German Residential Landlords

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1 Europe/Germany Equity Research Real Estate Research Analysts Ben Richford Marios Pastou German Residential Landlords INITIATION Demand boost from immigration outweighs risk of higher interest rates We initiate coverage of the German residential property sector with an Outperform rating on Grand City Properties (TP 20.10, c.18% upside potential), Neutral ratings on Deutsche Wohnen (TP 25.40, c.7% upside potential) and LEG Immobilien (TP 77.70, c.7% upside potential) and an Underperform rating on Vonovia (TP 29.40, c.3% upside potential). Figure 1: German residential coverage pricing summary German Residential Ticker Mkt Cap (Bn) The companies have performed strongly, with a total return to shareholders of 38% p.a. over the past two years. We expect further strong risk-adjusted returns with average 7% NAV + dividend growth over the next three years. The biggest risk, in our view, is rising interest rates for a sector with higher financial and operational leverage than many commercial property REITs. A surge in immigration is bolstering an otherwise weak demographic outlook in Germany, which we think will continue to create tenant demand for the low-cost housing provided by the listed companies. We expect this demand to generate solid LFL rental growth of 2.5% over the next three years, which, combined with further efficiency gains and declining debt costs, should generate attractive annual FFO I growth of 7% based on our estimates. Grand City is our preferred stock: Its high value-creating turnaround business model is attractive, and, although we expect growth to slow as the business matures, this should be offset partially by its highly efficient cost structure and strong balance sheet. We prefer Deutsche Wohnen/LEG to Vonovia: We prefer the combined Deutsche Wohnen/LEG to Vonovia due to the combined entity's stronger rental growth prospects, lower capex, greater operational cost efficiency and stronger balance sheet. Please click on the links below for the individual company reports. Share Price Target Price Pot. TP Upside CS Spot NAV Prem to NAV Implied Prop Yld 2016e FFO I x 2016e Div Yld Deutsche Wohnen DWNG.DE % % 4.9% 23.4x 2.6% N Grand City Properties GYC.DE % % 14.8x 2.3% OP LEG Immobilien LEGn.DE % % n/a n/a N Vonovia VNA.DE % % 5.9% 18.4x 3.1% UP Weighted Average 6% 34% 5.8% 19.8x 2.9% Prices as of 28 September 2015; Source: Credit Suisse estimates DISCLOSURE APPENDIX AT THE BACK OF THIS REPORT CONTAINS IMPORTANT DISCLOSURES, ANALYST CERTIFICATIONS, AND THE STATUS OF NON-US ANALYSTS. US Disclosure: Credit Suisse does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the Firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. CREDIT SUISSE SECURITIES RESEARCH & ANALYTICS BEYOND INFORMATION Rating Client-Driven Solutions, Insights, and Access

2 E 2016 E 2017 E 02 October 2015 Key charts Figure 2: Mass immigration is stimulating incremental tenant demand No. of people Net Immigration Emigration Immigration 1200k Figure 3: which is unlikely to generate sufficient new supply as rents are too low to incentivise developers Number of completions Housing completions (lhs) Housing stock (rhs) 600k Total Housing Stock 40m 1000k 500k 39m 800k 750k 400k 38m 600k 400k 200k 0k 83k 79k 23k 44k -56k 60k 152k 240k 352k 433k 550k 300k 200k 100k 000k 37m 36m 35m 34m -200k 04A 05A 06A 07A 08A 09A 10A 11A 12A 13A 14A 15E Source: : Eurostat; 2014: Destatis; Credit Suisse estimates Figure 4: German home ownership is low but relatively cheap capital values encourage investor demand Indexed Nominal House Price (1995 = 0) Owner Occupied % (rhs) Source: Euroconstruct, Credit Suisse research Figure 5: The sector has recently tracked the yield on the German 10-year Bund Wohnen LEG Grand City Vonovia 10 yr Bund Yield (rhs) % % 0.9% 1.2% Germany Italy Spain France United Kingdom % 1.8% 2.1% Source: OECD, Credit Suisse research Figure 6: Grand City is our preferred stock due to its track record of highly profitable turnarounds Pre-Acquisition Mid-Turnaround Stabilisation Vacancy Source: Thomson Reuters, Credit Suisse research Figure 7: which should continue to deliver peer-leading value creation even as the portfolio matures E p.a. 2 Wohnen (post LEG) Grand City Vonovia 18% 16% 15% Rent 12% 11% Irrecoverable costs Admin costs Interest 8% 4% 9% 4% 6% Net cash flow (pre-tax, pre- capex) Source: Credit Suisse research. Key: grey windows=vacant unit; Euro coin=cash inflow; crossed out Euro coin = cash outflow Total Return FFO I per share German Residential Landlords 2

3 % of Maintenance by Own Craftsmen 02 October 2015 Figure 8: Deutsche Wohnen's takeover of LEG brings together two similar business strategies Outsourced Maintenance Vonovia Insourced Maintenance 1 Wohnen Grand City LEG Management for Third Parties as % of Own Portfolio Source: Credit Suisse research Figure 10: Headcount reduction seems another obvious area on which to save costs 250 Headcount per 1bn propery value (owned and managed) Headcount (rhs) 6,500 Figure 9: but privatisations is an area where Wohnen's management sees upside potential % Gain on Disposal Wohnen LEG 13A 14A 15E 16E Figure 11: even if there doesn't seem to be much property-level duplication to remove Wohnen ( 10.3bn) LEG ( 5.7bn) 200 5, , ,600 1,300 Berlin 75% Other 25% NRW 98% 0 Wohnen (post LEG) Wohnen (pre LEG) Grand City LEG Vonovia 0 Source: Company data, Credit Suisse research Figure 12: Vonovia will spend more than Wohnen, but achieve lower rental growth LFL rent growth (bar) Wohnen Vonovia 4% Total property spend psm p.a. (diamond) 40 Figure 13: and its balance sheet is not "blue chip" LTV 6 55% Vonovia 3% 2% 1% % 4 35% Wohnen post LEG Wohnen pre LEG LEG Grand City 13A 14A 15E 16E 17E 18E 0 3 A1 0 A2 1 A3 2 Baa1 3 Baa2 4 Baa3 5 6 Source: Gagfah data, Credit Suisse research German Residential Landlords 3

