Fair Value: EUR (-)

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1 InCity AG Recommendation: BUY (initiating coverage ) Risk: MEDIUM(-) Fair Value: EUR (-) 31 st March 2008 InCity promises high profitability InCity is a young company, launched at the end of The focus of its activities is residential real estate in city-centre locations in Germany offering a lifestyle choice for clients with high purchasing power. The company is therefore a niche player. InCity is a pure project developer. The capital lock-up seems limited and the profitability much higher compared with other German real estate companies. InCity currently reports half-yearly rather than quarterly results, and did it under German-GAAP (HGB) until the 1H07. It switched to IFRS accounting rules with the release of its FY2007 figures these days. The sales revenues of the InCity group increased by 119% to 53.4m for FY2007 compared to FY2006. EBIT (excluding IPO costs) increased by 152% to 7.3m for FY2007 and exceeded the company target of 7.0m. InCity intends to start dividend payments by 0.25 per share for FY2007. InCity has developed well but this has not been reflected in the share price performance since the IPO in March Reasons for the rather disappointing development are not company specific but instead clearly lie in the US subprime crisis and its consequences. Investors are likely to remain concerned for the next few months. But the German real estate market has not deteriorated and it does not look like doing so this year, especially not in InCity s niche. InCity shares therefore seem rather cheap compared with other real estate companies based on fairesearch s evaluation. Our price target is per share. The current share price represents a discount of around 70% on the target. The strongly growing project pipeline could lead to outstanding RoE after tax of over 40% in e. We place a BUY recommendation on InCity. Share price (dark) vs DJEuroStoxx (1 yr) Source: CBS Research AG, fairesearch, Deutsche Börse Internet: WKN: A0HNF9 Bloomberg: IC8:GR Share data: Share Price: Market capitalisation: Ø daily trading volume: Performance data: High 52 weeks: Low 52 weeks: Absolute performance (12 months): Relative performance (TecDax): 1 month 3 months 6 months 12 months Shareholders: Free float: Family Peto: Klaus Prokop: Thomas May: others: Sector: Real Estate ISIN: DE000A0HNF96 Reuters: IC8Gn.DE EUR 6.90 EUR 17.3m 2,300 EUR 9.50 EUR % 0.8% 4.2% 4.9% 5.9% 20% 37.5% 33.5% 2.0% 6.9% Management Board: André Peto Klaus Prokop Key data Y/E , EUR m E 2009E 2010E Revenues EBITDA EBIT Net profit EPS EV/EBITDA EV/EBIT P/E Source: CBS Research AG, fairesearch, company data Supervisory Board: Stefan Eishold Nils Erichsen Wilfried Widmann Close Brothers Seydler Research AG Phone: +49 (0) info@cbseydlerresearch.ag Close Brothers Seydler AG Institutional Sales: Germany: Uwe Gerhardt Phone: +49 (0) France: Bruno de Lencquesaing Phone: +49 (0) Close Brothers Seydler Ltd. Institutional Sales: United Kingdom: Ernie Ferriday Phone: +44 (0) InCity AG has contributed to this report, Information sourced from fairesearch Analyst Dieter Hein Close Brothers Seydler Research AG 1 Please notice the information on the preparation of this document, the disclaimer, the advice regarding possible conflicts of interests, and the mandatory information required by 34b WpHG (Securities Trading Law) at the end of this document. This financial analysis in accordance with 34b WpHG is exclusively intended for distribution to individuals that buy or sell financial instruments at their own account or at the account of others in connection with their trading activities, occupation, or employment.

2 Investment Summary Strengths Business niche with a clear focus on a promising client group Geographic focus on residential city-centre locations Project development with standardised handling procedures The capital lockup in the project development business seems limited, as InCity starts to sell units after the planned projects are agreed by contract Weaknesses Young company that does not yet offer the level of transparency investors like The success of the company depends on a few people No quarterly reporting Small market cap and low free-float of 20% may be too minor for institutional investors Opportunities German real estate market still looks underdeveloped compared with other European markets Growing project pipeline in an improving medium-term business environment for the real estate sector and the German economy Expansion of business segments offers synergy potential Threats Rise in interest rates increases funding costs Investors interest in the German real estate market could weaken further As a real estate company, it is exposed to market- and sector-specific risks InCity may grow too fast Close Brothers Seydler Research AG 2

