UniCredito Immobiliare Uno – Investment Case

Regular readers of this blog are aware that I have so far published two analyses about German open-end real estate funds. Today I turn to Italy to present a similar investment opportunity. UniCredito Immobiliare Uno is a closed end real estate fund which matures at the end of 2017. Most of the fund’s properties are located in Milan and Rome and are long term leased to reputable tenants. Based on my analysis, an investment offers a potential 15% IRR and a 1.3x multiple over a projected three year holding period.

After my post about Axa Immoselect, reader Max drew my attention to listed Italian real estate investment funds. Currently, a number of Italian closed end listed real estate funds are in the process of winding up their portfolios and plan to distribute the net proceeds to shareholders.

An introduction to Italian Real Estate Investment Funds

Real Estate Investment Funds (REIFs) were introduced in Italy in 1994. REIFs are managed by a management company (Società di Gestione del Risparmio / SGR) and are structured as closed-end regulated contractual funds. The REIF and the SGR are subject to the supervision of the Italian regulatory authority, the Bank of Italy. REIF’s assets have to be mainly property related assets and there are certain diversification rules to be observed. In addition, Real estate properties have to be evaluated twice each year on the basis of external appraisals. The regulation comes with relatively high operating costs. However, due to an advantageous tax regime, REIFs have been an appealing investment structure. Nevertheless, unitholders cannot manage the REIF or influence decision making. This role is only executed by the SGR, which has to be independent from the investors.

In total there are currently 364 REIFs managed by SGRs, but 93% are for qualified institutional investors only. The remaining 7% or 26 listed closed end real estate funds were issued for retail investors. These funds were issued between 1999 and 2006. 19 of the retail funds are currently in the process of winding up their portfolios and returning the proceeds to shareholders. The funds are listed on the Market for Investment Vehicles (MIV), a regulated market segment of Borsa Italiana.

At the end of 2013 the combined gross asset value (GAV) of this sub-market segment was EUR 5.8 bn. The following table provides an overview of the evolution of GAV since the beginning of 2009 (Please click to enlarge):

Given the weakness of the Italian economy in general and the low transaction volume in the Italian real estate market more specifically, many of the funds are far behind their original time frames for selling their assets. As a consequence, most of them appealed to the grace period or extended the expiry date of the funds maturity (if possible under the fund terms).

Most of the funds are currently trading with discounts to NAV ranging between 30% and 70%:

From the beginning of 2014 a number of private equity real estate investors including Blackstone, Capstone, Apollo, Fortress and GWM Group took notice of the wide spread and made public tender offers for the shares of some funds or in the case of Apollo acquired the remaining portfolio of a fund.

Mr. Renzi’s “Plan for Italy”

The OECD summarizes the economic outlook for Italy as follows:

“After contracting during most of 2014, the economy is projected to return to growth by mid-2015 and accelerate somewhat further in 2016. ECB monetary policy support is expected to ease financial conditions and facilitate a resumption of bank lending, which should raise investment. The projected revival of Italy’s export market will also support stronger growth. The overall impact of fiscal policy will be small in 2015, as tax cuts will be offset by spending reductions. Unemployment will begin to decline in 2016, but is set to remain at high levels, while wage gains look set to remain modest.”

As widely known Italy’s public debt-to-GDP ratios is one of the highest in Europe:

At the same time, it is also noteworthy that total debt to GDP (incl corporate and consumer debt) at 655% is close to Germany at 640%. The level of indebtedness as a ratio of income or earnings of consumers and corporates was 74% in December 2012, compared to a European average of 109%. Nevertheless, the public debt burden is of major concern and Italy has been one of the main beneficiaries of the ECB’s expansive monetary policy bringing interest costs down substantially.

In the outlook for 2015 which was published by The Economist in November of last year, Italy’s prime minister Matteo Renzi writes about his “plan for Italy”. In his essay, he summarizes the structural, social and economic reforms his government targets during its tenure:

• A new electoral law that produces a clear winner
• Transformation to a single legislative house
• Rebalancing of power between central and local authorities
• Make public administration more efficient
• Cutting trial times by half in the civil justice system
• Simplification of tax system
• Tax cuts for workers and corporations
• Cuts in public spending
• Reform the labour market

While the execution of this plan would be ambitious for any democratic country in the world, it is even more for Italy where political inactivity has prevailed for decades. To return to growth Mr. Renzi also counts on the European commission to allocate EUR 300 bn to kickstart growth in Europe and on the banking system to increase lending to Italian businesses and consumers.

