German Real Estate - Macro vs Micro
All,
Please refer to our analyses and videos of Aggregate and Adler, the latter to be updated before Q3.
If waves are there for surfing and if the trick is to ride them before they break, then German Real Estate is the type of wave we are looking for. It’s been building up for some time but in particular, towards the A-cities, it still has some more room to run before it's time to get out.
Real Estate vs Real Companies:
- We like good companies with bad balance sheets. Typically we also like when the solution to whatever problem lies within the company (locus of control is internal) and when we feel that management have the talent and plan to fix it and restore cash flow.
- RE and development is different. Companies are small and balance sheets are big. Whether or not some of the sub-par candidates in the sector are good companies (management seems to have been/be more aggressive than wise), operations are tiny and value is driven more by asset prices than by operating efficiency.
- That is not to say we don’t want to trust the decision making of their management teams. We think the vastly increased scrutiny should bring the best out of them - for a while - for long enough.
- Meanwhile, the long end of the stick is the asset valuation and therefore the - hot - RE market. Apart from stopping rampant acquisitions (seem to have just stopped by force) the key to the turnaround lies outside the company (external).
Fair Caution:
- Capital is more easily preserved than gained. Investors should err on the side of caution when valuing assets - including those of German RE companies and in particular (obviously) developers, whose valuations these days are frequently a leveraged derivative of future RE prices. Prices of non-yielding assets can fluctuate wildly and have done so in the past / will do so in the future when bubbles burst or cycles turn for other reasons.
- Especially land prices - the furthest derivative of RE are the most cyclical and can drop 80% when the music stops. Note that developers like Aggregate hold a lot of richly valued land, much of which underpins the NAV valuations the market bases its leverage thresholds on and also guides at least some of our decision making.
Seller’s Market:
- Those drops occur in bear (buyers’) markets. Markets with 1000 sellers for every one opportunistic buyer. Yet, what we have in Germany is not a bubble beyond what the wider world is experiencing and this market has 1000 buyers and 2 sellers - Adler and Aggregate.
- So as investors in public securities, with an investment horizon in these names of 6 months, for now, we have of course made an estimate of how long the bull market is going to go on for, but more importantly, we are not waiting for prices to fall significantly before taking a position in a seller of assets. Bar a need to liquidate large swathes of such assets in the near term, we even think that requiring a significant blanket discount to book today is a mistake that merely would - and should - shut us out of perfectly good opportunities.
Need to liquidate:
- None of the companies we are looking at so far appear to need an enormous amount from liquidations of such early-stage assets. - Aggregate should be under most pressure to sell something - forced. But relative to the size of the book it would not be a lot.
- Adler’s Consus also has assets it will need to sell to fund some of the other constructions. We are making up our minds on the name in more detail this week.
- Note that we believe that both companies should mark some of their assets down, but those are specific assets for specific reasons and at least at Aggregate we have not found a systemic theme that would require us to extend such mark-downs to the majority of assets.
Positioning:
- We have taken positions in Adler and Aggregate and might take more positions in adjacent names in the space. The Vonovia bid for Deutsche Wohnen illustrates the forces at play on the demand side of the market and while money supply stabilises, for as long as inflation is expected to drive rates (and not the other way round), asset prices have support.
Here to discuss,
Wolfgang
T: +44 203 744 7003