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Rating action

Scope Ratings GmbH (Scope) has today reinstated the issuer rating for German commercial real estate company Deutsche Konsum REIT-AG (hereafter ‘DKR’) at C/Stable. Scope has upgraded the rating of DKR’s senior unsecured debt to CC from C.

The issuer rating is supported by the company's debt restructuring in June 2024 and approximately EUR 110m of debt repayments to date since end-September 2023. However, the rating is constrained by the only short-term relief that the debt restructuring provided, which leads to an ongoing refinancing risk, as DKR remains highly dependent on either the successful execution of asset sales to free up the required capital or the extension and increase of secured financing with banks.

The full list of rating actions and rated entities is at the end of this rating action release.

Key rating drivers

Business risk profile: BB (revised from BB+). The assessment of the DKR’s business risk profile has been revised due to an expected prolonged period of subdued profitability and weaker asset quality.

The size of the portfolio declined, with Scope-adjusted total assets* falling to EUR 944m at the end of September 2024 (down 6% YoY). This was due to negative fair value developments (2022/23: -10.2%, 2023/24: -3.3%) and property sales (EUR 83m in FY 2023/24). Given the company's continued focus on deleveraging to refinance maturing unsecured debt at a reasonable cost, further property sales in structured processes are expected. However, with 167 properties at the end of September 2024, DKR remains one of the largest owners of retail parks, DIY stores and local shopping centres in Germany, giving it high visibility and access to the investment and tenant markets.

DKR's property portfolio remains diversified across Germany, but is concentrated in terms of tenants, reflecting the consolidated German retail landscape for food, DIY and non-food discounters. The top three tenants account for 35.2% (down 2.1pp YoY) and the top 10 account for 50.9% (down 4.5pp) of rental income at end-September 2024. The lack of tenant diversification is partially mitigated by the investment grade nature of the tenants and their largely non-cyclical nature.

Occupancy and WAULT have fallen to 86% (down 250 bp YoY) and 4.4 years (down 0.6 years YoY) respectively at end-September 2024, as the properties sold were relatively stronger in terms of occupancy and WAULT compared to the portfolio average. In the short term, Scope expects a slight reduction in vacancy rates, supported by the internalisation of asset management as well as new lettings from newly refurbished properties and new space concepts. As a result, occupancy will slowly improve back to 90%.

In FY 2022/23, the EBITDA margin decreased significantly to 56% (down 7pp YoY), mainly due to i) unallocated service charges, either due to vacancies or limitations according to lease terms, and ii) exceptional legal, consultancy and audit costs. Results for FY 2023/24 do not show a significant improvement, with the margin flat YoY. The EBITDA margin is forecast to be between 55% and 60%, as the increased focus on in-house asset management, which has upfront costs, as well as ongoing costs associated with balance sheet stabilisation (asset sales, debt restructuring, upletting) will keep pressure on achievable profitability high.

Financial risk profile: CC (unchanged). The financial risk profile is supported by the recent bond restructuring but constrained by the company's inadequate liquidity and continued reliance on external financing or asset sales to meet upcoming debt maturities.

In June 2024, DKR announced the successful completion of the restructuring of its EUR 70m (due April 2024), EUR 40m (due March 2025) senior unsecured and EUR 36m (due May 2024) senior secured bonds. Key elements of the restructuring included the issuance of two 'Namensschuldverschreibungen' (NSVs) of EUR 105.9m and EUR 40.0m respectively in the exchange for the remaining bonds. Both NSVs are secured and mature at the end of September 2025. The EUR 105.9m NSV has a cash coupon of 8.5% until the end of 2024 and 12.0% thereafter; the EUR 40m NSV has a cash coupon of 4.0% until the end of March 2025 and 12.0% thereafter. Since June 2024, DKR prepaid EUR 60m of the EUR 105.9m NSV.

The refinancing of the bonds and partial repayment of the NSVs, as well as the further debt reduction enabled by Obotritia's prepayments of EUR 11m in FY 2023/24, a further EUR 31m in October 2024 and EUR 7m in December 2024 on the loan granted by DKR, stabilised the leverage, with a loan/value of below 60% in December 2024, down from 62% a year earlier. Scope expects the loan/value ratio to remain between 55% and 60% over the next few years, supported by stabilising capitalisation rates and rents, with deleveraging dependent on either further asset sales or stronger rental growth.