4 Table of contents Key charts 2 Investment summary 5 Company comparisons 6 Track records 6 Relative valuation 6 Relative Premium / (Discount) to net asset value (NAV) 6 FFO multiples 9 Credit Suisse HOLT 10 Business models 12 Portfolios 14 Key characteristics 14 Portfolio size 15 Geographical focus 15 Rental growth 16 Maintenance and capex 17 Balance sheets 18 Economics, Demographics & Property Market Fundamentals 19 Company summaries 23 Deutsche Wohnen 23 Grand City Properties 23 LEG Immobilien 23 Vonovia (formerly Deutsche Annington) 24 Appendix 25 Key property terms, and market features 25 Third-party property valuations 26 HOLT Scorecard definitions 27 Valuation 27 Momentum 27 Financial Condition 27 German Residential Landlords 4

5 Investment summary Immigration is stimulating tenant demand Rent controls and security of tenure have long made renting appealing in Germany, and house prices that historically grew only in line with inflation for a generation reinforced its cultural acceptance. To international investors Germany has long appeared attractive as both low capital values and low owner-occupancy appear to offer upside potential. However, the chances of this international pricing anomaly correcting appeared low only a few years ago as the forecast for population decline seemed more likely to increase vacancy than stimulate demand. However, Germany has increasingly become a destination of choice for immigrants who bring with them demand for just the type of affordable housing so abundant in Germany. But constraints on new supply mean rents need to grow and / or yields tighten The typical unit owned by the listed companies was constructed during Germany's post World War II re-building and is part of a small block three or four units high. It's basic, just over 60 square metres (650 square feet), has two / three bedrooms and a dated plain white bathroom suite; the tenant installs their own kitchen, storage and furniture. Rent averages 4,100 per year and grows at a steady pace based on rent tables produced by local government. Regulation has prevented rents from growing as fast as construction costs which now means rents are generally too low to stimulate new development, acting as a significant barrier to new supply. The supply/demand dynamic and steady rent growth make this a relatively low-risk property sector. Platform efficiency and low cost of capital should expand the listed sector The listed companies own only 2% of the total housing stock, but have some of the biggest portfolios which are likely operated more efficiently than state or smaller, privately owned units. This platform advantage and access to lower-cost capital market funding make them natural industry consolidators. We expect further material portfolio expansion from the listed landlords in the coming years, which, coupled with ongoing cost rationalisation, should deliver attractive FCF growth. The financial success of potential sector consolidation would depend on the pricing of future synergies just as much as on property value. This would favour private-market M&A more than those in the public sector, in our view. Grand City offers the highest potential upside; and we prefer Deutsche Wohnen/LEG to Vonovia The four companies on which we initiate own over 8 of the total units owned in the listed sector and trade on an average 1 above 2015E EPRA NAV (3 to our Spot NAV), a 20x 2016E FFO I multiple which supports a 2.8% dividend yield. Grand City has a differentiated business model as a turnaround specialist that has made it one of the best-performing real estate stocks in Europe since its May 2012 IPO. It buys apartment blocks that are under-managed, typically with high vacancy and below-market rents, then re-positions them through intensive asset management, transforming net cash flow and greatly enhancing capital values. It has a lean operation and a strong balance sheet. Although we expect returns to reduce as the portfolio matures, we believe this is over-discounted in the share price. Deutsche Wohnen and Vonovia have both scaled up through acquisitions, most recently the 6bn proposed takeover of LEG by Deutsche Wohnen, due to complete by the end of this year. While the logic of removing cost overlap and reducing cost of capital are justified, takeover premiums erode much of the gains for the acquirer, in our view. We prefer the combined Deutsche Wohnen/LEG to Vonovia due to its stronger rental growth prospects, lower capex, greater operational cost efficiency and stronger balance sheet. German Residential Landlords 5

6 Jun-12 Aug-12 Oct-12 Dec-12 Feb-13 Apr-13 Jun-13 Aug-13 Oct-13 Dec-13 Feb-14 Apr-14 Jun-14 Aug-14 Oct-14 Dec-14 Feb-15 Apr-15 Jun-15 Aug October 2015 Company comparisons Track records Grand City has delivered by far the highest NAV growth, and we expect it to continue to outperform its peers, but by a smaller margin, over the next three years. We note that its returns are largely unrealised and unproven given few disposals. We expect Vonovia to deliver the lowest future NAV growth. Grand City's performance has been recognised with 66% per annum total returns to shareholders since its IPO, well in advance of its peers which have moved relatively closely together. Figure 14: Grand City has delivered the highest NAV+dividend returns and we expect this to continue Total Return p.a. Wohnen (post LEG) Grand City LEG Vonovia 7 Figure 15: Which should continue its impressive total shareholder return outperformance Deutsche Wohnen LEG Grand City Vonovia DAX % % 8% 19% 9% 15% 4% A E E Source: Company data (using EPRA NAV per share), Credit Suisse estimates Source: Thomson Reuters, Credit Suisse research Relative valuation Relative Premium / (Discount) to net asset value (NAV) Our company valuations are based on Spot NAV, our estimate of absolute value that consistently includes all assets and liabilities at their estimated current market value. Below are the key differences from company-reported EPRA NAV: Portfolio valuation: We mark all portfolios to market at the same date. Company valuations are below-market in our view based on transactional evidence, and comments from company management and other market participants. We note that Grand City's and Deutsche Wohnen's valuations have been updated more recently than LEG's and Vonovia's, but this is also indicative of faster price growth for these companies. We make adjustments to real estate principally to correct for the timing difference from the last valuation. This means bigger uplifts for LEG and Vonovia since they were not revalued at H1. We give LEG a bigger uplift due to expected stronger rental growth. We give a smaller further uplift to Deutsche Wohnen to reflect the strong yield compression in Berlin and a further uplift to Grand City as only part of its portfolio was revalued at H1. German Residential Landlords 6

