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High-quality office buildings
It’s been several weeks since talk of the merger first hit the headlines, and here at REFIRE we’ve been glad of a chance to mull over what the shape of the likely merged entity could be. In any event, it will take until the 21st August, the date of its AGM, for listed German REIT Prime Office REIT-AG to prepare for a barrage of questions as to its proposed marriage with the German division of the world’s biggest distressed debt investor, Oaktree Capital Group.
If the proposals go ahead – and it will need approval by at least 75% of Prime Office’s shareholders - a deal may be reached by the end of this year to create a new publicly-traded property company, which would have a gross asset value of about €2.3bn, with 64 individual properties and annual rental income of €147m.
Prime Office approached Oaktree in Cologne recently after taking stock of its own prospects, leading to a sombre statement at the presentation of its recent full year results, after which the possibility of sacrificing its REIT status was mooted by analysts and observers.
Prime Office REIT-AG’s story is basically this: As a property investment company it focuses on high-quality office buildings, mainly in western German cities, including Düsseldorf, Essen, Frankfurt am Main, Darmstadt, Heilbronn, Nüremberg, Munich and Stuttgart. Its 13 main assets are generally of high architectural merit, are fitted out to very high standards, and occupy prestigious locations. Nearly all have been thoroughly refurbished in the last ten years, which helps to keep maintenance and upkeep costs low. The net asset value of the 370,000 sqm portfolio is €908.5m. The properties are let out on long leases to big individual blue-chip tenants, such as BMW, Deutsche Post or Deutsche Telekom.
Hence, the risk of being negatively affected by sudden vacancy in a sizeable asset has always hung like a sword of Damocles over the company’s prospects, ever since the group was formed in 2007 out of a nationwide office portfolio held by a Munich closed-end fund group.
Under Germany’s REIT laws, a REIT must hold equity equal to at least 45% of its properties held as investments by the end of this year. Prime Office’s ratio was 43.7% at the end of March, up from 42.9% at the end of last year. The company plans to sell its 62,250 sqm SZ-Tower office building in Munich (headquarters of the Süddeutsche Zeitung newspaper) to help meet the requirement, it said in a statement.
Revenue at Prime Office fell 20% to €14.5m in the first quarter from a year earlier after it sold a property in Hamburg and a lease in Frankfurt expired. The amount of empty, un-leased space in its portfolio jumped to 23% at the end of the first quarter from 14% the previous quarter – a hefty hit (largely due to the loss of a big tenant in its Düsseldorf property).
Prime Office’s funds from operations (FFO) were €1.3m, down from €6.5m on the same period last year. Total financing liabilities at end-March were down by €50m to €593m, but the company is still paying an average of 5.5% on its loans – well above most of its peers, in this new low-interest rate environment. Market capitalisation prior to the announcement was a mere €192m, a discount of more than 50% to NAV, when a number of its peers are trading at or close to their stated net asset values.
Oaktree, through its German unit OCM German Real Estate Holding (German Acorn), is already an 8.6% shareholder of Prime Office since the REIT’s IPO and stock market listing in 2011, and so is familiar with the Prime Office’s holdings and its specific situation.
Prime Office’s CEO Claus Hermuth said in a conference call accompanying the company’s first quarter figures that management had decided last year that Prime Office needed a strong partner to help widen its asset base and to stabilise rental income flows. “We believe that a merger offers the potential to create a leading German property company with a focus on high-quality office properties with an attractive and highly diversified tenant base across major German cities and metropolitan areas”, he said.
The combined firm with Oaktree would have over 800 lease contracts and 64 buildings in 29 locations, gross asset value of about €2.3bn and potential to generate net cold rents of about €147m, he added.
If the deal gets approval, Oaktree would emerge as the majority shareholder in the new company, and would be permitted to attract new investors while retaining the option of exiting via a stock market flotation at a later stage. The Oaktree assets, valued at about €1.5bn, consist of two office portfolios bought in 2007 and 2008 from the Deka and Degi open-ended funds. Their tenant structures are much more granular than Prime Office’s with hundreds of individual lease agreements to manage.
REFIRE: Shareholders have a few months to ponder on the merits of the merger, or more likely on the price for their shares before dilution, and are likely to resist any attempts by the larger partner to press for a deal at what they consider below the true individual value of the assets in the case of dissolution. It’s worth remembering that IPD’s recent figures show that the value of income-producing office properties in Germany fell last year by 3.1%, compared to a 0.8% drop for commercial property as a whole in the country – and are probably still falling. Interesting months ahead.