GRNNF - Grand City Properties: A Hidden Gem In The Residential Sector

2023-06-20 18:47:50 ET

Summary

• Real estate sector's negative sentiment creates investment opportunities, such as Grand City Properties, which has a strong financial profile and trades at a deep discount to its NAV.
• Grand City Properties benefits from growing rents and falling vacancy rates, and its debt maturities are covered by existing liquidity through 2025.
• Based on P/FFO and P/AFFO multiples, the company has an estimated 55% upside potential.

Amidst the rising interest rates environment, the memories about the 2008 housing market crash are giving chills to investors, causing them to flee the real estate sector. As a result, real estate stocks have taken a significant hit and some of them are currently trading at a fraction of their prices in 2021. I think that such negative sentiment in the real estate sector creates an opportunity. Indeed, some companies which are overleveraged, especially with considerable amount of debt coming due in the short-term, will have a difficult time and may not weather the storm. Some sub-sectors like office space face additional challenges, due to the spread of work from home practices, which limit demand. On the other hand, a real estate company with strong balance sheet, long debt maturity schedule, no exposure to office space and sufficient liquidity on hand to meet its need in the next two years should be fine and offer significant capital appreciation potential once the monetary policy cycle turns to easing. The opportunity that I identified to meet these criteria is Grand City Properties ( OTCPK:GRNNF ), which appears to be trading at significant discount to peers.

Company overview

Registered in Luxembourg, Grand City Properties specializes in residential real estate. The company’s portfolio is primarily concentrated in Germany, while 17.3% of assets are located in London. It’s important to mention that Grand City Properties is not legally a REIT, hence there’s no legal requirement to pay dividends. Still, the company has been pretty consistent in distributing cash back to its shareholders up to this year, when the dividend was suspended due to increased market uncertainty.

Growing rents, falling vacancy

As property prices had a serious run-up in 2020-21, buying a home became more difficult. Also, the rising interest rates made mortgages less affordable. These two developments supported landlords as demand for renting increased. At the same time, rents continued to grow, acting as another driver of revenue.

Not surprisingly, Grand City properties reported improvement in both vacancy, which fell to 4.2% from 5.1% a year ago and average rent, which advanced to EUR 8.3/sq.m. As a result, net rental income for Q1’23 jumped 4.4% YoY to EUR 101.4M.

Property valuation discussion

One of the biggest concerns that investors have with real estate companies is the effect of potential fall in market prices of properties. Indeed, housing prices in most developed countries and in Germany (the primary market of Grand City Properties) have been falling recently . Naturally, some investors will be quick to extrapolate that fall to the balance sheet of the company. However, Grand City Properties have been pretty conservative and didn’t follow with significant revaluations, proportionate to the upswing on the real estate market. Looking at the company’s portfolio, the average book value prices per sq.m. in the main markets within Germany and London could be observed. As such, the total portfolio is carried at EUR 2,273/sq.m. The biggest regional market of the company – Berlin is carried at EUR 3,507/sq.m.

However, looking at data for the average transaction prices of properties on the German real estate market, the figures are considerably bigger. For example, properties in Berlin were sold on average for EUR 5,077/sq.m. Such a discrepancy gives Grand City Properties some safety cushion and allows it to dispose of properties around book values, despite the fall of property prices in general. As such, in Q1’23 the company sold EUR 145M of properties at only 1% discount to book value.

Debt looks manageable

Another big concern of investors in the real estate space is debt. However, Grand City Properties seems to have a solid financial profile with LTV ratio of just 35% or 46% if perpetual notes are accounted for. There are no significant maturities coming in the next two years and the current available liquidity of EUR 571M and EUR 100M of signed disposals should be sufficient to meet maturities through 2025. The average interest rate that the company pays on its debt is 1.4% with 91% of all borrowings either at fixed rate or hedged.

Valuation

At the moment of this writing, the company trades at around EUR 7.40/share (US$8.10/share), resulting in market cap of approximately EUR 1.3B. However, the NAV metrics suggest value of more than EUR 26.5/share or more than 3.5x.

Still, in the current environment of rising interest rates and falling property prices using NAV as a main source of valuation is not the most appropriate course of action. So I’m going to look to the company through FFO and AFFO multiples. For Q1’23, Grand City Properties reported FFO of nearly EUR 47M and AFFO of EUR 28.7M, as maintenance and repositioned CAPEX spending was elevated. Annualizing that gives a FFO multiple of 6.9x and AFFO multiple of 11.4x.

For comparison, the sector median values are considerably higher with Forward P/FFO of 12.68x and Forward P/AFFO of 15.00. The former implies more than 80% upside potential, while the later more than 30%. Taking the average of the two, results in around 55% upside potential if Grand City Properties was to reach the median multiples of the sector.

Interest rates risk

With a weighted average interest rate on its debt of 1.4%, Grand City Properties will face a severe hit if it was to pay current market interest rates. So the big question is how long the current tightening monetary cycle will persist and will the reversal to easing follow suit in a short period of time.

An encouraging sign that tightening should be coming to an end very soon is the falling inflation in the euro area. Another practical argument against prolonged high interest rates environment is the debt level of some euro area members like Italy . A repeat of the sovereign debt crisis is the last thing that the EU bureaucrats would want, so maintaining a high interest rate seems unlikely.

Looking at the other side of the Atlantic, the market is anticipating a series of rate cuts by the FED in 2024, so ECB may follow suit. Such timing will be excellent for Grand City properties as it won’t have to roll-over debt until 2026, given its current liquidity. This should allow the company to avoid the current high interest rates environment.

Conclusion

The negative sentiment in the real estate sector creates opportunities. I identify one such opportunity in Grand City Properties. The company has a solid financial profile with its debt maturities covered by existing liquidity through 2025, growing rents and falling vacancy. At the same time, it trades at a deep discount to its NAV and the sector when compared through the P/FFO and P/AFFO multiples. Based on those multiples, I estimate 55% upside potential.

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