Currently, I see a window of opportunity for some German open-end real estate funds, which are in the liquidation phase. With seven properties to sell visibility in the case of TMW Weltfonds is quite high. In addition, two assets have recently improved their attractiveness to potential buyers. Based on conservative estimates, an investment offers a potential 26% IRR over a projected 34 month holding period.
Open-end real estate funds are still the most important retail investment vehicle for real estate in Germany. Currently, these funds are managing in total approx. EUR 80 bn which amounts to roughly 10% of German investment funds’ assets.
In 2008/2009, large withdrawal of capital at open-end real estate funds started and triggered a liquidity shortage at many funds. Therefore, these funds had to suspend the redemption of units. Based on legal provisions, this suspension can only be done for a maximum of two years. After this time period, most of the closed funds were not able to reopen. As a consequence, their managers decided that the right consequence should be to terminate the fund’s management with a three year notice. During this three-year period, the fund manager has to sell all the fund’s assets and distribute the generated liquidity step by step to the investors. If the fund manager cannot sell all assets within the three-year period, all remaining assets will by law be transferred to the fund’s custodian bank, which then has to liquidate the assets and distribute cash to the investors. This transfer triggers real estate transfer tax, and the custodian bank is normally not prepared to manage the remaining assets. However, so far the concerned custodian banks just handed back management of the liquidation process to the former fund manager. Most of the funds which are currently in the liquidation phase are trading at a substantial discount to its NAV. In some cases, this offers attractive investment opportunities due to good visibility of upcoming cash flows to unit holders. More information can be found here and here.
TMW Immobilien Weltfonds
TMW Immobilien Weltfonds (TMW) is currently at the end of the 3 year liquidation phase. The remaining assets will be transferred to the custodian bank at the end of May 2014. The remaining portfolio consists of six properties located in Hamburg, Paris, Amsterdam, Rotterdam and Houten. Apart from that, the fund indirectly owns a property in Bologna.
As of February the fund has approx. EUR 24 m of recourse debt. The remainder of EUR 22 m is related to the Italian entity. So far the fund made only minor distributions to its shareholders and used the majority of sales proceeds to reduce the debt amount. As of September 2013, they had provisions of EUR 16 m on their balance sheet. The current cash balance is EUR 89 m. The current appraisal value of the six properties is EUR 325 m. The NAV of the Italian entity and other indirect holdings is approx. EUR 9 m. Other assets sum up to approx. EUR 10 m (claims from accumulated interest and fx hedging). Hence, the official NAV as of February is EUR 395 m or EUR 26 per share. The share is currently trading at EUR 16 implying a 38% discount.
As the structuring of the Italian investment was not accepted by the Italian tax authorities, the entity holding this property has an exceptional tax liability of EUR 30 m. Nevertheless, there is the possibility that after the disposition of the property the fund will receive a small cash amount from this investment. To keep it simple, I will assume that the NAV of this investment is zero. I will also ignore the value of other assets in my estimation of TMW’s liquidation value.
It is to be expected that in a disposal process like this some of the last assets will be those that are the hardest to sell. However, the two largest properties in their remaining portfolio showed a very good performance over the last twelve months:
Sumatrakontor is a mixed-use grade A building in Hamburg which was completed in 2011. Occupancy has been gradually increased and has reached 90%. Current annual rental income is approx. EUR 7.2 m. The last appraisal was in October 2013, when the property was only 75% leased. Demand for these type of core assets is currently very high.
Prime office in Hamburg is currently trading at net yields (new asset, prime location, 100% leased) of 4.6%. For some reasons German open-ended funds are using gross yields instead of cap rates. To come up with an estimate of a prime gross yield, I am using a 20% operating expense ratio (which I think is conservative). This leads to a 5.8% prime gross yield. Given that Sumatrakontor has not been fully leased yet, I add 40 bps, which leads to an estimate of a 6.2% gross yield for this asset. This translates into a potential sales price of EUR 116 m.
Fortunately, there is also a comparable transaction of a property which is located close to Sumatrakontor. In March 2013 Dundee International REIT (an affiliate of Dundee Corp.) acquired the ABC-Bogen for a purchase price of CAD 93.6 m (EUR 70.4 m) from SEB Immoinvest. SEB Immoinvest is another German open-end fund which is currently in the liquidation phase. The purchase price was in line with the latest appraisal value. Based on a rental income of EUR 3.8 m the resulting gross yield is 5.4%. At the time of the transaction the property was 94% leased.
So I believe that a 6.2% gross yield for the Sumatrakontor is a relatively conservative estimate given the current market environment in Hamburg.
