28 Investment Properties

The additions in 2019 include € 493.0 million (2018: € 86.9 million) in production costs for new construction activities.

The total amount reported for investment properties as of December 31, 2019 includes right-of-use assets from recognized inheritable building rights and interim leasing arrangements in the amount of € 1,224.8 million (see note [E42] Leases).

The majority of € 1,223.7 million is attributable to right-of-use assets from inheritable building rights. This includes € 78.1 million (previous year: € 71.0 million) relating to the Spree-Bellevue (Spree-Schlange) property in Berlin. The property has been leased from DB Immobilienfonds 11 Spree-Schlange von Quistorp KG until 2044. The lease agreement includes an obligation to pay compensation for loss of use as agreed by contract. At the end of 2028, each fund subscriber is entitled to return his share to the property fund at a fixed redemption price. If all of the fund investors make use of this option, Vonovia is obliged to acquire the property at a fixed purchase price after deduction of borrowings. If more than 75% of the shares are returned in this way, Vonovia has a call option for the purchase of all fund shares.

Taking into account the inheritable building rights already included in investment properties in the amount of € 732.0 million as of January 1, 2019, that were reclassified to right-of-use assets, this results in additions to right-of-use assets pursuant to IFRS 16 in the amount of € 266.0 million in total.

This is mainly composed of the first-time adoption of IFRS 16 as of January 1, 2019, in the amount of € 217.9 million, as well as additions resulting from business combinations in the amount of € 38.6 million.

For the investment properties encumbered with land charges in favor of various lenders, see chapter [E40] Non-derivative Financial Liabilities.

Directly Attributable Operating Expenses

Rental income from investment properties amounted to € 2,077.9 million during the fiscal year (2018: € 1,897.8 million). Operating expenses directly relating to these properties amounted to € 218.7 million during the fiscal year (2018: € 195.1 million). These include expenses for maintenance, ancillary costs that cannot be passed on to the tenants, personnel expenses from the caretaker and craftsmen’s organizations, and income from the capitalized internal expenses. The capitalized internal expenses relate to the work performed by the Group’s own craftsmen’s organization and the management costs for major modernization projects.

Long-Term Leases

Vonovia as a lessor has concluded long-term leases on commercial properties. These are non-cancelable leases. The minimum future lease receipts from these leases are due as follows:

Fair Values

The value of the entire portfolio of residential properties was determined on the basis of the International Valuation Standard Committee’s definition of market value. Portfolio premiums and discounts, which can be observed when portfolios are sold in market transactions, were not included. Nor were time restrictions in the marketing of individual properties. Vonovia determines fair value in accordance with the requirements of IAS 40 in conjunction with IFRS 13.

Vonovia, in principle, measures its portfolio on the basis of the discounted cash flow (DCF) procedure. The Austrian portfolio was valued by the in-house valuation department for the first time in 2019. Under the DCF methodology, the expected future income and costs of a property are forecast over a detailed period and discounted to the date of valuation as the net present value. The detailed period for the German portfolio is 10 years. Due to the particular market situation in Austria and in order to reflect the extensive Austrian rent restrictions, a sales scenario involving the recurring sales of apartments is assumed for a subportfolio. In order to present these sales in the correct accounting period, the detailed period for the Austrian DCF model has been extended to 100 years.

The income in the DCF model mainly comprises expected rental income (current in-place rent, market rents as well as their development) taking vacancy losses into account. In Austria, it also includes sales revenues from a subportfolio. The expected rental income is derived for each location from the latest rent indices and rent tables (including empirica, IVD, the Austrian Economic Chambers (WKÖ)) as well as from studies on spatial prosperity (Federal Institute for Research on Building, Urban Affairs and Spatial Development (BBSR), Prognos, empirica, Bertelsmannstiftung, the Austrian statistical office, Statistik Austria, etc.). The expected sales revenues are derived from historical sale prices as well as market data (e. g., WKÖ, EHL).

On the cost side, maintenance expenses and administrative costs are taken into account. In Germany, these are taken into account in accordance with the II. Berechnungsverordnung and inflated in the reporting period (II. BV; German Regulation on Calculations for Residential Buildings in accordance with the Second Housing Construction Law, stipulating how economic viability calculations for homes are to be performed). These cost approaches are also transferred to the Austrian market. Further cost items are, for example, ground rents, non-allocable ancillary costs, rent losses and, in Austria, selling costs. Modernization measures carried out in the housing stocks are factored in by decreasing the current maintenance expenses and adjusting market rents.

