Reits are rebounding; keep an eye on lease renewals, though

Reits so far were bogged down by the covid-induced drop in demand for office spaces, which hit rentals and resulted in premature terminations of lease agreements.

“Indian Reits saw strong rental collections of over 99% in H1FY22 and were able to achieve healthy re-leasing spreads along with contractual escalations. Further, overall portfolio vacancy levels have remained stable in Q2FY22 as tenant exits have been balanced by fresh/new leasing," analysts at ICICI Securities Ltd said in a report on 17 November. That said, expiries of lease agreements in the fiscal’s second half, which have a bearing on their cash flows and distribution yields, will be a key monitorable for investors in these stocks.

A look at the September quarter performance of Mindspace Reit shows that its blended occupancy improved marginally on a sequential basis. It did a gross leasing of 0.9 million square feet (msf) for Q2FY22; of this, 0.4 msf was re-leased, while 0.5 msf covered new leasing. Of the total 1.6 msf expiry for H1FY22, the company has re-leased 0.8 msf, and has vacant/new leasing of another 0.8 msf. For H2FY22, of the 0.9 msf of expiries, the firm’s management is hopeful of being able to re-lease/renew around 0.4 msf, while 0.5 msf area is expected to be vacated.

In H1FY22, of the 0.8 msf of scheduled expiries, peer Brookfield India Reit has renewed 0.2 msf of area, while the balance 0.6 msf saw tenant exits. This led to a decline of 600 basis points in its same-store portfolio occupancy to 85% in the September quarter. One basis point is one-hundredth of a percentage point. For H2FY22, Brookfield Reit has scheduled expiries of 0.6 msf, of which the management expects to renew 50% of the expiry. The company’s management has pointed out a leasing pipeline opportunity of 3.2 msf across its portfolio markets and it expects to see strong leasing traction heading into H1FY23.

In the case of Embassy Office Parks Reit, occupancy level stood at 89% in Q2FY22, in line with Q1FY22 level, but lower than 92% a year ago. In FY22, it has total lease expiries of 1.9 msf, of which 0.4 msf was renewed in H1FY22 and exits up to Q2 total 0.5 msf. Of the balance, 0.9 msf may result in exits with a 64% mark-to-market potential, the company’s management said in a post-earnings conference call. The management also pointed out about a near-term fresh leasing pipeline discussion of 0.5 msf and RFPs of 14.5 msf in the Bengaluru office market.

Meanwhile, property consultant CBRE’s recent publication, India Market Monitor Q3 2021, highlighted that office supply stock touched nearly 13.5 msf in the September quarter, growing by about 30% sequentially. Leasing activity grew 140% sequentially during the quarter to touch 13.5 msf.

“The demand for office space was driven by tech occupiers (35%), followed by engineering & manufacturing companies (14%) and flexible space operators (13%). Rental values remained largely stable across cities with the exception of a marginal dip in Hyderabad. Looking ahead, as mobility improves and a comeback to the physical office environment picks up, overall absorption is expected to grow compared to 2020," said Anshuman Magazine, chairman, India & South-East Asia, Middle East & Africa, CBRE.

Sharing this optimism, Viral Desai, executive director - transactions, Knight Frank India, said, “Office rentals have faced marginal corrections due to the pandemic. But due to the extremely tight supply, the rentals for Grade A office spaces are expected to remain stable or can marginally increase in the next six months."

That said, there is a downside risk for investors in Reits. “We estimate the three Reits (Embassy/Mindspace/Brookfield) to offer distribution yields of 6-8% over FY22-24E along with 5-13% capital appreciation," added the ICICI Securities report.

While the return of people to workplaces bodes well for Reits, the trend in renewals and re-leasing would determine how fast they will rebound. Ergo, analysts believe shares of these Reits are unlikely to rally quickly.