Embassy REIT: Is this "Blackstone" promoted REIT is real diamond?

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Embassy REIT Background:

Embassy REIT is India’s first publicly listed Real Estate Investment Trust. Embassy REIT owns and operates a 42.4 million square feet (“msf”) portfolio of eight infrastructure-like office parks and four city‑centre office buildings in India’s best-performing office markets of Bengaluru, Mumbai, Pune, and the National Capital Region (“NCR”). Embassy REIT’s portfolio comprises 32.3 msf completed operating area and is home to over 200 of the world’s leading companies. The portfolio also comprises strategic amenities, including two operational business hotels, four under‑construction hotels, and a 100MW solar park supplying renewable energy to tenants

REIT India’s Past experience

While Embassy REIT being the first one REIT listed, I read an old JM Financial Report, which provided information about Ascendas India Trust, a business wsith Trust characteristic which is broadly comparable to REIT structure in India and has been listed since FY08 on Singapore Stock exchange. Over FY08-19 period, Ascendas reported property income growth of 12% CAGR, with RE portfolio increasing from 3.6 mn sq ft in FY08 to 12.6 mn sq ft as on June 2019. The instrument return since listing are as under.
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The above example provide some template about how one can expect REIT performance in India over long term.

Management fees/Expense charged for Management

As per information sourced from IIFL report, the Indian REIT structure charges appear reasonable when compared with other peers (which are listed in Overseas market) Find enclosed comparable table on same.

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The management insight details about various information parameter over last 8 quarters in Datasheet, Valuation report, Annual report, Financial Presentation and Conference call transcript. The link for same is enclosed herewith for latest quarter results.

Some key highlights are as under:
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Comparison of Embassy REIT with its peer

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Positives:

Performance history in Covid period

Embassy has longest tenure of listing history among all REIT. It was only REIT which continued it’s distribution during Covid period during March 2020-June 2020 period when India underwent countrywide lockdown

Acquisition of new assets

Embassy has successfully completed a major acquisition during Q3FY21 of Embassy Techviallage by raising additional units by way of QIP

Better asset portfolio

Despite having 72% assets in Bangaluru region, Rent per square feet is highest for Embassy at Rs 70/sq ft vis Mindspace and Brookfield.

Citywise Area Embassy Mindspace Brookfield
Bengaluru 72%
Mumbai 11% 41% 22%
Pune 10% 17%
Noida/Delhi NCR 7% 56%
Hyderabad 39%
Chennai 3%
Kolkata 22%
Rent per sq ft 70.00 55.20 62.00
Bengaluru 72.00 0.00 0.00
Mumbai 176.00 56.20 90.00
Pune 46.00 63.90 0.00
Noida/Delhi NCR 43.00 0.00 67.19
Hyderabad 0.00 51.30 0.00
Chennai 0.00 64.00 0.00
Kolkata 0.00 0.00 42.00

My expectation and working for information (Please Read disclaimer and note specifically for projection of return)

While an investor in REIT would take business and market risk, given that dividend distribution being exempted from taxation, REIT offer good risk adjusted post tax return for my risk profile.

Further, I have compiled an indicative distribution expectation for three REIT, from various sources. Please note that this are expectation of analyst/management and IT MAY UNDERGO MAJOR CHANGE given the volatile environment. The objective to provide this information is only to compile data from various sources and NOT to ADVISE ANY INVESTMENT.

Projected Distribution per unit Embassy Mindspace Brookfield
FY22 25.64 20.62 21.84
FY23 29.58 22.02 23.16
Source for DPU Kotak Report Axis Bank report Brookfield presentation
Unit price of 9Apr2021 313.9 299.93 239.5
DPU yield/Current price FY22 8.2% 6.9% 9.1%
DPU yield/Current price FY23 9.4% 7.3% 9.7%

PLEASE NOTE that every investor shall do his/her own assessment for risk profile and take personal investment decision. Secondly, my understanding of Tax exemption may not be correct and hence reader shall consult his/her tax advisor before making any investment decision.

Negative:

Return are indicative and NOT ASSURED like debentures/fixed deposits

The investor is REIT is subject to business and market volatility risk. The distribution from REIT is not an right of REIT investor. In case, business performance is adversely affect, like dividend, management may not distribute any amount to investor. Hence, REIT is NOT SUBSTITUTE TO DEBT PRODUCT.

