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Edited Transcript of DMRE.DE earnings conference call or presentation 14-Nov-19 9:00am GMT

Nine Months 2019 Demire Deutsche Mittelstand Real Estate AG Earnings Call

FRANKFURT AM MAIN Dec 6, 2019 (Thomson StreetEvents) -- Edited Transcript of Demire Deutsche Mittelstand Real Estate AG earnings conference call or presentation Thursday, November 14, 2019 at 9:00:00am GMT

TEXT version of Transcript

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Corporate Participants

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* Ingo Hartlief

DEMIRE Deutsche Mittelstand Real Estate AG - CEO & Chairman of Executive Board

* Tim Brückner

DEMIRE Deutsche Mittelstand Real Estate AG - CFO & Member of Executive Board

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Conference Call Participants

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* Andre Remke

Baader-Helvea Equity Research - Co-Head of Equity Research & Equity Analyst

* Ashley Heatwole

Shenkman Capital Management, Inc. - Credit Analyst

* Stefan Scharff

SRC-Scharff Research und Consulting GmbH - MD & Managing Partner

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Presentation

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Operator [1]

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Good day, and welcome to the DEMIRE Deutsche Mittelstand Real Estate AG Conference Call on the Q3 Report 2019. Today's conference is being recorded.

At this time, I would like to turn the conference over to Ingo Hartlief. Please go ahead.

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Ingo Hartlief, DEMIRE Deutsche Mittelstand Real Estate AG - CEO & Chairman of Executive Board [2]

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Good morning, everybody, to our Q3 call today. It's a pleasure to give you an overview of DEMIRE's successful development in the first 9 months 2019. With me here in this call is Tim Brückner, CFO; and Michael Tegeder, Investor Relations.

As I will start with the company presentation and the highlights of strategy and portfolio achievement, Tim will further discuss our financials thereafter. Finally, we will open today's Q&A session.

We begin with the strategy update. Our REALize Potential program that was implemented in early 2019 has 4 pillars. Just to remind you, acquisitions, DEMIRE is aiming to grow its portfolio by the ongoing purchase of real estate in the direction of EUR 2 billion. Asset management, the second pillar, DEMIRE focuses on realizing real estate potential through active and value-oriented real estate asset management. Financing, DEMIRE is going to realize enhancement potential in the financing structure. And processes, DEMIRE continuously optimizes its structure and its processes.

So the consequent execution of the REALize Potential program is a completion of the desired results so far. First and foremost, we were able to increase funds from operations after taxes and before minorities from EUR 18.3 million in the first 9 months of 2018 to EUR 24.5 million in 2019. This corresponds to a growth of 33%.

The EPRA-NAV increased compared with 2018 by nearly 7% to a solid EUR 5.87 per share. The portfolio was increased via portfolio acquisitions and valuation uplifts by EUR 0.3 billion growth to overall EUR 1.4 billion during the current year.

A focal point in the third quarter was to boost our portfolio activity. We sold 5 properties, who either had exhausted their potential or were not of an institutional size, and we were able to achieve proceeds with a premium of more than 30% compared with the property's last assessed valuations.

Coming to the letting performance. The letting performance of 135,000 square meters is more than 60% higher than the performance in the full year 2018. The rental income expanded by 9% to EUR 60.1 million, and the WALT has also increased to 4.7 years. The vacancy is still high with 10.9%, but the trend already shows a reduction. The profit from rentals of real estate is up to 14.7% to EUR 48.9 million.

During the third quarter, we prepared a corporate bond issue and carried out this issue in early October at favorable terms. The coupon is at 1.875%. This will significantly lower our cost of debt to below 1.9% and extend the maturity profile on the other hand. The positive FFO effect is to be seen in 2020 and thereafter, of course.

Net LTV is with -- 48.5%, still below our target. With the finalization of the bond process, we have EUR 150 million firepower for acquisition, and the pipeline is filled. We are confident that we succeed on that until the end of the year.

Based on the strong performance, we remain optimistic and confirm our forecast for the KPIs, rental income and FFO, which was raised in August.

