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Edited Transcript of AOX.DE earnings conference call or presentation 13-Aug-19 8:00am GMT

Q2 2019 alstria office REIT AG Earnings Call

Hamburg Sep 18, 2019 (Thomson StreetEvents) -- Edited Transcript of Alstria Office REIT AG earnings conference call or presentation Tuesday, August 13, 2019 at 8:00:00am GMT

TEXT version of Transcript

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Corporate Participants

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* Alexander Dexne

alstria office REIT-AG - CFO & Member of Management Board

* Olivier Elamine

alstria office REIT-AG - Chairman of the Management Board & CEO

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Conference Call Participants

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* Kai Malte Klose

Joh. Berenberg, Gossler & Co. KG, Research Division - Analyst

* Pierre Paren

BMO Capital Markets Equity Research - Analyst

* Thomas Rothaeusler

Jefferies LLC, Research Division - Equity Analyst

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Presentation

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Operator [1]

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Dear ladies and gentlemen, welcome to the conference call of alstria office REIT-AG regarding the presentation of the H1 results 2019. At our customer's request, this conference will be recorded. (Operator Instructions)

May I now hand you over to Olivier Elamine, CEO, who will lead you through this conference. Please go ahead.

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Olivier Elamine, alstria office REIT-AG - Chairman of the Management Board & CEO [2]

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Good morning, everybody, from cloudy Hamburg this morning. I'm here in the room with Alexander Dexne, which is alstria's CFO; and Ralf Dibbern, which is our Head of IR. My name is Olivier Elamine, I'm the CEO of the company and it is my pleasure to walk you today through the half year result of alstria.

Before we move on, short reminder on the disclaimer regarding forward-looking statement and duty to update. And without undue delay, I'd like to get into the heart of the discussion.

On the revenue and FFO side, the company has been performing in line with our expectation and we have confirmed this morning the guidance that we have provided for the full year. I think the first 6 months of the year, and we want to spend the bulk part of this presentation to discuss that, is that we have been operating in a market which have provided very, very strong support on the leasing side.

As you know, the German market has always been very liquid from the leasing side, but over the last few months this has like considerably increased, which will have translated into record leasing for the company in the half year -- the first half year. And we still have, from that perspective, a full pipeline when we look to the months ahead.

So we have signed 81,800 square meter of new leases. We have extended 66,700 of leases, which have sunk our EPRA vacancy rate to 7.6%. If you remember, our guidance to the market of EPRA vacancy rate tend to fluctuate between 12% and 7%, so we're getting at the very, very low end of where we feel comfortable in having it. We need the vacancy in order to create value, and I think the first half of the year is just a very strong demonstration about how this have value could be created through this vacancy.

We have been active in the transaction market, more on the sell side than on the acquisition side. We have acquired 3 assets year-to-date for a total value of EUR 30.1 million, I'll come back to that in the presentation. We have disposed 3 assets in the first half. We actually also sold an asset yesterday located in Kaiserslautern, so outside of our core market.

And our approach here is consistent with what we've been guiding the market to, so we're selling peripheral assets, assets in noncore location for us, as we believe that they are more susceptible to suffer in downturn, and the risk return profile currently is not favorable to those assets. And when we can, and that's a big if, we are happy to deploy the money into assets which are located more in core regions. But as we speak, the best opportunities that we find to invest are within our own portfolio and not necessarily in the market.

Our net LTV, again is at historical low at 29%. We have this year, as guided, used the opportunity of our half year result to do an evaluation exercise for the entire portfolio. And that exercise generates a valuation gain of slightly short of EUR 200 million, which have driven the EPRA NAV per share up 6.9% to EUR 16.19.

We will not go into the detail of the valuation within that presentation. As always, we have -- and I'm just mentioning that because the half-year valuation is a new process for us. We have updated the asset-for-asset valuation table, which is available on our website. So you can download on the website the valuation changes on an asset-per-asset basis and then get a better idea of how the market has been evolving from the value perspective.

