved out by — the yields have moved out by anywhere between 100 or 150 basis points and, in some cases, even more so. That does have an impact on your underwriting, your financing assumptions and is kind of separate from the 35% to 40% LTV discussion.

So I hear you that you refinanced EUR 200 million last week at very good rates. But more generally, the bond market and the financing market has become more expensive, let alone that access to capital markets at the moment is being debated. So how are you looking at just the increased cost of financing more in general?

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Philip Grosse, Deutsche Wohnen SE – CFO & Member of the Management Board [11]

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As I’ve said, we have many options here. And you are right in saying that spreads in the bond market moved fairly significantly. If I were to issue a bond, 10-year maturity in the unsecured market today, I would probably pay double the price I would have paid a couple of weeks ago. But that having said, what is still very much working is the banking market. And here, we don’t see any adjustments for risk premiums. Here, we have unencumbered assets of approximately EUR 7 billion.

So if the banking market proves more efficient for us, currently, that is the case, you will probably see more refinanced activity targeted towards that segment. And the banking market, to add, has proven to be very resilient even in stress times because banks have the possibility to refinance themselves in the so-called [fun fleet market], which has to be proven resilient to crisis as evidenced in many, many situations in the past.

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Sander Bunck, Barclays Bank PLC, Research Division – VP of Real Estate Equity Research [12]

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Okay, understood. And just with regards to the first one, was I right to understand that you remain — in that case, given those financing conditions, that you would be mainly interested in smaller developers, that those are at the moment more attractively priced than other alternatives?

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Philip Grosse, Deutsche Wohnen SE – CFO & Member of the Management Board [13]

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That is correct. And it’s in our view to add a far more efficient entry point into attractive markets.

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Operator [14]

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The next question comes from the line of Thomas Neuhold from Kepler Cheuvreux.

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Thomas Neuhold, Kepler Cheuvreux, Research Division – Head of Research of Austria [15]

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I have a couple of questions related to the Isaria acquisition and your combined EUR 3 billion development pipeline. Can you please elaborate a little bit on the time line of the execution of the EUR 3 billion pipeline and, from a currency standpoint, which portion you plan to keep on your own balance sheet and then which portion you want to sell? Can you also elaborate a little bit on the current development environment? Is there any risk that there are delays out of the coronavirus spread, and maybe construction companies are not able to continue the work? And going forward, and I was just wondering, from a strategic point of view, are you happy now with the size of the development operations activities you have? Or can you imagine that you further increase those activities going forward if you make here positive progress and good returns?

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Michael Zahn, Deutsche Wohnen SE – CEO [16]

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So first, generally speaking, I think the step to Munich is, for me, clearly, a smart step because we see a city and a surrounding still — which will outperform, in my view, Germany, biggest cities in Europe, we have purchase power. We have a strong economic situation there, which drives prices.

So if you look into this transaction, we bought or we will buy, first, land lots. Having this said, the idea is not to come now in a big, big situation as a developer. For me, it’s a situation, and you have seen this over the last 3 years. Pricing for land plots extremely increased, and this is a situation where we can buy cheaper, simply cheaper without any premium.

So driven by the — simply by the situation that liquidity is a need, cash is king. And also, the step to Hamburg, I would say, is very similar to Munich. Here, we have the second top city in Germany, where we, at the end, bought a lot of space, a lot of land where we can develop things which are needed, for example, assisted living.

So for me, it means, first, all transactions should be within our equity story. And that means we want to be and establish a company, a platform which is strongly focusing in metropolitan areas and cities.

On the other side, that means like last year, we, year-by-year, will streamline our portfolio. Today, we have around 24,000 units, which are not in the hot spots in Germany, which are not sizable. So that means, as I said, we see more and more stronger demand by [costs and] funds. And therefore, I would say — let me say, Isaria, we simply recycle money by selling nonstrategic portfolios to the market with smart prices and buying opportunities, in my view, with — on long term with a great, great prospect in value. That’s the idea.

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Thomas Neuhold, Kepler Cheuvreux, Research Division – Head of Research of Austria [17]

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I think my other question’s time line development or development [of sale] and also the operational risk [involved to this].

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Michael Zahn, Deutsche Wohnen SE – CEO [18]

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Time line, we said 10 years from today’s standpoint. And Munich, for us, offers great value upside. Therefore, Munich is 100% for hold, yes. If we see Stuttgart, it’s simply a complete other story. Because in Stuttgart, we have this development and nothing else. And from a size aspect, it makes more sense to sell to the market.

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Thomas Neuhold, Kepler Cheuvreux, Research Division – Head of Research of Austria [19]

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Okay, understood. And can you just comment briefly on what is going on operationally in the development business now? Any impact from corona? Or everything is still running smoothly?

