Current Risk Assessment
A scheduled risk inventory was performed in both the first and second half of the 2019 fiscal year. Extensive risk workshops were conducted in the second half of 2019 in parallel with the risk inventory. The changes described in the section entitled Changes to the Risk Management System were applied for the first time in the second half of 2019. The resulting risk report was presented to the Management Board and the Audit Committee. There were no unscheduled ad hoc risk reports in the 2019 fiscal year.
A total of 93 individual risks were identified for Vonovia in the second half of 2019, considerably less, i. e., 48 less, than in 2018. This drop is largely due to the change in value limits in the second half of 2019 mentioned above as well as to the aggregation of risks, particularly in connection with the company’s operating business.
Overall Assessment of the Risk Situation
In the interest of the company’s key stakeholders – customers, employees, suppliers, investors and society – Vonovia pursues a conservative strategy that focuses on security and sustainability. In addition, both the business model and the diversified capital market instruments used by Vonovia ensure that we have the greatest possible degree of independence from economic fluctuations.
The strategy also determines the company’s risk profile. Overall, the results of the risk assessment conducted in the second half of 2019 are as follows: The 93 individual risks identified do not include any risks threatening or endangering the company or its survival. Five risks that are significant to the company and 88 other risks were identified.
This means that, at the time this report was prepared, Vonovia’s Management Board had not identified any risks associated with future business development that the company cannot suitably overcome, or which could jeopardize the position of Vonovia SE, a major company included in the scope of consolidation or the Group as a whole in terms of revenue, assets and/or finances.
Summarized in the heatmap referred to above, this produces the following picture for the net risks identified at the end of 2019:
Net Risks
The amber risk that is classified as highly probable is the risk associated with the entry into force of the “Act on the Revision of Statutory Provisions on Rent Limitation” passed by the Berlin State Government (Berlin rent freeze).
The amber risks that are classed as improbable relate to the balance sheet risk Future market development leads to a drop in property values and the risk with an impact on profit and loss Deteriorating residential property market situation with regard to apartment sales.
The amber risks that are classed as highly improbable relate to the risks with an impact on profit and loss Nationwide introduction of a ‘rent freeze’ similar to the ‘Berlin rent freeze’ and Failure to fulfill obligations (from bonds, secured loans, transactions).
Details on the company’s four main risk categories are shown in the graphic below.
Risks Related to Strategy
Vonovia’s strategy is described in the Strategy section. Based on this strategy, the Management Board has not identified any significant or acutely threatening risks, let alone risks that could pose a threat to the company’s survival.
Overall, six risks, none of which have a material impact on Vonovia’s business development, have been identified in this risk category. These relate, in particular, to the strategy of making acquisitions when the right opportunities present themselves and the strategy of developing new fields of business.
Risks Related to Regulatory Environment & Overall Statutory Framework
The statutory provisions setting rent levels are highly relevant to Vonovia’s business development. The rent regulation initiatives that have emerged of late, for example, give rise to specific risks.
Vonovia has identified the Act on the Revision of Statutory Provisions on Rent Limitation introduced by the Berlin State Government as the biggest regulatory risk. The draft legislation was approved by the Berlin House of Representatives on January 30, 2020, and was published in February 2020. Although we believe that the current version of the Act is unconstitutional, we expect it to remain in place. As a result, we believe that this risk is extremely likely to materialize and have included the impact of the Act in our corporate plans, even though we expect the impact to be minor given the relatively small share of our portfolio in Berlin (around 10% of the overall portfolio) and in light of the options available to us for offsetting the impact of the legislation.
There is also a risk that other federal states in which Vonovia has a relevant share of its portfolio, or even the German federal government, could introduce similar regulations. While this risk would have a very considerable impact on Vonovia, we believe that it is very unlikely to materialize and expect the rent freeze legislation to be restricted to Berlin.
In addition to the risks associated with the statutory requirements on how rent levels are set, there are a number of risks resulting from possible changes to the other overall statutory conditions that are relevant to our business. Changes to tax provisions, for example, could result in a higher current tax obligation. Similarly, changes regarding the extent to which operating and ancillary expenses can be passed on could result in higher property management expenses or lower income in our Value-add Business. We do not expect these risks to have a material impact.
In order to be able to pick up on potential changes in the overall statutory framework early on, Vonovia is involved in active dialogue with policymakers and other stakeholders. Vonovia is also represented in associations and monitors the legislative procedure and recent court decisions on a regular basis.
