The German real estate market and our business are affected by changes in general economic and business conditions, such as the recent financial and economic crisis. The sovereign debt crises and the recent turmoil in the financial markets could lead to a slowdown or even a rever- sal of the economic recovery and could have a detrimental effect on the German real estate market and on our business.
Our core business is the management of residential properties and the sale of individual apartments. Accordingly, we rely significantly on rental income. Our performance, therefore, depends largely on the amount of current gross rental income generated or capable of being generated, the expenses we incur in generating such rents, the proceeds generated or capable of being generated, and the value of the properties. These performance factors and the value of the properties are subject to general economic and business conditions.
The global financial and economic crisis, triggered by the mortgage crisis in the United States and other factors, forced banks to take extraordinarily large asset write-downs on their balance sheets and led to a substantial increase in loan spreads in the financial markets. As a consequence, banks’ refinancing costs increased significantly. This triggered a worldwide economic crisis that expanded to essentially all business sectors, particularly manufacturing. Although many economies largely recovered from the economic crisis, the outlook has distinctly worsened recently and the economic environment may deteriorate again, for example, on the basis of the sovereign debt crises or the recent turmoil in the financial markets. As a result, the real estate sector would be significantly affected. This could lead to insolvencies among our business partners (including financial institutions that serve as hedge counterparties) and thus, result in us facing difficulties to obtain further financing or the effectiveness of our hedges. Furthermore, the creditworthiness of tenants and potential real estate purchasers could deteriorate. When tenants’ creditworthiness deteriora- tes, such as when jobs are lost, tenants may be unable to meet their payment obligations of the in-place rent plus the agreed incidental costs or will be forced to terminate their leases with us, which could result in us receiving less in-place rent. Moreover, it is possible that if the economy in Germany again faces a downturn, and consequently, the unemployment rate increases again, real incomes could stagnate or decline and come under additional pressure through increases in taxes, energy prices and the cost of living and, consequently, demand from potential tenants and purchasers of residential properties could decline. Additionally, demo- graphic developments or local employment conditions in certain core regions could affect the real estate market, particularly the demand for housing. In addition to the loss of in-place rent, we could also experience increased vacancies. In that case, it is possible that we will not be able to re-let the apartments on the original terms, or might be able to do so only after making additional investment to maintain the attractiveness of the property.
The key interest rate level is currently relatively low. It is possible that the interest rate for real estate loans in Germany and elsewhere will increase significantly in the future. Any such development could negatively affect the willingness of potential buyers to make real estate purchases, could require property portfolio value adjustments and could therefore constrain our sales of apartments. Additionally, due to the recent developments in the financial markets, financial institutions could require that borrowers in Germany meet more stringent qualifications. This could lead to potential buyers of residential properties refraining from the purchase of a property due to worsened financing terms or even the unavailability of credit. A significant increase in loan interest rates and more stringent borrower qualification requirements could also impair our
ability to finance property portfolio acquisitions through debt, and our ability and that of our competitors generally to refinance for some time. Consequently, we and our competitors could be forced to sell property portfolios at substantial discounts, due in large part to the difficult financing conditions experienced by buyers. As a result, we could be exposed to the risk of diminution in the fair value of our total portfolio and could be required to recognize the corresponding losses from the resulting fair value adjustments of our investment properties.
Worsening business and general economic conditions could impair the future performance of our property management business, single-unit sales (privatizations) business and our acquisitions, and have significant adverse effects on our net assets, financial condition and results of operations.
It could become more difficult, for various reasons, for us to acquire properties on attractive terms, which would impair the future performance and particularly the growth of our business. We may not be able to materialize the potential acquisitions in our acquisition pipeline.
Our commercial success depends, among other things, on our ability to continue to acquire residential property portfolios and properties with appreciation potential and/or rent increase potential in economically attractive regions at reasonable prices, with good tenant structure, in high-quality locations and at favorable occupancy rates, with sustainably high in-place rent or rent increase potential. Additionally, the success of our business model depends on our being able to integrate and successfully market newly acquired properties in our total residential portfolio. Management believes that Deutsche Wohnen currently has a sizeable acquisition pipeline. We may, however, not be able to materialize the transactions in our acquisition pipeline, for example due to financing shortages or the failure to reach mutually agreeable terms. In addition, it could become more difficult, for various reasons, for us to acquire properties at attractive prices.