7 Figure 16: Share prices imply that capital values are above last appraisals Capital value psm Implied* capital value Implied* gross property yield (rhs) 1,400 1,200 1, Wohnen Grand City LEG Vonovia 1 9% 8% 7% 6% 5% 4% 3% Figure 17: which is consistent with our expectations for further capital growth Valuation Company H1 reval Uplift 16% 14% 12% 1 8% 6% 4% 2% Last Co. Valn. Wohnen 30-June-15 Grand City 30-June-15 CS Uplift from H1 LEG 31-Dec-14 Vonovia 31-Dec-14 Source: Company data, Thomson Reuters, Credit Suisse estimates * Implied by replacing premium of market cap to our Spot NAV Debt: We include our estimate of the mark to market of debt. The companies generally do not disclose their own estimate; only LEG does as it reports EPRA NNNAV. We estimate that Vonovia's debt is most above market. Tax: We agree with the removal of deferred tax liabilities from EPRA NAV on the basis that these are unlikely to be crystallised. Goodwill: We exclude goodwill and intangibles. The value of future synergies are considered in our pricing model when comparing operating efficiency. This has the impact of reducing NAV for both Vonovia and Deutsche Wohnen due to recent and proposed M&A. Other: We adjust for earnings and dividends (note that all four pay dividends annually around the half-year end). Our Spot NAVs are an average of 9% below last reported company EPRA NAVs. Our Spot NAV for Deutsche Wohnen is pro forma for the acquisition of LEG; so the valuation uplift is for the combined portfolio and we strip out the goodwill on the LEG acquisition. Vonovia is pro forma for its acquisition of Südewo and its rights issue. Overall, we give the biggest uplift to LEG, mainly because its portfolio wasn't revalued at H1 and it has no goodwill to remove. Figure 18: Credit Suisse Spot NAVs are on average 11% below last reported EPRA NAVs % Real estate Goodwill Debt mark-to-market Other Total 21% 21% 11% 9% 7% % -1% -2% -1% -7% -9% -15% -14% -2-24% -26% Wohnen LEG Grand City Vonovia German Residential Landlords 7

8 Our pricing model determines relative value by considering additional future value drivers and adding or subtracting them from the average current market premium / (discount) to NAV to determine the warranted price as follows: Cost load: We consider the relative value of each platform by considering the future admin cost leakage as a percentage of asset value. Grand City is the most efficient. Available borrowing margins: We add value for access to lower margins as this is not included in the debt mark-to-market in our Spot NAV estimate. Deutsche Wohnen has access to the lowest marginal cost of debt and Grand City the highest. Tax leakage: As these companies are tax-paying non-reits, we deduct the NPV of future cash tax leakage from future value; however, these are largely sheltered by carried-forward tax losses for all companies. Balance sheet strength: We deduct value for companies with high leverage and low balance sheet flexibility. The lower leverage of Deutsche Wohnen and Grand City give them higher scores. Corporate structure: We deduct value for less shareholder-friendly corporate structures or governance. Grand City benefits the most owing to high insider ownership and a more entrepreneurial management team. External growth: We add value for expected value creation from acquisitions and capex. Grand City benefits most due to its track record of acquiring cheaply. Franchise value: We add value for expected value creation based on past performance and our understanding of the business models. Grand City scores highest due to very high past returns track record. We assume the takeover of LEG by Deutsche Wohnen completes at the current relative share price; as a result, we assign the same upside potential and rating to LEG. We also add our estimate of next year's growth in net assets to the warranted price to determine our target prices. Figure 19: Credit Suisse relative value pricing model Per Share DWNI (inc. LEG) GYC VNAN Last-Reported EPRA NAV CS-Spot NAV per share B Difference -15% 7% -2 C B/A-1 Share Price D Observed Premium to Spot NAV 35% 41% 27% E D/B-1 Average Premium to NAV 34% 34% 34% F Relative Pricing Factors (1=Best) Cost Load Available Borrowing Margins Tax Leakage =1 =1 =1 Balance Sheet Strength =1 =1 3 Corporate Structure & Governance =2 1 =2 External Growth =2 1 =2 Franchise Value =2 1 =2 Warranted Adjustment to Average -1% 8% -8% G Warranted Price H B x (1+F+G) One Year Growth Rate 8% 16% 4% I Target Price J H x (1+I) Target Price Potential Upside to Share Price 7% 18% 3% K J/D-1 German Residential Landlords 8

