Current Risk Assessment
A scheduled risk inventory was performed in both the first and second half of the 2020 fiscal year. In the second half of 2020, the risk inventory process was supported by extensive risk workshops aimed at identifying and assessing ESG (Environmental, Social, Governance) risks. This move reflects the realignment of Vonovia’s corporate strategy in the second half of 2020. The risk report was presented to the Management Board and the Audit Committee. There were no unscheduled ad hoc risk reports in the 2020 fiscal year.
A total of 106 (2019: 93) individual risks were identified for Vonovia in the second half of 2020. Specifically, the picture that emerges for each risk category is as follows:
This represents a slight increase compared to 2019. The increase is mainly attributable to the fact that ESG risks were taken into account for the first time in the second half of 2020. A materiality analysis was used in the 2020 fiscal year to investigate potential ESG risks for the first time and assess their materiality. Based on the outcome of this assessment, we have added seven new separate ESG risks to our risk register. One of these risks has been classified as an amber risk and six risks as green risks. The remaining risks in the risk register were assessed and supplemented from an ESG and a reverse ESG perspective as well as with regard to their impact on the environment and society at large. Even though they are only of minor significance to the company, the section below also looks at green ESG risks in view of the fact that they are being included for the first time.
As against 2019, the number of amber risks increased from five to six. There was one new amber ESG risk “Adverse structure of CO2 tax.” The number of green risks rose from 88 to 100. In detail, risks in the “Strategy” category increased from six to nine, with risks in the “Operating business” category rising from 49 to 52 and those in the “Regulatory environment” category climbing from 25 to 33. The number of risks in the “financing” category fell from 13 to 12.
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 company’s risk profile is as follows in the second half of 2020: The 106 (2019: 93) individual risks identified do not include any risks threatening or endangering the company or its survival. Six (2019: five) amber risks that are significant to the company and 100 (2019: 88) other green 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.
At the end of 2020, the net risks identified can be summarized as follows:
There are only minor changes compared with the 2019 heatmap.
In the 2020 fiscal year, we were exposed to the coronavirus pandemic, a situation that we were able to address without any significant impact on our corporate objectives. Thanks to the prompt establishment of an efficient crisis management system and the fact that a large proportion of the employees working in our corporate headquarters, in the regions and in our locations abroad were able to work from home, we were able to continue operating throughout. We were also able to provide our craftsmen’s, service and construction services on location without encountering any significant restrictions. Thanks to the responsible conduct shown by our employees, there have been no significant restrictions on our operations overall. As things stand at the moment, we consider a long-term coronavirus lockdown scenario to be highly unlikely and estimate that this risk is associated with a potential loss amount of > € 500 million. We believe that the risk of another short-term lockdown is likely to materialize and expect this risk to involve a low amount of loss.
The risk relating to the “Act on the Revision of Statutory Provisions on Rent Limitation” passed by the Berlin State Government, which was assessed as an amber risk (i.e. one that was very likely to materialize) in 2019, has materialized, meaning that it is no longer part of the 2020 assessment.
A new amber risk that we believe could potentially materialize is that relating to “Unfavorable exchange rate developments”. This relates exclusively to our business activities in Sweden. We believe that exchange rate developments could have a negative impact on our original projections for our activities in Sweden. The risk with an impact on profit and loss is currently considered to be associated with a considerable amount of loss of € 25-100 million. We have not used any corresponding exchange rate hedging instruments to reduce the amount of loss and have no plans to do so either.
A new amber risk that we consider likely to materialize is the risk with an impact on profit and loss associated with an “Adverse structure of CO2 tax”. The German government has decided to introduce a CO2 price as a management tool and climate protection measure. The tax on CO2 emissions per metric ton has already been defined for the period leading up to 2025. The “Climate Action Programme 2030” is also to look at changes in tenancy law with regard to the extent to which CO2 tax can be passed on. As the discussion regarding the extent to which CO2 tax can be passed on is still ongoing, we will assume for the time being that Vonovia will have to bear part of this tax. The expected loss amount is currently estimated at between € 25 million and € 100 million.
