Risk report

Risks from the financial crisis

In the financial year 2009, especially the risks which emerged due to the financial crisis were recorded in the context of risk management and appropriate measures initiated. From a financial crisis such as this, Deutsche Wohnen will have to face risks on both corporate level and on individual company portfolio level.

On Group level, especially the following risks can arise:

Financing risks: Banks could no longer be in a position or have the will to extend expiring credit facilities. It cannot be excluded that refinancing will be more expensive and that future contractual negotiations will take much more time. The refinancing volume of Deutsche Wohnen until 2011 inclusively is at EUR 37.5 million as of 12/31/2009, of which EUR 32.2 million are apportioned to 2010. The credit agreements include financial covenants, which could lead to extraordinary terminations by banks due to non-compliance. At Deutsche Wohnen, these are key financial figures that refer to the capacity to meet capital service [Debt Service Cover Ratio (DSCR) / Interest Service Cover Ratio (ISCR)] as well as to the debt-to-equity ratio depending on the rental income (multiplier). From the current point of view, we will be able to comply with these figures.

Shortfalls in rental payments: In the current economic situation, it cannot be ruled out that increasingly jobs will be cut. This may result in the loss of regular income of tenants and consequent failure to pay rents at all or when due. Management has added the tag of medium probability to the manifestation of this specific risk. Seen in advance, this risk can be met by initiating an immediate contact with the tenants as well as an early recognition system concerning lurking financial problems. Tenants could then be offered smaller and more affordable residential units from the diversified portfolio of Deutsche Wohnen.

Downward trend in buying interest: Both individual privatisations and bloc sales face the risk that the investments of potential buyers could be placed on hold, which would seriously hamper the sales strategy of Deutsche Wohnen.

Strategic Risks

Risk based on trend ignorance: When market developments or trends are not recognised, risks may result which threaten the very existence of the company. In order to decrease these risks, all segments are sensitised on a regular basis to carefully observe developments in their sectors and to bring changes to the attention of the risk management in a timely manner. They then launch further measures.

Legal and Corporate Risks

Legal risks that could lead to losses for the company, occur through non-compliance of legal regulations, failure to implement new or changed laws, lack of comprehensive provisions in signed contracts, or lacking management by the insurance companies.

Building decrees to stop construction work and even inadequate building permits can also have a negative effect because both may lead to unexpected costs and a delay in building construction work. Disposing of contaminates and the implementation of changed legal bases could cause an aftermath of increased expenditures.

Corporate risks: Furthermore, risks may occur due to realised or future corporate mergers. In order to take action against these risks, the Management Board orders a thorough analyses to be able access a comprehensive overview and to make proper suggestions on how to deal with the identified risks. Besides, the Management Board invites advice from the internal Corporate Law division, as well as from the external law consultant from a well-known law firm, even before such specific negotiations start. The Management Board is aware that strategic external growth is not to be pursued under all circumstances.

IT Risks

On 1 January 2009, Deutsche Wohnen AG introduced SAP as new Group-wide IT application after nearly one year of preparations and tests.

In principle, there is a risk of a total breakdown of the application, which could lead to considerable interruptions to the ordinary course of business of the company. For this reason, Deutsche Wohnen entered into contract with its IT service provider for functional business processes, maintenance processes, and administration processes as well as effective monitoring mechanisms in order to anticipate and to prevent such a risk which could imply loss of data.

Human Resource Risks

A decisive factor for the business success of Deutsche Wohnen AG are the employees with their knowledge and their special skills. The risk always remains, however, that Deutsche Wohnen could fail to retain the best-qualified and most suitable employees. We try to address this by securing a motivating working environment and by offering financial and non-financial incentives. We consider Deutsche Wohnen to be one of the most attractive employers in its branch.

Market risks

Market risks in the rental market could emerge if the economic climate in Germany continues its downward trend, which could cause the market gross rental incomes to stagnate or to drop. In addition, it may come to the point in a stagnating or shrinking economy that unemployment increases, which restricts the financial options of the tenants. Moreover, a decline in the available net income of people, be it because of unemployment, tax increases or adaptations, or utility expense increases, means the business development of Deutsche Wohnen will be influenced negatively by a decrease in new rentals, lower new leases, and an increasing vacancy rate.

Property Risks

Property risks may emerge for individual property, the portfolio, and the location of the property. On the level of the individual property, property risks have to do especially with maintenance neglect, damages to buildings, insufficient fire protection, or damage to / wear and tear of property by the tenants. Furthermore, risks may occur due to contaminated sites including burdens of war, soil condition, and pollutant in the building material as well as possible violations of building requirements. On the portfolio level, risks from a concentration in the structure of the holdings occur, which include e.g. increased maintenance and rehabilitation expenses and the aggravated non-rentability of housing units.

Financial Risks

In the case of a variety of shareholdings and a complex shareholder structure, increased transparency and enhanced control are necessary to prevent negative effects on the business development of the Group. Additionally, there is an increased dependence on commercial and taxational parameters. Inadequate planning and controlling, as well as insufficient control over equity earnings could cause a drop in revenue.

The fundamental change of taxational parameters (deduction limitations, EK02) can lead to financial risks.

Part of the financial risks for Deutsche Wohnen can also be a delayed cash flow in revenue and lending, as well as incidentals that lead to liquidity problems. Moreover, fluctuations in the appraising of property (IAS 40) through the negative development of the residential property market and in derivatives can lead to annual corrections affecting net income.

In the case of a comprehensive tender of fund interests by limited partners of DB 14, Deutsche Wohnen would be burdened with an additional liquidity requirement in the amount of EUR 49.0 million. This liquidity would have to be provided through financing or additional disposals. In the past, the limited partners tendered between 2.0 % to 6.0 % of the entire interests per year. These risks are being met through continuous monitoring and liquidity planning.

The essential risks to the Group relating to the financial instruments consist of interest-induced risk to the cash flow, liquidity risks, and default risks. Management prepares and monitors guidelines for the risk management of each of these risks. Default risk, or the risk that a contractual partner does not meet his payment obligations, is controlled by using borrowing limits and control procedures. There is no significant default risk for Deutsche Wohnen in relation to any individual contractual partner or a group of similar contractual partners. The Group daily monitors the risk of a liquidity squeeze by employing a liquidity planning tool. Deutsche Wohnen aims to have sufficient liquidity to meet future obligations at all times. The risk of changes in interest rates to which the Group is exposed, is mainly due to non-current liabilities with variable interest rates, which is essentially hedged through interest derivatives.

Investment Risks

The selection and planning of large-scale restoration measures may lead to an incorrect allocation of investment resources. It is also possible that the purchase of additional units does not live up to the return expectations. This could have a negative influence on the business development of the corporation. Moreover, incomplete declarations in Due Diligence reports and analyses as well as non-transparent allocation decisions and the non-observance of allocation directives (for example by claiming public subsidies with repayment consequence) can result in risks.

Further risk factors that are directly related to investments by the Group are those where the planned costs are exceeded, where deadlines are not observed, or facility standards are undercut. This can create additional expenditure for the company. Delayed commissioning, rental shortfall (in some case reduced rent), or insufficient defect tracking can also lead to an increase in expenditure. To minimise these risks, Deutsche Wohnen uses external and internal specialists as well as continuous project controlling.

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