COVID related uncertainty

Embassy REIT distribution has declined during 9MFY21 vis same period in FY20 due decline of income from Hotel Assets. The expected recovery from Hotel may take longer period due to COVID related uncertainty.

Secondly, COVID has changed the work space requirement for society and business. The flexi workspace and work from home are emerging as strong trends which may change long term demand for A Grade office space in which Embassy REIT operate. This may not only adversely affect Growth prospect, may also adversely affect demand and rent realization for Embassy REIT in future. Reader shall do his/her own assessment on this factor.

Disclaimers:

I have invested in Embassy REIT during last 3 months. My view may be biased due to my investment. I am not SEBI registered investment advisor. I am not suggesting any investment action to reader by this note. Reader shall do his/her own due diligence and/or consult his/her investment advisor before making investment decision. The projected distribution over next two years are my compilation from various sources and by no means shall be considered as assured distribution.

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Thanks for putting this up.
One risk I had in mind is the risk of government doing away with the tax exempt status of the REITs distributions in the form of dividend/SPV amortization.

They already have a weird rule where if the REITs pay income tax at lower rates then the unit holders need to pay full income tax on the distributions.

How big of a threat is this? It would kill a nascent industry but our system is capable of this I think.

Dis- Invested

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Thanks for starting the thread @dd1474. I’m also fairly bullish on the long term investment prospects for REITs at current valuations given the hugely favorable demographics (young population, 5-10 million joining the workforce each year for the next decade at least, etc.), cost arbitrage (outsourcing - India has approx. 50% market share of all global captives, 10-20% office rentals compared to west/APAC and cheaper labour) and market share consolidation towards grade A office suppliers.

Anyway few thoughts from my side on some positives mentioned in your opening post:

Most of the tenants have long term leases and cannot immediately shut shop and go away. There are big penalties involved in case a tenant does decide to terminate the contract midway. So it is important to track the trend of vacancies and whether MTM gains are being realized when they come up for renewals. While the distributions during this period illustrates the quality of its tenants, there was no other listed REIT during April - August which can be judged on this metric. If the pandemic situation continues for another 4-6 months with largely empty offices >75% employees wfh, that’s when we can really check if vacancies are still muted and business is going strong.

The key thing about the asset acquisitions is, are they DPU accretive? At that time’s prevailing market price of ~350, the acquisition was slightly DPU accretive only adding a few % point increase to DPU. I’d say the quality of the asset in this case was the highlight of the deal since ETV has occupancies of more than 95% which is unheard of in commercial real estate. But overall the deal valuations were not going to make much difference to unit holder returns over the short term.

Also, personally I’ve stayed inside Embassy Tech Square (right next to Embassy Tech Village) for 1 year between 2019-2020 while I was on a client project and first hand experienced the quality of the infrastructure / grade A offices. At that point in time, there was definitely huge demand for quality office spaces in that vicinity - that whole road, Bangalore outer ring road is filled with multiple grade A office complexes over a 5-8 km stretch.

I’m really surprised at the DPU projection for FY23 building in 15% growth in NDCF! If that does turn out, it’s currently available at a 9% yield. Can you share the Kotak report which explains this increase (wondering if this is on account of the big 1.1 msf pending lease out to JP Morgan) There is a huge risk with the current pandemic that rentals may not increase significantly until there is normal business resumption.

In terms of key negatives - I think you’ve already highlighted most of them. One more could be around the Embassy management (not REIT) - something which I wasn’t very aware. Saw this on Twitter and also now highlighted by someone else on the VP REIT thread. Would be great if people who know more about Jitu Virwani can share some details and why people have a very negative opinion about him.
https://twitter.com/moneybloke/status/1377103159055687681?s=20

A lot :slight_smile: . Screener info is not correct, better if you go through the company’s disclosures / investor presentations on exchanges.

Disc: Invested in all 3 REITs with Embassy allocation at 66%.

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The net revenue would depend on various tenancy expiry and hike in lease rent as well as higher area from new development in existing facility. In addition, as already mentioned, the hotel assets which have contributed positively during FY20 in cashflow, have now turned negative and hence reduced distribution. In case business resume normalcy in FY23, which is not certain, but have high probability in my view, we can expect one time major increase in distribution. Having said that, one may consider it optimistic assumption.

