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Hello, and welcome to today's ADO Properties call. [Operator Instructions] And just to remind you, this call is being recorded. So I'm now very pleased to hand you over to Rabin Savion, CEO at ADO Properties. Please begin, sir.
Thank you, Yu. Good morning, everyone. I'm Rabin Savion, and I want to welcome you to our Q3 2018 update call. With me is the rest of the senior management team, Eyal Horn and Florian Goldgruber. We get asked frequently who is driving the Berlin economy as there is no big German corporate which has their headquarters in Berlin. We always tell you that it's a well-diversified range of sectors, but Berlin predominantly positioned itself as the heart of the German start-up scene in a view to emerge as the Silicon Valley of Europe. It's not only us who is recognizing this. And 2 weeks ago, Siemens confirmed that they see this situation exactly like we do and announced that they will invest up to EUR 600 million into the transformation of their Berlin production sites into what they call Siemensstadt 2.0. It's an innovation campus which will provide the home to further high-tech companies and start-ups. This is especially interesting not only due to the size of the investment but also due to the location, which is in Spandau and not the typical hip and trendy Kreuzberg or Neukölln. This demonstrates that today, you can find growth and economic development everywhere in Berlin. Now let's go to Page 4 to give you the highlights of Q2 (sic) [ Q3 ]. Our operation is performing very well. On the back of a hard push in unit modernization, our like-for-like rental growth has further improved to 5.5%. Our accelerated CapEx program is in full effect, and vacancy has decreased since the start of the year by 50 basis points. Obviously, this increased level of modernization in units also means an increase in modernization CapEx, like we explained to you in last quarter. For our sold units, we achieved sales price close to EUR 4,000 per square meter, but as we always explained, this is driven not only by the strong Berlin market but also by one particular very high-quality project. This clearly demonstrates the hidden value in our portfolio. This quarter provided some challenges for us on the capital structure side with the bond process we stopped and the rating downgrade we received from Moody's. As a result, we fully focused on our activities on the necessary refinancing of our short-term debt. That also meant that we needed to put acquisitions on hold for the moment until we finalized our work on our capital structure. The first successful steps have been taken with the placement of our Schuldschein loan, and the next steps will follow until the end of the year to complete this process. In line with this, we have also decided to tighten our financing strategy, and we now guide to a target LTV of 40%, which we expect to reach in the course of the next business year. We can now move to Page 6 to look at our portfolio. Our average rents have further improved from EUR 6.57 to EUR 6.65 per square meter, while the average new letting rent stands at EUR 9.14 per square meter. This results in an average reversionary potential of 37%. If you compare it to the last quarter, you need to keep in mind that there was a special one-off letting included which will not be repeated. Having said that, with the current 37%, we're back in line. Looking at our fluctuation rate, we again see a stable figure of approximately 8% on average, which is an important driver to lock in the reversionary potential and, as such, confirming the sustainability of our business model. I will now hand you over to Eyal to discuss operation in more details.
Thank you, Rabin. Our continuous efforts to push on the units modernization program is paying off. We have managed to turn the negative vacancy effect we had in the last quarters and, by that, created a positive contribution to our rental growth. As expected, our like-for-like rises, indicating a strong rental growth of 5.5%. During the first 3 quarters of 2018, our construction management has released over 1,140 newly refurbished units. This very strong figure indicates a completion of over 120 units on a monthly basis. We see a great value creation in our modernization program, and we will continue to push forward in order to maintain this improvement for the coming quarters. Let's look at the table on the bottom left and see the breakdown of our maintenance and CapEx investments. As previously mentioned, we continued with our accelerated unit modernization program, which is now reflected in the cost of our CapEx investment. The total unit modernization CapEx remains stable at EUR 18.4 per square meter. This investment is continuously contributing an average, unlevered return of investment of above 20%. The repair and maintenance costs are at the level of EUR 7.5 per square meter, and the capitalized maintenance is at EUR 7.9 per square meter. We are taking further advantage of the long-lasting dry season which enable us to perform more works on public areas than originally expected. In addition to the capitalized maintenance and as mentioned in the previous calls, we have been putting many efforts to increase the energetic modernization volume as well, now reaching to EUR 2.9 per square meter. This is 120% higher in comparison to last year's average. In total, we have invested EUR 36.7 per square meter in our CapEx and maintenance program value creation. Let's now look at the graph on the right, showing the vacancy breakdown. The overall vacancy remains stable at 3.1%. Even after our strong and massive construction program, the distribution of the vacant units is still showing an overweight of units under construction. This indicates further potential for the coming quarters for both like-for-like and occupancy improvement. The vacancy split is as follows: 2.1% of the vacancy is still under construction, 0.8% is with the letting department, and the remaining 0.2% is with our privatization sales department. Our average in-place rent is currently at EUR 6.65 per square meter, which is up by EUR 0.08 from previous quarter. This further demonstrates the continuous rental growth in the Berlin market even on a quarterly basis. All the operational parameters are developing as anticipated and, therefore, are strongly supporting our 5% like-for-like guidance for 2018. I will now hand you back to Rabin.
