Is This The Time To Invest In REITs? Real Estate Investment Trust (REIT)

Real estate has always been one of the most popular investment options in India. This might be because of the tangible aspect. Although it is commonly referred to as a conventional investment, real estate remains a solid portfolio diversifier. Nonetheless, common wisdom holds that when interest rates increase, rate-sensitive sectors lose. And one such rate-sensitive sector is real estate. In August 2022, the Reserve Bank of India (RBI) increased the key policy rate (repo rate) by 50 basis points to 5.4 per cent. This was the third subsequent rate rise in a row.

However, recently, the Indian real estate market has grown remarkably, becoming a top alternative for investors. According to research, the real estate sector is predicted to rise from USD 200 billion in 2021 to a market value of USD 1 trillion by 2030, accounting for 13 per cent of India's GDP. Real estate investors have long felt that commercial real estate is a lucrative investment option because it provides a high return on investment (ROI) and extra income prospects.

With economic activity picking up and the bulk of the workforce returning to work, the demand for commercial real estate is skyrocketing. According to data, the commercial real estate industry in India is predicted to increase at a CAGR of almost 13 per cent between 2022 and 2027. Having said that, would this be an ideal time to invest in Real Estate Investment Trusts (REITs)? This article is an attempt to provide an answer. However, before we get started, let us first grasp the foundations of REITs and how they function.

Understanding REITs
When the economy is expanding and the government is putting more emphasis on infrastructure and real estate development, real estate investment trusts become very important to investors looking to obtain exposure to the real estate industry and benefit from their investments. A Real Estate Investment Trust, or REIT, is a corporation formed with the primary goal of channelling funds that might be invested in the operational functioning or ownership of real estate to generate additional income for investors.

How Does REIT Actually Work?
A REIT provides you a simple option to invest in real estate and works similarly to mutual funds. It offers the benefit of diversity as well as long-term wealth appreciation.

REITs, which are publicly traded on stock exchanges, are an excellent method to invest in the real estate market. The REIT business has a wide profile that allows investors to participate in real estate-related products. REITs may be divided into two types: equity REITs and mortgage REITs. Equity REITs own facilities such as offices, hotels, retail malls and condominiums generating majority of their earnings through rent.

Mortgage REITs oversee the financing of residential or commercial buildings, generating revenue from the interest received on mortgages or mortgage-backed securities (MBS) investment. REITs provide for the rapid and easy disposal of real estate assets. The country's economic narrative is dependent on infrastructure development, which contributes significantly to the economy and associated growth.

The goal behind REIT-backed investments is to assure that the real estate finance business is concretely structured so that investments in the sector are channelled for maximum growth. According to the fundamental principles of REITs, there may be grounds for investors to analyse these players in the present environment. For investors it provides a tax-efficient alternative to hold a portfolio of income-generating real estate assets, mostly office premises. Dividends (90 per cent of distributable cash flows must be paid out) and capital appreciation are the two types of returns.

As shown in the graph above, REITs appear to be trailing behind Nifty 50 index. However, it is important to understand that we have not accounted for any dividends received from REITs. On a year-to-date (YTD) basis, these three REITs have returned between 3 per cent and 15 per cent in terms of capital appreciation. Furthermore, Nifty 50 has returned 1.5 per cent during the same timeframe.

Mindspace Business Parks (July 2020) has returned 11.6 per cent, Brookfield India Real Estate Trust (February 2021) has returned 20.45 per cent, and Embassy Office Parks has returned 2.13 per cent since inception. The disparity in returns between Embassy and the other two is attributable to their inception. Embassy was incepted before the pandemic but the other two were launched in the post-pandemic era. REIT owners receive dividends in addition to capital appreciation. On a year-to-date basis, the distribution per unit or dividend yield was roughly 4 per cent to 5 per cent. Mindspace had the lowest dividend yield of 3.7 per cent, followed by Embassy with a dividend yield of 4.4 per cent, and Brookfield with a dividend yield of roughly 4.6 per cent.

REITs would be able to offer a steady or increasing dividend if they hold little debt or have low cost of debt that was locked in at a rate lower than the rental yield. According to SEBI regulations, at least 80 per cent of REIT assets must be operational and generating revenue. This reduces investors' cost and execution risks. Furthermore, as it is publicly traded, companies may benefit from cheaper financing costs or be able to acquire equity to expand by purchasing new assets.

Performance
Investors might take solace in the fact that all three listed REITs have performed well on key criteria. The essential measures in the most recent June quarter are occupancy, weighted average lease expiry (WALE) period, revenue, and margin. Moreover, evaluating their loan to value and average borrowing cost also proves to be helpful.

Embassy Office Parks
The portfolio of Embassy Office Parks includes a 100 Mega Watt (MW) solar park, 1,614 hotel keys (including under construction), and 12 commercial offices. The occupancy rate remained stable at 87 per cent, and the cost of debt remained at 6.9 per cent (64 per cent of its borrowings locked in). During Q1 FY23, Embassy Office Parks increased lease rents by 15 per cent on an average. Further, it anticipates a 14 per cent increase in rent this year, owing to the existing rent being 22 per cent lower than the market rate.

