Bettina Schragl

IMMOFINANZ Executive Board: “Market consolidation will also be an issue for the sector in CEE"

The most important event in the 2013/14 financial year was the spin-off of BUWOG, which was listed on 28 April. How would you describe the development so far?

Eduard Zehetner: We always maintained that IMMOFINANZ and BUWOG, as a single corporation, didn’t receive the market valuation they deserve based on the quality of their portfolios. And we were right: as an independent listed company, BUWOG has received a significantly higher valuation from investors than it did under the IMMOFINANZ umbrella. The discount between the price of the BUWOG share and the net asset value (NAV) has declined substantially since the initial listing. This discount, which was implicitly roughly 36% before the spin-off based on the IMMOFINANZ share price, fell by half on the first trading day alone. At EUR 13.2, BUWOG‘s initial trading price in Vienna was higher than we expected. And the share price has risen further over the past few months – the annual high up to now was EUR 14.75.

Birgit Noggler: Our road shows have shown that investors value BUWOG‘s business model as well as the focus on Germany and Austria. The first analysts’ ratings have also been very positive. At the same time, BUWOG finalised its major acquisition in Germany, the DGAG portfolio with roughly 18,000 apartments and a related management platform with nearly 300 employees. In other words, everything is going as planned.

But the IMMOFINANZ share is still trading at a high discount to the NAV.

Zehetner: The past months were not very helpful, above all due to the political unrest in Ukraine – but we’re not the only ones affected by these developments. If you take a look at the entire market since the beginning of 2014, our share has more or less followed the ATX.

How is the spin-off presented in the IMMOFINANZ financial statements for 2013/14?

Noggler: The separation of BUWOG is clearly reflected in the consolidated financial statements. We deconsolidated BUWOG following the spin-off, and then recognised the remaining 49% as an investment based on the equity method. You now see it as an investment in an associated company. The valuation at the time of recognition was based on the stock exchange price plus a control premium. This control premium was derived from external factors, meaning comparable transactions on the European capital markets, and reflects the de-domination agreement between BUWOG and IMMOFINANZ. The basic idea is that a third party who acquires a 49% package in BUWOG would be able to control the company and can therefore be expected to pay a higher price to obtain this control.

Zehetner: The use of the equity accounting method was possible because IMMOFINANZ no longer has control over BUWOG. You can see that in the composition of the five-member BUWOG supervisory board, which only includes one member of the IMMOFINANZ Executive Board.

In addition to the 49% stake, IMMOFINANZ also invested in a EUR 260.0 million convertible bond issued by BUWOG. What are your plans for these two investments?

Zehetner: We want to sell the BUWOG equity stake over the medium-term – but at least at the book value per share and with a minimal impact on the market. That’s what we said before the spin-off, and nothing has changed since that time.

As far as the convertible bond is concerned, BUWOG is entitled to call and redeem the bond at any time up to the end of January 2015. If they decide not to do this, we will place the bond on the capital market after the call option expires and use the proceeds to repay our bridge loan.

And where do you intend to invest the proceeds from the sale of the BUWOG shares?

Zehetner: In our real estate machine, more exactly in the expansion of our development activities and in portfolio investments in Eastern and Western Europe. Right now, in other words at the end of April 2014, our development projects under construction had an expected fair value after completion of EUR 773.2 million. We want to raise this level up to a maximum of EUR 2.0 billion over the medium-term with new projects, whereby the focus will be on our markets in Germany, Poland, Russia and Romania. Naturally, this expansion requires a higher capital investment.

Are you also planning dividends and share buybacks?

Zehetner: The necessary liquidity for such distributions has to come from the operating business. We announced that we intend to resume dividends starting with the current financial year. From the current point of view, we’re targeting a dividend of EUR 0.15 to EUR 0.20 per share for 2014/15 – whereby this can basically cover a dividend payment and a share buyback programme.

Noggler: We, as the Executive Board, will not be recommending a dividend for the 2013/14 financial year to the annual general meeting. The major part of the liquidity generated by IMMOFINANZ during the past year was invested in the purchase of residential properties in Germany to position BUWOG as a German-Austrian residential property company.

Zehetner: And that was the underlying requirement for the spin-off of a majority stake in BUWOG, where our shareholders received one BUWOG share for every 20 IMMOFINANZ shares. BUWOG also intends to follow a sustainable dividend policy and is expected to distribute approx. EUR 0.65 per share for 2013/14. IMMOFINANZ will then receive roughly EUR 32.0 million from its 49% investment.

