Housing Shortages And Capital Recycling Will Support Long Term Rental Income Potential

Catalysts

About Grand City Properties

Grand City Properties focuses on owning and managing residential rental properties, mainly in German cities and London.

What are the underlying business or industry changes driving this perspective?

• The persistent housing shortage in Germany, with declining building permits and subdued completions in urban areas, supports low vacancy of 3.6% and like for like rent growth of 3.7%, which can feed directly into higher net rental income and EBITDA.
• Undersupply and strong demand in London, combined with relatively flexible rent regulation, give Grand City scope to capture revisionary rent potential of 22% and sustain mid single digit like for like rent growth, supporting revenue and earnings.
• The company is recycling capital from disposals of mature assets at around 5.3% yield into higher yielding acquisitions at about 7.7%. If executed consistently, this can lift operating margins and FFO over time.
• A solid balance sheet, with 33% LTV, 95% hedging and €1.4b of liquidity, positions Grand City to act as a consolidator when smaller, pressured owners or developers sell assets. This may potentially add accretive external growth to EBITDA and FFO.
• Targeted CapEx of €19.5 per square meter on repositioning and maintenance, plus projects that create new rental space and improve energy efficiency, can support rent increases and lower running costs, which may improve net margins and property values.

Assumptions

How have these above catalysts been quantified?

• Analysts are assuming Grand City Properties's revenue will grow by 3.4% annually over the next 3 years.
• Analysts assume that profit margins will shrink from 72.6% today to 36.6% in 3 years time.
• Analysts expect earnings to reach €244.9 million (and earnings per share of €1.43) by about July 2029, down from €438.3 million today. However, there is a considerable amount of disagreement amongst the analysts with the most bullish expecting €376.5 million in earnings, and the most bearish expecting €167.7 million.
• In order for the above numbers to justify the price target of the analysts, the company would need to trade at a PE ratio of 10.7x on those 2029 earnings, up from 3.8x today. This future PE is greater than the current PE for the GB Real Estate industry at 8.9x.
• Analysts expect the number of shares outstanding to remain consistent over the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 10.34%, as per the Simply Wall St company report.

Risks

What could happen that would invalidate this narrative?

• Reliance on strong rental markets in Germany and London could become a weakness if new housing laws like the Bau Turbo or a pickup in construction materially increase supply over the next few years, which could slow rent growth and put pressure on revenue and net rental income.
• The model of recycling capital by selling mature assets at around a 5.3% yield and buying at about a 7.7% yield depends on distressed sellers and supportive transaction markets, and if transaction volumes fade or seller pressure eases, Grand City may be forced to accept thinner spreads or fewer deals, which could weigh on EBITDA and FFO.
• Although the current loan to value of 33% and low 2% cost of debt support the balance sheet today, future refinancing of bonds and perpetual notes at higher coupons than existing debt could lift finance expenses, which would reduce FFO and earnings, even if rental metrics stay healthy.
• Portfolio growth is increasingly linked to London and potentially new geographies such as the U.S., and if these markets underperform Germany in terms of rents, regulation or valuations, the shift in mix could drag on long term returns from capital recycling and ultimately impact margins, FFO and EPRA NAV per share.
• A meaningful part of recent profit comes from positive property revaluations and a one off deferred tax income linked to lower future tax rates in Germany, and if asset values stagnate or fall or tax assumptions change again, reported profit and earnings per share could be much lower than current levels.

Valuation

How have all the factors above been brought together to estimate a fair value?

• The analysts have a consensus price target of €11.08 for Grand City Properties based on their expectations of its future earnings growth, profit margins and other risk factors.
• However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of €15.4, and the most bearish reporting a price target of just €9.0.
• In order for you to agree with the analysts, you'd need to believe that by 2029, revenues will be €668.2 million, earnings will come to €244.9 million, and it would be trading on a PE ratio of 10.7x, assuming you use a discount rate of 10.3%.
• Given the current share price of €9.41, the analyst price target of €11.08 is 15.1% higher. Despite analysts expecting the underlying business to decline, they seem to believe it's more valuable than what the market thinks.
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.