Considering that there are several components of cost and revenue, which are assumed, the reliability of the product becomes tricky at least from the retail investor's point of view
A listed Real Estate Investment Trust (REIT) is completely different from listed equity. They are differently structured products meant for the conservative investors looking to generate returns slightly better than a pure debt instrument without compromising on consistency, predictability and protection of capital.
Embassy Office Parks REIT has come out with India’s first REIT to be listed on the exchanges. Owned and sponsored by Bengaluru-based Embassy group and private equity player Blackstone, the listed REIT would comprise a portfolio of seven office parks and four city centre buildings catering to office space. It has office space of 32.6 million square feet comprising of 74 buildings located in prime cities such as Bengaluru, Pune, Mumbai and Noida.
About 95 percent of this office space is already occupied by the tenants including 43.4 percent of them being Fortune 500 companies. The trust collects rentals from the tenants and this forms a bulk of its revenue.
If one invests in the REIT, investors will be allotted units thus they indirectly become part owner of these real estate assets. After deducting the direct expenses, management fees and taxes, the REIT would distribute 100 percent of the income generated from these properties to the unit holders; 50 percent in the form of dividends and 50 percent in the form of interest.
The issue and pricing
The trust is raising Rs 4,750 crore through the REIT from the new unit holders. Good thing is that the sponsors or the promoters are not selling their part and they will continue to hold 70 percent in the assets as unit holders and sponsors of these assets.
The issuers of the units have fixed the unit price at Rs 299-300 a share, which is at 20 percent discount to the net asset value (NAV) of about Rs 375 a share.
Independent valuers have calculated the NAV based on the discounted cash flows for a period of 10 years. This exercise will be repeated on a quarterly basis and the company will declare NAV as a guiding value.
Globally, REITs trade at a slight discount to NAV depending on the markets. At the offered price of 299-300, the yield works out to 8.5 percent on an annualised basis or 6.9 percent post tax, in the hand of receivers.
Increase in rentals, improvement in utilisation, under construction properties, other incomes like hotels and growth through acquisition of new assets are the drivers that investors could look forward to.
While the product prima facie may look at par with any other debt instrument, the real charm of this product is embedded growth in the NAV and yet providing sufficient safety for the conservative investors.
To illustrate the point, properties are leased on a rolling basis. But on a weighted average basis the lease expiry period comes to around 7 years. Because of the long expiry, the rentals in the respective market sometime often shoot up beyond the agreed rentals.
Currently, the company estimates that market rentals of its properties (on a mark to market basis) are high by about 33.6 percent. And 29.3 percent of the company’s area is expiring during the fiscal year 2019-23. This essentially means these rental renewals could have positive impact on cash flows and thus NAV.
The other important lever for growth is increasing utilisation. To put in perspective, there is still more room for occupancy ratio to go up. Secondly, today 89 percent of these assets are completed whereas 11 percent of them are in the development pipeline. Once they are ready, they will bring in cash flows.
Thirdly, it is trying to sweat its assets to get a second source of income. It has built two hotels and already making money from solar and other resources. Scope for such incomes would be in addition to the organic growth in rentals in these growing markets.
Deleveraging to add value
The managers would use close to Rs 3,700 crore of the IPO proceeds for retiring debt. Post this repayment, the debt to market value of assets would fall to 15 percent. This is quite conservative, considering that globally REITs are seen to have this ratio in the range of 30-35 percent. This is even much below the regulatory limit of 49 percent.
Our interaction with the management suggests that by way of repaying some of its debt, the company is keeping the capital ready to borrow in the future for growth. The good part of this strategy is the company is raising funds at 8.25-8.5 percent from the subscribers, whereas the deployment of the funds would take place in the region of 18-20 percent based on expected internal rate of return.
Effectively, favourable change in capital allocation towards remunerative properties would help in propping up the future cash flows.
To sum it up, Embassy Office REIT certainly seems to be better option than a pure debt instrument. It not only comes with reasonable safety but also offers growth as there are good enough avenues to add to the total returns in the hands of the unitholders.
The risk here is complexity of the product and structure. Its valuations are based on many futuristic assumptions, which may or may not be known at this stage. The NAV is based on the estimated future cash flows. Considering that there are several components of cost and revenue, which are assumed, the reliability of the product becomes tricky at least from the retail investor's point of view.Moneycontrol Research Page.