9 Despite Grand City trading at the highest premium to NAV, we believe it is undervalued based on our pricing model. Figure 20: The premiums to reported EPRA NAVs have been pared back since the surge at the start of this year Premium / (Discount) to NAV Wohnen Grand City LEG Vonovia 8 Figure 21: Deutsche Wohnen and LEG appear more expensive vs. our NAV compared to EPRA NAVs mainly because we exclude goodwill Prem to FY15 EPRA NAV Prem to FY16 EPRA NAV Prem to FY17 EPRA NAV Prem to CS Spot NAV % % Jun-13 Dec-13 Jun-14 Dec-14 Jun-15-2 Wohnen Grand City LEG Vonovia Source: Company data, Thomson Reuters, Credit Suisse estimates Source: Company data, Thomson Reuters, Credit Suisse estimates FFO multiples FFO (Funds From Operations) is the measure of recurring earnings reported by the German residential landlords (see Appendix for definitions). FFO is commonly disclosed in other listed real estate markets such as the US, even though the similar EPRA EPS measure is a more commonly used alternative in Europe. Like EPRA EPS, FFO is a non- GAAP measure, but it has no set rules in Europe other than precedent and is therefore open to interpretation with different methodologies adopted. Our FFO measures are standardised and in some cases differ from company-reported figures; for example, Grand City includes profit on its original cost in its FFO II rather than profit on book value. Figure 22: FFO calculation variances between companies Wohnen Grand City LEG Vonovia Best Practice No. of shares used Average Average Average Period-end Average Adjust for minority interests? Y N N N Y Adjust for equity hybrid interest? N/A Y N/A N Y Calculation traceable to the Income Statement? Y Y Y Y Y Deduct Income Statement Disposal Gains for FFO II? Y N N N Y Deduct total Capex for AFFO? Y Y Y N Y Source: Company data, Credit Suisse research In addition to measurement challenges, we believe FFO faces the following shortfalls as a valuation metric: Doesn't differentiate for quality of earnings, e.g. differences in property quality or nonproperty earnings such as third party management fees; Doesn't consider differences in capex; Doesn't adjust rental growth patterns that include uplifts every two (e.g. Deutsche Wohnen in Berlin) or three years (restricted units for LEG); Doesn't consider differences in risk, e.g. rewards high levels of leverage; German Residential Landlords 9

10 Doesn't account for improving / worsening future earnings; Doesn't consider marginal borrowing costs; and Ignores non-recurring items such as restructuring costs. Grand City has delivered the biggest increase in FFO per share in recent years and we expect this outperformance to continue with 18% p.a. on average for the next three years. Figure 23: We estimate Grand City's FFO per share will grow most over the next few years FFO I per share Indexed to FY14 Wohnen (post LEG) Grand City LEG Vonovia Figure 24: although Deutsche Wohnen is priced at the highest FFO multiple FFO I Multiple FY15E FY16E FY17E 25x 25x 23x 20x 21x 21x 21x 19x 20x 19x 15x 15x 13x 10x 5x 60 14A 15E 16E 17E 18E 0x Wohnen Grand City LEG Vonovia Source: Company data, Thomson Reuters, Credit Suisse estimates Credit Suisse HOLT HOLT is a proprietary Credit Suisse model based on standardised historical data that offers insight into relative valuations. It calculates a company's warranted price based on future discounted cash flows, which is considered a good fit for the long-term nature of real estate. The market-implied discount rate is adjusted for firm-specific risk factors. Based on HOLT, Continental Europe is one of the most attractively valued regions globally, with Japan being the most expensive. Figure 25: Continental Europe offers broadly fair value on a global comparison Source: Credit Suisse HOLT German Residential Landlords 10

11 Bottom Quartile Top Quartile 02 October 2015 Within Europe, Germany appears fairly priced, and better value than the UK, Belgium, Sweden and Switzerland. In addition, Credit Suisse's Global Equity Strategy team continues to view German residential as an attractive sector, predicated on structural undervaluation of properties relative to other European countries coupled with the expectation that Germany will continue to be one of the strongest economies in the euro-area. Figure 26: Germany offers slightly better potential within Europe Source: Credit Suisse HOLT Within the HOLT REIT scorecard, Grand City ranks in the top quartile while LEG and Deutsche Wohnen rank in the bottom quartile. Please see the appendix for the definition of the three factors we use for the HOLT scorecard. Figure 27: HOLT REITs European Scorecard September 2015 Company Name Ticker MktCap ($ bln) Scorecard Theme Ops Mom Val Overall Quintile GECINA GFCP 7.9 Best in Class HAMMERSON PLC HMSO 7.6 Best in Class PSP SWISS PROPERTY AG PSPN 3.9 Best in Class HUFVUDSTADEN AB HUFVa 2.6 Theme Neutral FONCIERE LYONNAISE FLYP 2.1 Theme Neutral GRAND CITY PROPERTIES SA GYC 2.1 Theme Neutral CA IMMOBILIEN ANLAGEN CAIV 1.8 Theme Neutral PATRIZIA IMMOBILIEN AG P1ZGn 1.8 Quality At Any Price F&C COMMERCIAL PROPERTY TRUST LIMITED FCPTL 1.8 Theme Neutral ST MODWEN PROPERTIES PLC SMP 1.5 Theme Neutral DAEJAN HOLDINGS PLC DJAN 1.5 Theme Neutral TLG IMMOBILIEN AG TLGG 1.1 Best in Class GREEN REIT PLC GN1 1.1 Theme Neutral DEUTSCHE WOHNEN AG DWNG 8.8 Worst In Class FONCIERE DES REGIONS - GFR FDR 5.3 Theme Neutral SWISS PRIME SITE SPSN 4.8 Worst In Class GREAT PORTLAND ESTATES P.L.C. GPOR 4.4 Worst In Class LEG IMMOBILIEN AG LEGn 4.3 Theme Neutral GAGFAH SA GFJG 4.3 Theme Neutral FABEGE AB FABG 2.3 Momentum Trap UNITE GROUP PLC (THE) UTG 2.2 Theme Neutral COFINIMMO S.A. COFB 2.1 Worst In Class BENI STABILI SPA BNSI 1.7 Theme Neutral LONDONMETRIC PROPERTY PLC LMPL 1.6 Theme Neutral KUNGSLEDEN AB KLED 1.2 Theme Neutral CONWERT IMMOBILIEN INVEST SE CONW 1.1 Worst In Class Source: Credit Suisse HOLT Last Month's Score German Residential Landlords 11

