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Monday 6 March 2017

Mergers and takeovers in the German housing sector - Real Estate Committee newsletter article, March 2017

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Mergers and takeovers in the German housing sector

Peter Vocke, Heuking Kühn Lüer Wojtek, Düsseldorf



‘One million apartments for Vonovia, to me this sounds like a reasonable figure on a mid-term perspective’, said Vonovia Chief Executive Officer (CEO) Rolf Buch, and the market believes him. Because Vonovia and other major players aim to feed their appetite for growth by acquiring massive portfolios, medium-sized investors are encouraged to compile portfolios in order to structure and resell them.

Within the past three years, the German housing sector has seen a series of large mergers and takeovers, starting in 2014 when the then Deutsche Annington announced the takeover of its rival GAGFAH. Given the fact that the two companies had nearly a similar size, with 200,000 lettable apartments of Deutsche Annington and 145,000 of GAGFAH, it turned out to be a good idea for Deutsche Annington to seek an amicable business combination agreement (BCA) with GAGFAH rather than a hostile takeover. Under the BCA, a ‘best of both world’ policy was agreed, providing for a competitive recruiting process for management positions just below the board of directors, a new headquarters, and a new name for the then combined company, being ‘Vonovia’. With the closing of the GAGFAH takeover in 2015, Vonovia – with currently around 340,000 apartments and a portfolio value of more than €23bn – became the second-largest listed real estate company in Continental Europe, directly after the French Unibail-Rodamco group, which is concentrated on commercial real properties.

However, in 2016, bullish Vonovia failed to acquire a majority of shares of Deutsche Wohnen in a hostile takeover attempt. Fighting tooth and nail, Deutsche Wohnen’s management stated that Deutsche Wohnen with its 150,000 apartments, approximately 100,000 of which are situated in Berlin, was better off alone, without having its portfolio diluted with Vonovia’s apartments, which predominantly arose from former public housing. Nonetheless, market experts believe that Vonovia’s next attempt is only a matter of time.

Recently, Vonovia managed to conclude 2016 with a 70 per cent-plus takeover of shares of Austria-based Conwert. It is believed that this takeover was successful due to both an amicable approach as well as a low threshold of 50 per cent plus one share. Conwert holds about 24,500 apartments in Germany and Austria.

Economies of scale – loans without mortgages

Merging large residential portfolios allows for some economies of scale, such as standardised information technology-based property management processes, and advantages through large-scale purchase of goods and services including construction works.

Less obvious advantages of scale are comfortable loan conditions. According to Standard & Poor’s, Vonovia has a long-term corporate credit rating of BBB+, with a stable outlook. Unimaginable for a homeowner or private real estate investors, this allows for loans not secured by mortgages.

Key legal aspects concerning acquisitions of companies with German properties

It is understood that real  estate transactions are complex processes involving manifold legal and commercial, as well as strategic questions that must be carefully structured to avoid expensive surprises at the end. From a legal perspective, an economically envisaged acquisition of a company with German properties can be executed as an asset deal, as well as a share deal. Regarding the specific real estate questions, the two forms of transactions, however, do not differ too much.

Besides the well-established general aspects of any real-estate due diligence (regardless of its place and jurisdiction) there are a number of specific German aspects, which need to be taken into account.

In the early stages of a transaction, the object of purchase often is only described and discussed under the properties’ mailing addresses without plot numbers. Therefore, a review and report on title require current excerpts of cadastral maps (Flurkarten), as well as land registry excerpts (Grundbuchauszüge). Because a change in ownership of real properties (except for certain exemptions such as heritage (Erbfall) or compulsory auction (öffentliche Versteigerung)) is only possible by registration of the new owner in the land registry, one fortunately always knows who the owner is.

Typical property-owning  special purpose vehicles (SPVs) are German limited companies (Gesellschaft mit beschränkter Haftung GmbH or GmbH & Co. KG) as well as Luxembourg or Dutch registered limited companies (SARL – Société à responsablité limitée or besloten vennootschap met beperkte aansprakelijkheid BV) or British limited companies.

The due diligence process comprises, of course, a diligent review and checking of the land registry for pre-emptive (Vorkaufsrechte) rights and other encumbrances that may render the acquisition more difficult or which may have a negative impact on the recoverability of the investment or its valuation.

Encumbrances may, for example, consist of a right of way (Wegerecht) or a right for pipes (Leitungsrecht) or other supply lines that normally play a minor role in the due diligence. Encumbrances may, however, also consist of servitudes (Dienstbarkeiten) that restrict the prospective use of the property. For example, a pre-emptive right or a re-conveyance notice (Rückauflassungsvormerkung) may secure use restrictions imposed by a former (municipal, other public or parochial) owner. While a pre-emptive right is not directly applicable in a share deal, some of the rights secured by encumbrances may include a change of control clause and, hence, are also relevant for share deals. Furthermore, depending on the investment strategy, encumbrances not applicable in a share deal may set the course for future recoveries and exit strategies, such as privatisation by selling residential units. For that reason a careful analysis of encumbrances is essential.

In an asset deal, it is common practice that financial encumbrances, such as mortgages (Hypotheken) or land charges (Grundschulden) are not taken over by the purchaser but have to be deleted by the seller at its own costs. Hence, such encumbrances do not play a major role in the due diligence process. In order to gain some security that the seller will achieve the deletion of the mortgages, the purchaser may ask for a prior informal statement of the seller’s bank that the purchase price is sufficient for the repayment of the loan. If in either an asset or a share deal mortgages are transferred, predominantly the loan agreements as well as the respective security documentation have to be examined in detail. In the acquisition of a company with subsidised (residential) properties, takeover of these subsidies by the purchaser is a key element. Subsidies may either consist of low-priced loans as well as of (non-repayable) grants for new construction or modernisation of buildings. Takeover of these subsidies has a direct impact on the economic framework of the acquisition. On one hand, low-priced loans can be considered in calculations. On the other hand, subsidies generally come along with rent limitations, a right of the subsidising institution to select tenants or other restrictions. While in a share deal no change in ownership takes place, subsidy agreements (in every case we have seen so far) contain change of control clauses. The question of whether or not and under which preconditions subsidies can or have to be transferred must be examined by the purchaser.