Thank you, Eyal. Let's move to Page 8 for a more detailed look into our privatization activities. During the first 9 months, we sold 50 units, which is in line with our strategy. Our average sales price of EUR 3,929 per square meter reflects an uplift of more than 37% compared to the value of our Central location properties. This figure is slightly influenced by one particular high-quality project we're currently selling. As mentioned previously, we see the demand in Berlin continuously increasing, while the building activity continues to be limited, and privatization prices should increase accordingly. We will, therefore, continue with our strategy and not accelerate our sales program. With that, let me now hand you over to Florian Goldgruber, our CFO, who will lead you through the financials.
Thank you, Rabin. [ A view on the third quarter ] with all the valuation, the changes in our balance sheet in Q3 have been only marginal compared to the changes we've seen in the last quarter. The total portfolio stands at a total of EUR 3.8 billion with the total balance sheet just shy of EUR 4 billion. At the end of the quarter, there was only one open commitment for acquisitions remaining, in the amount of EUR 17 million, which got settled at the beginning of October. Our EPRA NAV currently stands at close to EUR 50 per share. Looking at Page 11 on financing, a topic which takes, at the moment, the biggest part of our attention. The long-term debt profile at the end of Q3 is unchanged, and our net LTV stands at 42%. After the end of the quarter, we have seen a rating downgrade by Moody's after our decision to not continue a benchmark bond placement. We had immediately started to raise alternative sources as a replacement, but Moody's felt to act immediately, which also impacted some of the projects we were working on at that point in time. We're nevertheless committed to maintain an investment-grade rating and continue with our various refinancing projects, where we expect several updates for you until the end of the year. To demonstrate our strong commitment, we also decided to tighten our conservative financing strategy further and reduce our LTV target to 40%, which we expect to reach latest over the next business year. All our covenants confirm that and show a very healthy headroom. Let's now briefly look at the P&L, on Page 12. Driven by rental growth and the requisitions at the beginning of the year, we have seen income from rental activities grow to EUR 34.6 million in Q3 with the annual run rate growing to nearly EUR 140 million. Our NOI and EBITDA margins in Q3 are slightly below the 9-month figures but still in line with our expectations. The lower margin was driven by quarterly fluctuations but also by the buildup of additional resources we took onboard to develop our business further by adding additional functions like, for example, the furnished apartments. As a result, our EBITDA in Q3 increased overall to EUR 24 million. Looking at the financing cost, we still see the effect of the interest costs of our EUR 400 million bond, which we placed in 2017, and that is the main driver for the increase in the interest cost. Let's now move to Page 13 and look at the FFO. Our FFO in Q3 increased to EUR 17.3 million or EUR 0.39 per share for the quarter, an increase by 27% compared to the previous year. Privatization has been very positive and added another EUR 2 million to our FFO 2, especially driven by one particular project, as Rabin already explained. Moving to our guidance for 2018. We confirm our like-for-like rental growth guidance going forward at approximately 5%, which should positively impact our portfolio value, EPRA NAV, and EPRA NAV per share. We also expect our FFO run rate to be at least EUR 66 million after closing this -- all of the remaining transactions and also implementing the long-term financing structure. As already mentioned, we have tightened our LTV target to 40%, which we expect to reach latest over the course of the next business year, and our average cost of long-term debt is approximately 1.8%. And we remain on target for a dividend payout ratio of up to 50% of FFO 1. With that, I'm handing back to the -- for the Q&A session.