12 % of Maintenance by Own Craftsmen 02 October 2015 Business models All the companies except Grand City have their heritage from either state or corporate housing providers which were made more efficient by private equity owners before public market listings. Grand City's lack of legacy structure appears to be an advantage. Each of the companies has invested in computerised ERP systems which helps them manage processes and capture data. While this is a sunk cost, it would also be a valuable asset when competing with smaller, less sophisticated landlords. All the companies perform the core landlord functions of capital allocation and asset management internally, thereby controlling the decisions of which properties to own, who rents them and how they are maintained. They all operate a central customer call centre to assist with customer service and use third-party internet portals such as ImmoWest24 to market properties online. However, the companies have different approaches to how many additional functions should be performed by their own employees, with the biggest contrast between Vonovia which internalises as much as possible and Deutsche Wohnen which pursues the most outsourced model. Figure 28: Vonovia pursues the most in-sourced business model Vonovia Insourced Maintenance Figure 29: with a correspondingly high staff count when compared with peers 250 Headcount per 1bn propery value (owned and managed) Headcount (rhs) 6, , , Outsourced Maintenance 1 Wohnen Grand City (pre LEG) LEG Management for Third Parties as % of Own Portfolio Wohnen (post LEG) Wohnen (pre LEG) Grand City LEG Vonovia Each of the companies has a headcount of at least 500 which includes central functions and locally staffed offices. Vonovia has the highest number of employees, both in absolute terms and in relation to the size of its portfolio. It has brought more than half of its maintenance in-house by directly employing c.1,900 "craftsmen" who have skills such as electrical and plumbing to maintain its properties. In addition, Vonovia has expanded its central office skills to include expertise in finance, valuation and the procurement of everything from telecommunications to bathroom suites and windows. By standardising processes and performing them on an industrial scale, it aims to improve efficiency and lower per unit costs as well as save VAT and profit paid to third-party management firms. Grand City and Vonovia also manage properties on behalf of third parties which we consider is low margin and a potential management distraction. In contrast, Deutsche Wohnen management prefers to employ third parties to maintain its properties and does not pursue the breadth of activities chosen by Vonovia. LEG has a similar stated strategy and business model to Wohnen. Its rationale is that these activities are non-core and a management distraction. In addition, efficiency is assumed to come from creating competition for services from external providers who provide low-margin services. 2,600 1,300 0 German Residential Landlords 12

13 Comparing company efficiency of central services and property operating costs separately is complicated by the differences in business models and disclosure. However, we expect central overhead costs to fall as a percentage of rents as the companies acquire more assets. Comparing recurring EBITDA as a percentage of rent is probably the best way to compare the combined efficiency of property operations and central overhead, although we note that this measure favours higher-yielding portfolios. On this comparison, Grand City appears to operate the most efficient platform and Vonovia should see the biggest improvement as synergies from its acquisitions materialise. Figure 30: We expect further improvements in overhead cost as a % of rent Overhead margin Wohnen (post LEG) Grand City 25% Figure 31: which will feed into improved EBITDA margins, with Grand City appearing the most efficient Recurring Op. Profit Margin 9 Wohnen (post LEG) Grand City Vonovia % 1 7 5% 6 12A 13A 14A 15E 16E 17E 18E Note: Vonovia excluded due to difficulty in separating corporate overheads and maintenance-related costs, especially staff 5 13A 14A 15E 16E 17E 18E Deutsche Wohnen and Vonovia pursue privatisations (the sale of individual units to owneroccupiers) which appears to be a sensible strategy given attractive premiums to valuations of blocks. Deutsche Wohnen has stated that it intends to roughly double its privatisation programme by applying this strategy to the LEG portfolio. We also note that reported gross margins generally ignore (5-6%) sales costs as well as the cost and effort of splitting up blocks. Privatisations also run the risk of creating a block containing residual unsold units that can become inefficient to own and manage. Figure 32: Both Deutsche Wohnen and Vonovia have active privatisation programmes Volume of Privatisations (Sales Proceeds) m % Disposals as Privatisations (rhs) A 13A 14A 15E 16E 17E 12A 13A 14A 15E 16E 17E Wohnen (post LEG) Vonovia 63% 56% 49% 42% 35% 28% 21% 14% 7% Figure 33: which help both generate significant margins over book value on all disposals % Net Gain on Disposal Wohnen (post LEG) Grand City LEG Vonovia 13A 14A 15E 16E German Residential Landlords 13

14 Portfolios Key characteristics The companies generally own small apartment blocks mostly built in the two decades following World War II (e.g. 6 of Vonovia pre-the Gagfah acquisition which completed earlier this year). Average unit size is fairly uniform at 62 sqm (670 sf), which most often means two bedrooms. Units are usually rented unfurnished and the tenant supplies their own kitchen units and appliances which is made feasible by strong security of tenure and long average stay of over 10 years. Bathroom suites and windows are generally the landlord's responsibility. Rents average 5.50 psqm per month which equates to 4,100/unit/year. Rents rarely exceed 10 psqm premium rents are usually reserved for premium properties in the metropolitan areas of Munich and Frankfurt. Tenants typically pay utilities and service charges of around 4 of rent on top, making average total occupancy costs of 5,750 per year. The three bigger players have modest vacancy of 2-4%, whereas Grand City's business model of buying under-managed properties means that it has a higher vacancy of 12%. Reducing vacancy often involves additional expenditure by the landlord, but also the prospect of improving cash flow by increasing aggregate rents as well as reducing the share of service charge borne by landlords. Average value per unit is 62k, which, by comparison, would buy about one square metre in prime areas of central London. Figure 34: Key portfolio statistics Wohnen (plus LEG) Wohnen (current) Grand City LEG Vonovia Average Net Cold Rent psm pcm Yield % 6.5% % 6.7% 6.5% Vacancy % 2.6% 2.1% % 3.5% 3.4% Portfolio Value bn Portfolio m sm Total Units k Average size sm Capital value psm 1,011 1, ,004 1,021 Value/unit k per unit Source: Company data, Credit Suisse research German Residential Landlords 14