However, EBITDA interest coverage continued its downward trend (FY 2023/24: 2.2x; down 0.5x YoY), reflecting lower profitability as well as a rising weighted average cost of debt (end-Sep 2024: 3.9%; up 110 bp YoY and up 190 bp since two years ago). The cost of debt is set to rise further in FY 2024/25 due to the step-ups associated with the new NSVs, as well as higher underlying base rates for secured loan renewals. As a result, Scope forecasts a further deterioration in EBITDA interest cover to around 1.5x by end-September 2025.

Liquidity: inadequate (-4 notches). Liquidity remains insufficient as cash sources (EUR 1m cash at end-September 2024, barely break-even free operating cash flow under Scope’s assumptions and debt repayments made by Obotritia in the amount of EUR 38m in between October to December 2024) are not considered sufficient to cover cash needs (EUR 373m of debt maturing between end-September 2024 and end-September 2026 including loans where the fixed-interest period ends – annuity loans).

Scope expects that the majority of the maturing bank loans will be rolled over or refinanced, supported by DKR's good track record. In addition, EUR 20m of convertible bonds maturing in January 2025 were already converted into equity by one of the convertible note holders in December 2024¹. Scope therefore expects the remaining EUR 17m of convertible bonds due in January 2025 to be converted into equity as well, given the overlap between debt and equity holders.

However, the refinancing of the EUR 85.9m^a  NSVs due in September 2025 and the maturing EUR 17m Schuldscheindarlehen remains a significant short-term risk. As a result, DKR remains heavily dependent on either the successful execution of asset sales to free up the required capital or the extension and increase of secured financing with banks. Significant progress on the divestment programme over the next six to nine months could alleviate Scope’s concerns about the issuer's liquidity profile.

Supplementary rating drivers: -1 notch. Scope upholds the negative governance assessment (ESG factor: credit negative), which continues to result in a one-notch negative adjustment of DKR's standalone credit assessment. This is due to the perceived conflict of interest arising from the shareholder loan granted by DKR to Obotritia, as one of its major shareholders, former CEO and former Chairman of the Board Rolf Elgeti, is also a general partner of Obotritia.

One or more key drivers of the credit rating action are considered an ESG factor.

Outlook and rating sensitivities

The Stable Outlook reflects stabilised but weak credit metrics, with a loan/value of 55-60% and an EBITDA interest coverage of around 1.5x. The Outlook also reflects manageable short-term (next six months) refinancing risk, with secured bank debt expected to roll over and convertible bonds to be converted into equity.

The upside scenario for the ratings and Outlook is:

• Continued improvement in liquidity coverage as perceived by Scope, including an orderly refinancing of DKR’s upcoming maturities, supported by further reduction in senior unsecured debt enabled by further asset sales.

The downside scenarios for the ratings and Outlook are (individually):

• Further deterioration in DKR's liquidity or insufficient progress in the ongoing refinancing of upcoming maturities by 30 September 2025.
   
• A restructuring of liabilities that would result in losses to DKR's creditors.

Debt rating

Scope’s recovery analysis for senior unsecured debt signals a "superior" recovery, which allows for a two-notch uplift of the debt class rating above the issuer rating. However, the up-notching is limited to one notch due to the significant amount of secured debt ranking ahead of senior unsecured debt, and the issuer’s intention to top-up up secured financing to refinance unsecured debt positions. The recovery expectations are based on a hypothetical default scenario in FY 2024/25 with an enterprise liquidation value of EUR 523m, including a haircut applied to assets reflecting the higher of B category stress or the discounted loss in value linked to portfolio quality, and liquidation costs of 10% for insolvency proceedings. This compares with an expected secured financing of EUR 409m and unsecured financing of EUR 121m (including EUR 24m in convertible bonds, EUR 30m in senior unsecured bonds and EUR 67.5m in Schuldscheindarlehen).

The issuer's unencumbered asset ratio is estimated at above 100% at end-September 2024 (reflecting the partial repayment of the loan granted to Obotritia), providing sufficient collateral for bondholders. This justifies the senior unsecured debt rating of CC.

