FCR Immobilien — Rental income improves on growing portfolio

As well as significant growth in rental revenue, FCR was able to reduce personnel and material expenses by c 14% y-o-y in H120. While financing costs increased by c 23% y-o-y on the back of additional debt to finance portfolio growth, we note that FCR’s average effective interest rate was down for both its property-level debt and issued bonds in H120. The company’s funds from operations excluding property disposal/revaluation gains (FFO1) reached a positive €2.2m in H120 (vs negative €3.7m in FY19), while FFO2 stood at €2.8m. Although net income in H120 declined by c 20% y-o-y to €3.8m, this was mostly due to lower unrealised property revaluation gains (€0.9m in H120 vs €8.3m in H119).

The strength of the German property investment market was interrupted by COVID-19 as transaction volumes declined by over 47% q-o-q in Q220. This also seems to be reflected in FCR’s transaction activity, with only three disposals of relatively small properties in H120. While FCR is still focusing on portfolio expansion in FY20 (it acquired 10 properties in H120), it has not explicitly reiterated its earlier portfolio value target of €400–450m (vs c €300m in at end-2019).

FCR’s EPRA NAV per share increased from €10.93 as at end-2019 to €11.05 at end-June 2020 which, together with the €0.30 per share dividend payment, implies a NAV total return of c 3.8% in H120. Based on last reported NAV, FCR is currently trading at a P/NAV multiple of 1.04x, which represents a 19% premium to the broader peer average (but a 20% discount to its closest peers).

In FY19, FCR Immobilien adopted IFRS reporting for the first time (replacing German accounting standards – HGB), which resulted in the recognition of revaluation gains on its investment properties. Previously, these were accounted for as constituents of property, plant and equipment and gradually depreciated over time rather than being revalued. Even though the first-time valuation uplift for FCR’s current property portfolio was directly reflected in equity in FY19 accounts, the company recognised a c €8.3m gain on investment properties revaluation in the comparable H119 figures in its H120 report. At the same time, in H120 FCR reported only €0.9m in revaluation income, which affects the earnings comparability between both periods, with FCR reporting H120 EBIT of €7.9m and net income of €3.8m, against €9.3m and €4.7m recorded in H119, respectively.

FCR managed to improve its rental income from investment properties to €11.6m in H120 from €8.0m in H119 on the back of further portfolio expansion. This already reflects the initial impact of COVID-19, which was relatively limited (although the macro outlook for H220 remains uncertain). We believe this is due to the company’s focus on the German market (96% at 30 June 2020) and retail sector (76%) as FCR has high exposure to tenants in defensive sectors (food retail in particular, which makes up close to 40% of FCR’s portfolio). Management indicated in its H120 press release on 30 July that until that date, the company was able to sign 36 new and early extended lease contracts representing rental income of €5.7m (including €3.3m since end-March 2020). At the same time, it has waived rents amounting to €200k in the case of existing tenants. Higher rental income was driven by portfolio expansion to 83 properties at end-June 2020 vs 64 at end-June 2019, as well as certain asset management successes.

H120 revenues totaling €13.8m (against €9.6m in H119), were also supported by one-off (€1.3m) other income related to the sale of goods/merchandise from FCR’s hotel business, which was not recorded in the previous year. Through its subsidiaries, the company is operating two out of three hotels held in its portfolio (Il Pelagone and Westerburg) for which it posted a c 47% y-o-y revenue decrease to €0.8m in H120. We assume that this primarily resulted from safety measures imposed to limit the spread of COVID-19, which included lockdown and limitations on personal travel.

While FCR has been scaling up its business, it managed to reduce its material expenses (which primarily consist of property management costs, property taxes and material expenses related to its hotel operations) and personnel expenses by c 14% each in H120 (to €3.6m and €2.3m, respectively), with the later driven by average headcount reduction in the period from 126 to 102. Management believes that the recent development of its digital solutions (for instance in the area of vacancy rate optimisation and liquidity planning) should allow the company to grow its business without the need for headcount expansion.

While portfolio growth allowed FCR to record higher rental income, it has also resulted in a 22.8% y-o-y rise in financial costs to €3.6m on the back of additional bank borrowings (the company’s targeted leverage at property level sits at 70–80%) as well as a €30m bond offering launched last year. However, it is worth noting that in FY19 FCR also repaid its 2014 bond, which paid an 8.0% coupon, well ahead of the current weighted average for the company’s outstanding bonds at c 5.9%, according to our calculations. Furthermore, in March 2020 FCR launched a new bond placement with a volume of up to €30m and a 4.25% coupon.