If we look -- and we want to spend most of this presentation focusing on the operational progress of the company. So the portfolio size in terms of number of assets have remained relatively stable. The portfolio increased in value by around EUR 200 million. I think, and as you know, the average size of our asset is relatively small. We like small assets. We think they offer a better risk return profile in the market in which we operate, 13,000 square meter, EUR 35 million of value on average, obviously not EUR 35,000 value on average. And we had some kind of yield compression, 10 basis point yield compression between first -- between end of last year and half year, which also tells you that the bulk of the revaluation that we're showing today is coming from progress on the operational side.

Our vacancy rates have sunk from 9.7% to 7.6%. I think here, again, we're just delivering on the business plan and demonstrating that in the current market, the best way to add value, considering the low yield environment, is really to work out the asset and create the value on the asset.

Our WAULT is stable and that has been the case at around 5 years over the years, which also demonstrates that we're still able to sign relatively long-term leases. And the average value per square meter, from a capital value per square meter, remain at relatively low from my perspective at EUR 2,700 per square meter, up EUR 200 per square meter.

If we look into what was driving the revaluation gain over the first half, I think -- and that's to the point I was making before, we only have 10 basis point yield compression. So a substantial part of that has been driven by the like-for-like rental growth. We've been able to generate around EUR 9.3 million of annual contractual rent over the first half year as we translate in like-for-like rental growth of 4.9%.

I'm sorry to insist on that, but that's a like-for-like rental growth literally comparing the previous portfolio as the same portfolio of the year before. It's not comparing price per square meter or anything like that which would come up at a much higher number. And then this is partially offset by the transaction that we're doing, where the net impact of the transaction is minus EUR 6.5 million of revenue.

So we are in position today to offset most of the impact of the transaction by the increased revenue on the portfolio, and that's something -- that's a result we're very happy with. The 4.9% like-for-like rental growth probably explain around 65% of the incremental value that we've seen in the first half of the year across the portfolio.

We -- as I mentioned before, deploying the capital in the market today when we sell the asset is relatively hard today, especially we do underwrite our assets with unlevered IRR and our target unlevered IRR is between 6% and 8%, depending on the perceived risk return on the asset. So in the current environment where your starting yield is between 2% and 4%, it's kind of difficult to generate those kind of returns or actually to believe you can generate those kind of returns with reasonable growth assumption.

But luckily enough, we do have, within alstria's portfolio, substantial opportunity to invest capital and to invest capital at returns which are substantially higher than anything we can find in the market. And those investment are not available in 5 years' time or 10 years' time, they're available today and we are just spending the money right now to actually be able to crystallize this additional value.

We have, and this slide is not different from the one we showed at year-end, obviously development takes some time. We have currently -- we are currently working on investment project which over 2019 and 2020 represent around EUR 120 million investment in the portfolio with an expected yield on costs somewhere around 6.7% and IRR somewhere around 8% to 9%.

We expect, with the assumption that I described on this slide, that this could generate an additional EUR 1 per share of NAV. Again, not dependent on the market moving, but just dependent on the capacity of the company to execute its business plan. And I think having a portfolio like the one we have currently, with the opportunity to deploy capital in those kind of project in the current market, is something which is extremely valuable and will provide for organic growth for the company in the coming future.

And of course, it's not very helpful to have all these opportunities in the portfolio if you're not able to deliver on them, and I think we've demonstrated over the first 6 months of the year the very strong capacity of the company to actually deliver on the business plan. So we're -- you don't hear us very much speaking about rental growth, how the market are dynamic, but at least you see us delivering on the results.

We have secured, in the first 6 months of the year, EUR 163 million of future cash flow for the company, and that represents around 78 new leases with an average lettable area of 1,000 square meter, an average of WAULT of 7.9 for the new leases and 23 lease extensions. We have on this slide some example of the different leases that we're signing. And I think what's remarkable today, and you can still see, is that the rent fee that we're seeing right now are still going down and the tenant incentive. So the effective rent we're getting on those leases is still going up as we speak.