3 Valuation To assess the fair value of InCity fairesearch carried out a valuation based on multiple comparisons, an earnings discount model and its WACC model. The company focuses on residential real estate in Germany. The peer group analysed by fairesearch therefore consists of five real estate companies that also focus on residential real estate in Germany. However, the business of InCity is somewhat special: it is a pure project developer. The business mix and focus of the specific peer group companies includes project development too but also other operations, so the peer group comparison is therefore somewhat limited in our view. Business mixture limits peer comparison The peer group comparison shows that the companies multiples differ considerably. This could be due to differences in their business mix, strategy, prospects, track record and free float and in market confidence in management skills. We therefore compared InCity s figures with the peer group average. The forecasts for InCity are fairesearch estimates, while the peer group forecasts are based on consensus and market figures. Our P/E-based multiples valuation suggests that InCity is undervalued. The target share price ranges from 9.20 for 2007e to for 2009e, based on the peer group average. The average target price for the 2007e-2009e period would be per share. Multiples comparison of major competitors (2007E 2009E) Company Price in Market cap m EPS`07 EPS`08 EPS`09 P/E`07 P/E`08 P/E`09 ALTA FIDES Deutsche Wohnen Franconofurt PATRIZIA Immobilien Vivacon Average InCity Based on average Source: CBS Research AG, fairesearch, Börsenzeitung, HSH NORDBANK The EV/EBITDA valuation indicates too that InCity is undervalued. The potential target price ranges from 8.1 per share for 2008e to 9.6 for 2009e. The average target price for the 2007e-2009e period would be 9.0 per share. EV/EBITDA comparison ( E) EV/EBITDA 2007E 2008E 2009E ALTA FIDES Deutsche Wohnen Franconofurt PATRIZIA Immobilien Vivacon average InCity based on average Source: CBS Research AG, fairesearch, HSH NORDBANK Close Brothers Seydler Research AG 3

4 In addition, fairesearch calculated a per-share net asset value (NAV) for the real estate portfolio of InCity. The calculated figure is a NNNAV (ie market value minus deferred taxes on capital gains). We estimate the market value of InCity s real estate portfolio to be around 10% above the book value. We deducted a tax rate of 30% for deferred tax liabilities on the forecast capital gains as well as some sales commissions and other costs. The NAV evaluation is a good tool for pure real estate portfolio investors with a buy-and-hold strategy. The value-added for the project development business of InCity seems limited, and also differs considerable for the specific peer group companies. Based on fairesearch s 2008 estimates, the potential target price for InCity s NAV is 6.30 per share. NAV comparison ( E) NAV 2007E 2008E 2009E P/NAV 2008E ALTA FIDES Deutsche Wohnen Franconofurt PATRIZIA Immobilien Vivacon Average InCity Based on average 6.3 Source: CBS Research AG, fairesearch, HSH NORDBANK We also evaluated InCity using our shareholder profit model, which is an earnings discount model. We decided to opt for this rather than a DCF model because the cash flow of a real estate company is often strongly influenced by inventory investments and disposals. Such cash flows are particularly hard to forecast. In fairesearch s view, the earnings discount model is a more reliable means of valuing that business. We calculate a fair value of per InCity share. One of our valuation tools is our WACC model, which is an EVA (economic valueadded) model. This model first checks whether a company generates enough operating income (including gross interest income but before interest on pension provisions) to cover the costs of both pensions and financial debt. These financing costs are deducted from the operating result, and the balance divided by the number of shares. Finally this result is compared with the company s current share price. The table below details fairesearch s assumptions and calculations. The WACC model yields an average target price for 2007e to 2009e of 44.7 per share. But the calculation includes some uncertainties as there is no company-specific ß available. We took therefore the average of some other German real estate companies. The average ß of 10 real estate companies of MDAX and SDAX were We calculated a premium for micro-companies and assumed a ß of 1.3 for InCity. Close Brothers Seydler Research AG 4

5 WACC Model m E 2009E Total Equity Gross Finan. Debt Pension Provisions Capital Employed (C/E) Cost of Capital: Risk Free Rate 4.30% 3.94% 3.94% Risk Free Premium 4.50% 4.50% 4.50% Beta* Cost of Equity (at) 10.15% 9.79% 9.79% Tax Rate 40.00% 27.00% 22.80% Cost of Equity (bt) 16.92% 13.41% 12.68% Debt Rate Premium Cost of Debt 5.38% 4.93% 4.93% Cost of Pension Prov. 6.00% 6.00% 6.00% Pre-tax WACC 7.97% 7.03% 7.43% EBIT Gross Interest Income Interest of Pensions Adjusted EBIT Market Value of C/E Gross Debt Minority Interest Pension Provisions Market Value of Equity Value per Share AVERAGE (07E-9E) 44.7 Source: CBS Research AG, fairesearch, * no company specific ß available InCity looks undervalued according to our peer group comparison based on P/E ratios, EV/EBITDA and NAV analysis, as well as on our shareholder profit and WACC models. The different valuation methods we used yielded fair values that ranged from 6.30 to per share for 2007e to 2009e. The average target price is per share and we have adopted this as our fair value. InCity price per share by different evaluation methods P/E valuation 14.2 EV/EBITDA 9.0 NAV (2008E) 6.3 Shareholder profit model 35.4 WACC model 44.7 Average price per share 21.9 Source: CBS Research AG, fairesearch Close Brothers Seydler Research AG 5