To give you a lively example for the execution of our REALize Potential program, let me elaborate on our office building in Bad Vilbel nearby Frankfurt.

It was part of the portfolio transaction that was closed in May 2019. The 26,000 square meter properties joined our portfolio with 69% vacancy and a EUR 1.1 million GRI. The purchase price was $31 million. Between signing and closing, we worked on a concept to realize potential of this building that we consequently executed in the last 6 months. Key was a transformation from a single-tenant property to a multi-tenant asset with ongoing investment of EUR 3.9 million. We established a tenant-related asset management and property management approach. Optimization of the stacking plan means movement of tenants within the building and installing a canteen.

In parallel, we started some marketing initiatives. Until today, we could manage to find 6 lease contracts for prolongation and 2 new contracts. The newest tenant, State of Hesse, with 5,000 square meters, will move in May 2020 and stay in the building for at least 10 more years.

So what are the achievements in figures today, pro forma and annualized? You see on the slide's right-hand side the market value increased by EUR 10 million to EUR 41.8 million, the vacancy halved to 35%, the GRI more than doubled to EUR 2.3 million as the WALT increased by 2.5 years to 7.1 years.

Back to the portfolio perspective. Follow me on Slide #7. Some more details on the leasing performance in the first 9 months of 2019. Compared to September 2019, like-for-like rental growth is with under 1% due to the repositioning of some properties over that from 2018. The closing of the already reported 2 portfolio acquisitions in 2019 with 4 offices and 5 department stores and the sale of -- and the sale and the closing of 2 assets leads to an annualized rental income of EUR 85.4 million. The EPRA vacancy is down to 20 bps to 10.9%, mainly due to the recent acquisitions of the retail portfolio, partly offset by the sale of the fully leased office building in Stahnsdorf. Signed rental contracts and the repositioning of the properties lead way to further decrease of vacancy in the near term.

The low level of upcoming lease maturities would stabilize vacancy rate further. You see it on the bottom right. Especially in 2021, if you compare this to the slides we showed you in the last quarter, we were able to reduce the risk of the lease expiry schedule by 5%. This is due to the promulgation of contracts and the sales of Stahnsdorf, where the tenant already decided to move out.

The portfolio breakdown is very stable with 67% of GAV contribution in offices. Compared to December 2018, the value of investment properties increased by 26.2% to EUR 1.4 million, driven by acquisitions and revaluation gains. The cost of the revaluation gain so far was mainly based on our operational performance. A new revaluation of this portfolio will be executed until year-end 2019.

The average asset value is up to EUR 15.3 million, so the direction is right. Two disposals with proceeds of EUR 18.5 million and a sales profit of EUR 8 million were closed in 2019. Further divestment of nonstrategical assets to be followed until year-end. The GRI yield of 6.1% across the portfolio is solid. You see our REALize Potential strategy on the operational-type works.

And now Tim is going to show you how it works on the finance side.

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Tim Brückner, DEMIRE Deutsche Mittelstand Real Estate AG - CFO & Member of Executive Board [3]

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Good morning, everyone.

I'd like to start with a quick overview of the refinancing of the outstanding bond 17/22 which, as you remember, was a strict high-yield structure that helped DEMIRE 2.5 years ago to lower the interest expense significantly to -- as you also will remember, to about 3%. What we did and executed in early October this year was a very successful placement of the EUR 600 million crossover-style senior notes bond with a coupon of 1.875% and a total yield of 2%. The rating agencies kept our rating and the product ratings stable. And what is very important for us, we achieved crossovers via bond, which clearly shows that the capital markets trust our strategy that points towards our aim to reach investment-grade rating in the future.

Why did we refinance our existing bonds? We wanted to strengthen our P&L going forward. We wanted to benefit from the strong capital market fundamentals, but we also wanted to extend our average duration of our liabilities, and all of that was successfully achieved.

The chart on the lower right demonstrates the evaluation of our nominal interest expense, as you recall, 3% at the end of 2018. In summer, we did a EUR 100 million secured financing, helped us to bring the nominal interest rates below 2.8%. And the pro forma of the bond refinancing, we lowered it to 2.2%. And at the end of November this year, we will also refinance or repay as a promissory notes outstanding, which will then help us to drive the nominal interest expense ratio below 2%.