We are obviously conscious about the fact that the German economy is slowing down. It's something we're monitoring quite closely. But as we speak, we're not seeing this impacting the letting market so far. We have no doubt that -- and again, we monitor that very closely, that this might happen at some point in the future. But as of today, we still have a very, very full pipeline of leases and we're very comfortable for what's going to happen at the end of the year.

I wanted to also take the opportunity to zoom a little bit into Düsseldorf. I mean there is more to Germany than just Berlin and the other markets which are performing relatively well. We did have -- the best performing market year-to-date has been Düsseldorf. Düsseldorf was the best performing market last year from capital value growth. And as you know, we have some kind of exposure to Düsseldorf. Again, this doesn't mean that the other market are performing worse but just taking a small look at this market.

We have reduced our vacancy in Düsseldorf by 44%, generated EUR 6.6 million out of the EUR 9 million we were mentioning before in Düsseldorf and signed up up to 41,000 square meter of leases in Düsseldorf in the first half. We did sign up, after closing, 6,500 square meters, that's the -- on the top left of the screen, the 6,500 square meter of leases we just signed after the closing, which would reduce our vacancy rate even further.

So we have here again a mixture of tenants in terms -- and diversified nature of tenants in terms of industry, in terms of sectors which are active in that market. And we're seeing very similar dynamics in most of the markets in which we are currently operating.

We have been -- despite everything I've just said on how difficult it is to buy, we have been able to find opportunities to deploy some capital. We have acquired 2 assets in Berlin and 1 in Düsseldorf for a total acquisition value of EUR 30 million. Average price per square meter at EUR 3,000 per square meter, so pretty much in line with what we have in the rest of the portfolio. In-place rent of EUR 10, average ERV of EUR 15.20. So there is some kind of room to revert back to higher rent going forward. And with the EUR 3,000 per square meter, there is room to actually end up generating decent return.

Those are harder and harder to find. I think in the current market environment, I could very easily sit here and tell you that we have a EUR 10 billion pipeline. There is at least 1 or 2 portfolio of more than EUR 1 billion which are currently on the market. But we're not participating into this race to the bottom in terms of yield and we still believe that we have, as a listed company, the luxury of not having to invest capital in the current market at return which are below par. We still have the opportunity to invest within our own portfolio and we should not sacrifice returns while we have the opportunity still to do this in our own portfolio.

At the same time, we are selling the periphery. We are selling assets at the fringe of our market or outside of our core market. We've been selling 3 assets in the first half, and the fourth one yesterday in Kaiserslautern, generating substantial profit compared to in-place values.

Having said that, we're also seeing here that the market for secondary assets is becoming more tight and people are also getting cold feet in that market. So this part of the market is also slowing down, which make us even more comfortable that this was really the right approach for us to kind of downsize as much as we can the portfolio in that part of the business. We look forward to continue doing that as we move forward during the year and reinvest the proceeds mainly within our own portfolio.

That is going to wrap up the presentation from my perspective. I think we're all here looking forward to our discussion, and I'd like to open the floor to the Q&A.

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Questions and Answers

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Operator [1]

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(Operator Instructions) We've received the first question. It is from Kai Klose from Berenberg.

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Kai Malte Klose, Joh. Berenberg, Gossler & Co. KG, Research Division - Analyst [2]

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I've got 2 quick questions. The first one is why the EPRA cost ratio went up relatively strongly year-on-year. So that's -- you mentioned that you had an increased number of employees, but maybe there are maybe there are some other reasons for that. And the second question would be on page -- sorry, on Page 4 of the report. You mentioned the net rent per square meter for the leases, could you indicate on average maybe how much you spend for refurbishment and for CapEx in order to get these (inaudible) rented out?

