Embassy Office Parks REIT: too early to trust?

Investors who can take a little bit of risk to generate a stable income have something to cheer for.  Embassy Office Parks recently launched India’s first Real Estate Investment Trust (REITs) IPO.

If you remember, SEBI laid down the framework for REITs in 2014. It took over four years for India’s first REIT to see the light of the day.

Since this is the first-of-its-kind offering in India, the ‘investor josh’ is high. That said, it’s important not to get carried away by the exuberance.

For those who don’t have any idea about REIT: it’s an investment trust that collects money from investors just like mutual funds, but unlike them, invests in a diversified portfolio of commercial properties with the aim of generating stable rental income.

What’s on offer?

Blackstone-backed REIT, Embassy Office Parks, aims to raise Rs 4,750 crore through its IPO issuance. The REIT will utilise approximately 78% of the IPO proceeds for the repayment of debt. It has earmarked another 10% for the acquisition of an asset. Anchor investors have already subscribed to 1/3^rd of the issuance.

Embassy Office Parks REIT IPO-facts

Background of Embassy Office Parks REIT

The REIT has a diversified portfolio of ‘grade-A’ properties constituting 7 corporate parks and 4 office buildings, 4 hotels and an energy park. It has a presence across 4 cities—Mumbai, Pune, Bengaluru and Noida and owns nearly 33 million sq.ft. of office space.

What are the positives?

• At the end of Calendar Year (CY) 2018, the committed occupancy rate of Embassy Office Parks was high, at 95%.
• As compared to other properties in the same vicinity, Embassy Office Parks collects 34% higher rents, thanks to the quality of its properties.
• Presence in only ‘grade-A’ properties may offer a cushion during challenging economic phases.
• It has a reasonably diversified base of 160 tenants that make up nearly 81% of gross rents. The REIT has some marquee global MNCs as its tenants, which include the likes of Google, Cognizant, ATOS, IBM and PwC among others.
• As per the rules, a REIT can invest only up to 20% of its assets in unfinished properties; the remaining 80% needs to be invested in completed-revenue-generating properties.
• As per the guidelines, a REIT has to distribute 90% of distributable surplus among unitholders.

And these are the negatives…

• Embassy Office Parks REIT has a higher exposure to tenants from the IT space, with the sector accounting for nearly 50% of its revenues.
• Although the REIT has been able to command a premium at present, the possibility of this continuing in future is subject to the supply of comparable properties in periphery areas. As you might be aware, owing to the emergence of big commercial hubs in the suburbs, rents are already off their peaks at premium locations in major cities, such as Mumbai.
• The units will be listed on BSE as well as NSE. But investors might face the problem of lack of liquidity in the secondary market.
• As per the regulations, the REIT will have to declare its Net Asset Value (NAV) only twice a year. This might offer no respite to investors who want to exit in the secondary market and earn some capital gains. Hence their exit will more be a function of demand-and-supply.

Is this issue for you?

It's noteworthy that investing in REIT and investing in real estate are different ballgames.

The primary aim of any REIT is to generate a stable rental income. Capital appreciation is a secondary objective. As against this, when you invest in real estate, your primary goal is to generate capital appreciation.

Speaking specifically about this offering, it might be suitable for investors searching for an alternative to fixed deposits. You can earn by way of capital gains as well if there’s any appreciation in the property value of the REIT.

Typically, rental yield at ‘grade-A’ locations is around 7%-9% and the scope for appreciation generally is in the range of 3%-5%. In other words, one can expect to earn 10%-14% returns through REITs. But the return isn’t guaranteed, nor are the distributions.

Tax treatment…

Income earned through distributions of REIT is taxable. Capital appreciations, i.e. gains arising from units held for over 36 months will attract a long term capital gains tax at 10%, else, profits will be taxed at 15%.

Our view

Considering all the positives and negatives, we decided not to rate this issue at the moment. Depending on its future success we might take a firm stand on Embassy Office Parks REIT. For now, we are cautiously optimistic about Embassy Office Park REIT.

Click here to access our detailed note on Embassy Office Parks REIT IPO.