The past financial year was better than expected for Deutsche EuroShop. Although the property crisis continues to claim victims, the Company has a positive future. CEO Claus-Matthias Böge and CFO Olaf G. Borkers talk to Dr. Ruth Vierbuchen, editor-in-chief of Handelsimmobilien-Report.

Dr. Ruth Vierbuchen: Why does DES invest exclusively in shopping centers and not in specialty stores or discounters, which also benefit from the difficult economics phases?

Böge: We have discussed the subject over the previous year and realised that it is not suitable for us because a) the risk-yield profile is not attractive and b) the rental agreements are a long way from the quality to which we are accustomed. For our shopping centers, we look for prime locations, properties with a wide industry mix and a wide risk diversification. We set store in long-term rental agreements and fully indexed rental agreements. Our business is robust and planable.

Dr. Ruth Vierbuchen: Keyword shopping center: The large centers are not infrequently regarded critically in connection with the subject of city development and its effects in urban retail. As an investor, what is your take on the subject?

Böge: Looking at the development in many cities the phenomena is apparent that the actual anchor, which has ensured that people come to the city for decades - the traditional department store - no longer works. And on the other hand, there are many successful retail concepts that move in the medium sized area. Retailers who require 1,000 or 1,500 m2 floor space cannot find retail space of a suitable size in small adjacent buildings in city centres. The result is that attractive retail offers do not make it into the city. And with them potential customers stay away from the city centres. It makes sense therefore to consider revitalisation of city centres with shopping centers. They offer new, flexible floor space in prime locations which can be adapted to the changing requirements of the retailers. I am thinking particularly of the many medium-sized cities in Germany.

Dr. Ruth Vierbuchen: Is the credit crisis having an effect on DES? If yes, in what way?

Olaf G. Borkers: We have a conservative financing structure. This protects us against credit risks because it makes us more independent of banks and interest changes. For many, this used to be rather an obstacle to investing in Deutsche EuroShop, but since the summer of 2007 at the latest it has proved itself as obviously advantageous for us. We can therefore say that the credit crisis has not affected us. However, we are expecting that the banks will demand increasing margins - even for a low-risk business such as Deutsche EuroShop.

In the first half of 2007, we renegotiated loans with a volume of around €160 million, partly as extensions and partly as refinancing with very long terms at favourable conditions. Credit will become a talking point for us in 2009 at the earliest - to a relatively small extent.

Dr. Ruth Vierbuchen: Did the credit crisis have an effect on the valuation of the portfolio?

Claus-Matthias Böge: Valuation is certainly an issue. However, we do not believe we are currently exposed to too much risk since the valuation of our portfolios is tangibly below the current, in our view overheated, market level. I can foresee a yield increase of perhaps 15 to 20 basis points.

Dr. Ruth Vierbuchen: Following the marketchanges in the wake of the credit crisis, since the summer of 2007, you have initially been reserved where further transactions are concerned. How in your view did the climate change towards the end of 2007?

Olaf G. Borkers: We made our last investment in December 2006, i.e. for us the prices for shopping centers were too high and the yields too low at the beginning of 2007. In our high-priced segment, there are relatively few transactions and these are in turn never transparent and involve incomprehensible prices. Overall, we can see that the competition has relaxed since the summer of 2007. Investors who operate with a high degree of financial leverage are active only to a limited degree. This means that today we have other competitors. These are equity strong investors, primarily the open-ended German property funds.

Dr. Ruth Vierbuchen: How did the financial year go for DES? Were the forecasts met?

Claus-Matthias Böge: We actually exceeded them slightly. Our forecast declined slightly in 2007 because we sold two shopping centers in 2006 and only in October did we acquire a new one. However, we finally generated a pleasing 3% increase in revenue, which was also the result of the indexing and turnover rent. For EBIT, i.e. the earnings before interest and tax, we had recently forecast between €72 million and €74 million and achieved €77.2 million. This was essentially connected to the fact the investment costs to be treated as expenses - a dimension difficult to comprehend - did not occur in the full amount. The normal operating costs are relatively stable. Of the rent, approximately 12% to 13% include the operating companies’ costs.

These measurement gains are included in profit after tax i.e. consolidated profit. This was pleasing at €50.8 million. All centers have been upgraded in value on average by 3.1%. The corporation tax reform helped us, since we were able to release €30 million in tax provisions. This helped in one instance. Overall, at €94.2 million we are below the €100.3 million profit we had in the record year of 2006. We are better than we had forecast and therefore very satisfied.

Dr. Ruth Vierbuchen: How did Deutsche EuroShop fair in 2007?

Olaf G. Borkers: Very well initially. We began at €28.08. We reached our alltime high in March at €30.68. The dividend in June was raised to €1.05. Then the subprime crisis hit in the summer, which also affected our shares. It must be noted however, that Deutsche Euro- Shop shares fell much less than those of its competitors. It was essentially quite contagious, affecting all property stock corporations. We ended the year at €23.50. That was a performance of -13% against +23% on the previous year. Looking at a five-year period, our shareholders have doubled their stake.

Dr. Ruth Vierbuchen: Do you have new projects planned for 2008? Also abroad?

Claus-Matthias Böge: We have a lot planned. However, there is not price tag attached yet. We have been thinking about whether we should start on these projects much earlier than previously. Previously we had only invested if there is planning permission and pre-letting of 40-50%. With a general contractor contract signed, the risks are relatively manageable. However, since the last time we acquired such a product was 15 months ago, we are considering whether or not to enter into the actual property development risk, i.e. collaboratively sponsor property development in a joint venture with ECE. The risk must not be allowed to overturn the Company or unsteady the ability to distribute dividends. However, it can certainly result in small losses in individual cases. Initially, we want to limit ourselves to one or two properties. The problem is simply starting this kind of business. The first properties have to work. If we hit the rocks in both cases, then we can really forget the idea. If both properties are successful, then we can talk about more. However, we still prefer the lowrisk properties.

