BUWOG hybrid approach enjoying high market acceptance

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Listed German-Austrian full-service housing provider BUWOG will next week conclude a cash capital increase by offering a total of up to 12.5 million Buwog shares with a subscription ratio of 1:8.

The company will announce on June 2nd the offer price for the shares, but the maximum price will be €30.00 (The current share price at 28th May is €25.66). At the current share price, BUWOG would expect to raise €326m. Existing shareholders are being given first option on taking up their rights, while unsubscribed shares will be offered to investors in an international private placement.

According to Andreas Segal, deputy CEO & CFO at BUWOG, "A timely investment of the generated funds primarily into acquisitions of new land plots in the three attractive markets of Berlin, Hamburg and Vienna demonstrates that we continue to execute on our organic growth strategy. This will allow us to move forward with the creation of a listed portfolio of newly built properties, enable significant growth in rental income through portfolios we have developed ourselves, and will strengthen our balance sheet structure in the medium term."

Full-service residential provider BUWOG has been in business as a housing provider for 65 years and currently holds a property portfolio encompassing around 50,700 units located in Germany and Austria. The shares of the company have been listed on the stock exchanges in Frankfurt am Main, Vienna (ATX) and Warsaw since the end of April 2014.

Last month BUWOG increased its guidance for recurring FFO for financial year 2016/17 from at least €108m to at least €113m. In March, the company's result for the first three quarters showed improved EPRA net asset value of 13.3% to €22.86, a lowering of its average interest on borrowings to 1.76% with an LTV of 44.7%, and importantly, an expansion of its property development pipeline to more than 10,500 units with investment of €3.1bn.

CEO Daniel Riedl said at the time, “Our strategic positioning with three business areas – Asset Management, Property Sales and Development – has proven to be a reliable success model, even in an increasingly challenging market environment. That will allow us to work profitably, and also strengthen this profitability in the future. BUWOG’s activities in both the investment and project development areas also allow us to expand in times of substantially higher property prices by developing projects for our own portfolio, instead of buying at high prices on the market."

REFIRE visited CFO Andreas Segal in his offices recently to discuss the company's restructuring of its financing, which has seen BUWOG reduce its property LTV to 44.7% by changing the borrower structure and improving its corporate and management rating. The current average financing costs including a convertible bond have come down from 1.90% last year to 1.76%, with an average maturity term of 12 years.

Segal has been the architect of a number of ground-breaking convertible bond deals in his career, and in September last year launched a €300m five-year BUWOG convertible bond – the first time a zero coupon bond had ever been issued by a property company in the eurozone.

The bond was oversubscribed and fully placed within an hour. The bond at conversion would have represented 9.58% of the company's outstanding share capital. The bond was set at a premium of 35% to the reference share price, at the time €23.26 per share.

"It's important to recognise that the investors who bought the bond were not drawn primarily by the interest rate, but by the equity story of what we're doing here at BUWOG. The steady rise in our share price (The share has risen 83% over the past three years, and 33% in the last 12 months alone) has been more than enough justification for the bond investors to invest and hold – they've since done very well."

Timing also plays a role in a major refinancing measures. In November last year BUWOG refinanced a senior €550m loan on a portfolio of 18,000 of its housing units with Berlin Hyp and Helaba, the original lenders on the portfolio. "This was a happy co-incidence of experience, market sentiment, timing, and a bit of luck, as there was concern at the time that the US presidential election could lead to volatility on the markets", said Segal.

BUWOG is currently preparing for talks with the big rating agencies Standard & Poor's and Moodys to apply for a corporate rating, which would be an additional arrow in his quiver of financing tools, particularly as a corporate rating could help become a more regular issue of bonds, rather than depending on bilateral financing via the classical banks, with bank spreads likely to be heading back upwards. At the moment there is only analyst coverage of the

Segal described the different financing approaches BUWOG is taking with its two-pronged Development-to-Hold and Development-to-Sell strategies. Of the 10,500 units in its development pipeline, for which BUWOG already owns sufficient land,

3,700 are for holding and 6,800 are destined for sale as condominiums. The likely LTV on the units for holding will be up to 45%, while it is likely to be much lower on the units for sale, as buyers make staggered payments in advance of final construction – but higher in the short term as BUWOG borrows more to expand for the next phase.

