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On 28th Mar’23, the Board of Directors of Embassy Office Parks REIT (Embassy REIT) has approved the acquisition of an under-development Sponsor asset in North Bengaluru of 1.4msf for an EV of Rs3.3bn (proposed acquisition cost is at a 4.5% discount to average valuation of two independent valuers). The acquisition is proposed to be funded through debt costing 8.1% p.a. by Apr’23 with rentals from Phase 1 of 0.4msf to commence from H2FY24 while balance 1.0msf in Phase 2 is expected to be delivered over FY27/28E (construction at an initial stage). As perour estimates, the acquisition is value neutral assuming rent commencement from Phase 1 from Apr’24 (Q1FY25) at rentals of ~Rs65/psf/month and Phase 2 from Apr’27 (Q1FY28) and we derive an EV of Rs3.1bn at an 8% cap rate for the acquisition which is value neutral (adjusted for FY24E interest cost). We retain our BUY rating with an unchanged Mar’23 NAV based target price of Rs425/unit assuming completion of Business Hub asset acquisition in FY24E. We retain our FY23/24/25E distribution/unit estimates of Rs21.6/22.7/24.4 unit, respectively. Any positive outcome on reversal of proposed taxation of debt repayment portion of NDCF introduced in FY23 Union Budget remains a key monitorable. Key risks are slow recovery in leasing and higher vacancy levels.

* Value neutral acquisition: The Board of Directors of Embassy REIT has approved the acquisition of a Sponsor Asset named “Embassy Business Hub” in North Bengaluru, India for a consideration value of Rs3.3bn. The asset comprises two land parcels totalling 2.1msf of which the Sponsor currently has 1.4msf as its proportionate area share and the REIT is acquiring this 1.4msf area. Of the 1.4msf, 0.4msf (Phase 1) is expected to be completed by Oct’23 (93% pre-leased to Philips India Ltd.) while the balance 1.0msf (Phase 2) is expected to be completed in phases starting from Sep’26. We assume rent commencement from Phase 1 from Apr’24 (Q1FY25) and Phase 2 from Apr’27 (Q1FY28) and derive an EV of Rs3.1bn at an 8% cap rate for the acquisition which is value neutral (adjusted for FY24E interest cost).

* Taxation of debt repayment/capital return portion of NDCF a key monitorable: The FY23 Union Budget carried a proposal to make the debt repayment/capital return portion of listed Business Trusts (including REITs) taxable from FY24. Currently, ~40% of NDCF distribution profile for Embassy REIT comes from debt repayment which would have become taxable from FY24 vs. being tax free up to Mar’23. However, as per various media sources, there may be some relaxation in the final version of the Budget proposal, with debt repayment not being taxed upfront upon distribution to a unitholder but may be adjusted against cost of acquisition to compute capital gains tax upon selling the unit. We await final clarity on the same pending an official notification from the Finance Ministry of the Government of India.

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