On point of Jitu Virwani, the twit you mentioned does not even provide how this person has adversely affected minority shareholder. Secondly, since listing, Mr. Virwani on board and REIT has distributed ~ Rs 40 per unit (Face value of Rs 300) i…e around 13% in seven quarters. Thirdly, I believe current management is mainly controlled by Blackstone (while Embassy also have stake and say in functioning). Hence, without any knowledge, I would cautiously try to understand what are past misdeed. On positive side, the REIT structure enforce 90% cashflow to be distributed to investors and hence provide limited cashflow to be mismanaged. Selling ROFO assets at very high value and charging very high management fees are only two avenue which can used by ulteriror objective management to adversely affect minority investor interest.

Thanks for your valuable comments.

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The management fee is one aspect but siphoning through gold-plated facility management contracts/one-off repairs would be another area to monitor. I think one must apply a 10-20% discount in NAV calculation to build a factor of safety here. One should ask apartment owners in Bangalore to understand the kind of steep decline in rentals they are experiencing. I was told that 20-30% cuts in apartment rentals are common. Companies are in no mood to call employees back. Additionally, these vaccines are effective for 6-8 months so even if the situation settles down, companies will go for up to 50% occupancy at least for the next 18-24 months. I would be interested @ 260-270 levels during the next market decline. I think even yield support is missing here.

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I can add some insight here as I live in Bangalore. Haven’t faced any reduction in rents, however my landlord has forgone the 5% yearly increase in rent as per the agreement for this year.

Can add insight here too. Used to work at Goldman Sachs which had an office in Embassy Golf Links Business Park. Now work at Visa. GS and JPM did call their employees back to office and then asked everyone to WFH again as cases shot up. With financial companies, everyone will be called to office as soon as possible and they will never ever go to a remote model.

With Visa, we are moving towards a hybrid model where a few days(2-3days) will be wfh and rest in office. So offices aren’t going anywhere.

Having worked at Embassy Golf Links, I can also add that it’s one of the best offices in India. Embassy really has best real estate all over Bangalore and nothing comes close to matching their standards. Have lived at Hilton as well in Embassy Golf Links and it’s also one of the better managed hotels in Bangalore.

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Nice analysis. Thanks.

Your estimate for FY23…Is the kotak report available in the public domain? I came across an ISEC report (in the public domain) with a much lower DPU. Any reasons why such a discrepancy in a stable business like this?

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Find enclosed key assumption and financials table for Embassy from Kotak report

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Following are key assumption ICICI Securtities report.

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While REIT is broadly stable business, the recent volatility, specifically in context of work from home, expected development of area under construction and hotel rooms demand, the analysts could have differing view. The timely completion of new building or delay by 6 months could materially affect cashflow.

For instance, while comparing the assumption, I understand that I-Sec have assumed nearly 5% annual increase in rent, while Kotak has assumed 8.8% growth in Rent in FY22 and further 6.8% increase in FY23. Further, while I Sec assume 4.3 mn sq ft under construction assets being available for leasing from FY24, while Kotak has assumed phased development based on presentation of the company.

Given the dynamic nature, it is possible that actual result may be completely different from both the projections (positive as well negative). Hence, I had very categorically said that please do your own due diligence before taking any investment decision. We can some guidance about how business would shape from management presentation and analyst projection. However, there is equal probability that actual performance may vary significantly from expectation.

Hope this provide rationale for variance among the analyst on Embassy REIT projections.

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Any long term view on Office Space occupancy given “Work from Home” trend is strong and looks to be continuing beyond pandemic?

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@Mukesh_Bansal Have a look at the other REIT thread. WFH is discussed there.
My 2cents are that we need to broaden our view point here. WFH may be necessary for a year or maybe even two but at some point Office culture will come back. However, at the end of the day it’s all just opinions… you need to ask yourself… 2 years from now will companies want to pay employees full salaries to sit at home and work? This may work for a few employees but defo not all of them. Companies would need some sort of physical presence and even if they fill their offices with 80 percent capacity in the future they’ll still need an office. Imo this risk is currently priced in at rs. 306 which imo is a throwaway price.

In the bullish scenario(Kotak) ie things go back to normal soon you’ll be getting a 8 to 9.5 percent (soon tax friendly) over next 2 years yield at cmp.
In an average scenario(Isec) you’ll be getting a 8 to 8.5 percent yield next 2 years.
In a bear scenario where rental yield stays flat and occupancy mirrors FY21 for a bit ie assuming yield stays the same from FY21 you are still getting a 7 percent yield.

