Becoming more core

Rafał Ostrowski, ‘Eurobuild CEE’: How is AERE doing at this turning point in its history, when the company’s leadership has just changed?

Josip Kardun, CEO of AERE: Firstly, the unique thing about Atrium is that it is the only listed company focusing purely on Central and Eastern European retail property markets that holds an investment grade credit rating. What does this mean? It means that we have a ‘-BBB’ rating with a ‘stable’ outlook according to Fitch and Standard and Poor’s. We finance ourselves on a couple of markets at the corporate level. I think there is no other company that does this in the CEE region, especially in our core markets – Poland, the Czech Republic and

Slovakia. The company is extremely financially robust if you look at our figures. The portfolio we have comes to over EUR 3 bln of real estate, currently with EUR 2.7 bln of cash flow producing assets. The cash flow this is producing will grow with our latest acquisitions and we want to continue along that path. We have also reduced the cost of our debt. Last year we raised EUR 350 mln from a bond with a seven-year duration at 4 pct interest, this year we raised a bond with an eight-year duration at 3.65 pct interest. So even though we are exposed to the Central and Eastern European market we have these very good conditions, mainly because of the trust of capital markets and in the management quality and the execution of the quality of the company.

Scott Dwyer, CEO of AERE in Poland: The EUR 400 mln in cash that we now have will see us through a number of acquisitions over the next 12 to 14 months. Poland represents just over 50 pct of the entire portfolio. The portfolio has changed and grown app. 2.5 times when it comes to the number of standing investments over the last six years. The Polish operating margin is close to just over 100 pct and the gross rental income generated in Poland accounts roughly for 50 pct of the total. So we see that having people on the ground and the strong balance sheet gives us a competitive advantage on how we analyse assets, how we analyse the market, and the speed with which we can move to acquire assets.

Rachel Lavine, former CEO (2008–2014) of AERE, now executive vice-chairman of the board: It is good to see what has changed in the last seven years in this company. The new investors, which were a consortium led by Gazit Gaia and CPI, took over in August 2008. The economic crisis hit in September 2008. And so the company to start with was in a very poor situation, having third party commitments of EUR 5 bln. We had to reduce this dramatically because this impacts the risk profile of the company. So I can very proudly tell you that it has been reduced to zero and the commitment we are taking on now is actually because we would like to develop

Promenada in Warsaw or Copernicus in Toruń, but we have zero third party commitment. Moreover, in 2008 our standing investment portfolio was EUR 1.6 bln and now we are at EUR 2.7 bln. Part of this (about EUR 760 mln) was bought from the market and we were buying mostly in the more mature countries, such as Poland, the Czech Republic and Slovakia, while the rest was development which will be transferred to income producing. We have increased the gla that we internally manage by 300,000 sqm to a total of 1.4 mln sqm. If you look at the occupancy, our starting point was over 93.5 pct, but we are now at almost 97 pct. As for the operating margins, we started with 70 pct and we are now at close to 96 pct. This was done by improving our efficiency. The management was internalised because the company at the beginning was externally managed, so we now have fewer employees, but they are much more efficient. Just to give you a sense of the numbers, if you improve by 20–25 pct on a EUR 200 mln income, this means that you are earning another EUR 40–50 mln. So as a result of all these achievements our EBITDA is now more than four times what it was seven years ago. We started at EUR 39 mln and we are now at EUR 176 mln.

You should never change a winning team, football experts say. What is the reason then for changing the company’s top management during a period of growth?

Rachel Lavine: I think that the numbers show that we have been working super hard for the last seven years. Two years ago I was already feeling that I have to think about the future, and the future may include me, but in a much more limited way. And as I thought that we didn’t have the right successor in the company, I started to look for someone younger in the industry who could take over and lead the company into its next phase. I think we did this in a very diligent way and one that was very responsible for the company. Josip, I think, is the right person to do it. He is nearly forty, he comes from this sector, and he knows our region – so his learning curve will not be so steep. And when he stepped in, we thought that there were other people who needed to be changed, so that we can take the next step. We have also both known Scott for many many years. He has spent even more time than us in Poland. He knows the real estate and retail centre market in our region and probably would be the best match for Josip. So on the one hand you can see there has been a lot changes, but on the other hand if you look at the wider picture and how it has been done – they are not sudden. We have been working together now for ten months, all the investors have met Josip, as well as all the rating agencies. When Josip was appointed deputy CEO, it was clear that in a matter of time, when we both felt comfortable, the change would happen.

So what is going to change now? Is there a revolution on the cards?