Olaf G. Borkers: AWe are also prepared to accept firesales - forced sales by investors who leave the German market disappointed or perhaps experience other problems. When they leave, we’re waiting. The question is: What do we really want? What can we do as small Deutsche EuroShop against large competitors? One advantage is that we are in a position to make quick decisions. And we have the cash necessary to make a rapid acquisition.

Dr. Ruth Vierbuchen: Going back once more to this possible development. Would that be in Germany or abroad?

Claus-Matthias Böge: We are pursuing both avenues.

Dr. Ruth Vierbuchen: How will the market in Eastern Europe develop? How far will you go along with it?

What must an investor especially take note of in these markets?

Claus-Matthias Böge: Our current view is not to go further than previously, i.e. Poland and Hungary, as Central Europe, are the eastern limits. We could include the Czech Republic, however, that is a small market. Poland is a larger market and we have a lot of interest in it. However, it is important that the best locations are acquired in a city, to reduce the pressure when competition increases. We have two properties in Poland. The Galeria Baltycka in Gdansk for example is not only a unique location, but also a unique offer. With a catchment area of 1.1 million people, the property is to a large extent unrivalled when it comes to product range. Even in Hamburg or Düsseldorf this property would be a genuine highlight. It really has no competition. That will not be the case forever. That is where the location plays a role. And the location is good - as are all our locations.

Dr. Ruth Vierbuchen: What value enhancement potential do you see in your current portfolio?

Olaf G. Borkers: Our shopping centers generate increasing rents by means of rental indexing. Rising rents should lead to increased values. However, the valuation is also dependent upon external factors over which we have no influence. We plan very much in the long term and our shopping center portfolio is still young, so we expect rental and value enhancement potential.

Dr. Ruth Vierbuchen: In your view, what potential does the German market still have for retail property?

Claus-Matthias Böge: That question cannot be answered generally. If we look at the area of shopping centers, we believe that this area has a clear future since there is a need for floor space in many cities. There is a great deal of the wrong kind of floor space, i.e. the divergence between good and bad is becoming wider and more empty buildings will be seen in the 1b locations. A prosperous future is only assured in the prime locations.

Dr. Ruth Vierbuchen: What role will foreign competitors play on the German market over the coming years?

Claus-Matthias Böge: The German market is very international and will remain so. There will be investors who keep their commitments here long term, as is necessary from a diversification perspective for example. Many are currently moving towards Asia. In my view, these are particularly the rather short-term orientated funds, financed to a high degree with outside capital.

Dr. Ruth Vierbuchen: Do you have the impression that the German market for retail property, which was previously in the background, has changed much since 2005? If yes, in what way?

Claus-Matthias Böge: Retail property is certainly not just something for specialists. However, many international investors focusing on retail property did not have Germany on the radar until just a few years ago. They have now become more interested. Strategic investors are currently not yet active. Overall, it can be said that the German market has woken up after a long sleep. The most serious development was the introduction of auctions in the professional property market. Projects are no longer given a price tag which can be negotiated; each bidder writes his or her own price tag and hopes to have submitted the highest offer. The is not what a businessman wants, since he wants to do business not buy art.

Dr. Ruth Vierbuchen: What is your view of the corporate tax reform? Have you been negatively affected by the interest barrier?

Olaf G. Borkers: Of course we welcome tax reductions, even if they involve an extension of the basis for taxation. We have benefited, and will benefit, from the tax reductions. We have released deferred taxes amounting to around 330 million - a one-off effect. Our tax rate will be lower in future. The corporate tax rate was reduced from 25% to 15%.

The interest limit is a significant and difficult issue for the property industry. According to intensive examination, we are currently not affected since we benefit from the escape clause. However, this is an examination which we have to repeat every year for a group which is always changing. Not all changes are manageable for us. I am thinking in particular of the market value of our shopping centers.

Dr. Ruth Vierbuchen: Why does this escape clause apply?

Olaf G. Borkers: The escape clause states that the equity ratio of the subsidiaries must at least approximate that of the Group. Since we are a company that finances more or less everything with 50% equity and 50% outside capital, the equity ratios of our subsidiaries are approximately identical to that of our Group. A 1% deviation in the equity ratio is permissible and in our view we move within this range.

Dr. Ruth Vierbuchen: What are your forecasts for 2008 for revenue, EBIT and earnings before tax (EBT)?

Olaf G. Borkers: Positive. Revenue will increase to €110 million to €113 million, against €95.8 million in 2007. EBIT should rise from €77.2 million to €90 million to €92 million, EBT from €37.7 million to €43 million to €45 million. Since we are unable to forecast the measured gains, they are not always included in these operating forecasts.

Dr. Ruth Vierbuchen: Finally, your Annual Report carries the motto The changing face of retail what kind of change can we expect from DES?

Claus-Matthias Böge: As our retailers change, our shopping centers also change. Our property’s great advantage is that we can relatively easily adapt it to the changing requirements of the retail industry.

We remain conservative, even if we are perhaps entering into somewhat more risky business with the project development in peripheral areas. However, when a company grows it must also change. We are convinced that we will have one or two interesting ideas we can realise.

Dr. Ruth Vierbuchen: Many thanks for the interview.