IGI Logo

REITs: Near-term weakness, attractive yields

Indian REITs saw strong rental collections of over 99% in FY21 and were able to achieve double digit re-leasing spreads along with contractual escalations. However, overall portfolio occupancy levels declined by 4-6% owing to continued Work-from-Home and second Covid wave leading to deferment of leasing decisions by occupiers.

Heading into FY22E, vacancy levels may rise further in H1FY22 but we expect this trend to reverse from H2FY22E assuming that vaccinations pick up accompanied by a gradual return to offices. Factoring in incremental vacancy levels rising by 2-3% in FY22E, we expect the three REITs (Embassy/Mindspace/Brookfield) to offer distribution yields of 7-9% over FY22-23E along with 13-18% capital appreciation as per current Isec target prices. While a rise in global interest rates is the key risk, cumulative potential returns of 20-25% provides adequate valuation cushion, in our view.

* Robust rental collections, FY22 expiries a near-term worry:

Indian REITs saw strong rental collections of over 99% in FY21 and were able to achieve double digit releasing spreads along with contractual escalations. A dampener was reduction in overall portfolio occupancy levels by 4-6% on like-to-like basis for Embassy and Mindspace REIT while Brookfield REIT retained flattish occupancy levels in H2FY21. This was owing to exits by tenants for scheduled expiries and early exits as well. Heading into FY22E, the second Covid wave may lead to further rise in vacancy levels in H1FY22. However, we expect this trend to reverse from H2FY22E assuming that vaccinations pick up accompanied by a gradual return to offices and possible pick up in international travel.

* Distribution mix of REITs to improve from FY22 onwards:

While the Mindspace REIT is already distributing over 90% of returns in the form of tax-free dividends, the Embassy and Brookfield REITs have also announced measures to improve the taxfree share of dividend plus capital return for investors. For Embassy REIT, the collapsing of the 3-tier structure in the Manyata SPV to a 2-tier structure from FY22E along with injection of Tech Village asset in Dec’20, may lead to a higher share of over 70% in the form of tax-free dividend plus capital return for FY22-23E. For Brookfield REIT, the REIT manager has now converted CCDs having face value of Rs10.1bn to equity in the Candor Kolkata SPV and we expect over 30% of the distribution to be in the form of tax-free dividend and capital return vs. 15% earlier from FY22E onwards.

* REITs offer attractive yields of 7-9% over FY22-23E:

We have factored in a fall in occupancy levels of 2-3% for the REITs in FY22E but expect the same to reverse from H2FY22E onwards heading into FY23E. We expect the three REITs to offer distribution yields of 7-9% over FY22-23E along with 13-18% capital appreciation as per current target prices. While a rise in global interest rates is the key risk, cumulative potential returns of 20-25% provides adequate valuation cushion, in our view.

* India’s long term advantages remain as a high-quality office hub:

While near-term news flow may be negative, 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 micromarkets 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.

To Read Complete Report & Disclaimer Click Here

For More ICICI Securities Disclaimer https://www.icicisecurities.com/AboutUs.aspx?About=7

Above views are of the author and not of the website kindly read disclaimer