REIT Analysis: Embassy Office Parks

After a lot of delays, India will finally get its first Real estate investment trusts (REIT) listed on its bourses. The initial public offering (IPO) of Embassy Office Parks REIT (Embassy REIT) will open on March 18 and closes on March 20, 2019. The price band has been fixed at Rs. 299-300. Through this issue, the company proposes to raise Rs. 4,750 crore. The minimum bid size is 800 units and then in multiples of 400 units. The company will offer 15.83 crore units. If minimum bid size is 800 units you will have to shell out at least Rs. 2,40,000 if you want to apply for this maiden REIT IPO. The money so raised will be used for partial or full repayment of debts, acquisition of the Embassy One Assets currently held by Embassy One Developers Private Limited. The units are proposed to be listed on the National Stock Exchange and BSE. This will constitute at least 10 per cent of the issued and paid-up units on a post-issue basis.

What are REITs?

Real estate investment trusts (REITs) is an investment vehicle that owns or finance income-producing real estate in a range of property sectors. These companies have to meet a number of requirements to qualify as REITs. Most of these REITs trade on major stock exchanges.

About the company

The Embassy REIT was settled on March 30, 2017 as an irrevocable trust under the provisions of the Indian Trusts Act, 1882. The Embassy REIT was registered with SEBI on August 3, 2017 as a real estate investment trust. As of now, the Embassy Sponsor and the Blackstone Sponsor are the sponsors of the Embassy REIT. They have placed 33 million square feet of office and hospitality assets under its proposed REIT, which comprises seven business parks and four city-centric buildings spread across Mumbai, Bengaluru, Pune and Noida.

Of the 33 million sqft, about 24 million sqft is operational with 95 per cent occupancy, yielding a rental income of over Rs. 2,000 crore annually. Another 3 million sqft area is under construction and 6 million sqft is in the pipeline.

There are certain investment conditions applicable to the Embassy REIT under the REIT Regulations and is required to ensure following investment conditions under Regulation 18 of the REIT Regulations:

• Invest not less than 80 per cent of the value of its assets in completed and rent and/ or income generating properties;

• Not more than 20 per cent of the value of its assets may only be invested in certain permitted forms of investments (whether directly or through a company or LLP) which include, among other things, under construction properties, completed but not rent-generating properties, listed or unlisted debt of companies or body corporates in the real estate sector and specified securities, etc.

• For projects implemented in stages, the portion of the project (including any land which is contiguous and an extension) that is not completed and rent or income generating is required to be counted as an under construction property;

• Not less than 51 per cent of the consolidated revenues of the Embassy REIT, and the Asset SPVs, other than gains arising from the disposal of properties, must at all times arise from rental, leasing real estate assets or other income incidental to the leasing of such assets.

India is an attractive office real estate market with 7.5 – 8.5 per cent operating income yields, which are at a 175-575 bps spread to Grade A office assets in other Global cities. Rents across the top 7 Indian cities have grown at an approximately 4.9 per cent CAGR as of March 31, 2018. Strong absorption, moderating supply and declining vacancy are amongst the key drivers for this healthy, consistent rental growth.

The Embassy REIT portfolio is located in four gateway cities of India (Bengaluru, MMR, Delhi NCR and Pune) which include the country’s financial centre, technology hubs and political capital. These markets represent 77 per cent of India’s office absorption from 2013 to Q1 2018.

Embassy REIT’s markets have grown at a 4.2 per cent CAGR since 2013 with Bengaluru and Delhi NCR representing double-digit rent growth over the same period. Portfolio occupancy for their assets has remained above 92.8 per cent at the end of each of the last five fiscal years. As at March 31, 2018, committed occupancy for our portfolio is 95.0 per cent as compared to 85.6 per cent for the markets where we have a presence (higher by 940 bps)

The table below highlights the key statistics for these sub-markets:

 Key Portfolio Information—Commercial Offices

Financials and recommendation

The Embassy REIT reported a compounded annual growth rate (CAGR) of 6 per cent and 66 per cent in its topline and bottomline respectively in the period between FY16 and FY18. Even in the latest nine-month ending December 2018, the company reported profit growth of 34% on a yearly basis. Nevertheless, the correct way to analyse RIET is assessing the growth in net distributable cash flow (NDCF). In the same period (FY16-18), the growth in NDCF is 8.2 per cent.

Annualising the latest nine-month cash flow (net profit + depreciation), which we assume as NDCF comes to around Rs. 738.37 crore. The Embassy REIT is issuing 15.83 crore of units at a rate of Rs. 300 every unit. NDCF for every unit comes to around Rs. 46.6. Applying unit price divided by NDCF as a proxy to PE ratio, it comes to around 6.4x. This looks attractive given increment in rentals of around 5 per cent annually and capital appreciation.

Therefore, we advise our readers to apply for the REIT. You can also use this to diversify your portfolio instead of directly investing in real estate.

*40 or lower – Avoid Investment, 41 to 45 – Risky, 46 to 50 – Invest with limited exposure, 51 to 55 – Investment recommended, 56 & above – Excellent Investment