6 InCity shares do not look expensive relative to other real estate companies. However, the whole sector has underperformed in 2007 and 2008 to date after a strong performance in The weakness of some real estate markets, such as the US, UK and Spain, seems to be taking its toll on institutional investors interest in the real estate market as a whole. The global financial turmoil caused by the socalled US subprime crisis has been a disaster for real estate companies. But the German real estate market has not deteriorated and it does not look like it will do so this year. InCity shares therefore seem rather cheap compared with other real estate companies. InCity is growing strongly and expanding in its business niche. It is a very young company, with no track record of its own; but the two members of the board, who are the majority shareholders, brought in their former real estate business and their business track record. Investors in InCity shares must therefore be convinced by the skills of the management and its business model, which we assess as very attractive: our forecasts place InCity s profitability much higher than that to competitors and other German industrial sectors. We estimate a RoE after tax level of between 44% to 51% for 2007 to 2010e. This is clearly above the international threshold rate of 15%. The average target price is per InCity share and we have adopted this as our fair value. This represents upside potential of more than 100% from the current price per share. Price target of per share and RoE above 40% Close Brothers Seydler Research AG 6

7 Company Profile InCity AG is a comparatively young company. It was set up in November The first capital increase was in July 2006 and mainly consisted of assets in kind from the two members of the board who brought in their former real estate business and their business track record. Another capital increase of 500,000 new shares resulted from the IPO at 9.25 per share. The company has been listed at the Entry Standard on the German stock exchange since March The focus of its activities is residential real estate in city-centre locations in Germany. InCity has stated that it specialises in the planning and construction of highquality properties in central urban locations and enriches the residential spectrum with a lifestyle aspect for clients with high purchasing power. The company is therefore a niche player. Focus on residential real estate The company has a clear growth strategy. The IPO helped the company to gather the funds needed to finance the expansion of business volumes and the business model. InCity is now actively operating in four business areas: own project development, joint venture project development, real estate services and inventory optimizer. Types of buildings acquired 2006; total 34,000 sqm Types of buildings acquired 2007; total 94,000 sqm 33% 36% 37% 40% 31% 23% Old buildings Listed old buildimgs New buildings Old buildings Listed old buildimgs New buildings Source: CBS Research AG, fairesearch, InCity Source: CBS Research AG, fairesearch, InCity In December 2007 InCity announced that the members of the board had acquired another 3.74% from other shareholders. In addition, the member of the board and other core shareholders extended the lock-up period until the end of The company s main owners are the two members of the board, Andre Peto (and his family) and Klaus Prokop, at 37.5% and 33.5% respectively. The free-float is only 20%. The shareholder structure is detailed in the chart on the next page. Close Brothers Seydler Research AG 7

8 Shareholder structure of InCity AG 2% 7% 20% 33% 38% Free float Family Peto Klaus Prokop Thomas May Other Source: CBS Research AG, fairesearch, InCity Most young companies face some problems because they lack transparency and a track record, and in this is also the case for InCity. The company reported under German GAAP (HGB) until 1H07 and only publishes half-year and full-year reports, which makes it more difficult to compare it with its peer group, all of which reports under IFRS accounting rules. International institutional investors in particular are unlikely to be interested in investing in a company which reports under German GAAP. InCity therefore switched from HGB to IFRS for the FY2007 report. In addition, the company wants to switch from a stock listing at the German Entry Standard (risk capital for young companies) to a listing on the EU-regulated market. InCity does not currently intend to change from its six-monthly reporting periods to quarterly reporting. There may be no need to switch from a business standpoint, as a property project s development period is between 12 to 18 months; but quarterly reporting is an industry standard. InCity split up its business into two segments by 2008: Project Development and Real Estate Investment Services (REIS). Old sub-segment Services was restructured and belongs now to REIS. Close Brothers Seydler Research AG 8

9 Group structure of InCity Source: CBS Research AG, fairesearch, InCity Project Development InCity s business focus is the planning and realisation of high-quality residential real estate in city-centre locations in big German cities and growth regions. InCity says it covers the complete value chain of its business: project research, real estate due diligence, management and control of the value-added process, and sales distribution. InCity is not a real estate investor and therefore does not hold a portfolio of property. The acquisition of the project properties is strictly sales oriented. InCity does only projects which development process fits into its standardised handling procedures. The cost development of the projects is controlled by a database -assisted system. Under InCity s investment criteria, a property it acquires must: Minimum return of 18% be marketable, as confirmed by its sales department; suit standardised project handling; have a good to very good city-centre location; pass due diligence; have potential for being extended; Close Brothers Seydler Research AG 9