15 Increasingly Urban 16E 17E 18E 19E 16E 17E 18E 19E 16E 17E 18E 19E 02 October 2015 Portfolio size The four companies have doubled portfolio size in the past four years, adding over 350k units, although more than half of this came from the acquisition of listed peers. Relatively efficient platforms and access to competitively priced capital make the listed landlords the natural buyers of portfolios from smaller private and state owners, which we expect to be the source of further portfolio additions, especially given the high proportion of small, private investors in Germany. Figure 35: We expect the group to expand towards 1m units in the coming years Units LEG Wohnen (post LEG) Grand City Vonovia 1,000k Figure 36: with Vonovia being the most active Acquisitions Volume Disposals Volume Acq. Yield (rhs) Disp. Yield (rhs) 5bn 11% 800k 600k 4bn 3bn 2bn 7% 4% 400k 1bn 4% 200k 0bn 7% - 1bn 11% 0k 11A 12A 13A 14A 15E 16E 17E 18E 19E Wohnen (post LEG) Grand City Vonovia Source: Credit Suisse estimates Geographical focus Vonovia pursues a pan-germany strategy which seems to fit with its scale ambitions. Grand City also pursues a pan-germany strategy, but appears to be more explicitly focused on urban areas than Vonovia. Wohnen's Berlin concentration will be diluted by LEG; Berlin currently dominates Wohnen's portfolio. Despite LEG being the most geographically focused with its concentration in the state of North Rhine Westphalia (NRW), we believe it is the least concentrated in urban areas. Deutsche Wohnen's 75% exposure to Berlin and its Frankfurt portfolio give it the biggest exposure to metropolitan areas and we believe this is a key determinant of its high rental growth expectations. We note that these are difficult to quantify and are our assumptions based on company disclosure and discussions with market participants. Figure 37: LEG and Deutsche Wohnen will lose their attractive geographic focus when they combine 10 Berlin Former East Germany (excl. Berlin) Figure 38: which will also dilute Deutsche Wohnen's urban concentration NRW Former West Germany (excl. NRW) Wohnen (pre LEG) 8 6 Grand City Wohnen (post LEG) 4 2 Vonovia Wohnen (post LEG) Wohnen (pre LEG) Grand City LEG Vonovia LEG Source: Company data, Credit Suisse research Source: Credit Suisse research German Residential Landlords 15

16 Rental growth Like-for-like rental growth before vacancy improvement has averaged mid-2% for both LEG and Deutsche Wohnen for the past six years. Despite the new rent control measures introduced in each of their core markets recently, we expect future rental growth to be maintained at past levels at least given strong tenant demand. Tenant churn often requires capital expenditure to refurbish units, but also creates the opportunity in some cases to improve rents. Churn rates are generally not disclosed, although we understand average tenure is over 10 years; i.e. less than 1 of units are vacated each year. Vonovia's markets appear to offer lower like-for-like rental growth prospects than Wohnen's or LEG's on average. Vonovia's management expects underlying market growth of c.1.4% (consistent with the 1.4% p.a. achieved by Gagfah over the past six years), which it expects to boost to only 2.3% with substantial investment (see Figure 41). Rent restrictions apply to about a third of LEG's portfolio which hampers annual rental growth, but offers longer-term reversionary potential as these properties are about 25% below market. The companies generally don't disclose rent reversion, but Wohnen does disclose the premium achieved on new rents over existing and, at an average of c.25%, this suggests a strong underlying market even if this compares newly refurbished units with older stock. Grand City's properties are likely to deliver the greatest improvement in like-for-like rental income in our view as mid-2% rental growth is expected to be boosted by significant vacancy reduction. Figure 39: Steady rental growth is a feature of the German residential sector 4% 3% Wohnen (post LEG) Wohnen (pre LEG) Grand City LEG Vonovia Figure 40: Vacancy reduction is likely to help Grand City improve its rent roll the most % Vacancy Wohnen (post LEG) Grand City Vonovia 16% 14% 12% 1 2% 8% 6% 1% 4% 2% 13A 14A 15E 16E 17E 18E 19E 13A 14A 15E 16E 17E 18E 19E German Residential Landlords 16

17 11A 12A 13A 14A 15E 16E 17E 18E 11A 12A 13A 14A 15E 16E 17E 18E 11A 12A 13A 14A 15E 11A 12A 13A 14A 15E 16E 17E 18E 02 October 2015 Maintenance and capex The peer group incurs routine maintenance costs for items such as fixing broken electrics or plumbing of c. 8 psqm per year on average, which generally doesn't increase rents or add to property value and is expensed in the income statement. Deutsche Wohnen and Vonovia each spends over 8 psqm, considerably higher than Grand City at around 6 psqm, although the gap is closer as a percentage of rental income or value. On average, maintenance reduces rental income by c.12%. Deutsche Wohnen has been spending more than LEG psqm but a similar amount as a percentage of value. The group also spends about 8 psqm per year on "modernisation and capex" that enhances value either through higher rents or by attracting new tenants and is typically capitalised. Although renovating vacant units accounts for much of the costs, it also includes building improvements such as new cladding or extensions. Vonovia is expected to be the biggest spender averaging 18 psqm (c.1.7% of capital value per year). Figure 41: Vonovia is spending significantly more than peers and we expect this high rate to be maintained psm p.a. Maintenance Modernisation and Capex Capitalised Spend % (rhs) 35 65% 30 6 Figure 42: partly to improve the quality of the Gagfah portfolio which was underinvested in the recent past psm Underinvestment (below 15 psm) Other 20 Modernisation Maintenance Wohnen (post LEG) Grand City LEG Vonovia 55% 5 45% 4 35% Source: Gagfah data, Credit Suisse research German Residential Landlords 17