Further areas of restrictions in use arise from so-called social charters (Sozialcharta). The major players in the housing sector came to their position by acquiring large portfolios formerly owned by public entities, including, for example, the German national railways. Selling these portfolios was a balancing act for the former owners: on the one hand, the aim was to get rid of expenses and to generate free cash. On the other hand, it was essential to maintain a certain influence in order to protect tenants’ needs (who may be their current or retired employees). As a result, in social charters, as part of the purchase contracts, certain restrictions were imposed, such as protections against the cancellation of lease contracts, requirements for certain minimum investments in repairs, maintenance and/or modernisations, job protection of employees taken over and restrictions for the privatisation of condominiums. The social charters often run for ten to 15 years and are secured by severe contractual penalties. When acquiring a company bound by a social charter, it has to be analysed diligently to know which restrictions are still applicable and what influence these have on operations and recoverability.

In addition to the report on title, the question of sustainability and endurance of lease contracts by nature is another key issue of real estate due diligence.

Concerning commercial lease agreements, the so-called ‘550-issue’ is one of the major points, which has the following bakground: section 550 of the German Civil Code (Bürgerliches Gesetzbuch) provides that lease agreements that are concluded for more than a year have to be concluded in writing. If this form provision is not complied with, such lease agreements can be terminated by either party within the statutory notice period, which regularly is after the first year within a six-month notice period to the end of the quarter. Jurisprudence developed a large number of requirements to comply with this written form requirement. For example, that the lease agreement must be concluded within one single document or a row of documents where each subsequent document specifically refers to the respective previous documents. While the aim of the 550-provision initially was to protect a purchaser against the existence of unexpected unwritten lease agreements, which are automatically transferred to the purchaser by law, the 550-provision has in practice turned into the opposite effect for purchasers. Because it provides for a termination by both parties to the lease agreement, purchasers have to worry about premature cancellations of long-lasting lease agreements and, thus, a negative commercial impact on their investment. To avoid this, 550-issues can be sorted out prior to signing of the purchase contract by, for example, concluding a form curing supplement agreement to the lease agreement between seller and tenant.

Furthermore, commercial lease agreements have to be examined to assess whether any index clauses, turnover rents or graduated rents agreed upon are in fact effective.

Whereas both commercial as well as residential lease agreements normally provide for a net rent plus service charges (the latter settled and re-conciliated on an annual basis), the German Civil Code sets a narrow framework for residential agreements.

Hence, concerning residential agreements, one normally only looks into the template used for a number of properties. Due to a change in jurisprudence, almost all older agreements are considered to have void clauses concerning renovation obligations of tenants.

Because the purchaser is responsible for the repayment of rental securities provided by tenants to any previous owner (even if securities were not handed over to purchaser), it is of importance to make sure that securities are held and transferred properly by the seller.

The due diligence concerning public law comprises, depending on the investor’s needs and strategy, evaluating (existing or envisaged) building permits as well as public development costs. The latter are always charged to the current owner, regardless of when the respective development works took place. Thus, it should be requested from the relevant authorities whether there are any costs to be settled.

An asset deal has to be notarised by a German notary, generating fees for the notary and the land registry office (Grundbuchamt) that are fixed by statutory provisions and, hence, are not subject to negotiations. Normally the purchaser bears these costs.

A share deal may also be notarised abroad, for example, in the jurisdiction where the target has its registered office. However, it has to be analysed very carefully whether or not such notarisation meets the equivalent criteria developed by the jurisprudence. Pursuant thereto the notarisation, in general, must conform with a German notarisation to be accepted by German courts. Otherwise, the notarisation might be void and, hence, the transaction as such invalid.

As a result of an asset deal, lease agreements are transferred automatically by law to the new property owner. Other contracts, such as property management or other service contracts are not transferred automatically and it has to be agreed in the sales and purchase agreement (SPA) whether such contracts shall be transferred (subject to the service provider’s consent).

The real estate transfer tax (RETT) depending on the respective state (Bundesland), varies from 3.5 to 6.5 per cent of the purchase price. As common practice, the purchaser bears the RETT, while the seller and purchaser are jointly liable with respect to the tax authorities. RETT also becomes due when 95 or more per cent of all shares of a property holding company are directly or indirectly acquired by just one party. A RETT-blocker scheme requires at least an acquisition of 94.9 per cent with the remaining 5.1 per cent held or acquired by a third, that is, not affiliated, legal entity.

The overwhelming number of more than 23 million rented apartments are owned by individual or small or medium-sized companies. Antitrust requirement even in major acquisition therefore are never a big issue. The merger control authority, in theory, could impose resales on an investor, concerning parts of its portfolio that create a dominant market position in one city. However, the German merger control authority cleared plans for Deutsche Annington to combine with GAGFAH without any conditions and obligations.

Opportunities for investors

As described above, the German residential market still leaves a lot of space for M&A. For small and medium-sized investors, disposals of the major companies as part of their portfolio adjustments also provide opportunities: properties outside the core regions of major companies can be both of good quality as such and, in many cases, offer attractive, sometimes spectacular, yields.


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