10 have a ceiling height at least 2.75 metres, even in new buildings; have good natural light; have a potential net yield of at least 18%, according to preliminary calculations; and gain a unanimous board decision in favour of purchase. InCity run its business in two sub-segments: own project development and joint venture project development. Own Project Development In this segment, InCity buys commercial real estate or property in underdeveloped areas. It plans and constructs the project, refurbishing or rebuilding as necessary to convert them to residential use. It then sells the property either in its entirety or split into apartments, retaining all revenue and profit. The standardised handling procedures of InCity help to realise economies of scale. InCity acquires all properties through its own subsidiaries, whose status as limited companies mitigates the risk for the parent group. Joint venture project development InCity does not buy the real estate project in this sub-segment by its own. A partner or a common subsidiary, Gesellschaft bürgerlichen Rechts (GbR), acquires the object. In both cases, InCity carries out one part of the value chain and the partner the rest. The risks and returns from a specific project are shared under an agreed ratio between the partners. InCity said it gets usually a share of 40 to 60% of the earnings out of such a German atypical silent partnership. Close Brothers Seydler Research AG 10

11 Clients InCity has two client target groups: owner-occupiers (about 65% of units sold in 2006) and investors (about 35%). Sales by client group 35% 65% Owner-occupiers Investors Source: CBS Research AG, fairesearch, InCity InCity regards its owner-occupiers as falling into two main groups, both seeking a high-quality lifestyle in city centres: young seniors in their 50s, both couples and single people, who want to move back to city centres after their children have left home; and couples or singles in their 30s who want to live in city centres. InCity plans and constructs its projects with these core clients in mind (see section Central urban lifestyle housing as new trend below). The offering for investors differentiates regarding their personal annual income: retail investors with an annual income of up to 100,000 and those with an annual income of up to 250,000. The retail investors are party interested in reducing their personal income tax through real estate acquisitions. The German government subsidises the reconstruction of listed properties by applying high annual depreciation rates. The purchase of such listed properties, which are of special architectural or historical interest, is therefore a very attractive way for investors and owner-occupiers to reduce their personal annual income tax burden. However, they must buy the listed property before InCity starts to renovate it, as they cannot otherwise enjoy the favourable depreciation rules. InCity therefore requires little or no own equity to finance these projects. The third investor group is made up of institutional real estate investors, who are mainly interested in entire real estate projects or in acquiring a real estate portfolio. Close Brothers Seydler Research AG 11

12 Distribution InCity has a twin-track sales concept to sell its projects to investors: its own sales force and third-party sales. The company uses a wide-spread developed network of local and national brokers for third-party sales. InCity co-operates with freelance professionals as well as with local and national capital investment sales organisations. InCity has set up its own selling activities through ikp21, its own Internet platform for owner-occupiers ( This database-assisted selling activity currently focuses on the Cologne/Bonn area. More than 1,000 potential clients are currently registered on InCity s database. It allows the company to contact the client with offers tailored by size, quality and price. InCity sees its own Internet platform as one of its core assets. The ikp21 distribution network differentiates itself from the classical real estate sales distribution as it targets the pro-active owner occupiers. This client group is looking for suitable investments by the internet. Ikp21 is very successful at the Cologne/Bonn area. InCity said it get more as 50% of its clients which invest in the Cologne/Bonn area by the internet platform. The target is to extend the internet selling to other regions and to open the internet platform partly to other real estate companies. Prospects Project development is InCity s core business. A second segment was set up in November 2007 with the REIS segment. Project development could be split into the two sub-segments own project development and joint venture project development but the company has only released a combined revenue figure for 2006 and Thus there is a lack of historic earnings data at the level of subsegments. Our company earnings forecasts are at the end of this report. InCity s specialised business model and its first released group figures are promising. The sales volume of the project pipeline should have tripled in If InCity can realise a planned return of at least 18% per project, the RoE outlook for coming years is excellent, especially as projects should yield returns within less than 18 months, giving it an advantage over other real estate companies in terms of capital lock-up and interest expenses. The resulting turnover is higher than for real estate investors. The sales department starts to sell units in the project planning period. In the case of listed buildings, it has to sell the properties before renovation begins. On the other hand, InCity runs a short-term business and needs a constant supply of real estate in attractive city-centre locations. The current local focus of InCity on the Cologne/Bonn/Dusseldorf and Weimar/Erfurt areas is based on the business background of the two board members, who are the majority shareholders. In particular, the Weimar/Erfurt area is not well-known as a growth area in Germany. The Close Brothers Seydler Research AG 12

