The BB issuer rating for Germany-based Adler Real Estate AG (Adler) is driven primarily by the rating supportive business risk profile. This is attributed to the company’s scale, achieved despite Germany’s fragmented, low-risk residential real estate industry, and the well-diversified portfolio by geographies and tenants.

Negative rating factors include weak asset quality, due to comparatively low occupancy rates, and the limited potential for rent increases. In addition, Adler has relatively high leverage and low free cash flows, which increase the dependency on external refinancing.

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Business risk profile

In Scope’s view, Adler benefits from the German residential real estate market, which has low cyclicality and stable tenant demand. In the nine months to September 2017, Adler improved slightly in terms of rent (+1.4% – core portfolio) and market share (net growth by 3,192 residential units). Even so, this does not alter Scope’s moderate view on the company’s market position. With around 50,000 residential units and EUR 3.4bn of assets (end-September 2017), Adler is medium-sized compared with German peers. As such it benefits from a decent diversification of geographies and tenants, which Scope believes enhances the ability to offset cash flow volatility arising from economic cycles, industry dynamics, regulatory changes, and the loss of individual tenants.

The EUR 180m disposal of ACCENTRO Real Estate AG in December 2017 is judged by Scope to be slightly positive for business and financial risk profile of the company, as it reduces the exposure to the more volatile trading business. This aspect compensates for the loss of the ability to generate cash through this segment.

Scope views negatively Adler’s exposure to markets with a high price elasticity of tenants. Demand in most of the company’s core markets – with the exception of Berlin, Wolfsburg and Leipzig – is expected to reduce over the next decade, which should also limit the potential for rent increases. In addition, according to Adler, one-third of its tenants rely on governmental subsidies to pay rent. While this boosts the stability of rental income, it also further limits the ability to increase rent. This is evidenced by the core portfolio’s like-for-like rental increase of only 1.4% for the year ending 30 September 2017, compared with 3% for peers with better-quality portfolios.

EBITDA margin excluding sales was 37% for the year endling 30 September 2017, up from 20% in 2014. Though supported by economies of scale and rental growth, the figure was still slightly weaker than peers’ (50%). However, despite lower portfolio growth, the company expects to sustain the overall increase in profitability, targeting an EBITDA excluding sales of between 45% and 50% in the long term. This should benefit from:

• an expected rise in occupancy to above 90% by YE 2018, driven predominately by the disposals of assets with below-average occupancy rates: ACCENTRO (2,000 units – executed end of 2017) and the non-core portfolio (3,300 units – planned for 2018).
• improved economies of scale via the internalisation of key operational functions, including property, facility and energy management; the centralisation of IT infrastructure; and the introduction of shared services.

These two aspects also reduce the operational expenses that cannot be passed on to tenants.

Financial risk profile

EBITDA interest expense improved to a moderate 1.7x at end-September 2017 from 1.4x at YE 2016. This was due mainly to the redemption of high-yielding liabilities, financed by a portion of the EUR 422m generated by the Conwert disposal in January 2017. Adler reduced its weighted average cost of debt to 2.7% (3.5% in Q3 2017) by repaying EUR 605m of promissory notes at end-November, covered by a EUR 800m bond issuance. The liability restructuring is estimated to increase funds from operations by EUR 11m and reduce annual amortisation by EUR 1m from 2018 on. Scope expects Adler to repay high-yielding liabilities quickly, which would reduce interest expense further. The repayment of promissory notes and high-yielding debt should, in Scope’s view, maintain debt protection above an EBITDA interest cover of 1.7x.

The loan/value ratio reduced to nearly 60% as at YE 2016 for the first time since Adler changed strategy in 2012, thanks to EUR 199m of fair-value adjustments and a reduction of Scope-adjusted debt (SaD) by EUR 118m in 2016. This is well ahead of Scope’s expectations as of last year; on the other hand, the agency judges the German market to be overpriced (see Corporate Outlook 2018), and loan/value is increasingly sensitive against the changes expected for interest rates. Nonetheless, Scope views positively management’s public commitment to reduce loan/value to a sustainable level of below 55%, underpinned by a further EUR 148m reduction of interest-bearing liabilities in the first nine months of 2017. As a result, Scope expects loan/value to decrease below 60% at YE 2017. In addition, should the non-core portfolio be disposed of in 2018, the resulting reduction of SaD by over EUR 150m would likely maintain the loan/value levels going forward.