[Operator Instructions] Our first question is over to the line of Charles Boissier at UBS.
A few questions from my side. Could you come back on the rationale for lowering the LTV target to maximum 40% versus 45% previously. I think what I understand from you is that it's very much linked to the rating downgrade. And I just was wondering, is there any additional reasons like driven by shareholders or external growth prospect? Or is there anything else that makes you want to lower below 40%? A related question, when do you expect to get back to Baa2? If you take those actions, do you think that could be a rating -- a grade back in early 2019? Still on the financing, I was wondering -- you mentioned that you're working on several refinancing projects. I don't know to what extent you can comment on them, but if you can, it would be great to hear some indication of maturities and cost. On external growth, marginal cost of debt, obviously, is going up. Renting yields are down. The cash flow accretion from external growth now is very small, as it is before reversion. So I just was wondering if that is changing at all your view on future acquisitions. And is the 30,000-unit target by 2020 still your assumption given acquisitions are on hold, as you said? And finally, apologies for so many questions. My last one is on the ADO Group. I just was wondering if they are still jointly controlled by Shikun & Binui and Dune? And do you expect that to change at all?
Thank you, Charles. Let me probably start now -- if anything is missing, clearly, just follow up. I'll try to go through the questions, let's say, number by number. First, you were looking at the change in the LTV strategy. The reasons for the change in the LTV strategy is clearly influenced also by the rating downgrade we've seen, but that was not actually the only reason for that, because the argument that the rating agencies brought up is something that we've, actually, clearly also seen in the market. And one of the reasons for us to tighten the LTV strategy is actually -- is basically the other side of the coin from all the valuation gains. As you know, over the last couple of [ billion dollar ] years, we've seen a continuous increase in our valuations, which were not fully supported by cash flow growth but also coming from a very strong yield compression in the Berlin market, which we, in general, see as a very positive sign for the market. But it's from a -- especially from a financing and risk perspective, brings one downside, that your cash flow coverage is actually weakening and worsening if you maintain kind of a stable LTV target. So if you look back, we -- when we IPO-ed the company, we had actually an LTV target of 50%. We tightened that already in the meantime to 45%. Exactly with the same argument that we've seen values going up, cash flow covers coming down. And that is exactly the logic behind that step. So I would even say we would have also taken this step even if we wouldn't have seen the rating downgrade. As I said, this has nothing to do with any concerns about external growth or finding opportunities or similar questions that might arise around it but are purely driven from a cash flow coverage and credit profile metric thought process. Looking at the next topic, clearly, we are, as I said, committed that we want to have a stable investment-grade rating. So -- but also working, clearly, with the rating agency here. I think the key step for the moment now is actually not getting back to Baa2. That is kind of the medium-term goal. The first step is really to have stable, but -- an outlook and hopefully maybe even an outlook that might be under review but on a positive review and not under kind of a negative watch. That is the goal. Does that mean immediately kind of we're targeting back to a Baa2? That's something that, clearly, the rating committee at Moody's needs to decide. But I think we have a very strong focus on that because we think that is the appropriate level where -- which is reflecting our risk profile of the company and -- if not even better. And that is also where we're working to. You also asked on the financings, we mentioned that it's a very wide range of different products we're working on. So -- and it's difficult at the moment to give a lot of detail, but they are projects with maturities I would say ranging between 4 to 8 years. Their margins are really subjected really to terms and also, especially the structure if we're talking secured or unsecured. All in all, we currently are not expecting any material impact on our average cost of funding when we're looking at these projects because it will be a combination of funding sources, which even are kind of lower cost interest than what -- where we are standing, but you also will have some projects which have a higher cost of funding. All in all, as I said, we're not expecting any significant impact on our 1.8 average interest rate. I believe the next topic you had was external growth and our kind of medium-term target to grow to kind of double the company by 2020. I think that 2020 was kind of never really a hard 2020 but kind of the interpretation that when we IPO-ed the company in 2015, that was the medium-term goal. Medium term was kind of seen as around 5 years. As we also pointed out in the past, we are not doubling the company just for the sake of doubling. This is -- we're -- this was driven by the volume of acquisitions we, in general, see in the market that make sense. That is where we came from. Really, having us now for a short period of time not looking at acquisitions at all is clearly setting us a couple of months back on this track. But it doesn't mean that we're completely changing the profile. As I said, we're not really concerned if such a doubling is actually materializing in 2020, if it's '21 or maybe even -- it could even be later if we would see acquisitions that would be accretive and support our profile.