18 Balance sheets Grand City and Deutsche Wohnen have lower leverage targets than Vonovia at 5. Grand City and Vonovia have both issued bonds and hybrid debt (and convertibles for Grand City); Deutsche Wohnen appears to have scope to expand its use of the capital markets, especially given its superior credit rating. Deutsche Wohnen's proposed takeover of LEG is an all-share offer. Figure 43: Vonovia has a 5 LTV target; Deutsche Wohnen and Grand City are more conservative LTV% Wohnen (post LEG) Grand City LEG Vonovia 6 Figure 44: Grand City has the most diversified sources of debt, mostly from the capital markets Bank debt Straight bonds Convertible bonds Hybrids A 13A 14A 15E 16E 17E 18E (S&P / Moody's) Wohnen (post LEG) (A- / A3 under review to upgrade) Wohnen (pre LEG) (A- / A3) Grand City (BBB / Baa2) LEG (-- / Baa1 under review to upgrade) Vonovia (BBB+ / --) Source: Company data, Credit Suisse research Deutsche Wohnen currently has the highest credit rating, one notch above LEG and Vonovia, and this is under review for an upgrade following the LEG acquisition announcement. We see this as a good proxy for the relative marginal cost of borrowing. Grand City's management has stated that it aspires to the same rating as LEG and Vonovia, which would be an improvement of two notches. Although weighted average cost of debt is distorted by the quasi-equity instruments (generally up from hybrids, down from convertibles), we estimate the impact is small, at most flattering the calculation for Wohnen by 35bps, which we estimate has the lowest rate along with Grand City. Interest rate risk is largely hedged for all the companies. Figure 45: Vonovia has the highest cost of debt, even adjusting for higher-cost hybrids Figure 46: Grand City's debt has the shortest duration; Vonovia has 5bn of CMBS debt expiring in Wohnen (post LEG) Grand City LEG Vonovia % Debt Expiring To onwards Av. Maturity (years) (lhs) % % % 1. 14A 15E 16E 17E Source: Company data (includes quasi-equity), Credit Suisse estimates Wohnen (post LEG) Wohnen (pre LEG) Grand City LEG Vonovia Source: Company data, Credit Suisse research 0 German Residential Landlords 18

19 Private sector debt, % of GDP Higher debt 02 October 2015 Economics, Demographics & Property Market Fundamentals Germany has Europe's largest population (83m) and largest economy. Unemployment is low and continues to decline; GDP per capita is amongst the highest. Figure 47: Employment rates are high and steadily increasing; well ahead of the EU average Working Age Employment Rate Germany UK France EU Average 8 78% 76% 74% 72% 7 68% 66% 64% Source: Eurostat, Credit Suisse research Figure 48: which supports relatively high and growing GDP per capita Germany France United Kingdom GDP per capita - EU= Source: Eurostat, Credit Suisse research Personal finances are strong due to a high savings rate, but home ownership is also low. Figure 49: Household finances are strong 23 Netherlands Belgium Figure 50: but housing wealth is lower Owner- Occupier % UK Spain France Less saving Italy Germany 1 9-1% 1% 2% 3% 4% 5% Household financial surplus, % of GDP Germany Average 2011 Germany Average 2013 UK Average 2013 EU Average 2013 Source: Thomson Reuters, Credit Suisse research Source: Federal Statistical Office, Credit Suisse research German Residential Landlords 19

20 Growth in home ownership could be supported by an ageing population as renting becomes less attractive. Household formation has been rising steadily over the past 15 years even during the post-millennium population dip. Figure 51: As with many Western countries, Germany's population is ageing Median Age (yrs) Figure 52: and household formation has been increasing, even during a period of population decline Total Population Higher Life Expectancy Assumption (lhs) No. of Households 83.5m Total Population (lhs) 42m No. of Households (rhs) 83.0m 41m Source: Eurostat, Credit Suisse research 82.5m 82.0m 81.5m 81.0m 80.5m 80.0m Source: Euroconstruct, Credit Suisse research 40m 39m 38m 37m 36m 35m Germany's birth rate is low and forecasters have predicted this could lead to a repeat of the population decline in the mid-to-late 2000s (see Figure 52), though this may not materialise if immigration continues at the current pace. Figure 53: A low birth rate is a major demographic challenge Birth Rate per 1000 Birth Rate - Germany Birth Rate - EU Average 12 Figure 54: but can be offset by strong net immigration since 2009 which is forecast to continue No. of people Net Immigration Emigration Immigration 1200k k k 600k 400k 200k 0k 83k 79k 23k 44k -56k 60k 152k 240k 352k 433k 550k 750k Source: Eurostat, Credit Suisse research -200k 04A 05A 06A 07A 08A 09A 10A 11A 12A 13A 14A 15E Source: : Eurostat; 2014: Destatis; Credit Suisse estimates German Residential Landlords 20