SaD/EBITDA was 15.4x at YE 2016, experiencing a further sharp decline from 21x in 2015. Due to Scope’s expectation of a more subdued investment policy and a slightly improving EBITDA, the agency forecasts leverage (measured by SaD/EBITDA) to remain stable for the coming years at around 15x (excluding one-off effects).

Liquidity

Adler’s liquidity is adequate based on Scope’s expectation that liquidity sources will exceed uses by about 6x in the 12 months to YE 2018. This follows the improved liquidity during 2016 due to the company’s new strategy, focusing more on organic growth instead of dynamic. The latter previously led to negative free operating cash flows.

In detail (YE 2017 forecasts):

• Unrestricted cash: EUR 292m
• Open committed credit lines: EUR 70m
• Free operating cash flow (t+1): EUR 148m
• Short-term debt (t+1): EUR 77m

Scope’s view is also supported by the company’s strong relationships with banks. The refinancing of the EUR 500m bond maturing in 2020 should be eased by the company’s unencumbered asset position of over EUR 1bn.

Outlook

The Outlook for Adler is Stable and incorporates Scope’s expectation of gradually increasing rental income for the core portfolio, driven by a rise in occupancy to above 93% by YE 2019 and like-for-like rental growth in line with inflation forecasts of between 1.5% to 2.0%. This is further backed by:

1. improving profitability (EBITDA margins of more than 45% according to Scope’s methodology) and
2. balanced cash flow from investment, including a continuation from FY 2016 of subdued capex spending as well as the disposal of the non-core portfolio.

Scope expects credit metrics to be more stable going forward, with an EBITDA interest cover of around 1.7x and loan/value ratio of below 60%.

A negative rating action is possible if debt protection as measured by EBITDA interest cover decreased below 1.5x or if the company’s access to external financing weakened.

A positive rating action is tied to a further improvement in the financial risk profile, i.e. if EBITDA interest cover increased above 1.9x and loan/value ratio reduced below 55%, both on a continuing basis.

Ratings affected 

Upgraded

• Issuer rating: BB/Stable
• Bond (ISIN DE000A1R1A42): BB+
• Convertible bond (ISIN DE000A1YCMH2: BB+
• Mandatory convertible bond (ISIN DE000A161ZA7): BB+
• Convertible Bond (ISIN DE000A161XW6): BB+
• Bond (ISIN XS1211417362): BB+

New

• Senior unsecured BB+
• Bond (ISIN XS1731858392): BB+
• Bond (ISIN XS1731858715): BB+

Regulatory disclosures

This credit rating and/or rating outlook is issued by Scope Ratings AG.
The rating analysis has been prepared by Philipp Wass, Director. Responsible for approving the rating: Olaf Tölke, Managing Director
The rating was first assigned by Scope on 25.07.2016. / The rating was last updated on 11.01.2018.

Methodology
The methodologies used for this rating and/or rating outlooks are Rating Methodology Corporate Ratings and Rating Methodology: European Real Estate Corporates both 2017 Jan. Available on www.scoperatings.com.
Historical default rates of Scope Ratings can be viewed in the rating performance report on https://www.scoperatings.com/#governance-and-policies/regulatory-ESMA Please also refer to 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 definition of default as well as definitions of rating notations can be found in Scope ’s public credit rating methodologies on www.scoperatings.com.
The rating outlook indicates the most likely direction of the rating if the rating were to change within the next 12 to 18 months.

Stress testing & cash flow analysis
No stress testing was performed. Scope performed its standard cash flow forecasting for the company under review.

Solicitation, key sources and quality of information
The rated entity and/or its agents participated in the rating process.
The following substantially material sources of information were used to prepare the credit rating: public domain, the rated entity, third parties and Scope internal sources. Scope considers the quality of information available to Scope on the rated entity or instrument to be satisfactory. The information and data supporting Scope’s ratings originate from sources Scope considers to be reliable and accurate. Scope does not, however, independently verify the reliability and accuracy of the information and data.
Prior to publication, the rated entity was given the opportunity to review the rating and/or outlook and the principal grounds on which the credit rating and/or outlook is based. Following that review, the rating was not amended before being issued.

Potential conflicts
Please see www.scoperatings.com. for a list of potential conflicts of interest related to the issuance of credit ratings.

Conditions of use / exclusion of liability
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