European Residential REIT T.ERE.UN

Scotia comments after conference

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Lack Of FFOPU Growth; One-by-One Asset Sales Is A Long Road To Surface Value

OUR TAKE: Mixed. We are keeping our SO rating unchanged (for now). Our target and NAVPU are unchanged at $3.50 and $3.85, respectively. We continue to see value but recognize that a fair bit of patience is required on the name. In late December 2023, ERE announced that the strategic review was concluded with no transaction due to a gap between buyers and sellers expectation (see our note titled “A Deal and A No Deal”). This was not the ideal outcome for unitholders; therefore, we expect ERE unit price to trade sideways in the near-term.

One-by-one asset sales is a bit longer road to surface value: ERE sold 14 suites for €5.1M in 2023, and another 14 suites were sold post quarter for €4.8M. Management mentioned that they expect to see accelerated pace of home sales ahead but did not provide guidance. Currently, they prioritize the assets that already had units sold in them. Privatization is a tried-and-tested monetization method in the Netherlands, and the sale price of individual units should be ahead of IFRS value (and in some cases 20% to 30% higher than that). Proceeds from the sales will be largely used to bring down the leverage (D/GBV at 57.6% as of Q4/23).

KEY POINTS

Impressive operating metrics: SP NOI grew 7.8% y/y in 2023. SP rents were up 7.2% y/y in 2023, while occupancy was slightly down 20bp to 98.5% in Q4/23. Despite regulatory restrictions, ERES has continued to print 4%+ rent growth (vs target of 3% to 4%) in recent years. SPNOI margins were up by 140bp y/y at 78.6% (77.2% in 2022).

High interest expense does not help FFOPU growth: While operating metrics are strong, higher interest expenses have completely changed the equation. Mortgage financing was done at 4.66% p.a in 2023. vs ~3% p.a. in 2022. We expect 2024 FFOPU to remain flattish in 2024 with +0.9% y/y growth versus -4.6% y/y growth in 2023. ERES has €80M (8% of total debt) mortgage maturing in 2024 at 1.39% p.a., we assume renewal rate of 4.5% p.a. in our model. 2025 will be an important year on mortgage maturities for ERES as €227M (23% of total debt) mortgage will be maturing at 1.87% p.a. 100% of mortgage debt is at a fixed rate. Leverage remains elevated as Debt to GBV increased by 110bp q/q at 57.6% – this was mainly due to write down on the portfolio value.

Valuation discount persists: ERES is now trading at a 37% discount to Scotia NAV (excluding DTL). High leverage, regulatory uncertainty, and external management structure have led to a sizable valuation discount. German residential names are trading at a 40% to 70% discount to NAV and ~13x AFFO multiple (vs ERES at a ~11x multiple). In the context of steep valuation discounts in Europe, ERES does not appear to be an outlier.