Consus Real Estate — Well-positioned to accelerate growth

Consus Real Estate (Consus) is a German real estate developer, headquartered in Berlin and operating across the nine largest German cities (Berlin, Dresden, Leipzig, Munich, Stuttgart, Frankfurt, Cologne, Düsseldorf and Hamburg). The current capital group was created as a result of the sizeable acquisition of CG Gruppe conducted in 2017. CG is one of the leading property developers in Germany, with a broad project pipeline for the upcoming years. The transaction was structured as a non-cash capital increase with a mixed non-cash contribution consisting of newly issued shares and debt issue. In 2017 Consus also acquired GxP German Properties, a commercial property corporation with a portfolio of 12 real estate properties. However, this transaction was considered an opportunistic investment, which led to the profitable disposal of GxP announced on 3 August 2018.

The company currently holds interests in a real estate portfolio of c €5.3bn, with further expansion opportunities resulting from already identified targets that would allow the company to almost double its portfolio size (by €4.8bn). Consus currently operates predominantly in the residential development segment (through CG Gruppe), where it is looking for build-to-sell opportunities (based on agreements with institutional investors). The company has created a well-integrated and self-funded business model, supported by a cash flow recycling approach. It also owns three commercial properties for rental income-generation purposes.

The residential development segment represented 85% of the company’s pro forma FY17 sales. With the sale of a commercial asset portfolio in June 2018 and the sale of its stake in GxP German Property AG in August 2018, Consus has positioned itself as a focused pure play real estate developer in Germany's Top 9 cities. The company’s commitment to the residential business is illustrated by its announcement on 2 August 2018 of an agreement to increase its stake in CG Gruppe (its property development subsidiary) from 59.1% to 75% on a fully diluted basis.

Consus specialises in the development of highly standardised rental apartment blocks with one- to two-bedroom apartments of 50-70 sqm. It is targeting the market segment, which currently exhibits the highest demand, rather than focusing on high-end luxury apartments designed for individual unit sales to private customers. Its unified approach towards construction works, as well as a bottom-up cost discipline, limits the expected average all-in-cost per sqm (targeted at €2,000–2,500 excluding land costs), simplifying the business plan and risk analysis for new capital outlays. The company has adopted a digital tool called Building Information Modelling (BIM), which helps reconcile all the project’s features as well as evaluate the potential impact of project modifications. This fully integrated real estate platform covers the entire value chain and enables the creation of a 5D virtual model of the property (including timeframe and logistics) to analyse potential risks and discrepancies. BIM also supports other aspects of the investment process, including cost and construction management as well as facility operations. It may also be used as a project management tool to plan, monitor and control development execution.

The company’s policy comprises investments in a broad and highly diversified project portfolio rather than large, single developments, which would increase operating risk. The risk profile is further minimised by the broad use of forward sale contracts with upfront payments for developed real estate, which provides Consus with both stable cash flows for the project financing as well as an end-buyer. A block sale of more than 100 standardised, fully let rental apartments to institutional investors is the preferred divestment option. The customer list of already concluded transactions includes, among others, Allianz, AXA Investment Managers and BMO Real Estate Partners. Pre-sale agreements – where 30% of the final price is received at the end of planning phase, another 60% before the completion of construction works and the remaining 10% once the project is completed – make up around 80% of the company’s revenues. The downside of this solution is the fact that the expected average forward selling price is lower than in the case of condo sale projects (with a targeted rental income multiple of 23x compared to 30x, respectively).

Because of forward sale agreements negotiated in the past, Consus achieved rental income multiples on sold projects at 18-19x in FY16 and 18-20x in FY17, which is somewhat below the current targeted range of 20-25x. However, it reached an average sale price per sqm of €3,130 and €3,335, respectively. Compared with the targeted average all-in-cost (land costs excluded) in the range of €2,000–2,500 per sqm, it implies a profit margin of c 40%. According to management, favourable market conditions should enable Consus to reach multiples in the range of 20-26x, which would further improve the bottom line and provide security against potential cost increases. With a growing development portfolio, the company may also benefit from economies of scale.