For one thing, the German real estate market has been characterized in recent years by a high level of buyer interest because German property prices were considered relatively attractive when compared with properties in other countries, and investors were thus able to achieve relatively attractive returns. Thus, many investors, including foreign financial investors, bought German residential real estate. As a rule, such investors acquire large property portfolios that are offered through auctions or tenders in which we also participate. Foreign investors, in particular, sometimes have considerable financial resources that allow them to submit high bids for property portfolios. In the past, the increased presence of foreign investors, as well as the generally high level of investor interest in German real estate, has caused residential property prices to increase.
Additionally, real estate inventories held by municipalities and the states have been privatized in Germany in recent years, especially prior to 2007. Our real estate inventory was also partially assembled through such privatizations. With respect to the decision to sell their real estate holdings, the states and municipalities are influenced by public opinion of such privatizations. If, in the future, public opinion in municipalities and states should increasingly turn against privatization, or if privatization activities are scaled back due to other political considerations, municipalities and states could cancel current privatization activities and refrain from initiating further privatizations. This could lead to a constriction of supply and an increase in prices of residential properties on the German market, which in turn could result in our having fewer or no properties available for acquisition, or our having to pay higher prices due to the limited supply.
If we are unable to acquire suitable properties on attractive terms in the future, this could limit our future growth. If there are only a few or no new properties available for acquisition, our earnings from the sale of a decreasing number of properties for disposal and/or our earnings from residential property management of a decreasing number of residential properties would decline. This could have a significant adverse effect on our net assets, financial condition and results of operations.
Our acquisition of additional property portfolios can be financed not only by taking on additional debt, but also by issuing and offering new shares in the capital markets. If we are unable to obtain the necessary capital on the capital markets on reasonable terms, we might be unable to make further acquisitions, or might be able to do so only to a limited extent or, if debt financing is available, only by taking on additional debt. In addition, any additional debt incurred in connection with future acquisitions could significantly negatively impact our loan-to-value ratio. If we are no longer able to obtain the debt or equity financing we need to acquire additional property portfolios, or if we are able to do so only on onerous terms, our further business development and competitiveness could be severely constrained.
We are dependent on regional market developments.
Our real estate inventories are concentrated in Berlin and the Frankfurt/Rhine-Main area (Frankfurt am Main, Wiesbaden and Mainz). Accordingly, we are dependent on market trends in Germany and, in particular, trends in these regional markets. The general conditions in, and the development of, the regional markets are important to our success. The key factors affecting performance and valuation also flow from the economic environment of these regional real estate markets. Performance and valuation are dependent on various factors, including demand, tenant creditworthiness, purchasing power of the population, attractiveness of the particular locations, the labor market situation, infrastructure, social structure, demographic developments, changes in household size and other factors influencing supply and demand for real estate in the respective locations and markets.
Because regional markets within Germany do not develop uniformly, our dependence on only a few regional markets can adversely affect our earnings targets in the event of a decline in the attractiveness of the respective markets; this can put us at a disadvantage as compared with competitors who have a more diversified property portfolio. Additionally, negative developments in our core regions would affect not only individual properties, but the total residential portfolio in the relevant core region.
The factors described above could lead to a downturn in the regional markets in which we own real estate. This could have a significant adverse effect on our net assets, financial condition and results of operations.
The forecast with respect to the funds from operations for Deutsche Wohnen Group may differ materially from actual future cash flows or revenue and earnings of Deutsche Wohnen Group.
This Prospectus contains forecasts and other forward-looking information relating to specific measures, including funds from operations of Deutsche Wohnen. Funds from operations is calculated by taking the profit for the period and adjusting it for gains/losses from disposals (net of cost of sales), restructuring and reorganization expenses, gains/losses from fair value adjustments of investment properties, depreciation and amortization, gains/losses from fair value adjustments of derivative financial instruments, accrued interest on liabilities and pensions, prepayment penalties and deferred tax expense/income and for 2009 also adjusted for the tax advantage from capital increase costs and for 2008 also adjusted for the profit for the period from discontinued operations and special DB 14 payout. In arriving at a forecast for funds from operations, our management makes certain assumptions regarding unforeseen events such as force majeure, legislative and other regulatory measures, the economic development of the real estate industry, the interest rate development, the development of the total portfolio and of some performance indicators (current gross rental income, vacancies and rental loss), expenses (real estate operating expenses, administrative expenses, staff expenses, and other operating income and expenses), the Nursing and Assisted Living segment, the financial market and the expenses spent during the re-letting process. Although management believes these assumptions are reasonable in the current environment, there can be no assurance that these assumptions will be consistent with actual future developments. Even if these assumptions are currently reasonable, they may be incorrect or inaccurate, since they relate to factors on which the Company has no or very limited influence. Should one or more of these assumptions prove to be incorrect or inaccurate, the subsequent funds from operations could differ materially from the forecast of the Company or of Deutsche Wohnen Group, particularly if interest rates change significantly.
Sales prices of our residential properties could come under pressure from competition and other factors.
Our Disposals segment can only be successful in the market if we succeed in selling the inventories of our total residential portfolio that are earmarked for sale at a profit. This depends primarily on the prices we can achieve in the residential real estate market, which are affected by various supply and demand factors. Government bodies or industrial companies that own residential real estate could increasingly seek to sell apartments to tenants, owners and investors, as well as to financial investors. For example, considerable housing inventories have been privatized in Germany in recent years. An increase in the supply of residential properties could put pressure on sales prices, particularly in the local markets in which we own residential property. In addition to increased supply, pressure on sales prices could also occur through a decline in demand or a combination of the two factors. As investment in housing in Germany has become an increasingly important element of retirement planning, private individual real estate acquisition has increased. If real estate becomes less popular as a retirement planning tool in the future, the demand for residential property could decrease, and, consequently, apartments could be sold only at lower prices. As a whole, lower sales prices for our apartments would reduce our earnings or even cause us to sustain losses.
Lower sales prices could also result in our being required, for the respective accounting period, to adjust the fair value of our total portfolio on our consolidated balance sheet, and to record losses on our consolidated profit and loss statement from the resulting fair value adjustments of our investment properties. Moreover, the absence of a liquid real estate market could temporarily make the sale of properties entirely impossible. Increases in the property transfer tax could also have a negative effect on the liquidity of, and demand for, real estate. In addition, low sales prices for real estate or a decline in sales would also lead to lower cash receipts, which could adversely affect our financial condition and results of operations.
We operate in a highly competitive market (including rentals and sales) in Germany in the field of residential real estate, commercial property to a lesser extent and senior homes. While most of our competitors are domestic, foreign competitors may try to enter the German real estate market and increase competition. The consequences of increased competition could be lower sales proceeds, lower margins, lower in-place rent and increased acquisition prices for property portfolios. Some of our current competitors could have a broader customer base to which they can sell properties or significantly greater financial resources than we do, and could build on these strengths by engaging in more aggressive pricing.
All of these factors could have a significant adverse effect on our net assets, financial condition and results of operations.
Our investments are predominantly investments in real estate. Due to the potentially illiquid nature of the real estate market we may not be able to sell any portion of our total portfolio on favorable terms or at all.
Our investments are predominantly investments in real estate for which there is a market with limited liquidity. If we were required to liquidate parts of our total portfolio, in particular on short notice for any reason, including raising cash to support our operations, there is no guarantee that we would be able to sell any portion of our total portfolio on favorable terms or at all. The general ability to sell parts of our total portfolio depends on the investment markets which may lack liquidity. In the case of forced sale, there would likely be a significant shortfall between the fair value of a property or a property portfolio and the price that we would be able to achieve upon the sale of such property or property portfolio, and there can be no guarantee that the price thus obtained would even cover the carrying amount of the property sold. Any such shortfall could have a material adverse effect on our net assets, financial condition and results of operations.