On this basis, the forecast cash flows are calculated on an annual basis and discounted to the date of valuation as the net present value. In addition, the terminal value of properties in the German portfolio at the end of the ten-year period is determined using the expected stabilized net operating income and again discounted to the date of valuation as the net present value. The discount rate applied reflects the market situation, location, type of property, special property features (e. g., inheritable building rights, rent restrictions), the yield expectations of a potential investor and the risk associated with the forecast future cash flows of the property. The present value calculated in this way is reconciled to the market value by deducting standard market transaction costs, such as real estate transfer taxes, agent and notary costs. As the detailed period in the Austrian DCF model has been extended to 100 years in order to present the sales scenarios in the correct accounting period, no terminal value is applied here. The commercial properties in the portfolio are mainly small commercial units for the supply of the local residential environment. Different cost approaches are used to those for residential properties, and discount rates were adjusted to reflect the market specifics.

The valuation is, in principle, performed on the basis of homogeneous valuation units. These meet the criteria of economically cohesive and comparable land and buildings. They include:

• Geographical location (identity of the microlocation and geographical proximity)
• Comparable types of use, building class, construction year class and condition of property
• Same property features such as rent restrictions, inheritable building rights and full or part ownership

The Vonovia portfolio also contains project developments, existing areas with construction potential and land areas with inheritable building rights. Project developments are measured using the cost approach until the construction work is complete. If the project is then to be managed within Vonovia’s own portfolio, it is measured at fair value using the DCF procedure described above once the construction work is complete. Existing areas with construction potential are valued using a comparable method on the basis of the local standard land value evaluated. Deductions are taken into account in particular for the readiness for construction and potential use as well as for likelihood of development and the development situation. Inheritable building rights granted are valued in the same way as the property portfolio using a DCF method. The input parameters here are the duration and amount of ground rent and the value of the land.

Vonovia determined the fair values of its real estate portfolio in Germany and Austria as of December 31, 2019 in its in-house valuation department on the basis of the methodology described above. The property assets are also assessed by the independent property appraiser CBRE GmbH. The market value resulting from the external review deviates from the internal valuation result by less than 0.1%.

For the portfolio of Victoria Park, the result of the external appraiser Savills Sweden AB in cooperation with Malmobryggan Fastighetsekonomi AB was applied. The valuation results of the external appraiser Savills Sweden AB were adopted for the Hembla portfolio. The fair values for the Swedish portfolio were also calculated using a DCF procedure that is comparable to the procedure used by Vonovia, as explained above.

The contractually fixed remuneration for the valuation report is not linked to the valuation results.

The right-of-use assets from leasehold contracts are recognized at their fair value. The fair value of the leasehold contracts corresponds to the present value of the standard market leasehold fee payments up until the end of the term of the hereditary building right in question. These are calculated based on the current amount of the ground rent. In order to calculate the present value, the leasehold fee payments are discounted using a property-specific interest rate.

The real estate portfolio of Vonovia is to be found in the items investment properties, property, plant and equipment (owner-occupied properties), real estate inventories, contract assets and assets held for sale. The fair value of the portfolio comprising residential buildings, commercial properties, garages and parking spaces, project developments, as well as undeveloped land and any inheritable building rights granted was € 53,316.4 million as of December 31, 2019 (Dec. 31, 2018: € 44,239.9 million). This corresponds to a net initial yield for the developed land of 3.1% (total portfolio including Sweden and Austria; Dec. 31, 2018: 3.4%). For Germany, this results in an in-place-rent multiplier of 23.5 for the portfolio (Dec. 31, 2018: 21.5) and a fair value per m² of € 1,893 (Dec. 31, 2018: € 1,677). The in-place-rent multiplier and fair value for the Austrian portfolio come to 24.7 and € 1,455 per m² (Dec. 31, 2018: 23.6 and € 1,346 per m²), while the values for Sweden come to 17.1 and € 1,899 per m² (Dec. 31, 2018: 14.6 and € 1,563 per m²).

The material valuation parameters for the investment properties (level 3) in the real estate portfolio are as follows as of December 31, 2019, broken down by regional markets:

The inflation rate applied to the valuation procedure comes to 1.6%. Net income from the valuation of investment properties amounted to € 4,131.5 million in the 2019 fiscal year (Dec. 31, 2018: € 3,517.9 million). For the Austrian portfolio, a sales strategy with an average selling price of € 2,053 per m² was assumed for 56.5% of the properties.