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Philip Grosse, Deutsche Wohnen SE – CFO & Member of the Management Board [20]

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I mean currently, there is obviously an impact. We are trying to keep urgent maintenance work up and running. But for complex refurbishments, but equally for new developments, the current corona situation impacts the capacity situation, so that has more or less come to a stop in the current situation.

My hope is that, let me say, margins will fall because a lot of private investments, especially in Berlin, are stopped. And I think, yes, in our negotiations for the future developments, I see a strong position also from us to idly achieve better prices than last year or last year — over the last years.

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Operator [21]

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The next question comes from the line of Veronique Meertens from ABN AMRO.

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Veronique Meertens, ABN AMRO Bank N.V., Research Division – Analyst [22]

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One last question from me. Just to check if I had it correct, so the refurbishments in Berlin are still going through?

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Philip Grosse, Deutsche Wohnen SE – CFO & Member of the Management Board [23]

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In terms of investments, what we do is that we continue to do investments as part of relettings. Because here, we undertake the required investments to effectively optimize rent levels according to the nationwide regulation in a view that the unconstitutionality of the Berlin rental law is going to be confirmed. For complex refurbishment investments, we will finish what we have started in Berlin markets. But for new complex refurbishments, we will allocate funds outside Berlin market as long as the law is in place.

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Veronique Meertens, ABN AMRO Bank N.V., Research Division – Analyst [24]

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Okay. Clear. But just one more question. So what if the Mietentdeckel would be ruled constitutional, then it could be that still a part in Berlin, you cannot increase the rents. Am I correct?

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Philip Grosse, Deutsche Wohnen SE – CFO & Member of the Management Board [25]

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That in principle is correct, but it’s not our expectation.

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Operator [26]

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The next question comes from the line of Kai Klose from Berenberg.

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Kai Malte Klose, Joh. Berenberg, Gossler & Co. KG, Research Division – Analyst [27]

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I’ve got 2 quick questions. The first one is more technical one. On Page 17, maybe you could explain what we had as EUR 29.7 million other expenses and then adjustments of order one-offs of EUR 28.1 million. And second and last question would be on Deutsche Wohnen’s own development pipeline, excluding Isaria, just as a reminder what you are planning to invest excluding Isaria for this year and in which regions it was supposed to be invested.

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Philip Grosse, Deutsche Wohnen SE – CFO & Member of the Management Board [28]

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Yes, Kai, on your first question, the increase in other operating expenses is predominantly the one-off in context of higher compensation payments, which we assume in context of the appraisal proceedings for the guaranteed dividend for GSW minority shareholders. If I adjust for that, the other operating expenses are virtually 0. Did that answer your question?

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Kai Malte Klose, Joh. Berenberg, Gossler & Co. KG, Research Division – Analyst [29]

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Yes. [And just starting to an end, the logic and end to this.] So it is — what kind of — what is triggering this high one-off expenses again?

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Philip Grosse, Deutsche Wohnen SE – CFO & Member of the Management Board [30]

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We have an appraisal proceeding, so a legal review of the compensation payment, essentially a guaranteed dividend, which we have to offer to the remaining shareholders of GSW. And that is usually a very lengthy process. I equally don’t expect that to end anytime soon. But based on the further valuation opinion, which has been ordered by the court, we have reasons to believe that this payment is going to be higher than what we currently pay, which is EUR 1.40 per share. And we have, in a cautious way, provisioned for that expectation of a higher payment. And the increase in other operating expenses is basically the NPV, the net present value, of these higher payments to GSW minority shareholders, which is somewhat compensated by also purchase price adjustments we receive from the RETT-blocker structure, which we have sold to a pension fund, that 5% that we have negotiated in that case of higher guaranteed payments that this will adjust the purchase price.

So here, we have a one-off income, which is partly recovering that. So as you can see, fairly technical. It’s a one-off, as I said. And adjusting for that, it’s essentially 0 other operating income expenses.

A question referring to our development business, excluding Isaria acquisition, that is approximately EUR 1 billion, which we intend to invest, and that is for development for the next 5 years.

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Operator [31]

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The next question comes from the line of Georg Kanders from Bankhaus Lampe.

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Georg Kanders, Bankhaus Lampe KG, Research Division – Investment Analyst [32]

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Yes. Regarding the reduction of the payout ratio, did I understand it correctly, this is only for 2019? Or is this a permanent issue? Because it’s not clear in the presentation.

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Philip Grosse, Deutsche Wohnen SE – CFO & Member of the Management Board [33]

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That is clearly only for 2019. We think it’s important, as Michael said, that we send a strong signal of support predominantly for our small commercial tenants, which are very much affected by that situation. But for this year, so dividend payment next year, no reason to deviate from our payout ratio of 65%.

