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REITs: Office reopenings: The rubber hits the road

Indian REITs have seen strong rental collections of over 99% over FY21-9MFY22 and have been able to achieve healthy re-leasing spreads along with contractual escalations in spite of Covid disruptions delaying return to offices. The only dampener is that vacancy levels across REITs have cumulatively risen by 500- 900bps between Mar’20 to Dec’21 owing to tenant exits. While the Omicron surge has temporality delayed the recovery in office leasing by a quarter, we expect this trend to reverse from Q1FY23E (Apr’22 onwards) with the improved pace of vaccinations across India, select corporates recalling employees to offices and gradual pick-up in international travel. While the jury is out on the eventual outcome of the back to office plans of various corporates, broad consensus is that 15-20% of employees may permanently Work from Office (WFO), 10-15% of employees may permanently Work from Home (WFH) while balance 60-70% of employees may work under a hybrid model of WFO with WFH. We expect the three listed REITs to offer distribution yields of 6-7% over FY23-24E along with 3-12% capital appreciation as per current I-Sec target prices. While a rise in global interest rates is the key risk, an acceleration in office leasing and cumulative potential returns of 10-17% provide adequate valuation cushion, in our view

* Leasing sees QoQ pickup in Q4CY21: As per Cushman and Wakefield, Grade A net absorption across India’s top seven cities increased to 8.5msf in Q4CY21 (up 2x QoQ) and is the highest quarterly absorption since Q1CY20. The absorption was driven by the infusion of new supply of 11.7msf of which a significant portion was pre-committed leading to higher absorption. RFPs/new enquiries also picked up pace and should fructify from Apr’22 onwards with the back-to-office plans of occupiers being delayed by a quarter owing to the surge of Omicron led Covid cases globally and in India.

* Recovery on the cards from CY22E: While the global surge in Omicron cases from Dec’21 onwards has temporality delayed the recovery in office leasing by a quarter, we expect this trend to reverse from Q2CY22E (Apr’22 onwards) with the improved pace of vaccinations across India, select corporates recalling employees to offices and gradual pick-up in international travel. While CY20 and CY21 were weak years with 20msf of net absorption each owing to Covid-19 impact, we expect net absorption to rise from Apr’22 onwards and we estimate net absorption of 26.8msf in CY22E and 30.0msf in CY23E.

* REITs offer attractive yields of 6-7% over FY23-24E: We have factored in a fall in occupancy levels of 200-300bps for the REITs in FY22E but expect the same to reverse by the end of Q4FY22E (Mar’22E) with a full-fledged recovery from FY23E. We expect the three REITs to offer distribution yields of 6-7% over FY23-24E along with 3-12% capital appreciation as per current I-Sec target prices. While a rise in global interest rates is the key risk, cumulative potential returns of 10-18% provide adequate valuation cushion, in our view.

* India’s long term advantages remain as a high-quality office hub: Our view is that the Indian office market retains many positives such as: 1) Limited number of 8-10 pan-India developers capable of building quality rental assets; 2) India remains one of the more affordable office markets in the world, with average rentals for Grade A office markets in peripheral/suburban micro-markets hovering around 1 USD/psf/month or Rs70-75/psf/month; 3) India leads in STEM (Science, Technology, Engineering, Mathematics) talent for technology assignments with over 2 million students graduating each year.

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