Description

Vonovia is the largest German residential REIT although the term REIT is a misnomer as there are no tax advantages unlike in US. Vonovia owns apartments all over Germany and is very diversified. It also purchased a residential property company in Sweden a few years ago which is a minor part of the portfolio.

Germany is a rent-control market. Rents are only allowed to grow at a certain rate per year. You can see below the very steady (and LOW!) rent growth in Germany regardless of market cycles. In the current recession/crash, rent growth will continue at a similar. This is very different from US where rent growth can collapse in a recession, and varies widely but also is much higher overall in bull cycles. 

All these years of rent growth suppression has meant that Germans are paying a lot less in rent than most other rich European countries.

This has meant that Germany is largely a rent market and not a home ownership market like US, UK or Australia etc. 

BUT a consequence of the years of rent growth suppression is that rent growth has not kept pace in building materials inflation growth. The yields and cap-rate on the properties are linked to German Bund yields. And since the Rents are locked, that has meant that NAVs are in effect driven by the low rent growth and any cap-rate compression. And this has lagged building materials growth so the replacement value is much higher as new building costs are much higher than existing portfolios. 

This has meant that newbuilding activity has dried up as a new costly building will generate sub-par returns as the rent generated on it would have to be compete with existing properties where rent is suppressed. This has meant that there is a robust market in refurbishment and upgrades. The reason is that the local authorities allow one-off 20-30% rent increase if a developer can demonstrate sufficient modernization. Vonovia has taken advantage of this to consistently modernize 5-10% of its portfolio per year for a 20-30% rent bump to translate into a 1.5-2.5% revenue increase. In addition to the regular 1.5% allowed rent increase, it has translated to steady 4% rent increases. 

Vonovia has innovated and has a plan of modular construction techniques at scale to build down construction costs that small/medium builders/owner cannot compete with as Vonovia is doing this modular construction at scale. In addition it continues to have a robust programme of modernizing its entire buildings as well as the individual apartments in those buildings whenever they open up / become available (from someone moving or dying etc). See below for the upcoming and explanding capex programme.

The lack of investment in newbuildings in general, plus cap-rate compression and a seach of real assets has all led to a surge in property prices and NAVs recently.  Although this price boom has been limited to Tier A cities. The country at large is slowly catching up and Vonovia (with a broad portfolio) will benefit.

By sweating its existing assets harder via modernization has meant that Vonovia's margins are slowly expanding. 

All this has resulted in steady cash flow, divs, and NAV per share growth.

I think Vonovia remains a fantastic long-term investment. Stock is trading at 19x P/E for next year, but I believe this is a high quality investment. Vonovia should easily grow earnings at high single digits for a decade sustainably by translating that 4-5% revenue growth with some financial and operational gearing into a 8-9% earnings growth. Coupled with a 3% div yield, you are looking at 11-12% total return which is decent for a 19x P/E stock with a lot of uncertainty in other areas. If NAVs appreciate closer to replacement (and prices for their properties are generally higher than their booked NAVs) then it's added bonus.  

Catalyst

Continued earnings growth. NAV appreciation.