Two Reasons For Optimism In The German Property Market

It’s times like these, when everything around the world has been sold off aggressively, that you come across apparently quite staggering value in small cap shares. You see a share selling for pennies, have a look at the company’s assets and find that there is a seemingly ridiculous discrepancy between price and value.

Today I want to talk about one such anomaly that. On the face of it, this one screams value. This company demands that we have a closer look – and see if it’s one that we want to buy and tuck away in the bottom drawer… or whether there’s a good reason that it’s so cheap and avoid it like everybody else. Let’s see…

Like paying 13p to own £1

Let me ask you a question. Would you like to buy €1.22 of German residential property assets for just 17 cents? Or even better, €1.68 worth? That’s like paying 13p to own £1 – sounds like a good deal, right? And yet these are the two figures for net asset value per share, quoted in last week’s results presentation from the Speymill Deutsche Immobilien Company (SDIC) , that hover tantalizingly above a share price of 17 cents.

Even with today’s massive distrust of property, as reflected in huge gulfs between share prices and stated values, this is an incredible discount. And it is all the more surprising considering that the market for apartments in Germany has two attributes that have suddenly come roaring back into favour. It is both dull and boring.

Far from having been whisked up by a typhoon of reckless optimism, German house prices have barely risen since 1990. Per square metre residential property in Berlin, Frankfurt and Munich costs €2500-€3500, less than the €5000-€7000 of Zurich, Rome and Amsterdam; and much less than the €10,000-plus figure of London and Paris, not to mention the €15,000 that you would have to pay for a square metre of living space in Moscow (this sounds like an accident waiting to happen!) and the €25,000 to inhabit the rarified climes of Monaco.

Two reasons for optimism in the German property market

With the majority of Germans indifferent to the charms of home ownership and happy to rent, the German residential property market has been stagnant for fifteen years, and the construction industry has been in a prolonged slump. But to the managers of the SDIC (which I first described in the October edition of Red Hot Penny Shares) this is not a problem but an opportunity, and their enthusiasm rests upon two things.

First of all, although the German property market has been going sideways for several years, this has not always been the case. A long-term chart of Germany’s house price index shows a steady post-war appreciation with barely a single year of decline. While German property prices sometimes don’t seem to go up much, they don’t seem to fall either. Indeed, even this year SDIC has reported a small increase in the value of its portfolio of 26,000 apartments.

The second reason for optimism is that it costs more to build new apartments than to buy existing ones, and this by a margin that could be as high as 40%. With Germany’s population of over-fifties set to rise from 31 million to 38 million by the year 2020, implying the need for an additional two million new homes, there is little danger of the existing housing stock being left empty. And yet, with prices where they are, only 70,000 new apartments were built last year – about one quarter of the number theoretically needed to keep pace with demand.

None of this though, has saved SDIC’s shares from losing 80% of their value over the last year. So let’s delve into the numbers and see if we can work out why.

Taking the Income Statement first, for the year to June, SDIC has given us several numbers to choose from. But the most relevant was the ‘Net Rent’ received of €70.6m, from which was deducted €25.6m of ‘Running Expenses’, the largest items of which are ‘Maintenance’, ‘Irrecoverable VAT’, ‘Bad Debts/Rent Arrears’, and ‘Land tax.’ Also deducted was SDIC’s Administrative Management Fee of €14.3m, and net interest on loans of €35m. That left less than nothing – a loss of €4.3m, in fact, meaning no dividend payment.

But last year SDIC was both assembling its portfolio and spending money on refurbishment, with the result that in March 13.2% of the properties – mainly apartments in mansion blocks – were empty. These are now being let, so SDIC offers another set of figures on what it calls a ‘Stabilised Basis.’ This assumes an occupancy rate of 95%, on which basis the portfolio delivers an annual net rental of €108.1m.

Although the interest charge is higher, the figures for Running Expenses and SDIC’s Administrative Expenses are broadly the same, and consequently these numbers deliver a bottom line profit of €11.4m. This equates to 3.4 cents per share, and since it is SDIC’s stated intention to pay all of this out as dividends, this implies a net yield of some 20% at the current share price. This, of course, assumes success in letting the vacant apartments, but since refurbished apartments have greater appeal than tatty old ones, this assumption is probably fair.

A 90% discount to net asset value

Now let us have a look at the Net Asset Value. This is derived from the value of the portfolio, as measured at June 30th by Messrs DTZ Zadelhoff Tie Lung GmbH, of €1.475bn less debt of €1,183bn. After adjustments for other minor items we are left with a figure of €413m, equivalent to €1.22 per share.

The value of the portfolio, though, is itself a derivation of the rent roll and as SDIC fills those vacancies it expects that this will boost both its income and the value of its assets. So once again we have a figure for the Net Asset Value, on the ‘Stabilised Basis’, that again assumes occupancy of 95%, as well as rental growth of 3% p.a. and a constant valuation yield. This produces a net asset value per share of €1.68.

Why then is the share price of 17 cents barely 10% of this figure? The income picture is not great but it is hardly a disaster, and the net asset value is a mile above the share price. As with every property company that reports at the moment, SDIC makes reference to its debt covenants, which relate to rental income coverage and ‘Loan to Value’, and the very mention of these perfectly normal banking conditions seems to be enough to give investors the willies.

SDIC merely says that the company is ‘not presently at risk of breaking these covenants’ without telling us – as some other property companies have done – exactly what the covenants are. However, given that the value of SDIC’s assets has actually risen in the two and a half years since SDIC was formed, it is hard to believe that there can be a problem.

This, to say the least, is an intriguing situation… and one that I intend to follow closely with the possibility that I will one day look to snap up this seemingly incredible bargain. For now, it stays on my list of shares that I’m not quite comfortable buying, but which are certainly worth watching.

Your chance to see Wall Street legend, Jim Rogers, for free

Before I go, here’s a couple of dates for your diary and an event well worth turning up to if you’re looking for interesting views and opinions on the market – and ideas for ways to invest.

The dates are 14 and15 November and the event is this year’s World Money Show London, at The Queen Elizabeth II Conference Centre. This is a great chance to join over three thousand other private investors and traders who will come from more than 25 countries to seek the education, knowledge and tools to profit in constantly changing global markets.

You’ll hear about the latest economic pressures on the markets and how to position your portfolio for maximum profits in the current environment.

It’s worth turning up just to catch Wall Street investment legend, Jim Rogers, making a rare London appearance, with the bold topic: “How I See the World Today and What I Am Doing About It.”

That’s a must-see presentation and there are plenty of other big names you can tap for market wisdom at a time when it’s going to be most useful to you.

To register FREE by telephone, call international freephone 00 800 1414 8888 (between 2pm and 10pm UK time) or on line by clicking here: The World Money Show Web site.

Tom Bulford
for The Penny Sleuth

P.S. Revealed: The "Leinster Profit Secret" - learn how £2,000 became £216,000... Click here today.

P.P.S. If you want to follow the insights of a small company investor, and uncover the hidden gems of the stock market, find out more about The Penny Sleuth by clicking here.

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Two Reasons For Optimism In The German Property Market

Like Paying 13p To Own £1