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Georg Kanders, Bankhaus Lampe KG, Research Division – Investment Analyst [34]

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And one other question I have regarding — for the Isaria acquisition. You mentioned that you are acquiring this development project, but do you also have access to additional personnel, especially in Munich, you would need it or not the case?

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Philip Grosse, Deutsche Wohnen SE – CFO & Member of the Management Board [35]

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Absolutely. We acquired the project, the pipeline, but we have also acquired the personnel consisting of approximately 80 people, but in a way that we are not acquiring the entire platform with all the legal and tax risks usually associated with kind of complex structures. But we have focused only to take over the personnel and the required infrastructure.

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Operator [36]

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The next question comes from the line of [Simon Stepic] from [Baader Research].

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Unidentified Analyst, [37]

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My first one would be in regard to your debt book, refinancing and LTV. And I wonder, could you please give a little bit more color in the refinancing you had for last week and then also your plans going forward for the outstanding bond, I think, of EUR 280 million? And additionally, could you also please tell me the LTV covenants you have on your debt book, especially on the bonds and maybe also on the bank loans, what the expectations of the bank is there?

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Philip Grosse, Deutsche Wohnen SE – CFO & Member of the Management Board [38]

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Sorry, I was on mute. On your second question on covenants, on the unsecured debt — actually, if I recall correctly, the debt covenant is 65% — 60% or 65% — sorry, it’s 60%. So there is so much headroom that I — there’s sufficient headroom.

In bank financing, we usually also have some covenants, which are usually a multiple of the current in-place rent and here for all of our financing double-digit headroom. So on the covenant side, in my view, essentially 0 risk. In terms of short-term refinancing, the next somewhat bigger maturity, which is coming due, is in fact our corporate bonds, where we have repurchased some of that. So outstanding is EUR 280 million that we have basically refinanced with the extension of a — with the short-term financing 10 months, which we did on Tuesday last week unsecured, as I said, for a gross yield of 0%.

And apart from that, we are currently preparing some smaller portfolios for financing in the banking market, as we currently consider this market segment to be most efficient. But essentially, until and including May, there is no refinancing need whatsoever. It will start as of June, given dividend payment and some maturing of debt.

But all in all, we are talking about refinancing needs for the remainder of the year of approximately EUR 1.2 billion. So it’s very much manageable.

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Unidentified Analyst, [39]

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Okay, great. And the second question would be in regard to your evaluation. I saw the capitalization rate was lower, especially in Berlin. And I wonder, could you please tell me how the impact of the rental cap was incorporated in that and what the appraiser’s at in that regard?

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Philip Grosse, Deutsche Wohnen SE – CFO & Member of the Management Board [40]

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Essentially, the rental cap was not embedded in the DCF model as of last year. The appraisers had the common view as to how to handle that from a technical perspective. But ultimately, how properties are valued, as you know, is a function of prices being paid in the transaction market. So ultimately, it’s not only a question of rent assumption, rent development assumptions you put in your model. Ultimately, it’s a question how that translates into potential adjustments of the capitalization rates. I have to say, if I look at our Berlin portfolio specifically, it’s currently valued at EUR 2,600 on a per square meter basis. So it’s a huge, huge discount versus replacement values. But also, it’s quite a comfortable discount versus price points we see in the broader market for institutional transactions as well as in the market for condominiums.

Looking at disposals, we also recently signed in Berlin at very attractive margins. I’m very comfortable on that point.

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Unidentified Analyst, [41]

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Okay, great. Just in regard to that. In Berlin, the capitalization rate was lowered really dramatically — or, let’s say, dramatically. I think it was 3.4% in Berlin for the year-end. And in Q2 ’19, it was, I think, around — or at last year 2018, it was 4%. It’s just I wonder, do you really see that translated in transaction prices, that increase? Or is it rather that the appraiser made changes in expectations and stretching out longer-term expectations at, let’s say, the 10-year end of the DCF?

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Philip Grosse, Deutsche Wohnen SE – CFO & Member of the Management Board [42]

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I mean first of all, what you see in the notes to our financial statements is our own valuation. So that is what we are putting in our model, which is then in the second step appraised by Jones Lang LaSalle, who’s coming to similar results. And yes, I mean, you’ve seen, once again, last year, an acceleration in prices in Berlin markets. And what you see in terms of our year-end revaluation is a reflection of the activity we have observed over the course of last year in the transaction market.

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Operator [43]

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We currently have no more questions coming through. (Operator Instructions)

There are no further questions. So I would like to thank everybody for joining today’s conference call, and I will hand you back to your host.

The next earnings call of Deutsche Wohnen will be on 13th of May 2020. For any questions in the meantime, please feel free to contact the IR team. Have a good day, and goodbye. You may now replace your handsets.