Scarce commodity: residential real estate remains in demand
Despite increased risks such as interest rates or regulation, residential real estate remains attractive - in addition, high discounts to the intrinsic value of real estate shares are enticing.
By Hagen Ernst, Deputy Head of Research & Portfolio Management at DJE Kapital AG
The Federal Constitutional Court declared Berlin's rent cap unconstitutional in April. The competence for rent law would lie at the federal level, but here, too, constitutionality has not yet been confirmed. Moreover, the rent cap has failed to achieve its goal of preserving affordable housing: The already scarce supply of rental housing in Berlin had collapsed by up to 50 per cent after the introduction of the rent cap. Likewise, rent relief in well-off neighbourhoods such as Prenzlauer Berg or Berlin Mitte was significantly higher than in socially weaker neighbourhoods such as Marzahn-Hellersdorf.
The myth of "exorbitant“ rents
Certainly, there are excessive rents in individual cases, especially in the luxury segment. Statistically, however, rents nationwide have only risen by about one per cent p.a. - and thus parallel to inflation - in the last ten years. Gross salaries have risen by an average of three to four percent p.a., except in the Corona year 2020. Thus, housing has actually become more affordable for the majority. Ten years ago, rental costs still burdened disposable income with 28.3 per cent, but in 2019 they only account for 26.1 per cent. In a European comparison, housing is also relatively affordable in Germany. This shows: The federal government's rent brake is working and instruments like the rent cap are not necessary. But in the run-up to the federal elections, the topic of rent regulation is high on the agenda of some parties - because half of Germany lives for rent.
Lack of living space
The problem is not rising rents, but the lack of living space - only building can help. According to the Federal Statistical Office, the number of building permits in 2019 rose by four per cent to 360,600 and the number of completed flats by two per cent to 293,000. The last time there were more was in 2001 with 326,600. Smaller measures such as making it more difficult to convert rental properties into owner-occupied properties in areas with a tight housing market should also help to improve supply.
More new buildings could also ease the situation in conurbations like Munich, Berlin, Frankfurt or Stuttgart. For two to three years already, rents in metropolitan regions with particularly high rents have been rising less strongly (or stagnating, as in Munich or Berlin) than in B-cities or in the countryside, where rents are much cheaper. Covid-19 has further strengthened the trend "out to the countryside". Thanks to home offices, living close to the city in the countryside has once again become a real alternative to the big city, especially for families.
Social housing neglected
However, too little is being done in the social housing market. Since 2002, the supply of social housing has shrunk by 55 percent to 1.137 million. Currently, only 25,000 social housing units are built per year, far less than the number of units that fall out of the social housing obligation each year. At least 80,000 new social housing units would be needed annually to combat the acute housing shortage. The state is therefore not sufficiently fulfilling its task of creating affordable social housing. The situation is particularly precarious in Berlin, which is governed by the red-red-green coalition. There, the stock of social housing fell by 20,000 to 95,700 in 2019 alone and would fall to 59,000 by the beginning of 2028 without countermeasures.
So far, there are no conclusive concepts, and instead the only option is the rent cap, which has now been overturned. The municipal housing companies also mostly fail to meet their targets. By September 2021, only 21,000 new flats will be completed, compared to the 30,000 promised. The housing shortage in Berlin is not likely to ease in the foreseeable future. According to Immoscout24, there are 137 enquiries for one rental flat ad - in Munich there are only 40, in Hamburg 53 and in Frankfurt 23.
At the same time, however, the need for social housing is growing: As a result of the Hartz IV reform, the share of the low-wage sector has risen from 16 percent to a peak of 24 percent and is currently 21.7 percent. In an EU comparison, Germany is one of the six countries with the highest low-wage rate. Moreover, unlike in the higher salary brackets, wages have only increased at a below-average rate, namely by one euro to 9.50 euros minimum wage from 2013 to 2019. Housing for the lower income brackets thus did not become more affordable. In view of increasing digitalisation, no trend reversal is discernible - ideas and concepts on the part of politicians are needed here.