Until recently, the company was also active in the commercial real estate segment, focusing on generating stable rental cash flows and creating value by active asset management. It has therefore introduced a Manage-to-Core strategy oriented at property optimisation through controlled investments and alternative investment strategies. However, Consus decided to exit this business gradually, as exhibited by the sale of eight commercial assets from its portfolio in May 2018 and the profitable disposal of GxP announced on 3 August 2018. The post-sale rental assets of the company include only three properties owned and self-managed by CG Gruppe. Consus has no intention of broadening the portfolio and would rather sell this residual portfolio or initiate development measures, which could involve a conversion into a residential property (eg in the case of Steglitzer Kreisel). The reason behind this strategic shift is the current demand/supply situation in the German commercial real estate market. Consus was looking for special opportunities to turn distressed real estate properties into high-yielding investments. The company targeted non-performing loans or almost vacant properties, located either on the outskirts of the largest German cities or in less prominent country regions. Due to a progressive shortage of office space to let, these bargain purchases are now hard to find and acquire on favourable terms. Consus positioned itself in a special niche, as it targeted investments of €10-50m per asset.

As at 31 March 2018, the company held a portfolio of 49 projects with total area of 1.3m sqm and €5.3bn in GDV including acquisitions completed in 2018 amounting to €752m. It consists of both residential and mixed-use projects in progress, as well as a certain proportion of yielding assets. As at 31 March 2018, the portfolio consists of projects in the planning phase (50.3% of GDV), under construction (31.6%) and newly acquired projects (14.2%, see Exhibit 2)

Even though the main focus of the development segment is on residential buildings, the company’s business often involves multi-use, district-like projects to meet the expectations of both customers and local authorities. Consus specialises in large blocks of flats, often grouped in conglomerates, which require not only housing space but also key infrastructure including office and retail space. This is a new trend as in FY16 the share of developed non-residential area was negligible. In FY17 this number increased to 10.4% and in the current pipeline the share of commercial property increases with each development stage. In the investments already under construction, commercial real estate constitutes 28.1% of developed space, while within already planned construction and projects in the planning stage its share rises to c 39%. Commercial area is an integral part of development projects and is expected to be included in sale agreements rather than being retained by Consus for rental income.

As of 31 March 2018, the company had already pre-sold or agreed to forward sale under letter of intent in the case of development projects with a GDV of €1.4bn, representing 27% of the total portfolio. The realisation of a development project, following the acquisition phase, usually takes 24 to 36 months and is then followed by a letting period before delivery to the institutional purchaser, which lasts from 12 to 24 months. The long realisation periods help Consus to maintain a well-diversified project pipeline in terms of delivery time. Out of top 10 largest, ongoing projects there are no more than three projects due in any given year.

On top of the 49 projects already in the company’s portfolio, Consus has identified 21 additional targets, with c 900,000 sqm of saleable area and an estimated GDV of €4.8bn. The targeted land is distributed across Germany’s top nine cities as follows: Hamburg 27%, Stuttgart 27%, Berlin 22%, Munich 17% and Frankfurt 6%, with the remainder in Leipzig. Successful acquisition of all the identified targets, if the company decides to proceed and secures the required funding, would put the total GDV above the €10bn mark and the total area in excess of 2.2m sqm.

H118 has seen multiple changes to the company’s management board. On 9 January 2018, new executive was appointed as Andreas Steyer was nominated to become chief operating officer (COO). In February 2018, the company’s chief financial officer (CFO) and member of the management board, Dr Jürgen Büser, passed away after a short but serious illness. The vacant role was filled by Benjamin Lee, who was appointed on 3 April 2018. On the same day, responsibility for the key IR and PR functions was transferred to the COO, Andreas Steyer. Furthermore, on 31 May 2018 Consus announced that the chief executive officer (CEO), Norbert Kickum, would return to Aggregate Holdings (Consus’s main shareholder). He had been leading the company through the transformation process from a pure commercial asset company into a residential developer (he was replaced by Andreas Steyer).