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Alexander Dexne, alstria office REIT-AG - CFO & Member of Management Board [3]

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Kai, it's Alex. I'm taking the cost ratio. I mean there are 2 elements to EPRA cost ratio going up. One element is that with working out the vacancy, with turning the portfolio from a more bias towards single-tenant, more monolithic structures towards a more multi-tenant diversified base is just more personnel-intensive. So we have been increasing personnel which support our development activities, our refurbishment activities and really just increase the capacity to run what is a more complex portfolio. And the value creation that Olivier has been discussing is just the outcome of those investments.

The second point is, and this is something that you -- obviously you also see in the personnel costs and in the SG&A that the company is reporting, we had quite a bit of a rally of the share price in the first 6 months of this year and this drives then the share-based compensation that we -- which is obviously a noncash expense but still is something that is reflected in those numbers. And these are, from my perspective, the 2 main drivers that you can see in the cost ratio going up.

So while the investment in the personnel is a more lasting thing, the adjustment in the share-based compensation valuation is something that is obviously directly linked to share price performance.

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Olivier Elamine, alstria office REIT-AG - Chairman of the Management Board & CEO [4]

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Kai, this is Olivier. Just on your second question with respect to the cost or the money we're spending in order to secure those leases, first of all, it's a good point. I think it needs to be clear to everybody that leasing assets in Germany doesn't come for free, and capturing the rental uplift is not something that comes for free. We will provide, obviously at year-end, like a much greater detail about how much CapEx went on an asset-per-asset basis. This is something we did not do for the half year. But just to give you an order of magnitude, we're spending somewhere between EUR 500 and EUR 600 per square meter to basically achieve those kind of leasing results. And this is basically translated into a higher quality, which is requested by tenant today to basically generate higher rent.

And what's interesting, and this is really for us the most interesting part, is that we're getting a substantially higher yield on those investments than anything else you can find in the market. And that's really the attractiveness, having the opportunity to have a building in Hamburg rented at EUR 12. You invest EUR 600, EUR 700 per square meter and then you can rent it at EUR 20, obviously provides you with substantial additional value compared to anything else you can find in the market.

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Operator [5]

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At the moment, there are no further questions. (Operator Instructions) We've received the next question, it is from Pierre Paren of BMO.

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Pierre Paren, BMO Capital Markets Equity Research - Analyst [6]

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Can you hear me?

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Olivier Elamine, alstria office REIT-AG - Chairman of the Management Board & CEO [7]

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Yes, absolutely.

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Pierre Paren, BMO Capital Markets Equity Research - Analyst [8]

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I just have a couple of follow-up question. Just on acquisitions. So you indicate unlevered IRR target between 6% and 8%. And you indicate also in the slide that the current market yield is between 4% and 4.5%. So if I assume an organic rental growth of, let's say, 3% to 4% per year, it doesn't seem that this unlevered IRR target is unreachable. So if we can have more color on that, maybe I'm missing something here.

The second question, on acquisitions still. So your acquisition volume was pretty low in the first half. Is it deemed to accelerate over the year? And maybe putting perspective on other German commercial companies, your peers, do you have like some kind of acquisition pipeline? Because your peers have quite aggressive acquisition pipelines, so if we can have some color on that, too. And just a detail also, maybe I missed it, on the renewals you achieved in the first half at EUR 11 on average, how does that compare with previous leases?

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Olivier Elamine, alstria office REIT-AG - Chairman of the Management Board & CEO [9]

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So Pierre, maybe on the -- I mean first of all, on the -- your first question with respect to -- if you assume 4%, 4.5% rental growth and you start from a 4%, 4.5% yield, what I mentioned is that your initial yield today if you buy in some of the central location in the top 6 German cities, your yield is probably going to be more around 2% to 4%, not 4% to 4.5%. I mean 4% to 4.5% is like 20 months ago. So you're starting from a very, very low yield.