From a risk perspective, said Segal, the BUWOG strategy is lower risk than that of classical developers, because in case of adverse market movements, the company could always hold on to the high-quality apartments that it is building for Development-to-Sell. As an asset management company, it could easily adapt its strategy to manage more units.

At this stage of the cycle, this is a good time for development activities, and Segal sees BUWOG as having a certain first-mover advantage. (Not surprisingly, as we report elsewhere in this issue, larger groups like Vonovia are also shifting resources into their development activities, rather than just hunting for elusive portfolio acquisitions.)

"On the capital markets, interest in development is rapidly rising. We do everything we can to make our business model extremely transparent and understandable to investors and analysts. Being effectively a REIT – although not in the legal sense – with a development arm that's targeted at the cash-rich business of privatisation, we can anticipate yields that pure buyers of existing stock can't really expect. With less risk than a traditional developer. This growth story is a big benefit to us in the capital markets."

From several discussions with Segal, we have long been aware of his professional philosophy regarding loan-to-value ratios, and the long time horizons he brings to bear in weighing up the risks and benefits of high versus low LTVs. At some point the benign conditions we are currently enjoying will tip in the other direction.

"The LTV is a function of the risk-return approach of a company. It's great when the company has many liabilities that it pays little interest on – it can really boost your return on equity. But this only works up to a point. The higher my LTV, the higher the assessment of my risk, and - all else being equal - I worsen my financing conditions. It's a game of high equity yield and high leverage on the one hand, versus high leverage and worse conditions on the other."

"If your LTV is too high, then as a result of the risk-return consideration, you'll pay for it in the form of a 'discount' in the equity markets. You don't earn the premium that other players do – you can't raise capital accretively like others do, and you're at a competitive disadvantage in acquisitions, for example."

"An LTV for a big company can't just be altered at the press of a button – it needs refinancing, time, costs. You have to consider very carefully in which phase of the cycle you have what degree of debt. In the medium term future we're heading into a higher interest rate environment which will have a bearing on property valuations. Companies with lower LTV will suffer less from pressure on their share prices, they'll have less negative consequences from interest rate rises, and they'll be in a position because of their balance sheet structure to take advantage of downturns in the market, for example in M&A activities."

"Hence LTV is relevant for a company's strategy, its ratings, its methodology and dogma, its profit, and its risk-return. You have to be constantly working on your financial toolbox, like continually tracking a moving target. In the last ten years since the financial crisis, the real estate industry is aiming more for a say, best-practice LTV of 40% instead of the 65% more common then."

"Remember, in our industry rates of between 3% and 5% are more normal in the long term. And in capital-intensive industries like ours, when interest rates rise share prices always suffer. Our job is to steer the company's business model sustainably to demonstrate to the capital markets that you can create shareholder value beyond just the duration of the cycle."

Segal's enthusiasm for BUWOG's hybrid model of both property manager and project developer led the discussion on to similar strategies by other companies. Interestingly, BUWOG says it is increasingly looking outside of Germany to find comparable peers from whom it can learn and optimise its model.

The companies that BUWOG now measures itself against are NOT the Deutsche Wohnens, Vonovias and TAG Immobiliens of its German and Austrian domestic market, but names like Kaufman & Broad, Nexity, Taylor Wimpey, Avalon Bay, Gecina, Icade, Altarea, Hibernia, Equity Residential, Toll Brothers, Neinor Homes, Cairn, Persimmon, Barratt, Berkeley, Bellway, Redrow, Crest Nicholson, Bovis, JM, Bonava, and Maisons France.

Higher yields than a normal REIT, with less risk than a normal developer. The markets certainly seem to be buying this message.