Despite interest rate rise and more regulation: residential real estate remains interesting
The risks for residential real estate are likely to be a possible rise in interest rates and stronger regulation. Especially the latter threatens trouble if the Red-Red-Green Party wins the federal elections. Despite the rise in interest rates in the USA, yields on 10-year federal bonds have only risen slightly or even remained negative. The decisive factor will be that the current inflationary pressure does not continue and that the central banks can maintain their low interest rate policy. Inflation rates should slow down again in the second half of the year. If the headwinds from the interest rate and regulatory side do not increase, property prices could continue to rise, although not at the same pace as before. Overall, housing remains scarce. In addition, new construction costs are rising more and more, which makes existing properties correspondingly more attractive. The risk premium between rental yields and interest rates also remains attractive at currently over three percent.
The high in the Green polls has also led to a stronger correction in some cases, so that real estate stocks are generally trading at discounts of over ten percent to their net asset value (NAV). The valuation of the real estate portfolios is also rather conservative: at DW, for example, the portfolio in Berlin is valued at 2,858 euros/m2. According to CBRE1, the market prices for multi-family houses at the end of the first quarter were 3,459 euros/m2 and 5,266 euros/m2 for condominiums.
More monopoly: takeovers create large groups
Vonovia has also recognised this and is offering 52 euros per Deutsche Wohnen share as part of a voluntary takeover bid. Including the dividend of 1.03 euros, this results in a takeover price of 53.03 euros - just above the current NAV of 52.50 euros and thus a premium of 18 percent over the last closing price or 25 percent over the weighted average price of the last 3 months. The purchase price for DW amounts to approximately 19 billion euros and is to be financed by a bridge loan of 22 billion euros and a capital increase of up to eight billion euros (up to 30 percent of the outstanding shares). The result is by far the largest real estate group in Europe with a portfolio of 550,000 flats - primarily in Germany, but also in other countries such as Sweden or Austria. Vonovia expects synergy effects of 105 million euros annually, which should be leveraged by 2024. Although both groups are already very efficiently positioned, this synergy should be achievable given the size and increasing digitalisation.
It will be exciting to see whether at least half of DW's shareholders will accept the offer. There should be no antitrust concerns, as the housing market is dominated by private and public providers. Things will only get tricky in Berlin. Of DW's 150,000 flats, 113,000 are in the greater Berlin area. Vonovia has 43,000 out of more than 400,000, which means that with 156,000 flats out of a total stock of 1.97 million, the group would have a market share of around seven per cent in the capital, which is quite critical. In addition, there is already strong resistance from initiatives such as "Expropriate Deutsche Wohnen". Vonovia is trying to counteract this by committing to increase rents by only one per cent p.a. until 2024 or only in line with inflation until 2026. In addition, it wants to sell 20,000 units preferentially to municipal housing companies in Berlin.
The market initially took a negative view of the planned takeover of DW because of the outstanding capital increase of up to eight billion euros (just under 30 per cent of the outstanding shares). Nevertheless, the takeover should also pay off for Vonovia shareholders. After all, DW is being acquired at a conservative NAV of 52.50 euros. The Berlin portfolio is currently valued at only 2,853 euros/m2, around 20 per cent lower than the current market price. Moreover, the price increase of around five per cent since the beginning of the year in Berlin and the synergy effects have not yet been taken into account. The discount to NAV is currently highest at Vonovia - and therefore offers a good opportunity to invest in real estate across Germany and beyond. In addition to the significant discount to NAV, one saves the time-consuming administration in contrast to direct investments in real estate. Moreover, the share is liquid and can be sold at any time.
TAG and LEG as further profiteers
Another profiteer is TAG Immobilien AG. It is benefiting from the stronger price and rent increases in B-cities and peripheral locations and the further appreciation of the still low-priced east of Germany. This trend is supported by digitalisation and home offices. In addition, TAG is unlikely to be as much in the focus of potential regulatory tightening as it has little presence in expensive conurbations. With an average rent of 5.48 euros/m2, TAG offers rather inexpensive housing and has the greatest potential for rent increases. LEG Immobilien AG, as a smaller portfolio holder with a clear focus on NRW, is also unlikely to be affected as severely by a possible increase in regulation, as the government in NRW tends to be more landlord-friendly.
1 CBRE Group (Coldwell Banker Richard Ellis) is a global service provider for the commercial real estate sector.
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