REFIRE Interview: ZAR Real Estate Holding

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The Munich-headquartered ZAR Real Estate has set itself the ambitious goal of being the leading Manage-to-ESG residential housing developer in Germany over the coming years.

REFIRE met with ZAR’s Martin Hofmann (CEO) and Daniel Argyrakis (CFO) recently to find out more.

REFIRE: Mr. Hofmann, Mr. Argyrakis, please give us a brief potted history of ZAR Real Estate

ZAR Real Estate: The modern ZAR Real Estate Holdings was established in 2018 by our sole shareholder, Marco Zarges. Marco had already gathered more than 15 years of experience as a property investor and portfolio holder in the German market with various companies. ZAR originally focused exclusively on project development, specifically the earliest phases of development – creating planning and building rights. This was our strength – bringing plots or brownfields, but also greenfields – to the stage of planning permission, and then selling the mature properties or plots to potential companies that would then realise and build out on them.

We still have ten such current projects, located in some of Germany’s biggest cities, including Nuremberg. This has obviously become more difficult in the current market climate. But because of the history of our company, which saw us owning 13,000 apartments in eastern Germany until Marco Zarges sold them at the end of 2017, we decided eighteen months ago to pivot into classical investment into German residential property.

Our main goal is to buy and reposition properties with greatly enhanced energy profiles – as some describe it, Manage to Green, while we call it Manage to ESG.

- ZAR Real Estate

This seems to be a popular strategy among investors at the moment...

We’re not just buying property in the hope that the market will improve. Although we ARE able to buy currently at big discounts from funds or institutional investors who have to sell. But our main goal is to buy and reposition properties with greatly enhanced energy profiles – as some describe it, Manage to Green, while we call it Manage to ESG – so that they’re energetically ‘fit’ for the EU’s goal of climate neutrality by 2050.

How many properties do you own, and where did you find them?

We now have almost 10,000 residential units, which we identified through various means, mainly through our own network. One large portfolio deal was a classic off-market deal, where a seller took the opportunity to sell before the pressure on refinancing became too much. We’ve also bid successfully for smaller portfolios in bidding auctions run by brokers. We’re only interested in portfolios, not individual properties, as it’s much more cost- and time-efficient.

The supply gap in German residential is set to widen enormously, with new supply falling to about 200,000 units annually for the next few years – way below the government’s pledge of 400,000 a year. There’ll be 2 million more people living in Germany by 2030, and they’ll all need living space. Rents have risen by between 4% and 7% in the last two years and are set to rise further. Demand, and along with it rental yields, have also increased.

Who is selling portfolios into the market, and what are their main reasons, given the depressed state of the market?

People’s motivations differ. In one case, we bought from a seller whose portfolio was a long way from ESG-conformity. He knew he’d have to invest, but he didn’t trust himself to do so – not because of the costs involved, but because he lacked the professional know-how. He preferred to sell to somebody who did have that know-how, which in this case was us.

There are also large institutional investors who bought at the peak of the market and are seeing much lower valuations for their stock. Book values are sinking, they have refinancing issues and liquidity bottlenecks, and they may have to sell. They may not be abandoning their strategy, and might even be buying other portfolios elsewhere, at more favourable prices. But this is where we come in with an offer to buy.

And what gives you an edge over your competition?

We ARE seeing more competitors now on the buyer side, similar to us - although the numbers are manageable. But our edge is that, while many people TALK about ESG, we really put it into practice. There are two key issues in our active managing of the properties – the structure of the property, and whether it’s in an A-city or a B-city. We completely refurbish the facade in series, given the poor insulation of so many buildings from the 70’s and the 80’s. There is a large amount of funding available from the German government via the KfW bank – in some cases up to 45% of every euro invested in the refurbishment.

How does this affect the tenant, who suddenly has a new landlord and - presumably - plenty of disruption?

If we renovate the facade, we are allowed by law to impose a modernisation charge on the tenant, of between €2 and a maximum of €3 per square metre per month. This is of course strictly regulated. But by renovating only the facade, not entering into the tenant’s apartment, and giving the tenant lower ancillary costs as a result, we can charge a modernisation levy.

The second strategy that give us an edge is our sole concentration, with a new joint venture partner, on installing completely new heating systems. This involves quickly converting the properties from conventional energy supply of gas and oil to a heat pump system. In this case we wouldn’t need to refurbish the façade, which in itself is very capital-intensive.

Our holdings in Germany have an average energy rating of E, which equates to about 200 Kilowatt hours. With our partner, who has made us their Preferred Partner, we can improve this to an A-rating, which equates to about 50 Kilowatt hours. This would put us into the top 15% of housing managers in the country, would give us full compliance with the EU taxonomy, and remove any fear of us being landed with stranded assets. Within the world of ESG, we believe that energy efficiency is the single most important thing – lowering ancillary costs for the tenant, and lowering CO2 emissions from the property.

