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Demand tailwinds emerging for REITs: IIFL Capital Services

12 Sep 2022 , 02:06 PM

Growing clamor on return to work

Industry interactions done by analysts at IIFL Capital Services and recent news-flows suggest employers are hustling hard to bring employees back to office, albeit on a hybrid work model. Listed REITs and top CRE developers are currently witnessing 30-50% of daily physical occupancy (versus 50-70% employees back on hybrid mode), with regional disparities (Mumbai, Chennai higher attendance versus lower in Bengaluru/Hyderabad). Over the next 1-2 quarters, analysts at IIFL Capital Services expect a steady increase in physical occupancy, although hybrid work model is expected to continue. In the US (current physical occupancy ~40-45%), many companies have issued mandates for employees to return to office on a hybrid basis after Labor Day. Steady increase in physical attendance will drive leasing demand, as many companies have hired employees more than the seating capacity of the premises.

Proposed changes to SEZ Act, to act as leasing demand tailwinds

IT-SEZ accounts for ~25% of commercial real estate of top 8, and is witnessing rising vacancy levels (~13% in Q1CY22), post the end of tax benefits in 2020. During 2011-2019, the share of SEZs in overall leasing was ~30%, which in 2020-21 has declined to 18-19% (Source: C&W). To revive the SEZs, government has proposed Development of Enterprise and Service Hubs (DESH Bill), which as per media reports, entails removal of restrictions around foreign currency payments, allowing partial de-notification of SEZ premises, leading to developers being able to attract a wider set of occupiers in such premises. The listed REITs have nearly 60-87% of their portfolio as SEZ – much higher than the industry. Hence, analysts at IIFL Capital Services see a meaningful impact in leasing momentum once the bill is cleared in the Parliament.

Q1FY23 leasing demand strong; Bengaluru leads the recovery

C&W data suggests strong leasing momentum for Q1FY23, with gross and net leasing volumes of 23/10msf being the highest since the start of the pandemic. Bengaluru is leading the demand with 30% share in gross leasing and ~50% in net leasing. In line with the Industry, the 3 listed REITs also reported a strong gross leasing performance of ~3msf (up 56% YoY/86% QoQ). This led to stable occupancy levels to marginal improvement for blended occupancy levels in Q1FY23 with EOP/MREIT/BIRET at 87/82/83%, respectively, for their respective completed portfolio.

Strong FY23 demand outlook to impact FY24 distribution meaningfully

EOP/BIRET have guided distribution for FY23/H1FY23 respectively, and is expected to be broadly flat YoY. MREIT does not give a formal guidance, although it also expects flat distribution over next few quarters. However, occupancy levels should meaningfully move up YoY in FY23, driven by strong gross leasing trends, especially for MREIT and DCCDL that have achieved strong pre-leasing for under construction projects. The 3 REITs/DCCDL is guiding to >90% committed occupancy over the next 3-4 quarters, which should drive a robust NOI and distribution growth in FY24/25.

Upgrade EOP to Buy post recent weakness

REITs have delivered a total annualized return of 13-25% since their listing, and their recent performance has also been broadly steady, despite recent rise in interest rates. For FY23, analysts at IIFL Capital Services see REITs yielding 5.2-6.2%, while for FY24 they see a stronger growth leading to yields of 6.5-6.8%. While MREIT/BIRET trades at ~3% premium to NAV, the recent weakness in EOP (14% discount to NAV) offers attractive entry point. Analysts at IIFL Capital Services have upgraded their recommendation on EOP to Buy, while maintaining an Add on MREIT and Reduce on BIRET.

Valuation and Recommendation