Now assume a base is set in any of the above scenarios. From that base rental yield will rise 15 percent every 3 years. Add the new acquisitions and shift to tax friendly structure and things can only go up from the current 7 percent yield from here. You have a nice 20 percent discount to NAV too so there is definitely a margin of safety now. Think of it as if someone has given you a chance to buy an office in Bangalore, at a discount, 1 square meter at a time(1 lot) so you don’t need a loan, and with professional managers handling rentals with big MNC clients and it all makes sense.

On a side note: a question to anyone who owns REITs abroad. Considering REITs are considered a safe investment in the USA are there any firms in the USA who rent from an REIT and also invest in it?
For eg. Imagine if there’s Company A Paying Rs. 1 lakh a month for rent (for calculations sake) to Embassy office. Company A could hedge their rent payment by investing 1.5 crores into Embassy in the stock market itself. This would lead to Embassy paying them a yield of 8 percent which they could then use to pay the rent and basically get an office rented for free by parking their excess cash in Embassy :slight_smile:
Has this happened in the USA?
I’m sure there are current clients of embassy who are surely considering the same ie parking cash in Embassy and using the yield to pay off rent :slight_smile: (I’m doing similar though I’m not an embassy client)

Disc: Invested and adding over last few days at near CMP.

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@Malkd I agree with your thoughts on this. It is just not clear if a bear scenario is going to be at FY21 level or can go down by 25% or 50%.

Disc: Invested and accumulating more

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Unless there’s some huge corporate fraud proven I doubt the market would let it fall to those levels. A 25 percent drop would mean locking in a 11 to 12 percent yield and a huge discount to NAV I’d consider selling almost everything I own to buy that. A 50 percent drop would lead to locking in a 16 percent yield and a 200 percent return to NAV after just a few years wait… I would definitely sell everything I own to lock that in then :slight_smile: …
The market does make blunders(indigrid at 85 rs was surprising) but one can only hope that it makes one here. I suspect a max 10 percent downside though I find that doubtful too. Personally hoping for underperformance and further downside over the next 2 years so it can be accumulated slowly and without opportunity cost.
At the end of the day you have to ask yourself: Do you see a world without offices and cheap rents in metros in 2 years when covid is hopefully behind us? I don’t personally. What I see is a stable instrument that over 2 years can give a 30 percent capital appreciation+ Lock in 8+ yields at these prices.
Disc: invested.

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Inflation at 8 year high i.e. 7.5%. RBI is keeping interest rates low artificially. They can not keep low for long. Big QE all over the world is creating inflation. Everything is going up like sugar, oil, metal etc. So interest rates have to go up. If interest rates go up, REIT will go down, it will stop falling once inflation and interest rates stop going ip.

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If sugar and metal go up due to inflation, what would happen to Real Estate rent and price in long term? Would it go down? Very low probability in my understanding. In short term, it may have adverse impact but not in long term.

Also, as per latest RBI data release of monetary policy on 7 April 2021, CPI inflation is around 5% in February 2021 (latest available data). Extract from Governor speech is enclosed for everyone reference
https://rbi.org.in/Scripts/BS_PressReleaseDisplay.aspx?prid=51380

"9. While headline inflation at 5.0 per cent in February 2021 remains within the tolerance band, some underlying constituents are testing the upper tolerance level.

  1. Going forward, the food inflation trajectory will critically depend on the temporal and spatial progress of the south-west monsoon in its 2021 season. Second, some respite from the incidence of domestic taxes on petroleum products through coordinated action by the Centre and States could provide relief on top of the recent easing of international crude prices. Third, a combination of high international commodity prices and logistics costs may push up input price pressures across manufacturing and services. Taking into consideration all these factors, the projection for CPI inflation has been revised to 5.0 per cent in Q4:2020-21; 5.2 per cent in Q1:2021-22; 5.2 per cent in Q2; 4.4 per cent in Q3; and 5.1 per cent in Q4, with risks broadly balanced.