The Italian banking system is lagging behind its European peers

Italian banks seem to be in a better position than three years ago, when the solvency of several European countries including Italy was questioned. Mr. Draghi’s message “to do whatever it takes to preserve the euro” in July 2012, the provision of EUR 255 bn of ECB’s LTRO at a 1% interest rate over 3 years to Italian banks in 2011/2012 and the strengthening of their capital ratios targeting a Tier-one ratio of 9%(by raising equity) laid the ground for the stabilization of the banking system.

After the completion of the Asset Quality Review by the ECB in October 2014, it can be expected that Italian banks will now increase portfolio sales to manage regulatory pressure, further improve their capital ratios, create liquidity and improve the asset quality on their balance sheets.

With a stock of EUR 316 bn (as of December 2013) across all non‑performing loan (NPL) categories including restructuring, substandard and past due in the Italian banking system, Italy has the largest volume of NPLs in any eurozone country. Reason for that were a deteriorating loan quality during the period leading up to the global financial crisis due to the influx of foreign banks into the Italian market and increasing competition for loans. In addition, Italian banks seem to have poor servicing capabilities and therefore rely on a lengthy court resolution process. Moreover, there were limited NPL sales by banks from 2007 to 2012 due to a large gap between ask and bid prices.

NPL market activity has been limited in contrast to Germany, Spain and Portugal. A good summary of the “deleveraging opportunity” in Europe can be found here.

Regarding the NPL real estate segment Italy lags behind as it did not have the same severe slump in real estate markets that happened in Spain and Ireland and so has been able to wait before dealing with bad loans. However, investor interest seems now turn to Italy as competition for distressed assets intensifies in the more established European NPL markets. In addition, Italian banks have taken large provisions on their NPL portfolios over the last years. As a consequence, the banks coverage ratios increased substantially and the bid- ask gap between banks and potential investors has narrowed. Moreover, for instance KKR, Unicredit and Intesa are planning to set up a bad bank for NPLs with the goal to unwind these assets.

The Italian real estate market is still waiting for returning investor interest

While the transaction volume for non-performing real estate debt should profit first from increasing fund raising for Italian assets , direct real estate investments might also attract more investor interest going further. In addition to real estate funds, a number of publicly-owned properties have been offered to the market recently. Demand seems to hold up.

In Italy the property market remains weak, in line with conditions in the economy as a whole. Looking at the commercial real estate market in general, one can see that property prices remained relative stable until 2011 (left axis) and that transaction activity (right axis) seems now to bottom out at a low level (Please click to enlarge):

Source: Financial Stability Report Banca d’Italia 2014

During the first two quarters of 2014 EUR 1.3 bn has been invested in the Italian commercial property market, down by 25% from H1 2013 and quite below the mid year average from 2005 to 2013 (EUR 2.3 bn):

Recently, the market has been dominated by foreign opportunistic investors (e.g. Blackstone). However, interest from other market players like souvereign wealth funds (GIC) and insurance companies (Allianz, ING) seems to increase , which is supported by a number of reforms in the property sector announced by the government.

While Italy ranks 22nd in JLL’s transparency ranking just behind Austria, it is important to note that corruption and organized crime have a severe impact on the Italian economy in general and in particular on the real estate market.

Coming to the investment opportunity

UniCredito Immobiliare Uno (the fund) is managed by Torre SGR. Managing 10 funds (9 for institutional investors only), Torre has EUR 1.5 bn of gross assets under management. The investment manager is owned by Fortress Investment Group (62.5%) and Unicredit/Pioneer Investment Management (37.5%).

At the beginning of 2014 the fund was subject to a tender offer by Eurocastle and GWM Group for a 40.54% share of the fund at a price of EUR 1,850 per unit representing a 36.5% discount to NAV. Torre recommended not to accept the offer given the large discount to NAV. Eurocastle and GWM Group reached only 36.8% of the initially targeted amount. As far as I understand, after the completion of the tender offer Eurocastle was holding 11,929 units or a 7.5% share in the fund and GWM was holding 17,314 units or a 10.8% share in the fund. It seems to be likely that the two entities have been buying additional units in the open market afterwards. Interestingly, Eurocastle is managed by an affiliate of Fortress Investment Group, which is also holding a 62.5% share in Torre SGR.