Noggler: With respect to future share buybacks, we plan to withdraw the 9.00% of treasury shares that are currently used for financing after this debt is repaid or restructured.

Portfolio investments can also include acquisitions: do you see any opportunities for consolidation?

Zehetner: The market is definitely moving in this direction. The consolidation in the German residential property sector started several quarters ago because of the readily available synergies. BUWOG played a role in this process with the acquisition of the DGAG portfolio. With a view to the retail sector in Western Europe, Klépierre and Corio recently announced merger plans. We also expect further consolidation on the commercial property markets in Central and Eastern Europe. As the market leader in this region, we intend to play an active role and evaluate opportunities in our core markets with a view towards synergies and economies of scale.

What dimensions do you have in mind?

Zehetner: That always depends on the available opportunities, and can generally range from the purchase of individual investments or entire portfolios to mergers. However, any consolidation steps we take will be connected with obtaining entrepreneurial responsibility for IMMOFINANZ.

Are you also considering the further simplification of the IMMOFINANZ portfolio after the BUWOG spin-off and the separation of the West European residential properties?

Zehetner: Over the medium-term we definitely intend to remain by our current three commercial asset classes – retail, office and logistics. On the other hand, the spin-off of BUWOG and the realisation of larger transactions have demonstrated that we can react very quickly to market opportunities. For that reason, I wouldn’t exclude the possible sale of a segment from our retail or logistics business – for example our STOP.SHOP. retail warehouse chain – at a later date if the opportunities are available and the prices are attractive.

Is that one of the reasons for your focus on brand creation in the portfolio?

Dietmar Reindl: Exactly. Starting with the BUWOG residential property brand and including our STOP.SHOP. retail warehouse chain plus Deutsche Lagerhaus and LOG CENTER, which stand for our logistics activities in Germany and Eastern Europe, we have already established a number of successful brands that form the basis for further expansion in our core countries. With VIVO! we also launched a new brand in the retail segment during the past year. VIVO! shopping centers are positioned between the STOP.SHOP.s, on the one side, and large shopping centers, on the other side, with respect to size, focus and offering. What we have here are generally single-storey shopping centers with a strong fashion and entertainment focus that are ideal for smaller and medium-sized cities. It is planned to open our first VIVO! center in the last quarter of 2014 in the Polish city of Pila, the second presumably during the 2015 calendar year in Stalowa Wola, a city in the south-eastern region of Poland. We currently have five VIVO! locations in Poland in the construction or planning stage. This concept is also well suited for Moscow and the surrounding region.

What are your expansion plans for the STOP.SHOP.s and logistics?

Reindl: Under the LOG CENTER umbrella brand, we want to concentrate on the development of logistics projects in Romania and Russia, while Deutsche Lagerhaus is expanding its project pipeline in Germany. With our STOP.SHOP.s we are currently operating at 50 locations in six countries and are now starting to expand into Serbia – the first two locations have already been identified. The STOP.SHOP. concept is ideal for the Balkan countries because of the size of the cities, the purchasing power of the population etc. The feedback from tenants has been very positive.

Zehetner: We’re also continuing the roll-out of our STOP.SHOP.s in Poland. The second Polish location opened last November in Mlawa, Ketrzyn and Zary will follow in the second half of 2014. Ten further retail warehouses are planned for this country over the medium-term. In Romania, we will be entering the market with the STOP.SHOP. brand in the near future – we have a number of very interesting sites that are currently part of our land reserves. We also acquired and rebranded five retail parks during the 2013/14 financial year – four in Slovenia and one in the Czech Republic. These facilities are fully occupied and generate a high return. When we see attractive acquisition opportunities like this, we definitely take a closer look.

Reindl: International retailers value our large network. In order to realise the required economies of scale, they need a certain minimum number of locations when they enter a new country. They want a reliable partner and developer, just like IMMOFINANZ, who can move with them and quickly complete a roll-out in several countries.

The BUWOG spin-off shifted IMMOFINANZ Group’s geographical focus even more towards Eastern Europe. Nearly 70% of the portfolio is now located in the CEE region or Russia. Do you expect to continue this concentration with your future development activities?

Zehetner: We’re not really planning any major changes. But I don’t want to exclude a shift in percentage rates due to possible consolidation steps in the future. The specific circumstances and opportunities will make that decision.