The other thing you need to take into consideration is in order to achieve your 4% to 4.5% rental growth, you need to spend CapEx; that's bringing back to the question that was put forward by Kai before. You need to spend money to achieve those results. And I think if you blend all of that into an unlevered cash flow and you take reasonable assumption and you don't assume another 300 basis point yield compression at the exit, you're going to see that it's not that easy to get to the 6%, 7% unlevered IRR.

At the end of the day, I think another way to summarize everything I've just said is to look at the capital value, because the capital value is actually a very good indicator of how you perform. Assets trade today in Germany, if you look at the latest transaction which were announced by some of the listed companies in Berlin, at EUR 10,000 per square meter. I think you need to look at what kind of rent you need to achieve in order to generate a decent return on those kind of level. And then you need to be comfortable with those results. And alternatively, at the end of the day, when you make an investment decision, it's also a relative call. So do you have other opportunity elsewhere to invest money at a price which is -- or at a return which is going to be higher than what you find in the direct market?

And to that question, I'll answer it, yes, absolutely, we can invest that money in our own portfolio. And those are unsecured assets, we don't need to fight for, we don't need to go into a bidding war for, we don't need to kind of increase our price by 10% at each and every round. And because we mastered those assets, they are within our hands and we can invest and deliver those returns without making all those aggressive assumptions. So we are -- and we feel today that if you're a listed company, and if you've done your work properly in the past, you should own a portfolio today which offer ample opportunities to go through this period of time where we feel the asset at EUR 6,000, EUR 7,000, EUR 8,000 per square meter are really, really hard to -- at least is very difficult to justify getting a sustainable return over time.

On the pipeline, we do not have a massive pipeline. And as I said, it's not that it doesn't exist, it's by choice. We -- again, when we look at what we see on the market and as I mentioned before, there are currently at least 2 portfolio of more than EUR 1 billion that are trading out there. So if I want to sit in this chair and tell you I have a EUR 3 billion pipeline, it's very, very easy to do. I have the asset I can give you a list. And actually if you look into the press, there have been publicly available rumors about which assets are those.

But when you look at those assets, and again when we look at those assets relative to what we can have as an investment opportunity within our own portfolio, we don't see those as attractive opportunity right now, and we'd rather not raise equity and not increase our -- the need to invest beyond what we generate organically. And that's -- we believe in the current market, if you have the luxury not to be in a position where you have to invest, it's a luxury position, but it's a very valuable position because it's avoiding you of making a number of mistakes.

And you have a third question, but I'm not sure I noted it correctly.

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Pierre Paren, BMO Capital Markets Equity Research - Analyst [10]

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Yes, sorry. On the renewals, it was I think, on average, EUR 11 per square meter. Just wanted to know, maybe I missed it, the previous rent.

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Olivier Elamine, alstria office REIT-AG - Chairman of the Management Board & CEO [11]

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So usually a renewal is a very, very straightforward system where a tenant exercise an option. So the average rent -- sorry, before, the renewal is usually equal to the rent at the renewal because it's simply a tenant exercising an option, which is basically saying I'm going to continue the lease in the current state or form with the same rental condition.

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Pierre Paren, BMO Capital Markets Equity Research - Analyst [12]

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Okay. And just to get back to the first comment, so you're saying that current market yields for assets are in the 2% or 3%?

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Olivier Elamine, alstria office REIT-AG - Chairman of the Management Board & CEO [13]

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Yes.

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Pierre Paren, BMO Capital Markets Equity Research - Analyst [14]

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Do you think there is nothing on the market for assets like a net -- a yield around 4.5%? Is it really stick to things that you can find those kind of asset on such price?