In January 2018, Consus has announced a forward sale transaction with Bayerische Versorgungskammer (BVK) covering projects with an overall value of around €670m. As per the agreement, Consus will develop (through its subsidiary CG Gruppe) more than 1,740 apartments in Leipzig, Dresden, Frankfurt/Offenbach, Düsseldorf and Cologne over the next three to four years. The company received the first cash inflows related to this transaction amounting to €201m until May 2018. In the same month, it secured five new individual projects for a total expected sales volume of around €750m. They have been added to the CG Gruppe portfolio, increasing it to c €5.3bn of GDV.

On 15 May 2018 the company announced the divestment of eight commercial assets from its own portfolio, which was completed on 15 June 2018. This covered real estate properties with a GDV of €148m as of 31 March 2018 and an annual rental income of €10m. The trade translated into net cash proceeds to Consus amounting to €68.2m. In line with Consus’s cash recycling strategy, the proceeds will be reinvested in the expansion of the development business.

As the company has no intention of developing the commercial buy-to-hold business segment further, it announced the sale of GxP to Summit RE eight GmbH on 3 August 2018. The terms of the transaction have not been disclosed, but the company expects to generate a significant profit, resulting in a net debt reduction of c €140m.

Simultaneously with the divestments in the commercial lease segment, Consus is strengthening its development business. On 2 August 2018 it was announced that Consus’s stake in CG Gruppe would be increased to 75% on a fully diluted basis. The company will subscribe for a €50m mandatory convertible bond in CG Gruppe and receive the shares direct from Christoph Gröner (the main shareholder). He will be compensated with 8,333,334 new Consus shares, issued at a price of €12 per share and subject to the three-year lock-up period. He will also receive €67m in cash paid in stages over the next three years. This implies a total potential acquisition cost (both cash and non-cash) of c €217m. The deal will strengthen the equity base of Consus and its growth prospects with c €150m while limiting the cash paid out to c €67m. Following the transaction, a new extended Executive Committee of Consus will be formed by adding Christoph Gröner (CEO and founder of CG Gruppe) and Jürgen Kutz (Deputy CEO and COO/CIO of CG Gruppe).

The German real estate market is currently shaped by a number of demographic factors:

This is further assisted by strong macroeconomic factors, including a low unemployment rate (currently at c 3-4%), solid disposable income growth (+3.7% in 2017 according to Destatis) and record-low interest rates translating into high mortgage loan availability. Simultaneously, the house building supply side has so far been slow to respond to upward demand trends, which were largely a function of total construction costs in €/sqm being ahead of apartment prices for many years in Germany. Although residential building permits grew steadily in the period 2008-16 from c 150,000 to c 320,000, the Cologne Institute for Economic Research estimates that 385,000 homes would have to be build every year on average through 2020 to meet the demand for new properties. This compares with c 88,000 homes being built annually in top locations currently.

Supply growth is currently limited by persistent bottlenecks due to a shortage of workforce and general contractor capacity in the construction sector and overall longer processing periods for projects in the planning phase. This is illustrated by the 5.3% y-o-y decline in construction permits for new residential dwellings in 2017. The demand/supply imbalance puts upward pressure on overall investment costs, including a visible increase in land prices.

The issue of residential property shortage is clearly demonstrated by vacancy rates in the big seven locations (Berlin, Cologne, Düsseldorf, Frankfurt, Hamburg, Munich and Stuttgart), which currently stand at 2% (according to CBRE, see Exhibit 6), as well as increasing condominium purchase prices (see Exhibit 7).