Josip Kardun: It is not a revolutionary approach. Rachel and I started to talk about the change when nobody else yet knew about it. So it was her project. And I think what she was looking for were two things. Seven years ago, there was a lot to clean up, a lot to solve. In fact while other companies have had 50 years to grow up, Atrium had to do a lot of things in just seven years. And I think what Rachel was looking for was someone to go from a start-up feeling to a more cooperate environment, and for the company to be much more stable and very differently organised. Secondly, together with Scott and myself coming here, we are adding a lot of people with huge industrial depth in commercial real estate and shopping centres for the company. We have been very good on the financial side and on the capital markets, but we are also day-by-day better on the commercial real estate side. And don’t forget one thing, those who are willing to join our company now were not yet willing to do so a couple of years ago, when Rachel was still doing this whole turnaround of the company. To be honest, I would also have been very hesitant to join Atrium four years ago. Now it has become very attractive to me. It gives you more momentum when people see that something is happening and you can then acquire very good people from the market.

What are the next steps that you are planning?

Scott Dwyer: We are looking to complete the extensions of several schemes and to further stabilise Felicity – in addition to that we have also got to roll out the leases. We’ve got 240 leases to renew next year. We are continuing to change, to extend and to acquire and that’s become imbedded in our existing base. We are looking at the cities that have substantial sizes and economics of growth in the long term – we don’t want to invest in towns that have a net leakage of good talent or industry.

Josip Kardun: A company like ours should be able to buy one or two shopping centres in Poland or the Czech Republic a year for the next two or three years. We are looking at towns with at least 200,000 inhabitants and a catchment area of 500,000.

So what is the shopping centre size you would be looking at?

Scott Dwyer: For the last seven years the average has been about 40,000 sqm, so if you take out some of the smaller schemes the dominant size is between 45,000–60,000 sqm. And if the city is smaller we could go down in size, but I think to get the critical mass of retail you need to go over 40,000 sqm. But of course it is not just the macroeconomics of the city, you need to look at the underling catchment area of the asset, the recurring income growth that we require. We can see if the centre is undermanaged, what its reversion potential is in terms of the leasing, and if we can apply our economy of scale in order to get growth on a longer term basis and a stable income.

What would be the ratio between acquisitions and development?

Josip Kardun: In the past it has been two-thirds acquisitions and one third development. I think that the ground-up development is currently the model of the past, because the capital markets, the buyers are not waiting for the cash flow to kick in for two years. Everyone is now ready to buy more core, more expensive assets with history and a track record instead of going into development.

What did you mean when you once said that you wanted to bring your portfolio up to a higher level?

Scott Dwyer: What we are buying is going to be a bit more core. Generally we are looking at the better and bigger quality schemes. And we are furthering that with the existing solid base, which we are selectively extending. These are the projects that retailers know and they know how they have traded historically. This year the retail stock will go up by app. 2 pct. So in the total base it is growing organically, but you have to look at individual cities and we are taking a view on how the retail market is going to develop in these locations.

So you are buying centres that are good, but you don’t want to buy centres that need improvement?

Josip Kardun: Even good centres need improvement. But we are not an opportunistic buyer.

All opportunistic buyers tell you that vacancy presents an opportunity. Vacancy is never an opportunity – it is always a risk. What we are doing is taking advantage of the fact that we are not finance expensive, so we can buy good assets at less cost. We are moving to the downtowns, to the dominant centres of cities like Warsaw, but also cities like Bydgoszcz.

If you look for example at Białystok, eastern Poland is not what western investors will mostly look at. But we have an asset there, which is Atrium Biała, and retailers who want to go to Białystok are literally knocking on our door there. And even there we are constantly exploring the potential to see if we can extend or reposition. Why? Because its trading history shows that Atrium Biała is simply dominating the catchment area there – and this is what we are looking for.

Are you looking for the best mall in town?

Josip Kardun: We are generally looking mostly at the best malls in town, but in big cities such as Prague or Warsaw we tend to look at the top five behind them.

Not many centres like this are up for sale.

Josip Kardun: No, but from time to time some come on to the market. This could also be something in which we would co-operate with big international investors. We can co-invest, we have the money, we can invest all the cash without finance, and we are an experienced property and asset manager. The big insurance funds like to have partners like us, because we can manage their assets. But on the other hand, we are co-investing heavily and their success is our success. But the top, top, top prime assets, which are huge, take time. We would also be involved with the most reputable international investors.

One of your most recognisable assets in Poland is Promenada in the capital city. You are currently extending the centre. How big is it going to be?

Scott Dwyer: We are doing the extension step by step. Initially we will extend it probably just by under 4,000 sqm to introduce a bigger flagship H&M store at the front of the centre, and this will free up space to start the internal development as well. So it is not as if we are going to be doubling the size from Monday to Tuesday, but it is an asset that has a fantastic location, a good track record and it is something that we can work on for the next six or seven years in order to continually improve it. This is what retail is moving towards in more mature markets. It is all about constant repositioning, constant changing – it is an organic animal. Promenada has the capacity to be extended and for space to be freed up, where we can do internal extensions, extending on our own land as well.

Josip Kardun: We have not made a big thing out of announcing it, but we have drawn up a seven-stage plan for

Promenada. And what I can tell you is that it will be significantly bigger than today. Because we want to move this asset up to a premiership level. The risk involved in doing this with Promenada is much lower, because it is an already proven location. For most retailers leasing space in the extension of an already well-functioning asset carries a much lower risk than entering a ground-up development. This is precisely the approach we have in Toruń.