What are your preferred locations and transaction sizes?

We look for a minimum transaction volume of €15 million, with no upper limit. We generally don’t buy in a city with fewer than 30,000 inhabitants. We prefer the western German states, where rents are typically higher than in the east, with the exception of Leipzig and Berlin. Many of our units are in North Rhine-Westphalia, where traditionally the ownership rate has been among the lowest. Our goal is to build up our holdings to 50,000 units in the next three years.

Phew, that would put you among the top seven landlords in Germany...?

We don’t want to be the biggest, but we DO want to be the market leader in Germany with energy-efficient refurbished properties.

What might prevent you from reaching that ambitious goal?

We are building our expansion plans based on the current legislation in the form of the Building Energy Act. If this were to change dramatically again – which we certainly do not expect – this would be our biggest hurdle, if oil and gas heating systems were suddenly to be subsidized again. Or if the large subsidy funding pots at the KfW were suddenly to be no longer available, as we experienced last year.

If the entire Building Energy Act were to be rolled back to where it was five years ago, we’d have problems. But that’s highly unlikely, since the Act embodies our CO2 targets as a society, framed by the European Union, along with the 2-degree target or the 1.5-degree target under the Paris Agreement. The Act is ultimately just the implementing of national legislation in Germany to achieve these targets.

Are all residential property prices still falling? We thought we were seeing a bottom...

We’ve been seeing a massive drop in prices across all energy-efficiency classes in residential properties compared to the valuations in 2020. We’ve been able to buy at up to 30% below appraised book values, a hefty discount. The worse the energy efficiency, the higher the discount. In the portfolios that we buy, we always have a certain number of properties with a C- or a D-rating, but the average overall is E. For properties with even lower ratings, you’ll have to invest heavily in insulation or system technology over the next few years.

Are there any properties you wouldn’t buy, at any price?

We’d avoid buying anything with 25% vacancy or more. This generally means there’s a problem with the micro-location or the properties are of very poor quality. Some properties have had no maintenance in over 20 years, the decay is patently visible, there might be fire safety deficiencies – these would be too risky for us. We’ve heard of portfolios on the market selling at a multiple of six or seven – that’s not good value, that’s downright cheap. Whoever buys those will need to have deep pockets, because no bank would touch such a portfolio.

Financially, can you handle all this expansion from your own resources?

Banks are going to be an essential part of this, of course. It’s an attractive product for the banks, who have to keep their own loan portfolio green. They have a strong interest in financing projects with ESG components, such as we’re offering. Smaller projects, such as our €15 million minimum size, can be financed by local banks and Sparkassen. For larger deals, the regional banks and commercial banks are offering good levels of financing, much more readily available compared to project development. For example, our recent purchase of 350 apartment units in Cologne was done with the help of a senior loan from LBBW, in addition to our own equity.

But we’re also interested in talking to foreign providers of capital to see if they’ll support us in generating the scale we need, and in participating in generous returns over the longer term. For some, this might be the perfect chance to gain exposure to German residential, with serious long-term upside potential. Not so much from sales, as our goal is to build up the portfolio. But the larger the portfolio you have, the wider the range of refinancing options at a later stage, whether through green or sustainable bonds, tapping into the capital markets or a public listing. The energy-efficient refurbishment of housing stock will open up many new financing options in the future.

And as we further roll out our strategy of Manage-to-ESG, we’re certainly open to several forms of co-operation with third parties, whether as a club-deal with a fund structure, or a project-related deal with a Luxembourg fund vehicle, which are familiar to many foreign investors. Or even a classic joint venture.

How are foreign investors viewing the market?

Investors continue to be fundamentally interested in German residential property, for a variety of well-understood reasons. They see how far prices have fallen. They’d like to buy direct, but often they don’t have a local partner to work with. A lot of German institutional money is holding back right now, through general hesitancy and uncertainty. It’s a good moment and a good opportunity for foreign investors.

What would you describe as your other strengths at ZAR Real Estate?

We have a breadth and depth of experience in our 20+-man team that you’d be hard-pressed to find anywhere else. We can anticipate things very quickly and react to them. We have short decision-making paths, making us much more nimble than large owners. A quick call to our main shareholder and you’ve got a decision fifteen minutes later – it’s been like that since we started on this Manage-to-ESG residential path eighteen months ago. That level of response helps gives us a definite edge.

Our new partner, with whom we’re rolling out our new strategy exclusively, cited this agility and flexibility as a key reason for signing with us. Our partner’s patented process, together with our distribution, can be a real game-changer. Once we reveal who it is – which we will do, hopefully at the Expo REAL – we really think this will cause a stir in the market. We believe we have identified a person and an approach to the major problem of upgrading the energy efficiency of housing stock in Germany and making it affordable. This is hugely exciting.