Scope Ratings affirms the BB- Corporate Issuer Credit Rating (CICR) of Adler Real Estate AG (ADLER). Simultaneously, Scope withdraws the rating at the issuer’s request.

The affirmation of the BB- rating for ADLER is driven primarily by an adequate business risk profile, which benefits from the size achieved in the fragmented and low-risk German residential real estate industry, and is characterised by a fairly diversified portfolio in regard to geographies and tenants.

Negative rating factors include ADLER’s relatively high leverage and low free cash flows, which increases the dependency on external refinancing.

KEY RATING DRIVERS

Low industry risk: ADLER benefits from currently stable tenant demand resulting from its exposure to the less cyclical residential real estate industry in Germany. Scope sees the potential for tenant demand to grow further in 2016 and 2017, supported by the influx of refugees in 2015 and 2016, as well as a robust German economy bolstered by continuously positive market conditions and growing investor demand. Together with the constantly low interest rates, the prices of residential real estate in Germany has increased by 30% since 2013, which Scope believes will continue in 2016, positively influencing the company’s leverage.

Good geographical diversification, but risk of declining demand: ADLER’s portfolio is well balanced across Germany, with the top five markets representing 83% of its total portfolio. However, the majority of ADLER’s markets show weak fundamentals, with market declines expected going forward. ADLER is therefore exposed to markets in which customers have high price elasticity, thus the potential for rent increases is rather limited. The downside risk for ADLER should be somewhat mitigated by its average rent per square metre – lower compared to market rents in those regions.

High tenancy diversification: Thanks to the portfolio’s strong growth and company’s focus on the residential segment, ADLER’s tenancy base is very highly diversified. However, ADLER still suffers from bad debt impairments of EUR 5m in 2014, or 6.2% of gross rental income. Thus, Scope judges the credit quality of ADLER’s tenants to be weak. Bad debt impairments have had a negative impact on both the company’s profitability and financial risk profile.

Improving profitability, with EBITDA margin of 45% expected for 2015: Profitability was driven by the company’s sales activity in 2015, which represented almost 50% of total revenues. As a result ADLER’s profitability is in line with the profitability of industry peers. EBITDA margin, excluding sales activity expected at 32% in 2015, though driven by the portfolio’s strong growth during the year, would still be weaker than that of peers. However, with reduced portfolio growth rates, the overall trend of improving profitability should remain stable in the coming years, with adjusted EBITDA margins targeted at above 45%.

Relatively high leverage set to continue: ADLER’s loan-to-value ratio (LTV) jumped to 72% in 2013 after it implemented an aggressive growth strategy, financed foremost by debt issuances. However, ADLER now benefits from the size achieved in terms of market capitalisation and growth strategy, enabling a shift of refinancing with equity instead of capital market debt. As a consequence, ADLER’s LTV is expected to sink below 70% for 2015 (2014: 73%); and by YE 2017 Scope expects this to fall under 65%, due to additional valuation uplifts thanks to positive German market conditions, a further shift of refinancing with capital market equity, and the expected streamlining of the portfolio.

Strong liquidity expected for 2016-2017: ADLER’s weak expected liquidity ratio of 37% for 2015 should improve solidly with the successful refinancing of debt, due in August 2016, obtained by acquiring 22.4% of shares in Conwert Immobilien Invest SE (Conwert). In detail, ADLER has to extend or repay EUR 164m of debt in the next 12 months, which represents around 7.5% of its total debt. Scope believes this debt can be refinanced due to the comparatively low LTV of below 60% for (i) the properties (debt of EUR 36m) and (ii) for ADLER’s stake in Conwert (debt of EUR 128m).

OUTLOOK

The Outlook for ADLER is Stable, driven primarily by the positive medium-term prospects for the German residential real estate market. The Outlook is however offset by uncertainties in the short-to-medium term with regard to ADLER’s future policy on mergers and acquisitions.

In view of the withdrawal of the CICR, Scope does not indicate numerical triggers for a rating change.

REGULATORY AND LEGAL DISCLOSURES

Important information
Information pursuant to Regulation (EC) No 1060/2009 on credit rating agencies, as amended by Regulations (EU) No. 513/2011 and (EU) No. 462/2013

Responsibility
The party responsible for the dissemination of the financial analysis is Scope Ratings AG, Berlin, District Court for Berlin (Charlottenburg) HRB 161306 B, Executive Board: Torsten Hinrichs (CEO), Dr. Stefan Bund.

The rating analysis has been prepared by Philipp Wass, Lead Analyst
Responsible for approving the rating: Olaf Tölke, Committee Chair

Rating history (Date | Rating action | Rating)
19 February 2016 I Withdrawal
19 February 2016 | Affirmation | BB- Outlook Stable
20 February 2015 | Affirmation | BB- Outlook Stable
2 July 2014 | Downgrade | BB -Outlook Stable
8 March 2013 | Initial | BB Outlook Positive
The rating outlook indicates the most likely direction of the rating if the rating were to change within the next 12 to 18 months. A rating change is, however, not automatically ensured.

Information on interests and conflicts of interest
The rating was prepared independently by Scope Ratings but for a fee based on a mandate of the rated entity.

As at the time of the analysis, neither Scope Ratings AG nor companies affiliated with it hold any interests in the rated entity or in companies directly or indirectly affiliated to it. Likewise, neither the rated entity nor companies directly or indirectly affiliated with it hold any interests in Scope Ratings AG or any companies affiliated to it. Neither the rating agency, the rating analysts who participated in this rating, nor any other persons who participated in the provision of the rating and/or its approval hold, either directly or indirectly, any shares in the rated entity or in third parties affiliated to it. Notwithstanding this, it is permitted for the above-mentioned persons to hold interests through shares in diversified undertakings for collective investment, including managed funds such as pension funds or life insurance companies, pursuant to EU Rating Regulation (EC) No 1060/2009. Neither Scope Ratings nor companies affiliated with it are involved in the brokering or distribution of capital investment products. In principle, there is a possibility that family relationships may exist between the personnel of Scope Ratings and that of the rated entity. However, no persons for whom a conflict of interests could exist due to family relationships or other close relationships will participate in the preparation or approval of a rating.

Key sources of Information for the rating
- Website of the rated entity
- Annual financial statements
- Valuation reports, other opinions
- Annual reports/semi-annual reports of the rated entity
- Current performance record
- Information provided on request
- Data provided by external data providers
- External market reports
- Press reports / other public information

Scope Ratings considers the quality of the available information on the evaluated company to be satisfactory. Scope ensured as far as possible that the sources are reliable before drawing upon them, but did not verify each item of information specified in the sources independently.

Examination of the rating by the rated entity prior to publication
Prior to publication, the rated entity was given the opportunity to examine the rating and the rating drivers, including the principal grounds on which the credit rating or rating outlook is based. The rated entity was subsequently provided with at least one full working day, to point out any factual errors, or to appeal the rating decision and deliver additional material information. Following that examination, the rating was not modified.

Methodology
The methodologies applicable for this rating (Corporate Rating Methodology, Rating Methodology - EUropean Real Estate Corporates) are available on www.scoperatings.com. The historical default rates of Scope Ratings can be viewed on the central platform (CEREP) of the European Securities and Markets Authority (ESMA): http://cerep.esma.europa.eu/cerep-web/statistics/defaults.xhtml. A comprehensive clarification of Scope’s default rating, definitions of rating notations and further information on the analysis components of a rating can be found in the documents on methodologies on the rating agency’s website.

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