That will help us further to improve our unsecured debt ratio to more than 60%. It will have a meaningful impact on our FFO going forward, and it provides us with more than EUR 80 million additional firepower for new acquisitions and to expand our portfolio. And what is also on the agenda is that we use some of the assets currently secured for the Schuldscheindarlehen to increase our leverage a bit further and grow our portfolio to drive the valuation of the company and help our FFO next year.

On the following slide, we have a quick overview of our funds from operations. And what Ingo already pointed out, we increased that versus the previous year by more than 30%. That is due to strong operational performance, new acquisitions, as you already know, but also effects kicking in from lower interest expenses and some effects from improved tax burden.

Rental income is up to EUR 60 million, mainly driven by recent acquisitions and some catch-up indexations that we executed earlier this year.

Finally, we can report profit from rental up to -- up 15% to EUR 48.9 million due to improved -- improvement in the utility costs and service charge management and also, again, obviously, new acquisitions.

Very important for the company is if you look into our numbers in a bit more detail that the profit for the period, excluding revaluation gains, turned positive. So we managed to strengthen the P&L of DEMIRE such that going forward, and also strengthened due to the refinancing of our bonds, we will be able to report positive earnings without revaluation gains in the future.

On the next slide, some balance sheet positions. Investment properties increased due to acquisitions and some revaluations in the first half of this year. We are quite positive. And as Ingo already pointed out, when we sell properties, we are usually able to sell them significantly above book value. So we believe that there's some headroom in our valuations.

The financial debt package increased, driven by the financing that we executed in summer by EUR 100 million. And when we look at our EPRA-NAV per share, given our positive performance, we also increased that from year-end 2018 from -- on a fully diluted basis, from EUR 5.50 to EUR 5.87.

Some bigger overview of our financial profile. Net LTV, as said before, getting closer to our target ratio of 50%. And we already said that we wanted to go further into the investment-grade territory, so it might still be that we save it over the LTV ratio of 50%. But as you see, currently, we are approaching it from below, and we are currently not planning to expand it significantly.

Average cost of debt, as I said before, lower. And if you compare us now with our peers in the market, by year-end, we are pretty well in line with all our listed peers and with the commercial portfolio in Germany.

The debt book overview on the top right-hand side shows some significant cash and cash equivalents. So we are able to execute further acquisitions. We have the senior unsecured notes. And we have some bank loans, as you know, and also our Fair Value REIT AG debt book is still at roughly EUR 100 million.

With this, we wanted to go quickly to the outlook. The outlook remains unchanged. So we believe that we will achieve rental income of between EUR 80.5 million and EUR 82.5 million and funds from operations I after taxes and before minorities of about EUR 30 million to EUR 32 million.

With this, we would close the main part of the presentation and open the floor for questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question today comes from Stefan Scharff of SRC Research.

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Stefan Scharff, SRC-Scharff Research und Consulting GmbH - MD & Managing Partner [2]

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I have a couple of questions. The first is in Leipzig, the vacancy rate of the logistics property went up from 14% at half-year results to now 21% at 9M numbers. Can you give us a bit of details here?

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Ingo Hartlief, DEMIRE Deutsche Mittelstand Real Estate AG - CEO & Chairman of Executive Board [3]

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Okay. It sounded like you have a couple of questions there.

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Stefan Scharff, SRC-Scharff Research und Consulting GmbH - MD & Managing Partner [4]

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Yes. Okay, I can continue.

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Ingo Hartlief, DEMIRE Deutsche Mittelstand Real Estate AG - CEO & Chairman of Executive Board [5]

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I will answer it right away. So [Q] sales moved out, and they had 2 -- 20,000 square meter roughly. And we already have lease contracts for this 20,000 square meters with other tenants. So we will see a reduction until the year-end, again, to 11%.

