Wednesday, 8 January 2014

Investing in German commercial property via Dundee International Reit

It seems to be a joke to invest into the German market via a toronto based entity, but Dundee has access to very cheap funding from German banks with weighted average interest rate of just 3.44% as of September, 30th due to its scale and the valuation looks promising.

Units outstanding
Dundee International Reit's units number is in flux, which makes it difficult to establish the right denominator.
 The diluted weighted average number of Units assumes the conversion of the Debentures and incremental unvested deferred trust units related to the Deferred Unit Incentive Plan represented by the potential Units that would have to be purchased in the open market to fund the unvested obligation.
The convertible debentures have the following charakteristika:

Convertible debentures
principal amount 30.09.2013161,000
interest rate5.5%
maturity7/31/2018
conversion price at any time by the debenture holder13
redeemable by trust 31.08.2014-30.08.2016 if unit price >125% conversion priceprincipal amount plus accrued and unpaid interest
redeemable by trust 31.08.2016-31.07.2018 principal amount plus accrued and unpaid interest
max conversion units12,384,615

As the conversion price is way above the current unit price and the yield of the units is higher than the interest rate of the debentures, I don't view the debentures to be dilutive to investors purchasing units at current prices. I will exclude them from outstanding units:


30.90.2013
Weighted average Units outstanding basic per unit amounts109,116,985
Weighted average Units outstanding diluted per unit amounts122,552,770
adjusted for convertible diluted per unit amounts110,168,155

Due to the Distribution Reinvestment and Unit Purchase Plan, the number of units outstanding, will increase with each distribution each month.

Operating Figures
 Space for which the Trust receives head lease payments is reflected as vacant space; increase in occupancy to 91%, if such head lease space would be reflected as occupied space.

[CAD 000]Three months ended September 30per adjusted unit
Occupancy rate (period-­‐end)86%Euro/m²
In­‐place rent per square foot/monthCA$ 0.95€ 7.41
Investment properties revenue56,9150.52
Net rental income 39,4790.36
Funds from operations23,0010.21
Adjusted funds from operations21,3710.19

The company provides relevant figures readyly. But their properties revenue differs from what I used as gross rental income, but luckily they provide in-place rent:
Revenues from investment properties include base rents, recoveries of operating expenses including property taxes, lease termination fees, parking income and incidental income.
As at September 30, 2013 the portfolio consisted of 299 properties, comprising approximately 15.5 million square feet located in Germany. 

sq.foot15,544,300
square metre1,444,113
property value CAD '0002,185,360
property value Euro '0001,569,943
value Euro / m²1,087
value/in-place rent*occupancy = yield7.04%

The property value and gross rental yield looks OK to me. For commercial property I would have expected a higher yield. If the property is really of the high quality as the company suggests, this would explain the yield.  Due to the weighted average interest rate of just 3.44%, the company can leverage their properties to the benefit of unitholders at current rates.

Tenant concentration
This is commercial property, which normally doesn't have the risk mitigating tenant profile of residential property.

Tenant composition 31.09.2013Total GRI (%)
Deutsche Post 39.6
ERGO Direkt 3.2
Imtech 2.5
AIG Europe Limited 2.2
Google Germany GmbH 2.1
BNP Paribas Fortis SA/NV 2.1
State of Bavaria/Technische Universit√§t M√ľnchen 1.6
Maersk Deutschland A/S & Co. KG 1.5
Jobcenter Berlin Mitte – Federal Employment Agency 1.4
Deutsche Telekom 1.4
Other third-­‐party tenants 42.4
Total 100

This means a more in depth look at the conctracts with their main tenant Deutsche Post is warranted. Overall I don't see any risk due to bankruptcies of the blue-chip tenants. Some of the space leased to Deutsche Post is occupied by Deutsche Postbank.
Deutsche Post committed to remain in approximately 764,000 square feet of space pertaining to its 2014 early termination rights and exercised its termination rights with respect to 1.1 million square feet, or approximately 5.1% of the Trust’s current GRI. As a result of working closely with Deutsche Post and focusing on better understanding its space requirements, we have retained it as a tenant in many of our properties for extended terms. Of the 1.1 million square feet of terminated space, we have plans to re-­lease, redevelop or sell approximately 519,000 square feet. This leaves a balance of approximately 641,000 square feet to be dealt with going forward through similar actions. As part of the lease extensions, we agreed to provide Deutsche Post with an annual rent reduction of €1.7 million per year, effective as of July 1, 2014. Based on recent inflation rates in Germany, we anticipate that prior to July 1, 2014, this reduction in annual rent will be substantially offset by CPI rent adjustments provided in the terms of the Deutsche Post leases. In addition, the REIT will make a one-­time payment to Deutsche Post of €1.45 million to be used to improve the buildings and the tenant’s space.
The leases with Deutsche Post, which generally expire on June 30, 2018 (many of which provide Deutsche Post with an option to extend the term until June 30, 2023), comprise approximately 51% of the portfolio’s GLA and account for 40% of the portfolio’s GRI.

