DESH (SEZ) Bill: Catalyst for office leasing demand: IIFL Securities

Media reports suggest the Finance ministry has recently turned down the proposal by Commerce ministry, to provide tax incentives to units set up in SEZs as part of the Bill, which is likely to delay its passage and implementation. The government however in the meantime may allow relaxations like the recent decision of extending 100% WFH till December 2023. While all listed REITs stand to benefit from the DESH bill, analysts at IIFL Securities see the highest benefit to accrue to Mindspace REIT.

Phasing out of tax incentives made SEZs unattractive

The Special Economic Zone (SEZ Act) was set up in 2005 with an aim to boost exports. The Act offered a host of tax incentives, including Income Tax exemption on the export income of SEZ units. Indirect taxes like Central Sales Tax, Service Tax and State sales tax (currently GST) were also exempted. Ever since the Sunset Clause on tax incentives came into effect (April-2020), all direct tax holidays for occupiers got phased out (though indirect taxes still available). As a result, majority of new IT/ITes are non-SEZ (or getting converted into one), as existing SEZ spaces continue to have physical and other restrictions as well.

REITs have high exposure to SEZs

According to data from C&W — of the total ~550msf operational office space in India (top 8 cities) — IT/ITes-SEZ accounts for ~25% of the stock spread largely across Bangalore, Hyderabad, NCR, Mumbai and Chennai. SEZ offices are witnessing rising vacancy levels (~13% in Q1CY22 versus 7.3% in 2019), post the end of tax benefits in 2020. During 2011-2019, share of SEZs in overall leasing was ~30%, which in 2020-21 has declined to 18-19%. Listed REITs (with an operational area of 72msf across the three) have a high exposure to SEZs with 60-87% of their portfolio being developed as SEZ. Vacancy levels in the SEZ area comprise of ~60-75% of the total vacancy of listed REITs.

DESH Bill an attempt to revive SEZs

The government has proposed to replace the SEZ Act with DESH; as per media reports, the new Bill entails: 1) Removal of restrictions around only exports and doing away with maintaining a positive net foreign exchange. 2) Allowing multidisciplinary tenants across all SEZs and doing away with industry specific zones. 3) Relaxation in land continuity norms allowing partial de-notification of SEZ; other provisions aimed at developers being able to attract a wider set of occupiers. Per media reports, the Commerce ministry is proposing a concessional Corporate Tax rate of 15% until 2032, for all greenfield/brownfield units in these hubs.

Tax incentives remain a bone of contention

As per media reports, the Union Finance ministry has turned down Commerce ministry’s proposal to provide tax incentives to units set up in SEZs as part of the DESH Bill, 2022, holding it would be detrimental for units outside SEZs. With this objection, the government may have to modify the Bill that can delay the implementation. The Bill is unlikely to be presented in ongoing Winter Session.

DESH Bill critical for occupancy improvement; IIFL Securities retains recommendations/Target Prices on REITs

While leasing momentum till Q2FY23 had been robust, recent concerns on hiring in the Tech industry have weighed on the momentum in India as well. Many large RFPs (>1msf) have slowed down/have been put on hold, though smaller RFPs (40,000-50,000 sq.ft) continue to remain in demand. Physical occupancy remains at 30-40% for the industry, largely dragged down by third-party outsourcing firms and partially offset by R&D tenants having high occupancy.

REITs have delivered a total annualized return of 9-16% since their respective listing timelines, despite recent under performance. For FY23, analysts at IIFL Securities see REITs yielding 5.9-7.0%, while for FY24 they see a stronger growth leading to yields of 6.6-7.8%. REITs are currently trading at 10-18% discount to NAV and offer attractive entry point. Analysts at IIFL Securities have maintained Buy on EOP, while maintaining an Add on M-REIT and BIRET.