There is also a general risk that Vonovia will not comply with existing statutory requirements, or that these will be interpreted differently by the courts. This risk, however, is one that we consistently assess as very unlikely to materialize.
A total of 25 risks resulting from possible regulation or other overall statutory conditions have been identified. With the exception of the two risks relating to rent regulation described above, none of the risks would have a material impact on Vonovia’s business development.
Risks Related to Operating Business
A whole range of risks can arise for Vonovia in connection with the performance of its business activities. The main risks in this regard relate exclusively to a deterioration in the market environment for residential real estate.
By way of example, a drop in property values due to market-related factors can result in a reduction in the fair values of Vonovia’s portfolio in the context of the fair value measurement process, albeit without this impacting liquidity. Vonovia counters this risk by ensuring that its portfolio is diversified in terms of location. This reduces its reliance on local market developments.
Negative market developments can also have an impact on the opportunities for selling apartments and buildings. Vonovia has established a stringent process for setting sale prices in order to monitor this risk. In addition, sales volumes, prices and margins are reported to the management team on a regular basis so that the company can respond quickly to market developments.
Besides these two significant risks, we have only identified risks related to the operating business that would not have any material impact on Vonovia’s business development. In total, 49 risks related to the operating business have been identified.
For example, structural risks, e. g. arising from the materials used in construction or relating to fire protection, could arise in Vonovia’s portfolio due to insufficient information on how the building construction work was executed. This applies, in particular, when Vonovia purchases portfolios. Risks can also emerge as a result of changes in structural regulations. Vonovia counters this risk by carrying out regular inspections and checks on its properties, ensuring that any faults identified are rectified immediately, developing and implementing suitable fire protection concepts and implementing any amendments to construction regulations as part of a structured process. This procedure is also incorporated directly into the process for integrating real estate portfolios purchased by Vonovia.
Risks in the Development segment arise throughout the entire developmental cycle of the individual projects. Particular examples are higher construction costs, project delays or lower demand when the apartments are sold to third parties. In order to counter these risks, Vonovia has established detailed due diligence measures that it applies whenever it purchases land as well as in its project and contract management activities. Furthermore, we closely monitor market developments. If necessary, Vonovia also has the option of adding apartments that it intended to sell to third parties to its own portfolio.
When it comes to the development of new fields of business in the Value-add segment, risks can arise from the design and implementation of the business models. Market conditions such as procurement prices or customer demand can also develop differently than expected. As well as taking the usual precautions as part of the internal control system, Vonovia addresses these risks using a detailed innovation controlling system that defines set “stage gates” for decision-making regarding the further implementation of new fields of business.
We do not believe that climate change gives rise to any significant direct risks at the moment, e. g. caused by extreme weather conditions with heavy rain and the potential for floods.
Risks Related to Financing
Ensuring a balanced and sustainable financing approach focusing on security as well as extensive access to the equity and debt capital markets at all times is extremely important for Vonovia’s business development. This orientation is also reflected in the risks identified in relation to financing.
The possibility of non-compliance with obligations under existing financing arrangements (covenants) gives rise to a single significant risk relating to financing, but one that can have a very considerable impact. Thanks to the processes and methods put in place by Vonovia to monitor these obligations, we believe that this risk is highly unlikely to materialize.
There are also a number of financing-related risks that are not of any material significance to Vonovia’s business development.
Unfavorable interest rate developments, for example, could result in higher interest expenses for Vonovia in the long run. Vonovia counters this risk using a diverse range of debt capital instruments, a balanced maturity profile and a large proportion of fixed-interest financial liabilities as well as an optimized level of debt.
Failure to comply with key financial figures or the assessment of our market positioning could also result in us losing our current ratings (S&P: BBB+/Stable/A-; Scope: A-/Stable/A). Given our financing strategy and the prerequisite that acquisition decisions cannot have any impact on our rating, we believe that this risk is very unlikely to materialize.
Vonovia is also exposed to a liquidity risk in its ongoing business activities. We have established extensive liquidity management processes in response to this risk. Vonovia also has a sufficient working capital facility available at all times and enjoys access to short-term money market securities. This means that, as of the reporting date, Vonovia SE has sufficient cash and cash equivalents and short-term financing options to guarantee the ability to pay of all Group companies at all times.