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Stefan Scharff, SRC-Scharff Research und Consulting GmbH - MD & Managing Partner [6]

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That's good. Okay. My second question is the vacancy rate and the new property in Bad Vilbel was already successfully reduced from 69% to 35%, now just half of it. Can you maybe give us an outlook or a plan for the remaining 35% or your negotiations to further bring down this vacancy?

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Ingo Hartlief, DEMIRE Deutsche Mittelstand Real Estate AG - CEO & Chairman of Executive Board [7]

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Yes. The repositioning is still underway. As said, we are investing EUR 3.9 million into the properties. And this is not done yet, but we are already under negotiations with 2 other tenants. So we are quite confident that we can bring new tenants in the next couple of months maybe until the year-end.

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Stefan Scharff, SRC-Scharff Research und Consulting GmbH - MD & Managing Partner [8]

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Okay, fine. How much CapEx have you spent in the first 9 months? And how much do you expect for the full year, for the fourth quarter?

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Ingo Hartlief, DEMIRE Deutsche Mittelstand Real Estate AG - CEO & Chairman of Executive Board [9]

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In the first 9 months, the CapEx, as you see in the slide, is $1.7 million. This is below our expectations. So we will spend more CapEx in the last quarter.

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Stefan Scharff, SRC-Scharff Research und Consulting GmbH - MD & Managing Partner [10]

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And the total number?

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Ingo Hartlief, DEMIRE Deutsche Mittelstand Real Estate AG - CEO & Chairman of Executive Board [11]

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We are going to try to hit 2.5%. But it is a difficult discussion because IFRS balance accounting is kind of different from what you do in HGB. And so activation of investments is difficult in comparison to what we see in the P&L.

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Stefan Scharff, SRC-Scharff Research und Consulting GmbH - MD & Managing Partner [12]

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Okay. So -- but the total number for the total year could be around EUR 2.5 million or...

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Ingo Hartlief, DEMIRE Deutsche Mittelstand Real Estate AG - CEO & Chairman of Executive Board [13]

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EUR 2.5 million to EUR 3 million is our goal.

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Stefan Scharff, SRC-Scharff Research und Consulting GmbH - MD & Managing Partner [14]

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Okay, okay. And with regards to the deal pipeline, you did something to bring up the portfolio size. And perhaps are there models to come in the next month to come nearer to the EUR 2 billion target? And as you mentioned, you have the EUR 150 million firepower now. Even after the bond issue, the financial ratios look fine, so there's financial scope to bring up the portfolio size.

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Ingo Hartlief, DEMIRE Deutsche Mittelstand Real Estate AG - CEO & Chairman of Executive Board [15]

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Yes. Remember, we are selling properties as well as we acquire properties. So this is a trade-off, of course. Until now, we have sales of more than EUR 30 million. You have to subtract it from the portfolio side. But on the acquisition side, we are under negotiations with 2 properties, very close to the end, and this will bring us more than EUR 100 million in new GAV into the portfolio hopefully until the end of the year. But if we don't succeed in this short period, we will succeed it in the next -- early next year.

But the pipeline, I said, is filled. And when the bond is executed, we are in the process of execution. And when the bond is executed in the early beginning of next year, we can start over and invest this EUR 150 million properly.

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Tim Brückner, DEMIRE Deutsche Mittelstand Real Estate AG - CFO & Member of Executive Board [16]

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Maybe, Stefan, just a verification. It's Tim. When we were talking about CapEx right now, this is pure activated CapEx when you wanted to -- you may have wanted to ask also for any kind of construction expenses that you see in our P&L. The P&L figure is EUR 5.4 million for the first 9 months of the year, and we expect up to EUR 4 million for the remaining quarter.

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Operator [17]

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(Operator Instructions) We will now take a question from Andre Remke of Baader Bank.

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Andre Remke, Baader-Helvea Equity Research - Co-Head of Equity Research & Equity Analyst [18]

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A couple of questions also from my side, maybe starting with the sort of purchase or firepower of EUR 150 million. Does this include refinancing already? It's the first question, please.

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Tim Brückner, DEMIRE Deutsche Mittelstand Real Estate AG - CFO & Member of Executive Board [19]

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This includes the refinancing of the bonds, but does not include the potential partial refinancing of the Schuldscheindarlehen.

