The Details
Before understanding the business model of Embassy Office Park, it is important to know how business is conducted through a Real Estate Investment Trust (REIT). REITs own and operate real estate properties. It generates rental income on these properties. So, an investor who invests in such a trust receives a share of the rental income. Returns earned on a REIT have two components. One is debt and the other is equity. Through the debt component, an investor earns income through interest and dividend. And once a REIT is listed and gets traded in the secondary markets, the appreciation through trading forms the equity portion of returns.
Globally, investors keenly track the spread between the rental yield of REIT and government bond interest rate. The higher the spread, the greater is the investor interest in the REIT. The capitalization rate in India is 7.5-8.5 per cent, which is 175-575 basis points higher than Grade A office assets in other global cities.
Business
Embassy Office Park owns 32.7 million square feet (msf) of commercial office leasable space in Bengaluru (60 per cent), Pune (14.4 per cent), Mumbai (16.2 per cent), and Noida
(8.9 per cent). The market value of its total leasable area is Rs 31,480 crore. It added 4.1 million square feet (msf) of commercial space in 15 quarters. It plans to develop another 7.9 msf in the next few years. About four-fifths of its tenants are multinational corporations (MNCs). Its top clients are IBM, Cognizant, PwC and Nokia, together making up about a third of its total gross rentals.
Technology companies form nearly half the gross rentals, followed by financial services and research consulting. In the geographies where the company operates its properties, there is a huge gap between the rents charged by the company and the rent these markets charge. There is potential of 34 per cent mark to market gains for the company. About 30 per cent of the lease rentals of its properties are up for renewal in the next four years ending 2023.
Performance
Revenue rose 5.8 per cent annually in the past two fiscals to reach Rs 1,766 crore in FY18. Its net profit rose 66 per cent annually to Rs 258 crore during the same period. In the first nine months of the current fiscal, it reported revenue of Rs 1,493 crore and Rs 285 crore in net profit. Embassy’s occupancy rate of rental assets stood at 95 per cent as of December 2018. It has maintained occupancy greater than 93.4 per cent in the past three fiscal years. According to RHP, the company’s net operating income is expected to be Rs 2,144.7 crore in FY21, up from Rs 1,641 crore in FY19. Contracted growth, vacancy lease up development and releasing are likely to boost its net operating income.
After utilisation of the IPO proceeds, its total indebtedness may be less than 15 per cent of market value. This compares favourably to key office REITs in Asia and the 49 per cent regulatory limit.
Valuation
Investors could expect yield of 7.4-8.3 per cent pre-tax in FY20, according the projected cash flow in Embassy’s RHP. This is quite comparable with fixed deposits offered by several banks. Analysts believe REITs can offer 3-5 per cent of annual capital appreciation.
Investors must bear in mind that the actual return on REIT will be calculated based on a few factors, such as post-tax return, income tax slab, holding period, and other sources of income. Accordingly an investor should consider investing in REIT.
Given the minimum investment size of Rs 2.4 lakh in the IPO, it appears to be an investment opportunity limited to high net-worth individual to diversify their portfolio allocation.
