After publishing an analysis about TMW Weltfonds in March 2014, I am presenting another opportunity to participate in the ongoing liquidation of several German open-end real estate funds. Similarly to TMW, Axa Immoselect is also in the final phase of selling its remaining assets. The values of the remaining portfolio were adjusted downwards several times in the past and the properties are located in different parts of Europe. Based on conservative estimates, an investment offers a potential 10% IRR over a projected five year holding period.
In case you are not familiar with this topic, I recommend to you reading first the write up about TMW Weltfonds where I give a brief introduction to this topic.
Limited downside risk due to high cash balance and large discount to net asset value (NAV)
After a three year liquidation phase the remaining assets of Axa Immoselect (the fund) were transferred to the custodian bank at the end of October 2014. After the transfer, the custodian bank decided to keep Axa Investment Managers Deutschland GmbH as investment manager. The total management fee remains unchanged at 0.6% p.a. of NAV.
The current NAV is EUR 793 m or EUR 16.47 per share. The current cash balance is EUR 375 m or EUR 7.78 per share. As of September 2014, the fund had provisions of EUR 32 m on the balance sheet. In the meantime fund management reported a reduction in provisions by EUR 15 m. The current appraisal value of the eight properties is EUR 413 m. As of December the fund has approx. EUR 30 m of non-recourse debt in its Italian entity. Apart from that, there is no bank debt outstanding. The share is currently trading at EUR 12 implying a 27% discount to NAV. More importantly 65% of NAV is made up of cash. Excluding cash the discount widens to 51%.
The fund management plans to make a distribution in late December this year. However, not all of the cash will be distributed. The management is incentivized to hold a large cash pile as they can charge higher management fees. Their official reasoning is that they need to hold the cash until all warranties and potential tax claims will expire. I assume that they will distribute EUR 168 m or EUR 3.5 in December and keep the rest as restricted cash.
Estimation of liquidation value and timing of future distributions
Originally, the fund had 65 properties before the decision was made to wind down. Today, the remaining portfolio consists of eight properties in eight different European countries:
The largest asset is a 52% holding in an office building in Dusseldorf, Germany. It’s a single tenant building leased to IKB Bank with a long term lease (more than 10 years). IKB Bank was the first German victim from the financial crisis and had to be bailed out by the German government. The bank’s operational focus has been reshiftedto the German Mittelstand and it returned to profitability in 2014. The current owner, Lonestar, is currently trying to sell the bank.
Based on the current appraisal value this asset makes up 13% of NAV. It is valued at a 5.6% gross yield or EUR 2,736 per sqm. The current valuation implies a rent per sqm of EUR 13 per month. This is slightly below the market rent. Given that the fund is not holding a 100% share a small discount to the appraisal value might be necessary. However, overall I believe that this asset can be marketed relatively easily close to current valuation.
The most problematic asset is located in Amersfoort, Netherlands. Based on current valuation, the office building contributes 9% to NAV. A number of downward value adjustments have been made in the past. However, the tenant will leave the building as the lease expires next year. So a large discount to appraisal value (up to 50%) seems to be warranted as the Dutch commercial real estate market is still in the doldrums. In addition, the asset was not included in a portfolio deal, when the fund sold all of its other Dutch buildings.
The retail centre in Antegnate, Italy, is 94% leased including a ten year lease to the anchor tenant, who is operating a hyper market in the centre (28% of space). The property makes up 7% of NAV and the current valuation implies an 8.1% yield based on appraised gross rents. Taking into account a risk premium for Southern European real estate, I believe that potential buyers might be eager to acquire the property at a 10% gross yield implying a 29% discount to the current NAV.
The fund owns a complex of two bordering shopping centres located seven kilometres from the city centre of Malmö, Sweden. The assets comprise 7% of the fund’s NAV. The property is 79% leased and the fund management is currently in negotiations with new potential tenants. At a 9% gross yield the property should be marketable implying a discount of 13% to NAV.
In Madrid, the fund owns a cinema complex including restaurants and parking lots (4% of NAV). The rental agreement with the cinema operator was extended recently and a new operator for the parking space was found. Occupancy rate is 92% and the valuation implies a 7.5% gross yield. With a 10% gross yield, the asset should be a very good deal for a potential buyer implying a discount to current NAV of one third.
Apart from that, the fund owns three office buildings in Prague (4% of NAV), Brussels (3% of NAV) and Luxembourg (2% of NAV). While the one in Prague is 85% occupied the other two properties face a very difficult market environment with high vacancy rates. While I apply a 10% gross yield for the Czech property, I take 12% for both Brussels and Luxembourg. This leads to a discount of 24% to current NAV for the three assets combined.
As a result, I come up with an estimate of liquidation value of EUR 14.4 per share. This implies a 20% upside to current share price. I think this is a very conservative estimate.
Going further, I assume that the properties in Dusseldorf, Antegnate, Malmö and Madrid can be sold throughout 2015 with two evenly split distributions taking place in June and December 2015. Moreover, I assume that the problem assets can be sold throughout 2016 with a distribution taking place in December 2016. This distribution should also include EUR 50 m of freed up cash. I expect the remaining cash and assets to be distributed to shareholders at the end of 2019. This leads to an expected IRR of 10.4% over a five year holding period.
I believe that the inefficiency in this market segment is the result of the large retail ownership in theses type of funds. Many retail investors are “disappointed” and just want to get out. Moreover, their banks advise them to sell these funds and to buy other products where the bank can make money with. In addition, for retail investors there is an unfavourable tax treatment in place concerning the downward adjustment of appraisal values which can lead to time consuming discussions with tax officers. Apart from that, there is limited interest from professional investors as many of them cannot invest due to regulatory reasons or due to insufficient liquidity.
Nevertheless, part of the discount is also justified due to the limited alignment of interest between fund management and fund holders. In addition, fund holders have almost no rights of participation during liquidation process.
Overall, I am of the opinion, that at current prices the fund provides another attractive investment opportunity in the field of open ended German real estate funds under liquidation.
For the portfolio, I will therefore establish a 4% position with a price limit of EUR 12.0 starting from today.
Edit 12/5/2014: Shortly after publishing this post, the fund announced that they will distribute EUR 4.8 per share on December 18th 2014. This is quite positive and substantially above the estimate in my analysis. I will therefore increase my purchase limit to EUR 12.5 per share.
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