The outlook for growth in the CEE region is positive. Have you seen any signs of a gradual improvement in the economy?

Zehetner: Eastern Europe is still not the growth story we would like to see. It would be good to have stronger impulses from the economy for our rental business. If you look at the first quarter of 2014, the GDP indicators were very good in a number of countries, but like I said: the situation could be better.

Reindl: In addition to comparatively healthy national budgets, we see an important growth driver in the pent-up demand in these countries compared with Western Europe. This positive growth development will also be supported by exports – above all to Western Europe – and increasingly by domestic demand. In Romania, there is a growing demand for high-quality logistics space. The logistics business is a type of early indicator for economic recovery among the commercial property asset classes. After the latest large-volume rental to Ursus Breweries (note: after the end of the reporting period), the occupancy rate in our Romanian logistics portfolio was at roughly 93%. And as I said before, we are planning to start new projects.

Zehetner: On the other hand, the economic recovery in Romania still hasn’t reached the local population. The increase in domestic demand has been very slow.

And how about the transaction market?

Noggler: There is a growing interest in East European properties. Of course, the CEE transactions still only represent a fraction of the volume in Western Europe – we’re talking about 6% of the total transactions in Europe during the first quarter of 2014. But you can detect a definite trend by investors towards Eastern Europe.

Zehetner: Based on the demand, we should see a clear yield compression in Eastern Europe over the next 18 to 24 months: in other words, the difference between exit yields in Eastern Europe and Western Europe should drop by almost half from the current level of roughly 200 to 300 basis points. I also expect a decline in exit yields in Russia, whereby the situation in Ukraine naturally represents an uncertainty factor. But Russia is currently attracting an increased number of buyers from China and the Arabian Peninsula.

Let’s continue with Russia: The BUWOG spin-off increased the focus of many investors on IMMOFINANZ Group‘s Russian portfolio. A number of things coincided recently: delays on the GOODZONE development project, a weak Ruble, the unrest in Ukraine. How would you evaluate the situation?

Zehetner: Our GOODZONE shopping center – which, by the way, has already opened – has set new quality standards in Moscow. The original plans called for GOODZONE to make a contribution to rental income in 2013/14 and offset the sale of other properties, above all Silesia City Center. Now this will happen in 2014/15 because of delays with the completion that were outside our influence.

Of course, the further development of the political unrest in Ukraine is an uncertainty factor that has a negative effect on the mood of investors as well as the population. What we would like to see is an early easing of the current tensions. A weak Ruble and general fears of war among the population are not supporting our business over the medium- to long-term because they lead to a decline in consumer spending. And that, in turn, has a negative influence on our tenants‘ revenues.

With regard to the weak Ruble, you recently announced your intention to possibly provide some support for your tenants. Has anything actually happened?

Reindl: As we indicated, we helped individual tenants in our Moscow shopping centers by offering them agreements for a limited period of time to offset the exchange rate effects in the first quarter of 2014/15. The rental income from our Russian portfolio is generally fixed in Euros or US Dollars, but a steady decline in the Ruble has a negative effect on our tenants’ cost structures. These temporary reactions were not broad-based – meaning for an entire shopping center – but arranged on an individual basis. We’re also talking about a period of only several months. During the 2008/09 financial crisis, this procedure proved to be a successful way of strengthening customer ties.

So there isn’t any change in strategy?

Zehetner: When you invest in a long-term asset class like real estate, you can’t throw your strategy overboard with every single disturbance. The current events in Ukraine are not helpful, but the Russian market is still characterised by a clear shortage of quality retail and logistics properties. And there’s one other point you can’t forget: the returns on the Russian market are clearly higher than in other parts of Eastern or Western Europe. In general, there is still substantial economic potential in Russia.

Is that the reason for your continued evaluation of development projects?

Zehetner: Yes, with a focus on the retail and logistics sectors in Moscow and the surrounding area. We will probably start a number of development projects in 2014/15, whereby we expect the total investment for each project will be in the high double-digit million Euro range – instead of triple-digits as in the past.

Reindl: In Moscow, the vacancy rate in these two asset classes recently equalled 2.5% – which really means fully occupied.

The occupancy level in the IMMOFINANZ portfolio fell by roughly five percentage points year-on-year to 85% in 2013/14. A result of the BUWOG spin-off?

