The stage is set for the launch of the first real estate investment trust (REIT) on Indian bourses. In its draft red herring prospectus (DRHP), Embassy Office Parks, a joint venture of real estate developer Embassy Group and US-based private equity giant Blackstone Group, has indicated plans to raise 5,000 crore through the REIT offer.

The moot question is: Will investors bite the bait after seeing a complete rout of real estate stocks?

Like mutual fund units, REITs offer returns through dividends distributed and the appreciation in the unit price. So, the world over and in mature markets such as the US, these instruments have offered an annual return of around 7-10%. Just as the performance of shares is linked to earnings, REIT returns hinge on the rental yields from commercial spaces and price appreciation of the units, depending on the trends in realty.

In this context, Embassy is hitting the markets when the real estate sector in India is emerging from murky deals and project delays to a transparent and accountable structure. Also, it boasts a portfolio comprising the commercial segment (seven office parks and four city-centre office buildings) that has fared better than the residential one where there’s still high inventory.

A report from CBRE Inc., a global commercial real estate services and investment firm, says vacancy levels in the top seven Indian cities have dropped from 23.1% in calendar year 2012 to 15% in 2018 (March) and are expected to fall further in 2019.

Embassy’s portfolio is on a strong foundation with 95% occupancy in FY18, about 93% over the last three years and about half the rentals accruing from Fortune 500 firms. Of course, while the 54.3% growth in rentals expected over the “projections period" in the DRHP may seem ambitious, it grew at a respectable 15.4% between FY16 and FY18. The assets have also seen a healthy growth in revenue and profit over the three years until FY18 along with the decline in finance costs. In other words, investors can gain on investments at current levels.

But there are risks too. Any change in the rental profile, be it tenants vacating the premises or rentals trending lower, will adversely affect returns. Further, in a buoyant equity market especially in emerging markets, it remains to be seen how the per-unit return from REITs will compare with equity mutual funds that give anywhere between 12-16% on an average in India. According to Shobhit Agarwal, managing director and CEO of Anarock Property Consultants Pvt. Ltd, “With REITs, the return on investment will be more structured, realistic and less risky." He adds that a 7-8% annual return may be a realistic expectation for those investors who are looking to diversify their portfolio beyond gold and equity markets.

Some analysts believe that with demand set to outstrip supply in regions linked to Embassy’s portfolio, returns may be 12-14% post-tax at least in the medium term. “A lot of institutional capital is chasing the limited investible Grade A office stock across top seven property markets," says Agarwal.

In the US, REITs have been in existence for several decades and when interest rates are very low, the average per year return hovers between 4% and 8%, with some unusually good years. In India, comparable instruments such as infrastructure investment trusts (InvITs) have failed to excite investors, with both the IRB InvIT and the India Grid Trust trading way below the offer price. The only difference is that in these InvITs, the assets are owned by the government, while in Embassy REITs, they are owned by the sponsor.

Still, being the first of its kind here, one needs to see how retail investors would react, given that the projected returns by analysts compare poorly with equity mutual funds and sovereign bonds. Some fund managers say that with interest rates set to rise in the country, the appetite for low-return instruments such as REITs may be less. Besides, it requires a minimum investment of 2 lakh per investor, which may keep a chunk of the retail investors away.

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