13 long-term targeted expansion into new geographic markets such as Munich, Hamburg or Stuttgart, partly by participation in industry consolidation, therefore makes a lot of sense in our view. Real Estate Investment Services InCity announced at the beginning of November 2007 that it would set up a new business segment, REIS, alongside its core project development business. The business model of REIS is to construct and sell real estate portfolios as a service provider. Real estate inventory optimizer InCity wants to use its existing deal flow for the new segment. It can now pick up city-centre properties for third parties which do not fulfil all the investment criteria of its core business. The company expects to gain synergies by deploying elements proven to work well in its core business value chain. Target is to purchase individual properties and to assemble these into portfolios which are sold to international institutional investors. These investors are interested on real estate portfolios in Germany with an investment volume of 30m to 50m. But such portfolios are mostly not available. InCity want to bundle single properties to bigger portfolios which have to be restructured and fulfil the needs of international institutional investors regarding the right size and real estate structure. InCity focus on the Cologne, Bonn and Dusseldorf area for these portfolio investments and is using its market insight there. The development of the new business segment has been funded with 6m in mezzanine capital from an investor and borrowed capital. The first step has been the acquisition of properties in the Cologne, Bonn and Dusseldorf area and bundling them in one portfolio with a value of up to 50m. The next step is to sell the portfolio to earmarked investors in the second half of InCity aims to develop and to sell one portfolio per year. The first project has been finished successfully. InCity sold a portfolio of seven properties in Cologne for 17m to the Danish fund Core Property Management A/S. Services The company offers third parties all its real-estate-related services: property research, due diligence, project development and management, and construction site supervision and control. InCity acts as a service provider in this segment and takes on no risk or capital. InCity offers the construction supervision by its own resources or by third party management (Allobjekt). InCity is using its own Internet distribution platform as well to support the sale of third party properties. Prospects Close Brothers Seydler Research AG 13

14 InCity sees an opportunity to build up a business segment that will generate additional cash flow with low risks and low equity capital. It expects projects will take much less time to complete than in its core business, while profitability will be at a similar level, as the deal spreads are lower but the total asset/turnover ratio is higher. The business model of the new segments looks interesting. But InCity has to prove that it can set up a consistent medium-term deal flow. One deal is not enough. Close Brothers Seydler Research AG 14

15 The industry The German residential real estate market has developed differently from those of other European countries. Prices for residential real estate have risen strongly in most European countries since 1998 but not in Germany, where they have remained more or less unchanged over that time. Meanwhile, we have seen the property bubble bursting in some markets, such as in Spain, Great Britain, Hungary or Ireland. The strong expansion in housing output was driven by considerable price increases and has led to overcapacity, resulting in a downturn in the high property prices in former boom markets. In Germany there was no real estate pricing bubble and therefore no burst. European housing market price development (1998 = 100) Country Average change per year (%) Hungary Spain France UK Norway Ireland Sweden Netherlands Italy Poland Denmark Finland Switzerland Germany Source: Euroconstruct There are some reasons for this development in Germany. Firstly, the country s poor economic development has led to weak demand in the past years. Secondly, the German government has for decades subsidised the building of new residential properties via tax benefits. Demand for housing was huge in Germany after widespread destruction in World War II. After the war, the trend was supported by growth in the population and GDP. In particular, after German reunification in 1990 the government had to encourage private equity to invest in the ailing East German real estate market by offering tax benefits. The lack of private investors and private owners had left much of former East German real estate stock in a disastrous condition and caused a deficit in supply. Government measures to boost the building of new residential properties worked well too well, indeed, as the government cancelled the tax incentives too late, causing a deficit in demand for Germany. Close Brothers Seydler Research AG 15

16 General trends in the German residential real estate market However, we see signs of a turnaround in the German residential real estate market. On the one hand, new builds more than halved from over 500,000 in 1995 to 211,000 for The building licences for new dwellings in Germany fell by 31% yoy to 136,000 for the first nine months of On the other hand, the German Federal Office for the Building Trade and Regional Planning expects that the number of households will continue to increase in Germany as a result of the general reduction in household size. Experts estimate an annual new housing demand of 340,000 units in Germany. The supply of new buildings has not met the high demand in Germany for several years. This deficit should lead to increasing or at least stable housing prices in Germany with strong local differences, of course. The building of new homes more than halved Germany had 39.2 million households in 2005, with approximately 82.7 million household members. This marked an 11% rise in households and 3% growth in the number of household members from 1991 levels. The average household size decreased from 2.27 people in 1991 to only 2.11 in The German Federal Statistical Office forecasts that this trend will continue for more than a decade and will peak at around 41 million households in This should have a positive effect on demand for dwellings even if the population stagnates or decreases but the number of households will continue to increase in Germany Projection of number of households in Germany Year In mln Change E E E E E E E E Source: The German Federal Statistical Office, CBS Research AG, fairesearch InCity s strategy of focusing on residential real estate in German metropolitan regions reflects a clear trend that has continued for some years of residents moving back into the centres of the big cities. The overall price development for apartments has been flat over the last years in Germany, but with considerable differences between regions. The average price for a flat in Düsseldorf increased most, by 7.7% to 290,200 for Feri Rating & Research expects the following price development in German urban centres. Close Brothers Seydler Research AG 16

17 Expected annual price increase for flats in German urban centres (200?-2014) Source: Feri Rating & Research, CBS Research AG, fairesearch In addition to the forecasted population growth in urban areas, there is another positive trend for InCity s business. A study conducted by market research institute empirica indicates that the average residential space per capita will rise from 46 sqm to 56 sqm in the old German states and from 38 sqm to 55 sqm in the former East Germany. Space per capita in sqm West Germany East Germany Source: empirica, CBS Research AG, fairesearch Close Brothers Seydler Research AG 17