Simultaneously, the German real estate market experiences continued strong interest from both domestic and foreign institutional investors, with forward funding/purchases likely to accelerate in 2018 (in particular the affordable housing segment), according to CBRE.

Demand in the German office market remains strong, with H118 take-up standing at 1.8m sqm, which is 18% ahead of the 10-year average and only 4% below last year’s strong number, according to Colliers. At the same time, supply increased only moderately and, as a result, Colliers forecasts take-up at 3.5m sqm in 2018, below the 4.2m sqm in 2017 (although it does not rule out 3.8m sqm given the strong demand). The vacancy rate for big seven cities reached a new record low level of 3.7% at end-June 2018. As a consequence of the above, average office rents increased across all big seven cities, with the strongest growth recorded in Berlin, Munich and Frankfurt (at 22%, 10% and 7% y-o-y in H118, respectively). The low vacancy rates in central business district (CBD) locations in selected cities has triggered the relocation of activities from CBDs to the city fringe submarkets (eg Munich, Hamburg, Düsseldorf).

Like other Germany-listed companies, Consus has a two-tier board structure, where the management board sits beneath the (non-executive) supervisory board.

Management board

Andreas Steyer (CEO) joined the company on 1 January 2018 as COO and was subsequently appointed as CEO on 31 May 2018. He has more than 25 years of management experience in the real estate sector. He served as CEO of DEMIRE Deutsche Mittelstand Real Estate as well as MD of Deka Immobilien Investment. His prior experience includes Österreichische Volksbank (ÖVAG), Ernst & Young Real Estate and Arthur Andersen Real Estate, where he managed the real estate business.

Benjamin Lee (CFO) joined the company on 3 April 2018 from Aggregate Holdings (Consus’s majority shareholder) and was appointed CFO. He has 25 years of experience in the global financial industry, including 14 years at UBS Investment Banking in London and five years as board member and CFO of London Mining.

Axel Harloff (chairman of the supervisory board) has held the position since 2017. In 2016, he became the main shareholder and MD of ERWE Retail Immobilien. He also served as the chairman of ACCENTRO Real Estate’s supervisory board since 2014.

Professor Hermann Wagner joined the board in 2018. He is a professor at the Frankfurt School of Finance and Management and a supervisory board member at Aareal Bank and PEH Wertpapier, as well as deputy chairman of SQUADRA Immobilien.

Dr Friedrich Oelrich has been a member of the supervisory board since September 2017. He is also the chairman of AVANA Invest’s supervisory board, as well as spokesman of the management board at Brainfama Consult.

Organisation

After the recent disposal of GxP German Properties, Consus’s capital group includes only one majority owned subsidiary. CG Gruppe (75% shares owned by Consus) is a market leader in Germany in the development of residential apartment houses for institutional investors.

Shareholders and free float

The company is currently undergoing significant changes in the shareholder structure as a result of consecutive capital issues having been executed within a short time period. On 24 July 2018, Consus announced the completion of a capital increase through a new share issue to existing shareholders and then to institutional investors in a private placement. A total of c 18.2m new shares (out of 39.9m offered) were sold at the issue price of €7.2 per share, raising c €131m. Consus intends to use the net proceeds to fund additional growth in its development business pipeline. The Aggregate Holding, who owned c 68.6% of total shares prior to the placement, has partially executed its subscription rights with the intention of spending at least €75m, which equals c 10.4m new shares. An additional €2m worth of shares has been acquired by the company’s CEO, Andreas Steyer. On 3 August 2018 another share issue was announced, but this one is addressed to Christoph Gröner (CEO of CG Gruppe) only, as a partial settlement of the agreement that increases Consus’s share in CG to 75%. The issue price has been set at €12 per share.