Sensitivity Analyses

The sensitivity analyses performed on Vonovia’s real estate portfolio show the impact of the value drivers influenced by the market. Those influenced in particular are the market rents and their development, the amount of recognized administrative and maintenance expenses, cost increases, the vacancy rate and interest rates. The effect of possible fluctuations in these parameters is shown separately for each parameter according to regional market in the following.

Interactions between the parameters are possible but cannot be quantified owing to the complexity of the interrelationships. The vacancy and market rent parameters, for example, can influence each other. If rising demand for housing is not met by adequate supply developments, then this can result in lower vacancy rates and, at the same time, rising market rents. If, however, the rising demand is compensated for by a high vacancy reserve in the location in question, then the market rent level does not necessarily change.

Changes in the demand for housing can also impact the risk associated with the expected payment flows, which is then reflected in adjusted amounts recognized for discounting and capitalized interest rates. The effects do not, however, necessarily have to have a favorable impact on each other, for example, if the changes in the demand for residential real estate are overshadowed by macroeconomic developments.

In addition, factors other than demand can have an impact on these parameters. Examples include changes in the portfolio, in seller and buyer behavior, political decisions and developments on the capital market.

The table below shows the percentage impact on values in the event of a change in the valuation parameters. The absolute impact on values is calculated by multiplying the percentage impact by the fair value of the investment properties.

Contractual Obligations

In connection with major acquisitions, Vonovia entered into contractual obligations or assumed such obligations indirectly via acquired companies, among other things in the form of Social Charters, which could limit its ability to freely sell parts of its portfolio, increase rents or terminate existing rent agreements for certain units and which, in the event of a breach, could give rise to substantial contractual penalties in some cases. Moreover, when acquiring and financing some of the properties in the portfolio, Vonovia also entered into an obligation to spend a certain average amount per square meter on maintenance and improvements.

After a certain period of time, these obligations often cease to apply either in full or in part. As of December 31, 2019, around 139,000 residential units in Vonovia’s portfolio were subject to one or several contractual restrictions or other obligations.

• Sale restrictions: As of December 31, 2019, around 64,000 units were subject to sale restrictions (excl. occupancy rights). Around 18,000 of these units cannot be freely sold before a certain date. Sale restrictions like these include a full or partial ban on the sale of residential units and provisions requiring the consent of certain representatives of the original seller prior to sale.
• Preemptive rights on preferential terms: Around 7,000 residential units from the “Recurring Sales” subportfolio can only be sold if the tenants are offered preemptive rights on preferential terms. This means that Vonovia is obliged to offer these tenants the residential units at a price that is up to 15% below the price that could be achieved by selling the units in question to third parties.
• Restrictions on the termination of rent agreements: Around 102,000 residential units are affected by restrictions on the termination of rent agreements. These restrictions include notice to vacate for personal use and notice to vacate for appropriate commercial utilization. In some cases, units are covered by a lifelong ban on the termination of rent agreements.
• Expenses for minimum maintenance and restrictions on maintenance and modernization measures: Around 57,000 apartments are subject to minimum maintenance obligations. As a minimum maintenance obligation no longer applies, the weighted average of the annual necessary spending on maintenance and modernization has changed to € 10.84 per m². Furthermore, around 55,000 residential units are affected by restrictions relating to modernization and maintenance measures, which are designed to prevent changes in socio-economic tenant composition (i.e., to limit luxury modernization). Some of the restrictions to prevent luxury modernization have been agreed on a permanent basis.
• Restrictions on rent increases: Restrictions on rent increases (including provisions stating that “luxury modernization” measures are subject to approval) affect around 65,000 residential units. These restrictions could prevent Vonovia from realizing the rent that could potentially be generated from the units in question.

In many cases, in the event that all or part of a portfolio is transferred or individual residential units are sold, the aforementioned obligations are to be assumed by the buyers, who are in turn subject to the obligation to pass them on to any future buyers.

Under structured financing programs, Vonovia is subject to fundamental restrictions on the use of excess property disposal proceeds, such restrictions being particularly in the form of mandatory minimum capital repayments. Excess cash from property management is also restricted to a certain extent.

All contractual obligations that have a material impact on the valuation were taken into account accordingly.