21 E 2016 E 2017 E 02 October 2015 Much of Germany's apartment supply was built in the post-world War II decades, so is roughly 50 years old and mass produced. Low rents make the construction of new apartments uneconomic in many areas, which means supply is unlikely to react strongly to any pick-up in demand. Figure 55: Around 4 of the stock was built in the 30 years post World War II; less than 1 was built in the past 15 years % Residential built in the period 45% Figure 56: Housing completions have been picking up, but remain low Number of completions Housing completions (lhs) Housing stock (rhs) 600m Total Housing Stock 40m 4 35% 500m 39m 3 400m 38m 25% 2 300m 37m 15% 200m 36m 1 5% 100m 35m m 34m Source: Federal Statistical Office, 2011 micro-census, Credit Suisse research Source: Euroconstruct, Credit Suisse research Renting is culturally accepted in Germany, owing mainly to the security of tenure and modest rents. Although these rents are beginning to rise, they still remain low in comparison with other countries, and the government has implemented controls in an attempt to reduce the effect on household spending. Figure 57: Germany's housing market is the cheapest in Europe, well below the euro-area average Figure 58: and housing expenditure as a percentage of disposable income is also low 160 House Price-to- Income Ratio 100 = Long term average 3 25% % Disposable Income spent on Housing % % 0 Source: OECD, Credit Suisse research Source: OECD, Credit Suisse research German Residential Landlords 21

22 H H H H H H H H H H H H H H H H H H H H H H H October 2015 Rents have been rising across Germany after a period of decline and stagnation post 2000 with an average increase of 1.7% p.a. over the last 10 years according to JLL. However, rents in Germany's big cities have grown much more strongly, such as the 3.8% p.a. recorded in Berlin. Investor interest has also picked up after a slump during the downturn, with the listed companies significant participants. Figure 59: Rents have been rising especially strongly in metropolitan areas such as Berlin Rent psm Average Berlin rent (median) Figure 60: Transactional volume has been growing Market volume (no. of units) Source: JLL Source: JLL German Residential Landlords 22

23 Company summaries In aggregate, the four companies account for over 8 of the German residential properties owned by the listed sector. Please see the company reports for more detail. Deutsche Wohnen (link to Deutsche Wohnen report) Deutsche Wohnen owns 142k residential units valued at over 10bn which are 75% concentrated in the dynamic Berlin market, helped by its acquisition of Berlin-focused listed peer GSW in The company was floated in 1999 by its former fund manager, Deutsche Bank RREEF, which pursued a business model centred on privatisations of individual units. It suffered during the downturn due to high leverage and has recently adopted a more conservative leverage policy. Deutsche Wohnen has embraced an outsourcing business model, preferring to buy in property management and renovations from local providers and recently spun off its nursing home operating business. Management recently announced the takeover of LEG which will increase owned residential units to c.250k worth around 17bn. The portfolio weighting in Berlin will decrease to 48%, NRW will become 36% and Rhine-Main roughly 6% the three largest regions of the company post the LEG acquisition. Grand City Properties (link to the Grand City report) Grand City Properties owns a 66k unit portfolio valued at over 3bn which is 32% located in North Rhine Westphalia, 17% in Berlin, 21% in Dresden / Leipzig / Halle and 3 elsewhere. The company was established by London-based financier Yakir Gabay in 2004 and has seen exceptional growth since, funded initially by private investors, before accessing public equity and debt through its May 2012 IPO. A public holding company controlled by Mr Gabay, Roundhouse Capital retains a 34% equity interest in Grand City. The business has enjoyed high real estate returns by acquiring under-managed assets, sometimes from distressed sellers, for low capital values and improving them through a combination of capex and intensive management. As the company grows to improve operational efficiency, the proportion of high-return potential turnaround assets is diluted. LEG Immobilien (link to the LEG Immobilien report) LEG owns 110k residential units valued at 6bn at H1 which are geographically focused in Germany's economic heartland of North Rhine Westphalia with major holdings in Dortmund (11%), the District of Mettmann (1), Münster and Düsseldorf (5%). The company was seeded in 2008 when c.7 of the current portfolio was acquired from the state of NRW by Goldman Sachs and private equity company Perry Capital. The seed portfolio came with a restrictive covenant ("social charter") that stipulated minimum annual investment and employee rights which expires in The Goldman / Perry business plan to cut operational costs through combining disparate companies was largely executed before its IPO in January It has since grown through piecemeal, bolt-on portfolio acquisitions. Management recently recommended the takeover by Deutsche Wohnen, which is expected to close at the end of German Residential Landlords 23

24 Vonovia (formerly Deutsche Annington) (link to the Vonovia report) Vonovia is the largest listed German residential landlord with c.370k units valued at 23bn (including the Südewo acquisition). The portfolio is geographically diversified across Germany with significant concentration in North Rhine Westphalia (32%), Hesse and Saxony (1 in each region) and Berlin (9%). Vonovia has grown aggressively through a series of large portfolio acquisitions, most notably the listed company Gagfah with 144k units acquired in December Gagfah was controlled since its IPO by private equity company Fortress until it exited its investment in It had a poor downturn precipitated by refinancing uncertainty and subsequently cut expenditure on its properties substantially. Vonovia recently entered the index of Germany's largest corporates, the DAX 30, two years after being floated by former private equity owner Terra Firma in July Terra Firma established the company in 2001 with a 65k unit portfolio acquired from state railway company Deutsche Bahn and added a 140k unit portfolio from energy company E.ON in Like other private equity owners it pursued a strategy of privatisations. Management's claim that its platform could manage a million units suggests that further acquisitions are likely; these could focus on private or state owners given that Vonovia's CEO has recently played down press reports surrounding further acquisitions of other listed players (Handelsblatt, 27 August 2015). Management's belief in economies of scale extends to an internalisation of processes including employing its own "craftsmen" to maintain and improve its properties as well as the bulk procurement of materials such as windows and bathroom suites as well as ancillary services such as telecommunications services. German Residential Landlords 24