Which country is your main target?

Josip Kardun: I think the two main markets are Poland and the Czech Republic. Poland with 1.3 bln of real estate is already very big. Scott is leading 130 people here. In the Czech Republic we have now acquired our second large shopping centre, and another in Slovakia. We are looking for big follow-ups to these purchases.

What about Russia, where you also have some assets. What are you going to do with them in the present situation?

Josip Kardun: We have a well-diversified portfolio of seven assets with a total value of  EUR 450 mln. This is yielding very well for us – a 12 pct yield. So it is generating a very nice income there. After the credit crunch we basically restructured the portfolio. We are one of the few euro-denominated service chargers. We have introduced this to 50 pct of our international retailers. What we are experiencing in Russia is that the footfall is still going up, but for the first time in the last few years, the ticket size for expenditure is stagnating. So what we will mostly face in Russia is a stagnating economy. And you also have to face a number of issues regarding the ban on certain products. What the future holds for Russia, I can’t say. But I can tell you that we are still growing in Russia, We are growing slower than we used to, but we are still far away from what happened after the credit crunch.

Are you going to sell anything in Russia?

Josip Kardun: We are not selling anything – and we are not buying. At the moment we are simply managing our portfolio very well, as we have a very good team. But what you can see with those acquisitions, the more we buy in Poland, Slovakia and the Czech Republic, the smaller the weight of the Russian portfolio is in our entire portfolio – now app. 17 pct. Even if this goes further down, I think having a certain amount of Russian exposure would not be bad for the group, since Russia is providing a very nice cash flow.

Are you considering opening to other markets?

Rachel Lavine: Our target is the CEE region. Maybe if the market was not able to absorb our company’s capacity the board would consider other markets. But for the time being it seems that it can absorb us very well.

You have recently sold 73 supermarkets in the Czech Republic, why?

Josip Kardun: We want to turn more and more to shopping centres, because we can add much more value to complex commercial buildings than to stand-alone supermarkets.

But if you had a very good price on a good shopping centre would you sell it?

Josip Kardun: No, because we are a real estate group. We are basically a holding firm and this is not where we are coming from. Our answer is: if  a good quality asset becomes interesting to sell, because with this money you could get a much better asset, then we might consider it. But if we, for example, finish Promenada, we would do that to keep it for the longer term. I am sure that we will get tremendously good pricing for it, but it is not the trading model that we are following. It is cash-flow driven.

What is your recipe for turning an asset into a good asset. How do you do it?

Josip Kardun: Many people have tried to do a lot of strange things on emerging markets, for example, opening a Jurassic Park in a shopping centre, adding a lot of leisure, and this and that. I think instead you have to do a lot of small things and very professionally and then line them up – and it is all this that adds up to making the difference. What I mean by this is the functionality, the customer friendliness, a family shopping centre, getting the right retailers lined up – not those that you personally like, but those that research tells you the customer will like – and then also apply what we are doing in the new centres. I am not saying we never copy good ideas. If something works well, why not to copy it? This means implementing good ideas and reacting to the changes on the market.

Are your shares a good investment?

Josip Kardun: Yes, of course. If you look at 2009 onwards, the company was increasing the dividend by close to 15 pct every year. If you now look at the dividend we have approved for the next year, we are on a 6.5 pct dividend yield. Who is paying such a dividend in Central and Eastern Europe on a quarterly basis? And this has been the case for the last 5–6 years. So this is a unique offer. In the past from the banks you were getting interest of 4 pct. Now you are getting 1.5 pct, if you are lucky. So I think in the future the dividend payment will become more and more important for any capital investor and this is what we are trying to push. Because this is what we as the management can do – we have no influence on the weather in Poland, but we can push the cash flow up, the EBIDTA up and pay the dividends. ν

Three on top

Josip Kardun has been AERE Group’s CEO since December 1st, 2014. He joined the group as COO and deputy CEO in February 2014. Previously he was the chief investment officer and the head of the mergers and acquisitions and transaction management group at ECE Projektmanagement. Prior to that he worked for Sonae Sierra, where he was general manager of Sierra Management Germany, with responsibility for leasing activities and centre management.

Scott Dwyer is the CEO of AERE in Poland. Previously he served as the executive vice-president and head of portfolio management of Heitman International. Prior to that he acted as the general manager of ING Real Estate Development International. He has also worked for Rodamco Europe, which later became Unibail-Rodamco, where he served as the country manager for Poland and the managing director for Central Europe.

Rachel Lavine. the former CEO of AERE Group (2008–2014), is currently the executive vice-chairman and a member of the board of directors. Formerly she was the president and CEO of Plaza Centres (Europe) BV and prior to that the president and CEO of Elscint. She has also served as an external director of Dor Chemicals and for other public companies.