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What’s in store for India’s first commercial REIT as it hit the market with Blackstone teaming up with Embassy Group


  • Overview of the partnership and assets of Embassy Office Parks
  • Comparison of the Indian commercial office market space with other developed markets
  • Road ahead for India’s REITs market

 

The much-awaited Real Estate Investment Trust (REIT) for India’s maiden commercial REIT is set to make its official debut. Embassy Office Parks, a joint venture of Embassy Group and the US private equity firm Blackstone Group is all set to file with the Securities and Exchange Board of India (SEBI). The company proposes to raise over Rs.5,000 crore through its REIT issue. This development comes years after the rules were notified by the government, the initial notification from the SEBI was in September 2014.

The proposition for the REIT from Embassy Office Parks comes with a portfolio, which includes over 74 buildings across seven best-in-class office parks and four prime city-centre office buildings in Mumbai, Bengaluru, Pune and National Capital Region. Additionally, Blackstone will also include its own commercial assets such as the Express Tower at Nariman Point and 247 Park at Vikhroli in Mumbai. The proposition is expected to list a total of 33 million sq. ft. under the REIT, of which 24 million sq. ft. has been completed and has an occupancy rate of 95%. Moreover, as of March 31, 2018, about 81.4% of the gross rentals are from the company’s 160 marquee tenants and about 43.8% of the tenants include Fortune 500 companies such as Mercedes, JP Morgan Chase, Microsoft Corporation, Cisco Systems, IBM, Wells Fargo and Alphabet (Google).

Morgan Stanley, Kotak Mahindra, JP Morgan, Merrill Lynch and Karvy are leading the offering. Axis Capital, Credit Suisse, Deutsche Bank, Goldman Sachs, HSBC, IIFL, JM Financial and Nomura are also working on the deal.

The Indian office real estate market space has changed significantly since the early 2000s, with Grade A office stock area growing more than 20 times from approximately 25 million sq. ft. (in 2000) to approximately 548 million sq. ft. as of March 2018. The reason for this growth can be attributed to various factors such as the robust growth of the Indian economy, investor-friendly policies and increased transparency. This stock in India is concentrated in the top cities of the country, with Delhi/National Capital Region, Mumbai, Bengaluru and Pune leading the pack. The stocks in these cities stand at 98.26 million sq. ft., 113.35 million sq. ft., 138.60 million sq. ft. and 46.86 million sq. ft., respectively. This is much higher as compared to other major cities in Asia such as Shanghai, Hong Kong and Singapore, which have a total stock of approximately 101.44 million sq. ft., 77.85 million sq. ft. and 56 million sq. ft., respectively.

India’s first REIT has a very promising future if we look at it from its current state of business operations. Embassy’s REIT portfolio has a healthy occupancy rate of 95% as of March 31, 2018. The vacancy of 5% is primarily concentrated in Embassy TechZone in Pune, Embassy One in Bengaluru and Embassy 247 and FIFC in Mumbai with the vacancy of 23.6%, 20.6%, 18% and 17%, respectively. Further, these vacancies are due to valid reasons such as construction completion, ongoing repositioning and strategic upgrades. But, notably, these properties are those that have good prospects and are expected to be leased in the next year or so resulting in additional rental revenue of Rs.2,086 million over the next three years. It is due to the long-term nature of the company’s existing leases that it is well positioned to achieve further organic growth through a combination of re-leasing to existing tenants at market rents of its properties, which the company believes is 34.5% above in-place rents.

Although Embassy Park’s properties are at par with the global best both in the terms of the infrastructure and the quality of tenants, the valuations as assessed by CBRE states that Embassy’s assets per square foot value are much lower than that of Grade A properties in New York, Tokyo and Hong Kong. These countries command valuation which stands close to $150 per square foot, implying 82.9% to 95.2% higher rentals than that of Embassy’s properties. But the capitalisation rates for such properties in India stand at a much higher premium rate at 7.5% to 8.5% for assets of similar quality and tenant profile than that of countries like the United States, Japan and China (as detailed in the below chart).

Historically, REITs at a global level have delivered very competitive returns (8% to 10% per annum) and their comparatively low correlation with other assets makes them help an investor to diversify its portfolio and reduce risks and increase returns. In addition, the best advantage that is offered by REITs is its liquidity, which is otherwise unavailable in real estate investments. Hence, with transparency being a key feature for REITs as they are heavily monitored and with Embassy’s Office Park’s impressive background, it has sparked a lot interest from investors, who are hoping that it will be worth the bet, especially based on the fact that India is one of the highly sought-after service hubs by global corporations. Furthermore, considering this will be the first listing of a REIT in India, it will be an important day for Indian institutional real estate. The data from Anarock suggests that currently, about 50% of the office space stock in India can qualify for REITs, an improvement of over 30%, two years ago, which is a good indicator for the growth prospects of a market that is still maturing. A clear indicator that the market is gearing itself for the launch of REITs by developing institutionally investable commercial assets. Yes, looking into the Indian real estate sector, it is the residential space that is in the greatest need for institutional funding and not commercial or office space. But the lack of defined rental policy and a logical tax regime with a single point of taxation makes it impossible for the residential space to be currently included in the REIT space of India. According to India and South East Asia’s Chairman for CBRE, ‘REITs are a historical event for India’s real estate sector. It shows the maturity of the Indian real estate market as only mature economies have a REIT structure in place. It will show that we too can transact as per international standards.’ Another Indian REIT to look forward in the near future is IIFL Real Estate Ltd., which is planning to list its commercial assets under the REIT.

*As of March 20, 2019, the REIT issue by Embassy Office Parks REIT got subscribed 2.57 times as per data from the National Stock Exchange.

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