Furthermore, the assessment of the amber risk “Deteriorating residential property market situation with regard to apartment sales”, which has an impact on profit and loss and which we consider unlikely to materialize, is unchanged as against the previous year. The demand for residential property ownership remained very high, even during the coronavirus pandemic. In the 2020 fiscal year, Vonovia was able to continue with its privatization strategy.
The balance sheet risk “Future market development leads to a drop in property values”, which was classed as an amber risk that was improbable in the previous year, has been downgraded to a green risk in 2020. We expect residential real estate to continue to show positive development with stable values in the markets in which Vonovia operates.
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’”, “Failure to fulfill obligations (from bonds, secured loans, transactions)” and the risk “Pandemic or similar events – long-term lockdown”.
The following overview presents the four main risk categories of the company in detail:
Risks Related to Strategy
Vonovia’s strategy is described in the chapter “Fundamental Information About the Group”. 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.
Vonovia has set itself an intensity target equating to a roughly 25% reduction in CO2 emissions in its German portfolio by 2030 compared to the baseline year, 2019, in order to achieve its climate objectives and meet the associated regulatory requirements. We currently consider the risk of non-compliance to be low and improbable.
In addition, Vonovia could be exposed to risks associated with non-compliance with statutory requirements and investor or analyst expectations regarding its sustainability reporting. We currently assess this risk as being associated with a substantial amount of loss, but believe that it is very unlikely to materialize.
Risks could also arise from a failure to meet stakeholder expectations and statutory requirements with regard to diversity. We currently assess this risk as being associated with a low amount of loss and believe that it is very unlikely to materialize.
Overall, nine (2019: 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, for example, give rise to specific risks. The “Act on the Revision of Statutory Provisions on Rent Limitation” passed by the Berlin State Government could have an impact on rent regulation at nationwide level. While this risk would have a very substantial impact on Vonovia, we consider it to be very improbable.
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, further 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.
Long-term economic slumps triggered by macroeconomic and geopolitical risks, such as escalating trade conflicts, the economic impact of the coronavirus pandemic or foreign policy conflicts, could have an adverse effect on the overall conditions for Vonovia. We currently assess this risk as being associated with a substantial amount of loss, but believe that it is unlikely to materialize.
Breaches of the Code of Conduct, the Anti-Corruption Policy and legal requirements relating to bribery and corruption could entail risks for Vonovia. We currently assess these risks as being associated with a low amount of loss and believe that they are very unlikely to materialize.
Potential legal disputes associated with guarantees for development projects could give rise to risks for Vonovia if general contractors that are liable to recourse were to become insolvent. We currently assess these risks as being associated with a low amount of loss and believe that they are very unlikely to materialize.
Failure to comply with working conditions that are required by law, such as minimum wage standards, safety standards, etc. as well as failure to respect human rights in the supply chain could result in risks for Vonovia. We currently assess these risks as being associated with a low amount of loss and believe that they are very unlikely to materialize.
A total of 33 (2019: 25) risks resulting from possible regulation or other overall statutory conditions have been identified. With the exception of the risk relating to nationwide 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.
A total of 52 (2019: 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 non-compliance with changing structural regulations. Vonovia counters these risks 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 can 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.
Failure to comply with statutory occupational health and safety and occupational safety management provisions could create risks for Vonovia. We currently assess these risks as being associated with a substantial amount of loss but believe that they are very unlikely to materialize.
What is more, crisis situations or catastrophes, such as floods, earthquakes, extreme weather events etc., could have an impact on our real estate portfolio and require specific crisis management measures. We do not believe that climate change gives rise to any significant direct risks at the moment, e.g., caused by extreme weather conditions such as heavy rain with the potential for floods. We have still to assess potential climate risks with a long-term focus.
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 number of risks in the “financing” category fell from 13 to 12. The “Interest rate risk for Sweden” that was recognized separately in 2019 is no longer recognized in 2020 due to group refinancing. It is included in the interest rate risk for the Group as a whole.
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.