Environmental, social and governance (ESG) factors

REIT tax status: DKR is in an ongoing dispute with the Potsdam tax authorities regarding its REIT status. In an audit for the years 2015-2019, the tax authorities concluded that the tax exemption should not be granted as the required free float of 25% did not exist when DKR was first listed in December 2015. DKR disagrees with this view, as a listing was not possible without such a free float and assumes, based on legal opinions, that the REIT status can be maintained. Nevertheless, DKR has paid all tax obligations arising from the derecognition of its REIT tax status as at end-September 2024.

Scope highlights the perceived conflict of interest arising from the shareholder loan granted by DKR to Obotritia, as one of the major shareholders, former CEO and later Chairman of the Board, Rolf Elgeti, is also a general partner of Obotritia. Scope acknowledges that Rolf Elgeti has stepped down as Chairman of the Board, but does not consider the conflict of interest to be resolved as he remains on the Board.

Scope also acknowledges the reduced ties to Obotritia and its subsidiaries, including the partial repayment of the shareholder loan provided, the insourcing of parts of the asset management and the dilution of Obotritia's stake in DKR to 25% in December 2024. The reduced ties to the main shareholder should give management the necessary freedom to act in the best interests of all stakeholders.

All rating actions and rated entities

Deutsche Konsum REIT-AG

Issuer rating: C/Stable, upgrade

Senior unsecured debt rating: CC, upgrade

*All credit metrics refer to Scope-adjusted figures.

a. An additional EUR 10m repaid in November 2024

Rating driver references
1. Company News 5 December 2024

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

Methodology
The methodologies used for these Credit Ratings and/or Outlook, (General Corporate Rating Methodology, 16 October 2023; European Real Estate Rating Methodology, 28 March 2024), are available on https://scoperatings.com/governance-and-policies/rating-governance/methodologies.
Information on the meaning of each Credit Rating category, including definitions of default, recoveries, Outlooks and Under Review, can be viewed in ‘Rating Definitions – Credit Ratings, Ancillary and Other Services’, published on https://www.scoperatings.com/governance-and-policies/rating-governance/definitions-and-scales. Historical default rates of the entities rated by Scope Ratings can be viewed in the Credit Rating performance report at https://scoperatings.com/governance-and-policies/regulatory/eu-regulation. 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 Ratings’ definitions of default and Credit Rating notations can be found at https://www.scoperatings.com/governance-and-policies/rating-governance/definitions-and-scales. Guidance and information on how environmental, social or governance factors (ESG factors) are incorporated into the Credit Rating can be found in the respective sections of the methodologies or guidance documents provided on https://scoperatings.com/governance-and-policies/rating-governance/methodologies.
The Outlook indicates the most likely direction of the Credit Ratings if the Credit Ratings were to change within the next 12 to 18 months.

Solicitation, key sources and quality of information
The Rated Entity and/or its Related Third Parties participated in the Credit Rating process.
The following substantially material sources of information were used to prepare the Credit Ratings: public domain, the Rated Entity and Scope Ratings' internal sources.
Scope Ratings considers the quality of information available to Scope Ratings on the Rated Entity or instrument to be satisfactory. The information and data supporting these Credit Ratings originate from sources Scope Ratings considers to be reliable and accurate. Scope Ratings does not, however, independently verify the reliability and accuracy of the information and data.
Prior to the issuance of the Credit Rating action, the Rated Entity was given the opportunity to review the Credit Ratings and/or Outlook and the principal grounds on which the Credit Ratings and/or Outlook are based. Following that review, the Credit Ratings and/or Outlook were not amended before being issued.

Regulatory disclosures
These Credit Ratings and/or Outlook are issued by Scope Ratings GmbH, Lennéstraße 5, D-10785 Berlin, Tel +49 30 27891-0. The Credit Ratings and/or Outlook are UK-endorsed.
Lead analyst: Philipp Wass, Managing Director
Person responsible for approval of the Credit Ratings: Sebastian Zank, Managing Director
The Credit Ratings/Outlook were first released by Scope Ratings on 31 May 2018. The Credit Ratings/Outlook were last updated on 13 May 2024.

Potential conflicts
See www.scoperatings.com under Governance & Policies/Regulatory for a list of potential conflicts of interest disclosures related to the issuance of Credit Ratings, as well as a list of Ancillary Services and certain non-Credit Rating Agency services provided to Rated Entities and/or Related Third Parties.

Conditions of use/exclusion of liability
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