Reindl: Exactly. The BUWOG residential properties have a high occupancy rate – which is typical for that asset class. Our focus for asset management is on the further reduction of vacancies, above all in the office segment. We’ve already implemented a number of operating measures to raise the occupancy in our office properties towards the level in our retail portfolio – in other words, over 90%. To give you a few examples: we decentralised our organisational structures to move us even closer to our customers and are also prepared to develop cross-border growth strategies for our tenants.

We also plan to invest more in the quality of our standing investments. The motto now is “in shape as new“. That will not only attract new customers, but also help us to remain an attractive partner for our current tenants. One of our latest projects involves the planned modernisation of our Polus Tower I and II office towers in Bratislava.

How would you describe the rental situation in the past year?

Reindl: We were able to hold rental prices stable, on average, in our core markets. You can also see that in a like-for-like comparison, by that I mean the development of rental income adjusted for property sales, acquisitions and completions. We only recorded a clear decline in Poland, where the occupancy level fell by 11 percentage points to 77.8%. This shift resulted from the sale of the fully rented Silesia City Center as well as higher vacancies in a number of office buildings and one logistics property. In these properties, several larger leases expired at the same time and not all of the contracts were extended. However, we’re working hard to rent this space and have already had some successful results.

You set another new record for the volume of property sales in 2013/14, but earnings were lower than the previous year. How does that fit?

Zehetner: It was a very successful year. We sold properties with a total value of slightly more than EUR 1.0 billion. Originally, we planned to sell EUR 2.5 billion of properties over a period of five years. In reality, we reached a volume of EUR 2.67 billion after only four years – and that at a double-digit margin over the book value. Our target for the future still calls for average sales of EUR 500.0 million to EUR 600.0 million each year.

Noggler: When you look at the results of property sales, you need to consider that the revaluation gains on two of the largest transactions – Silesia City Center and Egerkingen logistics property – were included in our earnings for 2012/13 as required by IFRS, but the derecognition of the properties and cash flows were only recorded in 2013/14. We called attention to that last year because our results on property sales were extraordinarily good.

The results from property development were negative.

Zehetner: Here we were confronted with the negative effects of the delays in completing GOODZONE and the related increase in construction costs. However, this shopping center has been completed and is now open. In Russia, we are also faced with the more cautious valuation of our properties by the external appraisers as a result of the Ukraine crisis. Development results were clearly positive not only in Germany, but also in the Czech Republic. That underscores our ability to do a profitable job, as long as we don’t have to deal with external factors or events from the past.

Valuation results were influenced by a purchase price adjustment for the Rostokino shopping center in Moscow. Could you explain this?

Noggler: According to the contract, the purchase price for Rostokino would depend, above all, on net operating income for the 2013 calendar year. In 2012/13 we increased our estimates for the expected purchase price to reflect the high occupancy in the shopping center. That reduced revaluation results by EUR 106.4 million in the 2012/13 financial year. The final negotiations took place in February 2014 and the purchase price was reduced by EUR 77.7 million, which had a positive effect on valuation results for 2013/14.

This reduction in the purchase price below our original estimates was, however, the result of our successful negotiations and not a deterioration of the market situation or lower valuation.

What other factors had an influence on valuation results?

Noggler: As regards foreign exchange effects, we benefited from the increase in the Euro versus the Russian Ruble. Revaluation results adjusted for foreign exchange effects were negative, above all in the Russian portfolio, due to the unrest in Ukraine and the imposed or threatened sanctions against Russia. The external appraisers have become more cautious concerning this market.

In conclusion, let’s take a look at refinancing. What are your major plans?

Zehetner: A replacement for the Forrest Finance CMBS structure is on our agenda for the current or next financial year. This financing has a volume of roughly EUR 200.0 million and bundles a number of our prime properties in Austria as mortgage backing. When the financing expires, we will have an opportunity to place a number of properties in Vienna’s inner city on the market – and this market has very attractive opportunities for sellers at the present time. The exit yields are low and the prices high.

Noggler: In general, the current interest rate environment is positive for our refinancing. For that reason we should be able to achieve very good results, even if the banks raise the margins.

And what about the 2018 convertible bond? The bondholders can exercise a put option in 2016?

Zehetner: We assume the convertible bond will be in the money by that time, that is to say the bondholders are going to convert into IMMOFINANZ shares.

This interview was conducted for the annual report for the financial year 2013/14, which was published today: