ADLER Real Estate AG : KPIs are moving into the right direction; we recommend subscription to new 5-year and 8-year tranches at yields of minimum 1.8% and 2.9%

Adler intends to buyback € 200m of its € 500m 4.750% notes due 2020 and to redeem bridge financing for the acquisition of Brack Capital Properties (BCP) from the issuance of new unsecured notes (expected ‘BB+’ rating) – potentially worth € 800m. - Adler improved its rental KPIs yoy in 2017. Gross rental income improved by 10.5% (adjusted for the sale of Accentro: 7.6%) yoy to € 264.4m (2016: € 252.4m; adjusted for the sale of Accentro: € 245.8m). Average rent (per m² per month) across the total portfolio rose by 3.4% to € 5.17 in (2016: € 5.01). Like-for-like rental growth was 3.7%. - Occupancy stood at 90.6% at end-December 2017 and was slightly higher yoy (2016: 90%). In the core portfolio, occupancy improved to 92.1% (2016: 91.4%). The number of units rose to 50,305 (YE 16: 47,662). The acquisition of BCP will add about 12k residential units. But Adler plans also to divest c.4k of non-core units. - S&P’s debt to debt and equity ratio totalled 67.1% at YE 17 (YE 16: 65.9%), which needs to decline below 60% in order to be rewarded with an investment grade rating. To achieve a corporate investment grade rating at the given capital structure, equity would need to rise by € 376m over a two-year period until end-2019. - >Credit Opinion - Our Positive credit opinion has not changed and still assumes that: 1/ the German residential real estate market will stay benign; and 2/ Adler will be able to further execute on its value-accretive strategy and improve its still relatively high LTV and low interest coverage. Interest-rate risk is high, but not an immediate risk yet.The unclosed sale of Accentro and Adler’s non-core assets as well as project Riverside and the development projects acquired together with the residential assets from BCP expose Adler to execution and construction risks.We now foresee an upgrade of the corporate rating to ‘BBB–’ in 2020 instead of 2019 as S&P sees debt to debt and equity above 60% in the next two years driven by conservative fair value appreciation assumptions. If S&P converts its positive outlook into an upgrade to ‘BB+’, then the rated unsecured issues would be rated ‘BBB–’.Recommendation - Prospectively, we believe that ‘BBB–’ rated peer bonds are the right benchmark.But investors view Adler rather as a ‘BB+’ risk. However, we recommend subscription to a potential 5-year tranche at a yield of 1.8% or more and to a potential 8-year tranche at a yield of 2.9% or more.In terms of existing notes we affirm our Buy recommendations for the 2021 and 2024 straight bonds and our Neutral recommendation for the 2021 CB. We change our recommendation for the 2020 bond to Neutral after yesterday’s price surge.