Well, regarding the ADO Group, Charles, there -- as you all know, there are 3 main groups in the ADO Group right now. It's Dune, which is led by the Dayan family. And currently, they hold approximately 19.7%; Apollo, which just purchased additional 7.2%, is currently holding 22%; and Shikun & Binui with 37.5%. So there is no joint control agreement between the different groups. And there is an announced AGM, which will be on the 26th of November, which will decide on the composition of the board. And I believe that, that will shed much more light on the future of ADO Group following that. So we will need to just hold and see.
Our next question is from the line of Marios Pastou at Crédit Suisse.
I just have a couple from my side. The first one is back on to acquisitions. I just wondered if -- just how many acquisitions you have in the pipeline and whether, as the next year comes along and you process your refinancing, whether you would make a start then straight back into an acquisition pipeline, then start building back up the portfolio? And then secondly, just on some regulatory headwinds, whether you've managed to take a look at and quantify any effects of the extension of the Mietspiegel reference period, any commentary on general regulations on the market?
Marios, thanks for the question. Regarding the pipeline, we absolutely see a growing pipeline. We're constantly moving in the range of anywhere between EUR 300 million to EUR 500 million pipeline. It's a typical thing that transaction volume is continuous. You can say that a lot of groups or individuals which don't possess the fully integrated management platforms, which need to go up today with tightened regulations and increased CapEx programs today, are those who are deciding to actually sell and exit the market. So we absolutely feel that the pipeline will be there once we're back on track. So we're looking forward actually to continue our acquisition process as soon as we're done with our capital structure.
Marios, this is Eyal. Can you just shortly repeat the question regarding the Mietspiegel reference period? You just wanted -- okay. So -- yes, well currently, of course, there have been the talks and the information that the rent index reference period will be extended to 6 years. Currently, it's on a 4-year basis. We even heard the further notice that there are some suggestions that it will come out also instead of every 2 years, it should come every 3 years. Well, this is, of course, things we're taking into notion. And definitely, it will general impact the rental growth and would slow it down. As we are a company which -- the total impact of the rent index, I would assume and say, it's less harsh than maybe on some of the peers. This is something that we will have to look on the future and see exactly how much basis points that could impact on the future like-for-like. But nevertheless, we do expect when this regulation will come into the effect, that we will have, actually, face a certain kind of a slowdown in the rental growth, which will be marginal, of course.
We are now over to the line of Jason Ball at ING.
I've got 3 questions, if I may, please. First of all, one of your peers put out some pretty positive second half valuation expectations this morning. Can you comment a bit on how you see the market at the moment and how your portfolio is shaping up for the full year valuation rounds next quarter? Second question, your detailed report mentions the acquisition of 19 commercial units after the quarter closed. I was wondering if you could give us a bit of context on that deal. Are those units purely commercial? And sort of how should we view that in light of the other recent commercial acquisitions that you've done? And then my last question, on the modernization and like-for-like rental growth, the pace of your modernization program remains quite high. I'm just curious, kind of how long can you maintain at that level? And what does that imply for your ongoing 5% like-for-like guidance? Is -- should we see this quarter as more of a one-off? Or is above 5% going to be sustainable for the next few quarters?