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Olivier Elamine, alstria office REIT-AG - Chairman of the Management Board & CEO [15]

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I think there are assets at 4.5% if you move into secondary cities, if you move into secondary location. And the asset that we're selling, we're selling at yield which are around the 4.5%. But at the end of the day, it's a question of risk return perspective. So we feel actually -- I mean to a certain extent, it's even cheaper to buy an asset at 2.5% in the city center than to buy at 4.5% in the outskirts of the city, because from a risk return perspective you're going to be better off. So I think the yield, at the end of the day, is also kind of a dangerous indicator. You need to look at this from a risk return perspective, and this is why we look at it more from an IRR perspective rather than from a yield perspective.

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Operator [16]

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The next question is from Thomas Rothaeusler from Jefferies.

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Thomas Rothaeusler, Jefferies LLC, Research Division - Equity Analyst [17]

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Just a follow-up on like-for-like rental growth, you showed actually the -- close to 5% growth rate there. And I think you referred actually to the fact that per square meter it would be much higher. Can you comment on that?

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Olivier Elamine, alstria office REIT-AG - Chairman of the Management Board & CEO [18]

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Yes. I think -- I mean what I was referring to is a hugely different way to calculate what like-for-like rental growth is in the industry. And one of the way is basically to consider the average rent that you have on everything which is rented and compare it to the -- so the average rent per square meter on everything which is rented and compare it to the average rent per square meter on everything which is rented like later on in the process. So which is basically the way -- I mean the main way which is used by all the rental companies. And that obviously provide substantially different result. What we call like-for-like rental growth is basically taking the entire portfolio, looking what was the rental income at the moment in time, and then at the end of the period, looking at what the rental income is on the entire portfolio. And obviously that leads to different results. And I'm just insisting that what we're showing here is the latter and not the value way of doing it.

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Thomas Rothaeusler, Jefferies LLC, Research Division - Equity Analyst [19]

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Okay. Another question on -- actually, one of your key peers reported actually results recently, and they're referring to residual value approach which they use for value in their developments. Is it a familiar approach for you? And do you also apply that?

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Olivier Elamine, alstria office REIT-AG - Chairman of the Management Board & CEO [20]

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I think there is many ways to value real estate. I mean there is DCF, there is -- I mean we use the so-called hardcore top-slice approach and equivalent yield. And actually we don't use anything, this is the methodology used by our valuer. But I'm not sure I follow-up your question because, obviously, the thermometer -- if you change the thermometer, it doesn't change the results. So eventually whatever methodology you use, the results you should get at the end is always the same. So I'm not sure what...

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Thomas Rothaeusler, Jefferies LLC, Research Division - Equity Analyst [21]

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Okay. Last one on -- I mean we recently had talks on rent controls for commercial leases actually. What do you think about that? How serious should we take that?

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Olivier Elamine, alstria office REIT-AG - Chairman of the Management Board & CEO [22]

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I mean the short answer is I don't know. And I mean, first of all, I'm not so concerned because we are the last person who has assumed that we're going to rent at EUR 50 per square meter in Berlin, so we don't feel so threatened by those threats. I think, I mean on the face of it, I think -- I mean it's probably hard in the resi space to get this. I think it's going to be even harder on the commercial space. And I also don't see where is the political gain can be. As much as I can see where politically you can gain from capping rent on resi, capping the rent for Daimler or Siemens it's hard to see where there is any political gain in there.

So I think it's less likely to happen. But we're not looking at that neither as a threat nor as a risk for the company. Average rent is at EUR 12. I mean the market rent today, as you know and as you hear, is probably closer to EUR 18 everywhere. So if they cap at EUR 18, I still have like a 30% increase in my rental income. So we're not so worried about that.

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Operator [23]

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As there are no further questions, I would hand back to you.

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Olivier Elamine, alstria office REIT-AG - Chairman of the Management Board & CEO [24]

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Well, thank you very much for your interest in the company. We will be back on the road come September. We're looking forward for our further conversation, and we will speak again for the third quarter result. Thank you very much and have a very nice day.

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Operator [25]

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Ladies and gentlemen, thank you for your attendance. This call has been concluded. You may disconnect.