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Standing tall in tough times

The Embassy Office Parks REIT (Embassy REIT) delivered a resilient performance in FY21 in a Covid impacted year with a NOI growth of 12% and NDCF distribution of Rs21.5/unit. In spite of COVID-19 headwinds which led to FY21 occupancies declining by 300-500bps in key assets, the REIT achieved 99% collection efficiency in office rentals and achieved contracted rental increases of 13% on 8.4msf of area in FY21. Owing to the second Covid wave in India, the Embassy REIT manager expects muted leasing activity for another 2-3 quarters with a possible revival in H2FY22E, which is in line with our sector view. We believe that the REIT’s low leverage (net debt/TEV of 0.25x), marquee tenant profile and de-densification of offices will enable the REIT to deliver 18% NOI CAGR over FY21-24E. We retain our BUY rating with a revised target price of Rs415/unit (earlier Rs391) as we roll forward to Mar’22 NAV. At CMP of Rs357, the Embassy REIT offers an estimated distribution yield of 6.2% in FY22E, 6.9% in FY23E and 7.5% in FY24E. Key risks to our call are a slower recovery in office leasing and higher portfolio vacancy levels.

FY22E expiries a near-term concern, expect recovery from Q3FY22:

The REIT has additional lease expiries of 1.9msf in FY22E of which 0.5msf is likely to be renewed with the balance 1.4msf at risk of remaining vacant until leasing activity recovers. While this may lead to a further dip of 200-300bps in portfolio occupancy in H1FY22, with increased pace of vaccinations and possible return to office by Sep’21 for many occupiers, leasing activity may see an uptick from Q3FY22 with a strong recovery estimated in FY23E. The REIT has deliveries of just 1.1msf in FY22E, all of which is in the ETV, Bengaluru asset and is fully pre-leased to JP Morgan.

Embassy REIT portfolio cushions the COVID-19 impact:

While incremental leasing is yet to pick up until international travel resumes and existing assets seeing tenant exits, the REIT’s current tenant portfolio which has ~43% of tenants in the technology domain with even smaller verticals such as financial services and research/consulting consisting of Global in-house captives is resilient to near-term weakness, in our view. Currently, the REIT’s top ten occupiers contribute ~39% of the gross overall rental income as of Mar’21.

Potentially higher tax-free share in distribution from FY22E:

Of the Rs21.5/unit distribution for FY21, 14% was in the form of dividend, 52% in the form of amortization of SPV level debt and 34% in the form of interest. With the collapsing of Manyata shareholding structure to a 2-tier structure from Q1FY22 and injection of Embassy Tech Village asset at the end of Q3FY21, we expect the overall share of tax-free dividends plus SPV debt amortization to range between 70-75% from FY22E onwards similar to the 78% tax-free returns achieved in Q4FY21. We estimate distribution yield of 6.2% in FY22E, 6.9% in FY23E and 7.5% in FY24E at CMP of Rs357/unit.

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