18 InCity s business focus seems to place it in an ideal position to participate in these trends. As 60% of all residential buildings in Germany are older than 30 years the redevelopment of such buildings is a growth market, particularly in good locations, from which InCity should benefit. We therefore expect increasing demand for residential real estate in areas where the InCity portfolio is located. Well positioned to benefit from residential trends In addition, we have seen the recovery of German economy. GDP increased by 2.8% in 2006 compared with a growth rate of only 0.9% for 2005, according to the German Federal Statistical Office. GDP growth slowed down somewhat to around 2.5% for In January 2008 the German government reduced its full-year GDP growth forecast to 1.7%, partly as a result of turmoil on the financial markets. The German residential real estate market has become more attractive to foreign investors. Property prices in other European countries have increased more strongly than rents, causing rental yield to decrease; by contrast, rental yields are stable in Germany and offer relatively high returns on invested capital. Furthermore, prices in the German real estate market appear to offer more upside potential than in the other developed European markets, which have already enjoyed substantial price increases. Foreign opportunity funds acquired around 700,000 housing units in Germany over the last 10 years ie more than 70% of the transactions for this period. But their share should fall in coming years, due to the real estate bubble bursting in some markets and subprime-related turmoil in the financial markets. The real estate business is currently not in favour with international investors. Overall we believe the outlook in Germany is less bright than a year ago in terms of both general economic development and the sector outlook but is still favourable for the business of InCity. German GDP growth is reducing unemployment and making the long-term investment environment more reliable. The declining supply of dwellings and an increasing number of households in Germany should cause real estate prices and rents to rise. That is good for the residential real estate business of InCity. InCity is a niche player Central urban lifestyle housing as new trend After decades of German people leaving city-centre flats to live in the suburbs, the trend has turned back in favour of city-centre living since the turn of the century. There are several reasons for this trend: an estimated two-thirds of new jobs created in Germany are in metropolitan areas and there has been a rise in the amount of childless couples, who are less likely to require houses with gardens than families with children are. InCity has investigated the demands of its target clients who are willing to buy a city-centre flat, with some interesting results. Around 75% of the interviewees wanted a flat of over 100 sqm and more than 60% preferred a flat with more than four rooms. The ideal flat had an average size of sqm and 4.2 rooms. Interesting was that the average household consisted of 1.9 people. Close Brothers Seydler Research AG 18

19 Ideal sqm per flat Readiness to pay a price premium to 100sqm 101 to 150sqm above 150sqm 0 10% more 20% more 30% more 50% more 100% more Source: InCity, CBS Research AG, fairesearch Source: InCity, CBS Research AG, fairesearch Flats are more expensive in the city centre than in the suburbs. But 95% of the interviewees were ready to pay a premium of 20% or more to live in a top citycentre location. The clients were ready to pay a premium of 33.5% on average. On the other hand, clients see the purchase of a flat as an investment: around 75% of the interviewees said that an increase in the value of that investment is important or very important. A great majority (92%) of the interviewees who were still living in the city centre were satisfied or very satisfied with that decision. No interviewee was less than satisfied. Importance of increase in property value very high high neutral low no importance Source: InCity, CBS Research AG, fairesearch Satisfaction of living in city centre very satisfied satisfied neutral Source: InCity, CBS Research AG, fairesearch Close Brothers Seydler Research AG 19

20 Commercial real estate Although InCity s business focus is on residential real estate in Germany, it has in the past taken up some opportunities presented by commercial real estate deals. Developments in commercial property also have an impact on it because its focus on good city-centre locations for residential properties places it in competition for locations with companies looking for city-centre office space. The German commercial real estate market has been booming for several years. Investment volume in German commercial real estate reached a record high in 2006, doubling from the previous year s level to 49.4bn. Investment volume increased by another 20% to 59.4bn in 2007, according to Atisreal. The investment volume in German residential real estate increased as well, by around 18% to 15.2bn in The general interest in German real estate continued to be fairly strong last year, despite the subprime crisis in mid Investment volume reached new peak in 2007 More than half of total turnover (52%) in German commercial real estate was invested in office space last year. It improved its status due to positive development in the biggest German office space locations. The share of retail properties decreased from 40% in 2006, which included the sale of the Karstadt real estate portfolio of 4.5bn, to around 22% for Logistics properties accounted for 5% in 2007 with a transaction volume of around 2.8bn ( 2.9bn in 2006). German real estate investments in bn % 2007 % Commercial real estate % % Residential real estate % % Total real estate % % Source: Atisreal, CBS Research AG, fairesearch Around 61% of the turnover or 36.1bn was made up of portfolio deals in 2007 compared with 62% in Investments in individual properties accounted for 23.3bn or 39%. Around 76% of the investments in German commercial real estate were made by foreign investors in 2006, falling to around 69% in 2007, and we expect their share to fall further in First-rate commercial real estate and properties on long-term leases should remain in demand. The total investments in the top six locations in Germany (Berlin, Cologne, Düsseldorf, Frankfurt, Hamburg and Munich) increased by 44% yoy to 30.7bn for The best location last year was Frankfurt, where turnover jumped by 82% to 7.9bn. Next was Berlin, with an increase of 65% to 6.9bn. Munich was up by 37% to 6.7bn, Hamburg 29% to 5.1bn and Cologne by 25% to 1.8bn for Only Düsseldorf saw a decline in turnover, by 7% to 2.3bn. Strong demand in top six cities Close Brothers Seydler Research AG 20

