Why Embassy Office Parks’ REIT offering is expected to get lapped up

The timing could not have been better. Embassy Office Parks’ REIT (real estate investment trust) initial public offering comes at a time when the commercial office space segment is upbeat. Office rentals are rising, supply is restricted and vacancies are at all-time lows. The issue opens on Monday.

But the pertinent question for an investor is: will the good times in this segment continue and will investors get a steady return on investment?

First up, let’s look at the reasons why the issue could garner support. One, the REIT offering is a joint venture of two well-known companies, realty developer Embassy Group and US-based private equity firm Blackstone Group.

Two, analysts say the price band of ₹299-300 a unit is reasonable. According to Motilal Oswal Financial Services Ltd, “Launched at a 20% discount to the net asset value, it offers an 8.25% yield to be distributed as dividend and interest in a 50:50 ratio.”

Three, the assets have a 95% occupancy rate for its office space in Bengaluru, Chennai, Pune and Noida that are prime centres of business activity.

Returns on REITs accrue from yield as well as appreciation in the unit price. According to Shobhit Agarwal, managing director and CEO of ANAROCK CAPITAL , “In Canada, average return on REITs was 10% in 2017, while in the UK, it was between 8-10% from a commercial and residential asset mix.” In India, he said, it could be higher. Note that commercial realty has withstood the challenges faced by the industry, and has fared much better than the residential segment.

But, then, returns hinge on continuation of the upswing. During an upturn, lease rentals increase and so does demand for REIT units, which in turn leads to an increase in the price per unit.

The Bengaluru region, which makes up nearly two-thirds of the total Embassy REIT assets, is among the better performing regions. However, there is pressure in some segments of Noida and Pune due to excess supply in some pockets.

Supply of A-grade office space holds the key to sustainable investor returns.

This apart, revenue of REIT companies might contract due to pre-term lease cancellations or a drop in market rents. In large office complexes, though, property management expenses may not shrink in line with decrease in revenue, which would upset cash flows. This again may affect cash flows and dampen investor returns, which then can reflect on the unit price.

That said, the Embassy-Blackstone REIT is on good ground. Leasing income is estimated to rise from ₹1,800 crore in FY19 to ₹2,500 crore in FY21, according to Motilal Oswal. This is driven by embedded organic growth, leasing of vacant spaces, on-campus development, acquisitions and the right-of-first offer with the sponsors. The right-of-first offer refers to property that the sponsors might want to offer for sale in the market.

Given that REIT returns over a three- to five-year period are estimated to surpass those from debt funds and fixed deposits, there should be adequate demand for the issue. Indeed, the Embassy Office Parks REIT raised ₹1,743 crore by allotting units to anchor investors on Friday. Of course, compared to fixed deposits, investors need to be willing to take slightly more risks as well.