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Hazik Siddiqui

Demire is exploring a range of options as it proactively looks at ways to address its 2024 maturity wall which includes a €600m 1.875% SUN due Oct-2024 (€550m outstanding post buyback) and €169m of bank debt.

Rising capitalisation rates have nibbled away at the market value of the German commercial real estate company’s portfolio, with Demire recently selling its biggest asset at a double-digit discount to FY 21 book value (the portfolio is evaluated annually).

Though Demire isn’t a forced seller, the valuation is indicative of the tough market environment for real estate in recent months. Nonetheless, we estimate the transaction will prove to be de-leveraging for the company and will add extra liquidity from the net proceeds. 

Despite of this, the 2024s continue to trade at distressed levels, indicated at mid-73.8 to yield 22.6% as of writing. With Q4 numbers due this Thursday (16 March), we take a look at the credit implications of its recent disposal, expected property revaluations for FY 22, the potential impact on LTV, refinancing options, and peer Hamborner’s performance.

Demire’s portfolio was last appraised in December 2021. Interest rates have increased markedly since then which has negatively impacted market values of its properties. For context, cap rates tend to have some correlation to underlying interest rates, though other factors such as location, asset size, etc. also impact rates. Rising cap rates with constant net operating income (NOI) depress property valuations.

Cap rates expected to widen in FY 22, source: 9fin.com

In December 2022, the German landlord sold its largest property Leipzig (LogPark) for a consideration of €121m — a 14.5% discount to FY 21 book value (€141.6m).

Increasing cap rate environment is better suited for acquiring new properties rather than selling, however it appears Demire is keen to shore up its liquidity profile ahead of the 2024 maturity wall which includes the €550m of remaining bond principal (post buyback) and €169m of bank debt.

Following the Leipzig asset sale announcement, 9fin reached out to Demire. An investor relations representative mentioned that the 14.5% discount should not be seen as a proxy for the expected revaluation of the remaining portfolio. The average revaluation at FY 22 will be similar to peers which have been in the negative single digits, they added.

The Leipzig asset sale will have a positive impact on the net LTV, even though it was sold at a 14.5% discount to FY 21 book value.

As per 9fin calculations, Q3 22 net LTV pro-forma for Leipzig would decrease to 48% from 51.2% reported. We estimate this drops lower to 47% when accounting for its €50m bond buyback in November as this was done at a 28% discount:

Asset sale had a positive impact on net-LTV, source: 9fin estimates

Demire’s selling approach is opportunistic at present, and it could target further asset sales to lessen the refinancing pressure. NuWays’ research predicts €250m of asset sales in 2023 alone.

Per our estimates, future asset sales should have a deleveraging impact as long as they are not sold substantially below book value. Moreover, the LTV ratio of individual assets (i.e. whether they are pledged for loans or not) is unlikely to have an impact on the consolidated LTV of Demire.

The 2024 SUNs rallied ~six points from 68.6 to 74.5 within three trading days of the Leipzig asset sale announcement. The uptick was likely due to (i) an improved liquidity position reassuring the markets; and (ii) improved net LTV as we illustrate above. 

Given expectations of a correction in the real estate portfolio, it becomes necessary to gauge the impact on credit metrics, specifically net LTV given there is a 60% LTV incurrence covenant on the bonds (9fin clients can see the legal QuickTake).

Our analysis suggests there is decent headroom available even after a high single-digit revaluation. Per 9fin estimates, a 9% decline in the real estate portfolio would bump up the ratio to 51.2% from the otherwise comparable figure of 47% we illustrate above.

Revaluation scenario analysis on Net-LTV. All calculations are PF for Leipzig sale & bond-buyback, source: 9fin estimates

Rising cap rates typically have a two-fold impact on real estate companies. Firstly, property valuations will decline if rental growth is flat, decreasing the equity cushion under creditors. Secondly, if a company has floating rate debt or an upcoming maturity, future financing costs are likely to increase substantially.

Demire’s current average cost of debt is 1.67%, benefitting from fixed interest payments on the 1.875% SUNs. This has resulted in a healthy interest coverage ratio of 4.6x as of Q3 22. These attractive levels will likely become a thing of past at the time of 2024 refinancing, thanks to rising benchmark rates and spreads.

If Demire’s future funding costs are close or equal to its cap rates, the new cost of debt would potentially exhaust a significant portion of NOI, and thereby increase Demire’s dependence on secondary sources of liquidity such as asset sales. To summarize, there is a risk that debt servicing could become more expensive than the cash flow generated by the company’s assets.

In November 2022, Demire bought back €50m nominal value of its unsecured bonds at an average market value of 72. With a healthy pro forma cash balance, and scope of further asset sales, the company could explore more bond buybacks to ease the way into the 2024 refinancing. This would also result in significant savings on principal amounts given current trading levels.

Another option which could be used in combination with bond buybacks is raising more secured debt. The company hinted in its December presentation its intention to raise more secured debt by stating, “Room for further mortgage loans as about half of the portfolio has not been pledged as securities under loan contracts”.

As of Q3 22, Demire had a 49% unencumbered asset ratio, leaving plenty of scope to raise more secured debt. Under the bonds docs, there is an incurrence covenant of net LTV below 60%, meaning in reality there is ~€140m of capacity currently. 

Understandably, the company may not want to pledge its entire portfolio, so this would ideally be used alongside an unsecured bond to repay the remaining 2024s. Additionally, more secured debt would prime bondholders, but the move could be viewed positively if proceeds are earmarked for repayment of notes.

Currently unsecured debt accounts for two-thirds of the total debt. We think this split will change in favour of more secured debt given high interest rates in the unsecured markets. As discussed, Demire’s focus would be on expanding the differential between its NOI and interest costs. 

Office leasing markets in Germany, which make up a significant part of Demire’s portfolio, remain resilient. An excellent report by CBRE shows that office properties in 2022 outperformed expectations, with a positive net absorption rate (take up of offices), strong rental growth and improved vacancy rates. A fully fledged recession has become unlikely, which should limit the negative pressure on rents and fuel the demand for office spaces.

Last month, peer Hamborner REIT-AG delivered a decent Q4 22 print, with income from rent & leases and FFO both increasing 6.4% and 27.2% YoY respectively. Property values declined by 1.8% over the previous quarter, suggesting that valuation risk is not extremely elevated. Similar to Demire, Hamborner REIT invests into German commercial properties in secondary locations.

Hamborner Q4 2022 results, source: Hamborner IR

If FY 22 guidance is achieved, Q4 22 rental income would be ~€19.1m. This would be lower than previous quarters, but explained by asset disposals done in 2022. We note that 70% of Demire’s contracts are inflation-linked, and therefore rent increases conducted throughout should support the rental income. The FY rental income could even slightly exceed the guidance of €78-80m given stable demand and the improving outlook.

FY 22 guidance is the midpoint of the range provided, source: 9fin.com

Demire’s Q4 2022 results will be released on Thursday morning, 16 March. The conference call will take place on Thursday at 10am CET / 9am UKT.

Demire bonds pricing in macro headwinds – Q4 22 earnings preview

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