Okay, then. Probably first, on the valuation, I think we're -- as you know, we've not given really a kind of a specific guidance for the valuation uplift, but I think what we -- we were looking also at the announcement of Deutsche Wohnen this morning. I think what -- then I -- when I look at what that means for the Berlin market and the expected yield compression, which you can actually extract out of their guidance, that is something which we definitely can confirm that we also see that as going the same direction. So we are clearly growing on -- over a 0.5 year period capital by a, let's say, big picture 2.5% that we always said will be kind of the base also for our value growth. When I look at the market development, I can definitely say I'm also expecting yield compression maybe going into the kind of -- to a similar level, as that's what we're kind of getting when we -- with our initial discussions also of our valuers and other market experts that this could be a level where we -- which we see. But as I said, they are very preliminary debates we had, and that might be -- could even be lower or higher. Your question regarding the commercial units, we integrated in October. That was actually one acquisition which you can find in the Q2 presentation. That is the one transaction which we mentioned there. It's actually one building in Berliner Strasse, a very attractive location, very similar characteristics to the -- to basically the normal commercial units we have in the portfolio. I think the only extraordinary of that one building is that this was the first time ever where we bought a commercial building in a stand-alone transaction and not as part of a portfolio. But the type of commercial units is 100% in line with the commercial units which we have in our portfolio. So there is no change in strategy or any kind of operational impact on that.
We can also say that this building, this particular commercial building is almost attached to one of our residential buildings. So it's really part of where we're operating, and it's -- we see it as a supported neighborhood facility, which gives us better efficiencies while we operate in those -- in this area.
Okay. So if I can just clarify, that's the same deal, then, that you discussed last quarter? This is not another deal.
Exactly. That is -- as usual, what you just see here is the difference between signing and closing off the transactions in -- as we always have.
As for the CapEx program, and back to your question, then, of course, I think as we have also mentioned in the previous quarters, we have basically prepared ourself in the previous quarters and built up, of course, within our construction management team that we're able and is able, of course, to deploy the amount of CapEx, which we are doing currently as we are, of course, working against and wanting and trying, of course, to give as many units back to the letting department and by that, of course, improve occupancies. I'm quite sure we will be able and will continue with that pace until we get to the result that we would like to see our occupancy in, and this something that we will continue while going forward. It's something we've done always, and construction was always a big part of our, actually, our model. As for the, of course, like-for-like rental growth, we would not want to see it as a onetime shot. So it is coming out very strong. It's 5.5%, and we expect to definitely hold the guideline of 5% for 2018, as mentioned, and -- hope to keep it up also for the upcoming quarters.
We now go to the line of Eric Wilmer at ABN AMRO.
Two questions from my side. Following the recently closed Schuldschein and bilateral facilities, where do you see your short-term interest rate develop? And how does this differ from when the bonds would have been pursued? And secondly, could you perhaps give a little bit more color on which neighborhoods in Berlin are currently most booming?
Eric, on the funding side, when we looked at the bond transaction and the nervousness in the market, we were facing a situation where it's able -- it's really difficult to predict where a bond could have been placed. And we've seen a kind of a worst-case scenario where the all-in cost for bond placement might have been even up to, like, 3%, which we felt as completely inappropriate for the risk profile that the company actually represents. Taking a look at the Schuldschein, for example, which might be probably most comparable to what we had in the bond placement, the Schuldschein process has been massively impacted, unfortunately, due to the rating downgrade by Moody's. Now there, we have still achieved all-in funding costs of 2.3% on similar term profile. That is definitely not what we expected to achieve with the Schuldschein. We're -- but that also is not only a volume of impact, but also the funding cost at that point in time. And we would normally expect to see that at a significantly lower level as soon as we stabilize the rating and the outlook there.
And for your second question, which districts today are more happening or more active in Berlin, well, in the beginning on the call, I mentioned that Siemens is investing EUR 600 million in the transformation of their production site in Berlin. And I actually specified -- which is in Spandau and not in a typical trendy location, such as Kreuzberg or Neukölln or others. So today, I can tell you given the increase of demand in Berlin, which is anywhere between 50,000 to 60,000 net migration and the limited supply which we have in Berlin today, we can see that every district today is actually booming. We can see even that outside the borders of Berlin is actually moving up, and rents are continuously growing there as well. Although we are just a pure play in Berlin and we're concentrating just in Berlin, we see today every district in Berlin, even if it's Spandau or Marzahn, is actually booming. We see that across the board. We see the demand moving forward in -- moving upwardly in every district, and we believe that this tendency will continue in the future.
[Operator Instructions] We have a further question and that's on the line of Thomas Rothaeusler at Jefferies.
Just one question on the rent reversion you showed in the third quarter now, which seems a bit lower than in the previous quarters and also lower than in the full year 2017. Can you comment on that? Or what is your expectation for the full year in this respect?