The official lifetime of the fund ended at the end of 2014. Given the weak demand for Italian real estate over the last years however, the fund management took the option to extend the lifetime until December 31, 2017 which was approved by the Italian regulator. In addition, the fund management made some adjustments to the fee regime. From the beginning of 2015, the annual management fee for Torre will be reduced from 1.525% to 1.15% of the NAV of the Fund net of unrealized capital gains. Moreover, the percentage of the management fee calculated on the portion of assets consisting liquidity and short investments (Italian sovereign bonds) will be reduced to 0.75%. On the other hand, Torre reduced the hurdle rate from 5% to 3% which the incentive fee to Torre is based on (the manager receives a 20% profit share above the hurdle rate).  Based on my calculation the hurdle as of December 2014 is EUR 2,704 per unit. The reported NAV per unit as of September 2014 is EUR 2,790. The fund’s share is currently being traded at EUR 1,850 with a discount of 33.7% to NAV.

As of June 30, 2014, current net assets are EUR 446.5 m. The combined appraisal value of properties held by the fund is EUR 407.5 m. Short term investment and cash make up EUR 39.4 m. Other assets sum up to EUR 7.9 m. There is no bank debt outstanding (Edit 1/30/2015: There seems to be a loan outstanding at SPV level; see below) and other liabilities are EUR 8.3 m.

Portfolio evaluation

The fund is holding 14 properties (incl a retail portfolio consisting of 6 small supermarkets) most of them located in Rome and Milan:

1) In million EUR

2) The fund entered into a lease agreement with Unicredit SpA. The appraised value of the lease agreement is EUR 89.5 m. Edit 1/30/2015: According to fund management the lease was terminated in Q2 2014 and refinanced with a loan at SPV level. However, I could not find this information in the latest reports.

The following table provides an overview of the development of the appraisal values starting in 2007:

Via Boncompagni 71/A used to be an office building and generated roughly EUR 7.0 m of rental income until 2009, when the fund decided to convert it into residential use. As far as I understand it took four years until the end of 2014 to receive the approval from the authorities for the redevelopment. Completion is now planned for 2017.The building will comprise of 145 luxury residential units. The property is located in a central location close to the US embassy. The new building is planned to have a gross floor area of 20,000 sqm. Assuming that the net saleable area is 16,000 sqm and the sales price per sqm will be EUR 10,000, the total sales price for the property could reach EUR 160 m. Including sales and marketing costs, I assume that total development costs will sum up to EUR 3,000 per sqm or EUR 60 m. Hence, this rough valuation leads to EUR 100 m for Via Boncompagni 71/A which is 23% below the current appraisal value.

The single tenant production and office building complex located in Stezzano is occupied by Brembo SpA. The company is listed at the Milan stock exchange and a leader in disc brake technology for the automotive industry. The company is highly profitable and well capitalized. Strezzano is close to Milan and a suburb of Bergamo. According to the fund’s reporting, the property is also part of Brembo SpA’s headquarter. With a long term lease in place the property seems to be fairly valued at a 7.4% gross yield.

The fund owns a retail portfolio of six small super markets in different locations (Milan, Verona, Pordenone, Perugia and two in Trieste). A long term lease exists with PAM SpA, a retailer with EUR 2.6 bn in sales and over 9,000 employees. Pam is owned by the privately owned financial holding Gecos. Most shops are located in the downtown area and are offering high quality food products. I do not think that these types of assets is overvalued at a 7.0% gross rental yield.

The fund holds a 100% share in so called a sub-fund (Torre Re Fund II). 41.1% of the shares are held directly and 58.9% through a SPV (Stremmata SpA). The two office properties in Milan represent one third of the fund’s NAV. As far as I understand this structure was chosen as it facilitates a disposition of the two assets to institutional investors.

The sub fund owns the property in Viale Sarca 222, which is Pirelli’s headquarter. It is located in Milan’s “Periferia Nord”. According to Nomisma, gross yields in this area range between 6.2% and 7.9%. Rents per annum and per sqm are between EUR 125 and 200. I could not figure out whether this is based on the gross or net area. Regarding the fund’s asset, management is only reporting the gross area and this translates into an annual rent per sqm of EUR 160 for Viale Sarca 222. In its reporting management also states that the rental level is 25% below the respective market index of Italian National Institute of Statistics (ISTAT).