Finally, FCR’s enhanced operating efficiency resulted in its FFO1 (which excludes disposal and revaluation gains) reaching €2.2m in H120. We note that while the H119 FFO1 figure was not disclosed, it stood at -€3.7m in FY19, based on our estimations. While we consider this a positive sign (as FCR is able to cover its operating and financial expenses with rental income), we also note that FCR has so far been more of a total return rather than a pure income play. The company’s strategy is based on ongoing portfolio rotation aimed at opportunistic purchases followed by measures to enhance rental income and subsequent disposals to realise added value. Consequently, its FFO1 to NAV ratio is relatively modest at c 2%. FCR’s FFO2 (accounting for property disposal and revaluation gains) was €2.8m in H120, of which €1.8m was reported in Q120, which illustrates the coronavirus-driven disruption to transaction activity.

In H120, FCR acquired another 10 properties, but sold only three properties as transaction activity in the German property investment market stalled in Q220. Management expects to accelerate portfolio expansion in H220 on the back of its full investment pipeline. Having said that, we note that its earlier target to expand property portfolio value to €500m at end-2020 (vs c €300m at end-2019) has been cut to €400–450m in response to COVID-19 (as disclosed on the release of its FY19 annual report). This target was not explicitly reiterated during the H120 report release. In the first six months of 2020, the company’s portfolio value expanded marginally to €309m. At the same time, during the recent capital markets conference in Munich, management announced its intention to sell its portfolio of development and ‘opportunistically held’ properties, including three hotel properties and three development projects in Bamberg (student living), Frankenberg (retail) and Spain (residential).

Management currently guides to rental revenue of €28.3m in FY20 (up 31% y-o-y). This is based exclusively on its existing portfolio, which at end-June 2020 generated annualised ‘cold’ rents of €20.5m (ie excluding pass-through of property-related costs, which we believe may add c 15% to this figure). We understand that the €28.3m also includes FCR’s revenues from the two hotels it operates (€2.6m in FY19), as well as one-off €1.3m in revenue from the sale of goods/merchandise reported in H120. At this stage, given the uncertain macroeconomic environment, which translates into limited visibility with respect to FCR’s portfolio performance in H220, it is difficult for us to assess whether this guidance will be met.

In early 2020, the COVID-19 economic slowdown started to spread across all business segments, including the German real estate investment market, which was initially well-placed to carry momentum forward from 2019 (transaction volume at a record high of €91.8bn), according to JLL. The Q120 figures reflected limited impact from the coronavirus, with the €27.9bn overall transaction volume constituting the second-best quarterly result historically and a more than 81% y-o-y improvement. Even though the €14.7bn recorded in Q220 is just 15% below Q219 figure, it fell 47% against Q120, which illustrates the magnitude of the slowdown. Interestingly, while around 40% of transaction volumes in 2019 were recorded in the office segment, this was down to 22% in H120 as residential property deals made up 35% (vs 24% in 2019). The share of other segments remained broadly stable, including retail (FCR’s primary focus) – 14% in H120 vs 12% in 2019.

Even though the number of sale transactions has been declining, it is attributable to limited supply rather than subdued demand, with the German property market remaining an attractive investment location as it is perceived as relatively resilient in the current environment. Consequently, prime yields in the office, logistics (benefiting from accelerated e-commerce expansion) and specialist retail segments remained strong in both Q120 and Q220 in the seven largest German cities, according to JLL. The yield in the office segment fell slightly over H120 from 2.93% to 2.91%, while the yield in logistics stabilised at 3.75%. The situation in the retail sector varies, with speciality properties with a food retail focus (which form an important part of FCR’s portfolio), local supply centres and hardware stores being still in demand, while yields for shopping centres continued to increase to 4.75% in Q220 against 4.20% in Q219 (and 4.50% at end-2019), according to JLL.

The COVID-19 crisis has also affected the commercial rental market, with retail take-up in inner city locations falling by c 24% y-o-y to just 190.9k sqm in H120, while the number of transactions decreased by almost one-third, according to JLL.

In Q220 FCR paid a dividend of €0.30 per share from 2019 earnings, which currently constitutes a 2.6% yield. As the last reported EPRA NAV per share stood at €11.05 at 30 June 2020 vs €10.93 as at end-December 2019, NAV total return reached 3.8%, according to our calculations. The company is currently trading at a P/NAV multiple of 1.04x, which represents a 19% premium to the broader peer average (including Demire, Deutsche Konsum REIT, Defama, Hamborner REIT and Deutsche EuroShop) of 0.87x. However, we note that FCR trades at a 20% discount to the average multiple for its closest peers (Deutsche Konsum REIT and Defama) based on last reported NAV per share.

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