Thomas, this is Eyal. Well, we currently see in the reversionary potential gaps more or less a quarterly volatility of -- especially coming, of course, from the inventory that we have for rent. We did have -- I think it's been something we said also in the past. It's quite difficult to look at reversionary potential on a quarterly basis due to the fact that it very much depends on the units that you have for rent, where they are located, what are their quality and so forth. I think also, if we look at the vacancy or occupancy, we could look that in this current quarter, in the third quarter, we had the vacancy in Central location showing 96.4%, which is currently the highest district where we have our vacancy. And with a 52% reversionary, while it's actually showing that we still have a lot of potential in the upcoming quarters while we would actually modernize those units, which are currently not in the letting inventory but, therefore, in the under-construction inventory. And there will be, again, the one that will contribute more to the reversionary towards the end of the year. In this quarter, we were dealing with a bigger inventory from the City Ring, where, of course, the gaps in between in-place rent and market trends are a bit lower than what you used to see in Central. And therefore, we have these movements from one quarter to another. Looking at the end of the year, I think we would like and we would see somewhere more around the reversionary potential we've been used to see also back in 2017, which is somewhere close to 40%.
But a higher level is unlikely?
I think when you look at the market, how it's developed, clearly, I think we see the market at least developing in line with the like-for-like rental growth. So we're not expecting this reversionary potential to come down, I think, ignoring, clearly, the special effect which -- in Q2, which we had, which Rabin mentioned. And in fact, there is always -- you need to be careful with the quarterly fluctuations in the figures, but as I said, we see this 37% as around the 40-ish level, which we have seen in the past. We definitely see there is stability if not growing reversionary, but that doesn't mean that each quarter, you're adding a couple of percentage points there.
Okay. Maybe to follow up on this, I mean, especially on furnished apartments. Any update here or it's just like same level of [indiscernible] with the recent tour?
Well, I think -- well, it's -- we are continuing with the furnished apartment, as we mentioned in the past. So we are actually on full pace on that project. Of course, trying to further source further units from the portfolio and increasing that volume. We are still, of course, currently finding ourselves in a relatively minor amount of units, which we are able to furnish. And therefore, of course, I think it's a little bit still premature to give more insight on that. Perhaps coming up on the fourth quarter where more units will already be finalized and furnished and rented, and we'll be able to give a little bit more color on that. But of course, as a general note, we are very pleased with the way that things are currently moving with the furnished apartments. The demand is definitely there. High prices that are being demanded are also being paid by the tenants. So basically, we do still see that as a very positive niche to our portfolio. It's very much appreciating to the kind of units that we are possessing, especially, of course, in the Central location. And therefore, it would definitely be a great add-on as we go along.
Okay. Maybe a very last one. On the Moody's downgrade, is it possible that you can provide some more detail? What was the key rationale for them to downgrade?
I think the -- Moody's was concerned about our liquidity situation after we decided to pull out of the bond process, and -- because clearly, with EUR 500 million of bond proceeds coming in, you have a different liquidity position than what we had. As you know, we were using the -- exactly, one of the few to actually place a benchmark-sized bond, the commercial paper program and the RCF as a backup to actually be able to pre-fund acquisitions before we put them into their permanent structure. As I said, this decision had a, I think, very good economic reason. For why, because we felt that the rates we could have achieved in the bond market were absolutely the wrong levels, especially also for our equity investors. So we were -- decided to actually go out there and pursue different funding sources. Our expectation was actually that Moody's also will give us the necessary time, because we, as you can imagine, did not pull out of a bond and then we're sitting idle and saying, "What are we doing now," but we had a Plan B already drawn up with various steps, as you've seen also with the Schuldschein process, and we were rather surprised by the quick action Moody's felt that they needed to take. It's -- that's something which I can clearly -- we also see it a little bit maybe influenced by the change in the rating methodology, because this was coming just a couple of days before they actually reviewed our rating. But that might be unfortunate timing. As I said, we'll deal with that and we'll try to bring that up to the level which we feel appropriate.
Okay, at this stage, there are no further questions in the queue. So I'm going to please pass it back to you for any closing comments.
Thank you, Yu, and thank you all for joining our Q3 update call.
Thank you very much.
Thank you.