Based on the fund’s annual report the other building (ViaMonte Rosa 91) is not owned by the fund, but there is a lease agreement with Unicredit Leasing SpA in place. The lease agreement has been valued at EUR 89.5 m. The total appraised value of the asset is currently EUR 179 m equalling a 7.6% gross yield. The property is located in the “Semicentro” of Milan where gross yields are between 6.0% and 7.8% and annual rents per sqm range between EUR 226 and 240. In its reporting management states again that the rental level is 25% below the market index Italian National Institute of Statistics (ISTAT).

Edit 1/30/2015: According to fund management the lease agreement for Via Monte Rosa 91 was terminated in Q2 2014 and refinanced with a loan at SPV level. However, I could not find this information in the latest reports.

On December 28th, 2014 the fund management reported that they received a purchase binding offer by Partners Group AG on 100% of the units of the sub fund and that they have provided exclusivity to Partners Group AG.

The two assets are long term leased to blue chip tenants and are both valued with gross yields above 7%. I assume that the sub fund can be sold with a 10% discount to appraised value.

There is only limited information available regarding the other four properties. The fund is currently awaiting approval for the redevelopment of Via Dehon, 61, in Rome to convert this building to residential use. In Milan, Via Larga 23 is a residential property where most of the units have been sold over the last years. In Piedimonte San Germano located close to the highway A1 between Rome and Naples the fund owns a shopping centre incl a hypermarket and sixty small shops. According to the latest half year reporting the centre is 83% leased. The property itself is leased to the fund’s SPV (Emporikon Srl) at a rent of EUR 0.65 m per annum. The fund does not disclose the rental income Emporikon receives from the tenants of the building, so it is difficult to come up with the rental yield for this asset. The shopping centre in Terni seems to be mostly vacant. Due to the limited information, I estimate a 20% haircut to the appraised value of each of these four assets.

Putting these assumptions all together I conclude that the realizable NAV is EUR 2,461 per share. Assuming that the Milan properties can be sold until the end of Q1 2015 and that the proceeds of EUR 830 per share will be distributed at the end of June 2015 together with the distribution of the remaining proceeds at the end of 2017 the expected IRR for this investment is 15.0% and the equity multiple 1.33x.

How to handle a potential oversupply entering the market?

As already mentioned above, assets worth more than EUR 5.0 bn will be offered to the market over the next years coming from the retail closed end funds alone. This provides a systematic risk to the supply/demand situation in the market as demand for commercial real estate over the last years has been weak though there are indications that interest from potential buyers is picking up.

However, the government has reacted and introduced some laws to mitigate the sales pressure. At the end of August the so-called “Competitiveness” Decree was approved, introducing the option of exceptionally prolonging the term of retail property funds by a maximum of two years. This option had to be exercised by the end of 2014 and allows extending the term of funds reaching maturity by 31 December 2015 until 31 December 2017. To my knowledge at least three funds (Tecla, Beta Immobiliare and Delta Immobiliare) have made use of this new legislation.

In addition to that, the government enacted a new law in September 2014 to encourage the setup of more Italian REITs (“Società di Investimento Immobiliari Quotate or “SIIQs”) to be listed on the stock exchange. Inter alia the law targets the harmonization of the tax regime applicable to SIIQs and to Italian real estate investment funds with the goal to erase any mismatch between the tax regime applicable to SIIQs and the one applicable to Italian real estate investment funds. As this article elaborates, the new legislation might give the real estate funds the opportunity to transform into a SIIQ and to avoid the liquidation of their portfolios. As a consequence, the existing shareholders could receive shares in the newly built SIIQ and a potential fire sale at the fund’s maturity could be avoided.

Conclusion

With fears about the Eurozone remerging (e.g. “Grexit”) and financial market participants desperately waiting for additional asset purchases by the ECB is it a good idea to invest in one of the supposedly most vulnerable countries?

The fact is, that the Italian property market has been neglected by investors over the last years. The market is lagging behind Spain and Ireland were market sentiment has improved substantially over the last year. Now interest from institutional investors seems to return to the market. Chances are high that at least some of the reforms targeted by the Italian government will be implemented. There is also no indication that pricing for commercial/residential real estate has been reaching an elevated level (not to mention bubble territory like in the German residential real estate market where far too low interest rates are tempting for homebuyers to overpay). In this market environment UniCredito Immobiliare Uno offers the opportunity to buy a good quality portfolio of real estate at a 25% discount to my estimation of NAV. On top of that an investor does not have to worry about creditworthiness as the fund has no debt financing in place.

In one of my last posts, I announced that I will start to accumulate a 2% position in UniCredito Immobiliare Uno with a share price limit of EUR 1,900.

Disclaimer

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!