Consus is one of only a few listed residential real estate developers in Germany and is well positioned to benefit from favourable fundamentals in its core markets. We have identified several upside sensitivities for Consus shares:

There are also a number of factors that present downside risk to the business and consensus forecasts:

Consus’s capital group was formed in 2017 following the acquisition of CG Group (the residential developer) and GxP Group (the commercial real estate business). The company started to consolidate GxP using the equity method from 11 November 2017 onwards, ie for less than two months in FY17. CG Group’s results are consolidated from 1 January 2018 and are therefore not reflected in Consus’s FY17 figures. Consequently, the Q118 financial statements are the first to present fully consolidated numbers, but without comparable data for prior periods.

The pro forma statements have been prepared with the assumption that both subsidiaries have been acquired as at 1 January 2017 and that the disposal of eight commercial properties finalised in June 2018 was effective as of the same day. To fully reflect these items, the company has introduced the required adjustments, including reducing CG’s margin on development projects and accounting for additional interest expenses related to the issue of convertible bonds.

As per these pro forma figures, Consus achieved total revenue of €215.0m in FY17, 14.6% of which resulted from letting activities and 85.4% from property development. The share of the former would be higher if not for the asset disposal impact reducing this type of revenues by 19%. As the company has already announced the sale of GxP and expressed no interest in developing this business segment, the share of this income source is expected to decrease in the future. However, this could be replaced by the additional sales in the development segment, which will remain the main focus of the company’s activity, fuelled by the additional cash inflows from asset disposals.

On a pro forma basis, EBITDA for the period amounted to €110.8m, which represents a margin of 51.5%. It was mainly driven by the profitability of CG Gruppe, which further supports the decision to concentrate on this segment. The company recorded €109.7m of financial expenses, driven mainly by CG Gruppe’s borrowing activity. As CG continued to acquire new investment opportunities, it was predominantly reliant on external financing driving higher interest costs. CG Gruppe (which represents Consus’s residential development business) reported revenue of €205.2m in FY17. The sales from property development amounted to €161.5m, while construction and other services accounted for €22.1m and the remaining €21.6m was earned in the letting activities of investment properties. CG Gruppe completed four development projects in FY17, compared to only two in FY16 and therefore recorded an improvement in EBITDA and EBIT amounting to €120.1m and €119.0m respectively. As financial expenses more than doubled in FY17, earnings after tax were negative.

Total group debt as of 31 March 2018 amounted to €1,520m with average interest of 6.3% and included Consus bonds of €150m due in 2024, convertible bonds of €200m due in 2022, commercial debt and development loans. With the cash and cash equivalents amounting to €48.7m, excluding the assets divested in June 2018 and considering the sale of Consus’s stake in GxP, the company’s pro forma net debt equalled c €1,180m. The ratio of net debt to EBIT pre-PPA (purchase price allocation), based on medium-term EBIT pre-PPA target (c €300m) amounted to 3.9x (10.8x based on pro forma data) and was higher than the targeted value of 3.0x. This is associated with the significant expansion in business scope currently underway. Based on the market consensus (although only one provider, Hauck & Aufhäuser), the company is expected to record EBITDA CAGR of 105% in the upcoming periods (2018-2020e), which should result in an improved leverage and gearing situation.

The limited number of domestic comparators for Consus has guided us towards including international peers in our analysis. This is not a strict comparison and should only be taken as a guide. There are differences among the companies displayed below, but the essential nature of business, in that land is bought, developed and then resold with a profit, remains the same. It is worth noting, though, that although Consus is sensitive to the global macroeconomic climate similarly to the peers below, its forward sale agreements with staggered payments provide significant revenue and cash flow visibility over the medium term.

Despite the recent rally in Consus shares, driven by M&A activity, the consensus data suggest that Consus’s shares trade at a discount to peers, based on both P/E and EV/EBITDA ratios for FY19e. The widening discount to peers can be explained by the current lifecycle stage of projects undertaken. The company is closing the land bank building period and will now move to the revenue-generating construction phase. The expected increase in the bottom line explains the declining multiples in FY19e vs FY18e. As the company does not expect to declare any dividends before FY20, we have not included a dividend yield comparison in our analysis.