21 Investments in top German commercial real estate cities in bn % 2007 % Berlin % % Düsseldorf % 2.3-6% Frankfurt % % Hamburg % % Cologne % % Munich % % Source: Atisreal, CBS Research AG, fairesearch In 2008 the changed environment due to the subprime turmoil is likely to result in real estate turnover falling short of the records reached in But turnover could still be at a good level, as Germany enjoys a relatively favourable pricing level. Rental yields could remain at the current level, with adjustments in different market segments. Take-up volume fell last year in some European urban areas, like London and Paris, compared with 2006; but rose by 14.5% in the nine biggest German office property locations in the same period. The average vacancy rate decreased by 3.5pp in 2007 for this group. The average prime rent was up by 4.7% in 2007 for the top nine German cities. Munich Take-up volume jumped by 24% yoy to 834,000 sqm in Munich for 2007, the highest growth rate of Germany s nine biggest cities in terms of office properties, according to Atisreal. The vacancy rate increased from 8.8% to 9.6% for The prime rent was up by 5% to 31 per sqm for Frankfurt Take-up volume was up by 1% yoy to 629,000 sqm in Frankfurt for The vacancy rate came down from 14.5% for 2006 to 13.3% for The prime rent increased by 7% to 37.5 per sqm for Berlin Take-up volume declined by 15% to 500,000 sqm in Berlin for 2007 compared with the year before. That was the weakest figure of the nine biggest cities in Germany in The vacancy rate was flat at around 8.2% for The prime rent was up by 7% to 22 per sqm for Hamburg Hamburg reached a new take-up record in 2007 with 564,000 sqm, up by 23% and the second-best growth rate of the nine top cities in The vacancy rate decreased slightly to 6.3% in 2007 and was again the lowest figure of the German peer group. The prime rent was up by 6% to 25 per sqm for Close Brothers Seydler Research AG 21

22 Fundamentals Business operations started in 2006 InCity was set up at the end of The two members of the board took part in the first capital increase in July 2006, transferring real estate project developments on which the two board members had worked before. InCity started its core business, the planning and construction of high-quality residential space in urban centres, in the second half of The first reports were released under German GAAP (HGB) accounting rules, which differentiate from the figures under IFRS accounting rules. The InCity group s sales revenues were 19.2m in its first business year regarding German GAAP (HGB). The own project development segment contributed 7.14m in revenue, joint venture project development 4.45m and services 7.55m. Change in inventories was 3.35m. InCity had booked interest expenses on bank loans as cost of materials rather than interest regarding HGB accounting, which reduced transparency. Pre-tax profit reached 1.4m for 2006, including the costs of the planned IPO. Pre-tax profit excluding IPO costs was 1.7m. The net profit of the group was 0.86m for InCity had 33 employees on average in Floor area handled by region (2006); total 34,000 sqm Floor area handled by region (2007); total 94,000 sqm 5% 11% 19% 25% 44% 18% 58% 20% Cologne/Bonn Weimar/Erfurt Berlin Rhine-Main/Others Source: CBS Research AG, fairesearch, InCity Cologne/Bonn Weimar/Erfurt Berlin Rhine-Main/Others Source: CBS Research AG, fairesearch, InCity FY2007 figures InCity currently reports half-yearly rather than quarterly results, and did it under German-GAAP (HGB) until the 1H07. It switched to IFRS accounting rules with the release of its FY2007 figures these days. Shareholder funds increased from 3.3m at the end of 2006 reagrding IFRS accounting to 10.5m at the end of Dezember 2007, of which around 4.6m were collected by the IPO in March InCity started an acquisition phase in 2Q07 after the IPO and bought real estate with a sales volume of 69m for its own project development operation and a share of around 18m sales volume from joint Close Brothers Seydler Research AG 22