The revenue of the Embassy Office Parks increased by 12 per cent year on year to ₹829 crore. However, due to the running costs of Hilton hotels and new expansions, margins declined and distribution cash flow declined 5 per cent. Having said that, its WALE is strong at 6.9 years, with only 4 per cent of its area up for renewal in FY23 and FY24. In terms of diversification, Bengaluru accounts for 74 per cent of total asset value, while the top 10 tenants provide 39 per cent of rentals. It also has the ability to expand its portfolio through building completion and property asset rights. With net debt at 27 per cent of capital, it has some leverage potential.

Mindspace Business Parks
In June 2022, Mindspace REIT maintained a consistent occupancy rate of around 82 per cent. Revenue increased 4.5 per cent year on year to ₹491 crore; however, net operating income increased just 0.5 per cent owing to rising costs. With its top 10 tenants accounting for 36.3 per cent of rental income, its office space portfolio is located throughout Mumbai, Pune, Hyderabad and Chennai. In the next three years, just 4 per cent to 5 per cent of its portfolio will expire, and its WALE is now 6.9 years. As of June 2022, the cost of debt is 6.9 per cent, an increase over the previous quarter's cost of 6.6 per cent. The fixed costs of its debt (including NCDs raised in June 2022 and July 2022) only make up 41 per cent. It has a modest leverage of 16.6 per cent.

Brookfield India Real Estate Trust
Brookfield India REIT experienced a rise in operational lease revenue of more than 9 per cent and practically flat net income. Between March 2022 and June 2022, the average period of new leases climbed from 8.4 years to 11.3 years. In the next two years, around 31 per cent of rents will expire. The loan-to-value ratio is 31 per cent, with borrowing flexibility. Its debt cost was 7.16 per cent. In June 2022, occupancy was consistent at 83 per cent, with a WALE of roughly seven years.

Its portfolio is split between the NCR (Gurugram and Noida), Mumbai, and Kolkata, with the NCR accounting for 67 per cent of the asset value overall. Additionally, there is a high level of income concentration, with the top five clients contributing for 51 per cent of the space that is rented. However, the company anticipates that with additional assets in the pipeline, this will fall to 39 per cent. Rights to new assets can also assist enhance operational income by 25 per cent over the following three years.

Which REITs Should you Invest In?
These three accessible REITs are relatively comparable on all essential measures. If location is important to you, Embassy Office Parks and Brookfield India Real Estate Trust are strong choices. However, you must ensure that you understand the degree of exposure to the area you are monitoring. If you want a well-diversified portfolio across the region, Mindspace Business Parks is the way to go. Likewise, if you prefer REITs with a high concentration of tenants, choose Embassy Office Parks or Mindspace Business Parks over Brookfield India Real Estate Trust.

Embassy Office Parks and Mindspace Business Parks are suitable for conservative investors. This is because the prognosis for leases is more stable. Furthermore, Mindspace Business Parks' balancesheet is excellent, with leverage potential. However, if growth and wealth appreciation is what you are seeking, Brookfield India Real Estate Trust has the most potential, followed by Mindspace Business Parks.

Conclusion
The reasons fuelling the need for office spaces in India include flexibility, comfort, and convenience. The majority of businesses in sectors such as IT, manufacturing, BFSI, start-ups, and even boutique enterprises are searching for office space to meet the demands of their employees. Furthermore, many businesses are intending to establish remote or satellite offices or expand to other areas, which would enhance demand for these spaces. Today's high-end, organised, and modern office spaces are fully equipped with all of the elements needed to give a superior work experience while also addressing health and wellness concerns.

For efficient corporate operations and great returns in the future, the decision-makers are investing in them. Because of increased awareness and the need to combat pollution and climate change, commercial real estate is seeing a surge in eco-friendly development. The emphasis for a sustainable future has turned to eco-friendly infrastructure construction, the usage of energy-efficient systems, renewable energy sources, rainfall and waste water management, greenery, and improved legislation.

To lower carbon footprints, real estate developers are placing a heavy focus on LEED, IGBC, GRIHA, and BEE certifications in construction. In the short term, back to work is expected to increase, resulting in an increase in demand for easily available supplies. Furthermore, due to vaccination coverage, a brighter corporate outlook, and pent-up demand, the industry is experiencing rapid rise in market enquiries. Demand is expected to revive considerably in the medium term due to improved corporate sentiment, greater outsourcing, and robust hiring.

As a result, demand will be driven by technology, global captives, flex, and new growth occupiers. As a result, REITs may be a suitable defensive asset class for investors seeking a consistent income during periods of volatility. While these will not provide extraordinary returns in terms of capital appreciation, they will minimise the downside risk, improving portfolio diversification.