 Deutsche Post may terminate Deutsche Post leases and Caroline DP Leases aggregating no more than 20% of the total annual Reference Rent payable under all of the Deutsche Post leases and Caroline DP Leases on June 30, 2014, and no more than an additional 10% of such rent on June 30, 2016. The “Reference Rent” for a lease is an amount set out in a specified notarial deed and may differ from the actual rent payable under the lease. To the extent that Deutsche Post does not exercise all of its available early termination rights with respect to any particular effective termination date, the unused portion may be carried forward, provided that Deutsche Post cannot terminate Deutsche Post leases and Caroline DP Leases aggregating more than 20% of the total Reference Rent of all Deutsche Post leases and Caroline DP Leases, considered as a whole, during any lease year.
This means there is subtantial risk regarding the Deutsche Post leases. Until June 2014, the Trust receives payments pursuant to a head lease for space terminated by Deutsche Post in 2012. Due to these payments, it effectively receives rent for approximately 91% of the space in the overall portfolio as at September 30, 2013. When this head leases fade away there will be an impact on the cashflows per unit. I think this tenant concentration may be the main reason Dundee International Reit is so cheap in relation to its current cashflows.

The lower in-place rent of the Deutsche Post properties in relation to market rent according to the quarterly report may mitigate some of the risk of re-letting the space. But as managment has granted Deutsche Post some discounts for the not terminated space I would take their market rent estimate with a grain of salt.


in-place rent 31.09.2013Market rent
€/m²/month overall€ 7.41€ 7.67
initial properties Deutsche Post€ 5.05€ 5.53
initial properties other€ 4.96€ 5.70
Acquisitions 2012 and 2013€ 14.18€ 13.63


Fee Structure

The REIT entered into an asset management agreement with DRC (“Asset Management Agreement”) pursuant to which DRC provides certain asset management services to the REIT and its subsidiaries. The Asset Management Agreement provides for a broad range of asset management services for the following fees:
  •  base annual management fee calculated and payable on a monthly basis, equal to 0.35% of the historical purchase price of the properties;
  •  incentive fee equal to 15% of the REIT’s adjusted funds from operations per unit in excess of $0.93 per unit; increasing annually by 50% of the increase in the weighted average consumer price index (or other similar metric as determined by the trustees) of the jurisdictions in which the properties are located;
  • capital expenditures fee equal to 5% of all hard construction costs incurred on each capital project with costs in excess of $1,000, excluding work done on behalf of tenants or any maintenance capital expenditures;
  • acquisition fee equal to: (a) 1.0% of the purchase price of a property, on the first $100,000 of properties in each fiscal year; (b) 0.75% of the purchase price of a property on the next $100,000 of properties acquired in each fiscal year; and (c) 0.50% of the purchase price on properties in excess of $200,000 in each fiscal year. DRC did not receive an acquisition fee in respect of the acquisition of the Initial Properties; and 
  • financing fee equal to 0.25% of the debt and equity of all financing transactions completed on behalf of the REIT to a maximum of actual expenses incurred by DRC in supplying services relating to financing transactions. DRC did not receive a financing fee in respect of the acquisition of the Initial Properties. 
As  my adjusted funds from operations per unit annualized is below 0.80 and number of units is increasing due to DRIP and CPI for Germany is positive, I don't view the incentive fee of 15% as dilutive for investors at current prices. The acquisition fee and financing fee I don't like because they promote a high asset turnover, which I don't view to be in the best interest of unitholders. I hope the company is not planning to do capital expenditures, as there is more risk involved than in just holding a portfolio. Thus I hope this fee will not come to fruition, but it kind of clouds the outlook. Who knows what's to come?

Valuation


31.09.2013of totalper adj. diluted unit
Investment properties2,185,36093.45%CA$ 19.84
Cash115,8324.95%CA$ 1.05
Amount in escrow8,8570.38%CA$ 0.08
total assets2,338,427100.00%CA$ 21.23
Debt1,287,41055.05%CA$ 11.69
Derivative financial liabilities22,4810.96%CA$ 0.20
Distributions payable7,2860.31%CA$ 0.07
equity979,72141.90%CA$ 8.89
Judging from the balance sheet Dundee International Reit doesn't look cheap. It trades just slightly under book value. On the other hand the operating figures are quite well. The leverage works clearly in favour of this company:

Three months ended September 30th, 2013CAD '000per unit*4yield @8.77
Investment properties revenue56,915CA$ 0.52CA$ 2.0723.56%
Net rental income 39,479CA$ 0.36CA$ 1.4316.34%
Funds from operations23,001CA$ 0.21CA$ 0.849.52%
Adjusted funds from operations21,371CA$ 0.19CA$ 0.788.85%
distribution per month and year
CA$ 0.07CA$ 0.809.12%

Conclusion
Dundee International Reit is no balance sheet bargain. The visibility regarding the return of capital to unitholders, mitigates much of the long-term uncertainty. The spread of the yield over German Bunds makes this interesting. The unitholders would be fine without any capital appreciation, because of the yield. I have initiated a small long position in Dundee International Reit. Goal is to increase downside protection in  equity portfolio because I think the markets are not cheap these days. If the stockmarkets would be to fall I would rotate back into non real estate equities, which I perceive to have lower downside riks as shown for IMW and KWG. If the markets continue to perform well this real estate equities are certain to underperform. IMW and KWG provide cheap assets at reasonable price to cashflows and Dundee cheap cashflows at reasonable asset prices.

[Author is long IMW, KWG, DI-UN.TO)

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