Eastview is an office building in a B grade location on the Eastern Inner Rim in Paris. After the completion of a redevelopment in 2010, the building had been on the market for quite some time. Last year the fund management found a tenant (Orange) for 82% of the leasable area. The lease term is 12 years.
The fact that the Eastern Inner Rim submarket is both central and cheaper than the Western Crescent of Paris and La Defense has been attracting occupiers over the last years. In May 2013 TMW sold Tour Vista located in Puteaux, the Western Crescent of Paris, for a gross yield of 6.5% (based on an occupancy rate of 77%). The building was redeveloped in 2007. Given the inferior location of Eastview, I apply a 50 bps premium, which leads to a 7.0% gross yield or a potential sales price of EUR 80.4 m (Based on an 82% occupancy rate and the latest available appraisal rent of EUR 6.9 m).
Apart from that, the Fund is holding four properties in the Netherlands. The Dutch real estate market is currently trading at a heavy discount compared to its neighbouring core markets reflecting the weak economic environment in the country. In addition, the total office stock is still too large and the options for transformation are limited. Vacancy rates in Amsterdam and Rotterdam are currently standing at approx. 20%. In the second half of 2013 transaction volume increased substantially as opportunistic buyers entered the market.
However, they still mainly focused on core office properties. Based on my information, TMW’s Dutch properties are all located in secondary locations. This is also the segment of the market where potential tenants can currently negotiate the highest incentives. In addition, Crystal Tower (Amsterdam) and Europoint III (Rotterdam) are both single tenant properties and have a remaining lease term of less than 12 months. I will apply a 20% gross yield for these two assets. Koningshof (Amsterdam) is currently 53% leased with an average lease term until 2019. I will take a 13% gross yield based on current rental income. Kromme Schaft in Houten is 100% leased to KPN until 2020. I will take a 15% gross yield given the extremely negative outlook for Houten. The current rent level for the fund’s Dutch assets is between EUR 10 per sqm (Europoint III) and EUR 16 (Crystal Tower). Though the current rent level for Crystal Tower might not be sustainable going forward, overall I don’t think that the assets are extremely over rented. The information I am using is coming from CBRE’S research site.
Below you can find an overview of the current portfolio excluding the asset in Bologna (numbers are in EUR millions):
For the remaining portfolio, I assume a liquidation value of EUR 253 m, which is 22% below the current appraisal value of TMW’s portfolio. From my perspective it is highly likely, that the management will be able to sale Sumatrakontor and Eastview before the handover of the fund’s assets to the custodian bank.
As already mentioned, real estate transfer tax will be triggered by the transfer to the custodian bank. Based on my information, fund managers are calculating with an 8% cost level. Based on the current appraisal value of the Dutch assets and the Italian property this translates into an additional provision of EUR 13 m or EUR 0.8 per share.
As a consequence, we have a portfolio liquidation value of EUR 253 m or EUR 16.7 per share. In addition excess cash is EUR 38 m (EUR 89 m-EUR 22 m-EUR 16 m-EUR 13 m) or EUR 2.5 per share. This translates into a liquidation value of EUR 19.3 per share or an upside potential of 20%.
Based on my projection, cash proceeds from the sale of Sumatrakontor and Eastview are EUR 197 m or EUR 13.0 per share. So assuming that the Fund will keep its current cash, but will distribute the sales proceeds, shareholders can expect a distribution of EUR 13.0 at the end of May 2014. In addition, I assume that shareholders will receive two distributions of EUR 3.1 each at the end of 2015 and at the end of 2016. Hence, an investor can expect a 26% IRR over a 34 month investment period.
Investor appetite for this type of investment seems to be relatively low given the negative returns many German open-end reals estate funds generated so far and the bad press they had. Though I have used conservative estimates, the risk return profile in the case of TMW seems to be compelling.
To put it differently, after a dividend of perhaps EUR 13.0 in May, shareholders would retain a stub position with an equity value of EUR 6.3 at an implied cost of EUR 3.0 to EUR 3.5, which gives upside on the remaining holding of approx. 100% over the next two and a half years.
I will establish a 5% position for the portfolio with a share price limit of EUR 16.5. Liquidity is low and it might take approx. 10 trading days to build the position assuming Wertart Capital trades one third of daily volume. Please click here for more information on WertArt Capital and the virtual portfolio.
The content contained on this site represents only the opinions of its author(s). I may hold a position in securities mentioned on this site. In no way should anything on this website be considered investment advice and should never be relied on in making an investment decision. As always please do your own research!