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Andre Remke, Baader-Helvea Equity Research - Co-Head of Equity Research & Equity Analyst [20]

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Okay, that's clear. Then the second question on your portfolio valuation. Ingo, you said, you mentioned or you said so far, the valuation for [deferred] assets maybe based on operating performance. Not getting a number, a precise number for the year-end valuation, but do you expect more to come from yield compression kicking in? Or will it be mainly also based on operating performance? What is your expectation here?

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Ingo Hartlief, DEMIRE Deutsche Mittelstand Real Estate AG - CEO & Chairman of Executive Board [21]

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We see still pressure on the prices, so yield compression could be seen until the year-end. But this is externally evaluated, so it's hard to be -- to foresee this. But what we can see is that we have some operational performance as well as we had in the first half year. So from this side, we expect pressure leads to an increase more than to a decrease.

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Andre Remke, Baader-Helvea Equity Research - Co-Head of Equity Research & Equity Analyst [22]

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Yes, okay. And then a very last question. When it comes to your rating, of course, you have targeted to improve the ratings. What are the key triggers here? You mentioned about LTV or is it simply the size of the company? What is your view on that? And probably, what are your net debt expectations from today's perspective when you would be able to talk about that?

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Tim Brückner, DEMIRE Deutsche Mittelstand Real Estate AG - CFO & Member of Executive Board [23]

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That's a good -- that's a very good question. Obviously, we discuss the rating implications of what we do intensively with S&P and Moody's, and the answer is pretty clear. And a real investment-grade rating is not achievable given our current portfolio size. But it is also clear that we have to move a bit further regarding all the other operational ratios like LTV, net LTV, FCC and other cash flow-related ratios. So we are very good on track regarding the ratios, but, obviously, we are not there given the size, but we can move upwards towards the investment-grade spectrum even with the current size. So we are working quite hard on improving our ratios to make the next step into the crossover territories that we have already entered.

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Operator [24]

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(Operator Instructions) We will now come to a question from Ash Heatwole of Shenkman Capital.

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Ashley Heatwole, Shenkman Capital Management, Inc. - Credit Analyst [25]

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Looking at Slide 7 on the bottom right, you reflect your lease maturity schedule. Can you share with us the degree of flexibility you have to approach your tenants in advance of lease expiry to extend? I'm just looking particularly for 2020. Do you see any risk here that you wouldn't be able to extend the listed 10% of your leases?

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Ingo Hartlief, DEMIRE Deutsche Mittelstand Real Estate AG - CEO & Chairman of Executive Board [26]

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Of course, we do. We have one big tenant, this is Deutsche Telekom, with 25% -- 24% now, 24% of GRI of our company. And we have some prolongations in 2021, and we discussed this with Deutsche Telekom at the moment in 3 properties. So we structure the properties. And in one case, for example, Stahnsdorf will react in another way. We sell the property if we see upcoming risks and don't see any further potential in the property. So this already leads to a reduction of the lease expiry schedule in 2021. Compared with the last quarter, there was a number of 20%, and now you see this 15%. This is an outcome from what you asked from the work with -- of this tenant and the approach in an early case.

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Ashley Heatwole, Shenkman Capital Management, Inc. - Credit Analyst [27]

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Right. But for 2020, does that 10% reflect Deutsche Telekom as well? Or is that another large tenant?

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Ingo Hartlief, DEMIRE Deutsche Mittelstand Real Estate AG - CEO & Chairman of Executive Board [28]

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No, this is a couple of several tenants. This is not Deutsche Telekom.

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Operator [29]

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As there are no further questions at this time, I would like to turn the call back over to Mr. Hartlief for any additional or closing remarks.

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Ingo Hartlief, DEMIRE Deutsche Mittelstand Real Estate AG - CEO & Chairman of Executive Board [30]

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Yes. Thank you very much for joining in our call, and we are looking forward for the next contact with you.

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Operator [31]

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This concludes today's call. Thank you for your participation. You may now disconnect.