  2. On March 31, 2021, the Government retained the inflation target at 4 per cent with the lower and upper tolerance levels of 2 per cent and 6 per cent, respectively, for the next five years (April 2021-March 2026). An inflation rate of 4 per cent over the medium term has now been successfully entrenched in the economic landscape. The experience with efficaciously maintaining price stability and the gains in credibility for monetary policy since the beginning of the inflation targeting framework in 2016 are reinforced by the retention of the target and the tolerance band. From the time after the Monetary Policy Committee (MPC) was constituted in September 2016, average CPI inflation for the period October 2016 to February 2020 – prior to the onset of the COVID-19 pandemic – was 3.8 per cent, down from the average of 7.3 per cent during January 2012 to September 2016. Our research suggests that trend inflation has moderated during the flexible inflation targeting period to around 4 per cent in recent times. The experience during the COVID-19 period has testified to the flexibility of the framework to respond to sharp growth-inflation trade-offs and extreme supply-side shocks over the course of the business cycle. Monetary policy over the next five years would aim at consolidating and building upon the credibility gains of the first 5 years of flexible inflation targeting."

So just wondering what is basis of 7.5% inflation in your understanding? This would assist all of us improve our understanding on the subject matter.

The data for March 2021 inflation as per Ministry of Statistic is available in enclosed link
http://mospi.nic.in/cpi

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The companies that rent out at Embassy tech parks generate much higher ROE from their business, so they would rather reinvest in their business or distribute via dividends/buybacks or keep it in any fixed instrument for strategic acquisitions (Now here REIT may come into picture just as a part of the fixed instruments the company want to park their money). REIT would never be their strategic investment for any purpose…

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@Rajesh1975
The reason these REITs are available at a discount is due to covid and interest rates since they borrow at higher cost for their debt and their rental rates are locked in for a few years at a time.
Usually the recent fall in interest rates rates would have led to a rise in REITs. Covid added a dual factor which prevented this from happening due to WFH/Lockdown worries. As interest rates rise over the next year or two the covid situation will also get better so the bottom could be near around CMP since it may have reached here already due to covid.
This a unique situation that may not get repeated again for a while and timing the market is impossible. So in the short term ie maybe even a year or two the prices of REITs may fall a bit further/remain stagnant which will give a very rare opportunity to accumulate in bulk over a period of time. However, there’s always a tipping point where investors favor an REIT vs bonds and at 8 percent this seems like a good entry point though the next few quarters or years may continue to provide one. As the situation improves(and it will at some point), rental rates will also increase once lockins are over and when interest rates fall again REITs will do well again(higher rents and lowered interest rates in medium/long term) and locking them in during these kind of periods is the best time to buy them.
In the USA REITs offer about 2 to 3 percent yields and hence why they are more prone to investors vs interest rates. in the long run India too is on the course to decrease yields from FDs/Gsecs etc. so while there will be some short term pain if they increase… in the long run REITs here could trade at 2 to 3 percent yields too just based on trends abroad(we ve gone from double digit to 5 in 25 years… the USA has gone from double digit to 2/3 in 35 years. Long term interest rates should continue to go down) which means we could have a short 2 to 5 years period or less to accumulate these to benefit from both capital appreciation and locked in high yields.

@Investor_No_1 my question was along the lines of them considering it as a fixed instrument only since REITs have a great track record abroad.

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This is my source of information. 10 year bond yeild is 6.1 %.
Dhiraj,
What you said about long term, I agree. This will protect capital too. You will get more rent if interest rates are more. Even more price of property and more rents.

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Thanks for sharing this article. In my opinion, while WPI can be considered, but it is generally volatile. Hence, I consider CPI over period as indicator for inflation. I am not economist and my understanding may be wrong.

However, if we read article is also raise point about low base of March 2020 and high volatility in WPI. Having said that, we have keep our eye and ear open.

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while there has been a good discussion on Embassy REIT everyone has missed one key development related to the Embassy group. They are merging some of their commercial and residential properties with Indiabulls real estate. Embassy REIT will act as a ready customer for the properties developed by this merged entity i.e. Embassy developers, this is definitely a win win situation for both stocks. As per the latest Indiabulls Real estate’s Investor presentation, the planned commercial projects in the combined entity will have a rent potential of Rs 4241 cr with a total area of 43.2 million sq ft.

"The merged platform will become the development arm for the listed REIT (Embassy Office Parks). The REIT will benefit by getting more developed assets, thereby increasing the yield of the REIT,” sources said. This is an excerpt from the bellow article, and this key development needs to be looked out for various reasons as it might benefit stockholders of both the companies or this deal might bring out some unseen red flags(as indiabulls group doesn’t have a clean reputation) which would again help us in avoiding future losses.

disc. Invested in Indiabulls Real and considering Embassy REIT after reading this thread

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This is a Feb 2020 news and mostly digested by market. Even before Corona understanding may not have any impact on any of the involved stocks.