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On the cusp of a rebound

The Embassy Office Parks REIT (Embassy REIT) delivered a resilient Q2FY22 performance with rental collections of over 99% (similar to FY21) and portfolio occupancy remaining flat QoQ at 88.5%. While possible fresh tenant exits of 0.9msf in H2FY22 remain a near-term dampener, with the REIT manager indicating a near-term leasing pipeline of 0.5msf and RFPs of 14.5msf in the Bengaluru office market, we maintain our view of a full recovery of occupancies to pre-Covid levels in FY23E. We believe that the REIT’s low leverage (net debt/TEV of 0.24x) and marquee tenant profile will enable the REIT to deliver 18% NOI CAGR over FY21- 24E. We retain our BUY rating with an unchanged target price of Rs415/unit based on Mar’22 NAV. With the REIT manager having successfully refinanced existing zero-coupon bonds of Rs45bn to coupon bearing bonds from Nov’21, this will result in optically lower REIT NDCF distribution of Rs1.5/unit in FY22E and Rs3.3/unit each in FY23E and FY24E. Key risks are a slower recovery in office leasing and higher portfolio vacancy levels.

* Expiries a near-term concern, expect recovery from H2FY22: The REIT had total lease expiries of 1.9msf in FY22E of which 0.4msf has been renewed in H1FY22. Of the balance 1.4msf of estimated expiries in FY22E, 0.5msf of exits have happened in H1FY22 and the REIT manager maintains its guidance for balance exits of 0.9msf in FY22E. However, with a near-term fresh leasing pipeline discussion of 0.5msf (over 80% in Bengaluru) and RFPs of 14.5msf in the Bengaluru office market, we estimate that with the increased pace of Covid vaccination, employees gradually returning to offices and pick up in international travel, leasing activity should pick up meaningfully going ahead and we building a full recovery in the REIT’s office portfolio to pre-Covid levels in FY23E.

* Flat FY22 NDCF guidance by REIT manager in line with estimates: Factoring in the second Covid wave impact, the REIT manager has given a mid-range REIT NDCF/unit guidance of Rs21.5/unit in FY22E (same as FY21) factoring in likely incremental tenant exits of 0.9msf in the remainder of FY22E and a 5% same-store YoY NOI decline ex-ETV asset. We currently estimate FY22E SPV to REIT NDCF of Rs24.6bn and REIT NDCF of Rs20.3bn or Rs21.4/unit (final payout to unitholders).

* Conversion of ZCBs to coupon bearing debt to optically impact yields: The REIT had issued zero-coupon bonds (ZCBs) of Rs36.5bn in May’19 at an annual coupon of 9.3%. While these ZCBs were due for maturity in Jun’22, the REIT manager has successfully refinanced these ZCBs as coupon bearing NCDs at an annual coupon of 6.5% on the amortised cost of Rs45bn. The conversion of the ZCBs to coupon bearing bonds will result in lower REIT NDCF distribution of Rs1.4bn in FY22E (Rs1.5/unit) and Rs3.2bn each in FY23E and FY24E (Rs3.3/unit).

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