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REITs: Resilience amid turbulence

Indian REITs have seen strong rental collections of over 99% over FY21-FY22 and have been able to achieve healthy re-leasing spreads along with contractual escalations in spite of Covid disruptions delaying return to offices. Commentary from REIT managers and large office developers indicates that the fall in portfolio occupancies of 6-9% seen in FY21-22 owing to Covid has bottomed out and occupancies are expected to reach pre-Covid levels of over 90% by Mar-Jun’23. While a rise in global interest rates and in India is the key risk, this also coincides with an acceleration in office leasing and we expect cap rates will remain in the 8- 8.5% range or even lower for high quality Grade A assets as market rentals have remained stagnant for 24 months and may see an upward trajectory considering that India offers affordable Grade A office rentals of ~1USD/sft/month. While near term distribution yields for Indian REITs over FY23-24E may appear low at 5-6%, we remain constructive on the long-term prospects of the Indian office leasing market and REITs providing a stable cash flow profile.

* Leasing sees YoY pickup in Q1CY22: As per Cushman and Wakefield, Grade A net absorption across India’s top seven cities increased to 6.0msf in Q1CY22 (up 65% YoY) in spite of Omicron related disruptions. The absorption was driven by the infusion of new supply of 14.0msf of which a significant portion was pre-committed. RFPs/new enquiries also picked up pace and should fructify from Apr’22 onwards with the backto-office plans of occupiers being delayed by a quarter owing to the surge of Omicron led Covid cases globally and in India. The quarter saw pre-commitments of 3.2msf for larger transaction sizes which augurs well for a recovery in the remainder of CY22E. While CY20-CY21 were weak years with 20msf of net absorption each owing to Covid19 impact, we estimate net absorption of 26.8msf in CY22E and 30.0msf in CY23E.

* Recovery on the cards from CY22E: Commentary from REIT managers and large office developers indicates that the fall in portfolio occupancies of 6-9% seen in FY21- 22 owing to Covid has bottomed out and occupancies are expected to reach pre-Covid levels of over 90% by Mar-Jun’23. While current physical footfalls are at 30-35% across India, this number may significantly improve to 60-70% by Mar’23 with the hybrid model of working remaining in place. With enquiries for new office spaces on the rise, REIT managers are focusing on speeding up capex to bring in new supply to cater to the demand and also intend to infuse sponsor RoFO assets in FY23E.

* Environment of rising interest rates coincides with improved leasing activity: During the Covid impacted years of FY21-FY22, the listed REITs in India have demonstrated resilience with almost 100% rental collections even with portfolio occupancies having declined by 6-9% over the same period. This was also a period when interest rates have been at record lows in India and REIT managers have utilised this window to refinance debt at lower costs to cushion impact of falling occupancies. Heading into FY23E, with interest rates rising globally and in India, there is a possibility of expansion in cap rates for Indian office assets to adjust to higher yield expectations. However, this rise in interest rates also coincides with an expected improvement in office leasing and inflationary impact translating to higher market rentals which have remained stagnant for the last 24 months. Hence, we believe that cap rates will remain in the 8-8.5% range or even lower for high quality Grade A assets. While near term distribution yields for Indian REITs over FY23-24E may appear low at 5-6%, we remain constructive on the long-term prospects of the Indian office leasing market and REITs providing a stable cash flow profile.

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