23 venture project development. InCity reported sales volume (overall sellable volume) at 174.5m on 15 November 2007, which it intends to sell in a period of 12 to 18 months. See the chart below for the development of InCity s sales pipeline. Development of sales volume (project pipeline) in m 31-Dec Jun Nov-07 Sales agreed by contract Reservation volume Volume of services agreed by contract and outstanding Orders in hand Properties at the selling stage purchased or agreed by contract Properties at the development stage purchased or agreed by contract Total sales volume Source: CBS Research AG, fairesearch, InCity The company started operating in 2H06. It switched accounting to IFRS at FY2007 annual report. The only comparable figures are therefore FY2006 and FY2007 results. The sales revenues of the InCity group increased by 119% to 53.4m for FY2007 compared to FY2006. Change in inventories were up by 39% to 14.0m. Total revenues rose by 95% to 67.4m for Cost of materials went up by 92% to 57.5m. Personal expenses increased by 36% to 1.9m. Other operating expenses were up by 50% to 3.0m. Other operating income rose by 33% to 2.4m. EBIT increased by 152% to 7.3m for FY2007 and exceeded the company target of 7.0m. Net interest expenses were up from 0.55 for 2006 to 2.3m for Pre-tax profit (excluding IPO costs) increased by 118% to 5.0m for Costs of the IPO in March 2007 of 0.54 were adjusted by InCity. Income tax ratio was at 40% for 2007 compared to 39% for Net profit rose by 114% to 3.05m. Net profit after minority interests was up by 133% to 2.96m for EPS rose only from 1.19 for FY2006 to 1.26 for FY2007 as InCity more than doubled its average number of shares by the capital increases in 2006 and InCity intends to start dividend payments by 0.25 per share for FY2007. RoE after tax was 43.7% for FY2007. RoE after tax was 43.7% for FY2007 Close Brothers Seydler Research AG 23

24 Income statement; IFRS m YoY Sales revenues >100% Change in inventories % Total revenues % Other operating income % Costs of materials % Employment costs % Depreciations % Other operating expenses % Total administrative expenses % EBIT* >100% Financial result >100% Pre-tax profit* >100% Tax expenses >100% Net profit* >100% Minority interests % Net profit after minorities* >100% Average number of shares EPS Source: fairesearch based on company data, * excluding IPO costs Segment reporting InCity has so far not released any segment reporting, apart from splitting up at 2006 annual report (HGB) sales revenues between project development, joint venture project development, and services. InCity announced at the beginning of November 2007 that it would set up a new business segment, REIS, alongside its core project development business. The business model of REIS is to construct and sell real estate portfolios as a service provider. No figures have been released so far. We would prefer to see a segmental split in future, identifying the profit contribution of project development, joint venture project development and REIS. Targets and forecasts The fresh shareholder funds from the IPO enables InCity group a growth strategy. Management published a company target for EBIT of 7m for FY2007 which it could exceed. InCity released some forecasts regarding its future earnings development until the year It targets a group EBIT of 10.9m for 2008e, 16.5m for 2009e and 20.5m for 2010e. We appreciate the detailed prognoses of the company. We believe that InCity could fulfil its targets in light of the real estate business cycle and its project pipeline. InCity intends a dividend pay-out ratio of 20% to 30%. We expect an excellent earnings development from InCity into next years. Condition for it is that InCity can realise its planned sales prices. The project pipe- Close Brothers Seydler Research AG 24

25 line has increased very strongly, from a sales volume of 57.7m at the end of 2006 to 174.5m on 15 November The planned period to sell the sales volume is 12 to 18 months. We forecast therefore a pre-tax profit of over 10m for 2009 and Shareholders could benefit from two tax effects from 2008 onwards. Firstly, German corporate tax reform should decrease InCity s income tax rate from around 39% for 2007 to around 35% from 2008 onward. Secondly, InCity holds most of its development properties in specific limited companies as subsidiaries, which allows it to realise disposal gains from stakes almost tax-free under current German law. InCity s overall tax ratio could therefore drop to even below 20% if it is able to sell parts of its properties as a limited company. InCity s new business strategy and its focus as a niche player should deliver enough future profit potential. The capital lock-up and interest expenses in the project development business should be limited as InCity starts to sell the units after the planned projects are agreed by contract. An outstanding ROE after tax of up to 50% for InCity into next years seems therefore possible. It also depends on the dividend payout ratio. However, investors are quite concerned about the future development of capital markets and especially the international real estate markets, and are likely to remain so for the next few months. But the German real estate market has not deteriorated yet and it does not look like doing so this year. Our detailed InCity group earnings forecasts are on the next page. Close Brothers Seydler Research AG 25

26 Profit and loss account e Profit and loss account ( e); IFRS in m yoy% 2008e yoy% 2009e yoy% 2010e yoy% Sales revenues % % % % Change in inventories % % % % Total revenues % % % % Other operating income % % % % Cost of materials % % % % Employment costs % % % % Depreciations % % % % Other operating expenses % % % % Total expenses % % % % EBITDA % % % % EBIT % % % % Financial result % % % % Pre-tax profit % % % % Taxes % % % % Tax ratio -39.1% -40.0% -27.0% -22.8% -20.8% Net profit % % % % Minority interests % % % % Net profit after minorities % % % % Average number of shares in mio EPS Dividend per share RoE pre-tax 71.9% 73.9% 66.3% 67.0% 57.1% RoE 39.8% 43.7% 46.9% 50.7% 44.6% Source: CBS Research AG, fairesearch, InCity Close Brothers Seydler Research AG 26