Q3FY23 Real Estate- REITs review: Long road to recovery

REITs reported a flat distribution for Q3FY23 on a QoQ basis, in line with the company guidance. YTD occupancy levels have seen only a marginal improvement on a same-store basis; physical occupancy witnessed a meaningful improvement during the quarter. Over the last one to two quarters, new headwinds have emerged for REITs: 1) Slower leasing demand driven by global tech hiring slowdown. 2) Delays in DESH bill leading to continuing vacancies in SEZ spaces. 3) 2023 budget changes impacting unitholder returns negatively. REITs are down ~20% from their peak/over last six months, although long-term fundamentals remain intact.

Q3 performance insipid, though broadly stable:

NDCF Distribution across three REITs was largely flat QoQ for Q3, and has been broadly in line with the guidance. NOI also witnessed a flat-to-marginal growth QoQ. For M9FY23, while NOI witnessed a robust growth (EOP 11.7%/MREIT 15%/BIRET - NM), it did not translate into NDCF growth (M-REIT: +3%/ EOP: -2.4%); driven largely due to higher interest costs and working capital-led outflows. Occupancy levels over M9FY23 have improved on a same-store basis, for EOP 1ppt (S-S-S), M-REIT 1.5ppt, BIRET 0.5ppt. Blended occupancy for Embassy has declined 1ppt due to addition of new area.

Further, REITs continue to pursue growth through: 1) Brownfield expansion – 6.6/3.1/0.5msf of assets are under construction for EOP/MREIT/BIRET respectively, and 2) Considering acquiring sponsor assets (EOP/M-REIT/BIRET – 7.1/2/6.5 msf respectively). Net Debt-to-GAV has been broadly stable for EOP, MREIT and BIRET at 27% (vs 26% QoQ), 17.6% (vs 16.8% QoQ) and 32% (vs 31% QoQ) respectively.

Leasing demand outlook muted: 

REITs have stated that large RFPs have slowed down in recent quarters, given the slowdown in hiring in the tech space. Companies in the US have paused capex on built-tosuit campuses. However, smaller RFPs between 50,000 to 100,000sq.ft continue to be in good demand. According to C&W, the total Q3FY23 net absorption still came in healthy at 11msf (up 11/25% YoY/QoQ), at an industry level. For CY22, the net absorption is ~37msf (up 66% YoY).

Budget changes a dampener for unitholders, Analysts at IIFL Securities await clarity:

The budget has proposed to tax ‘repayment of debt’ (ROD) from REITs in the hands of the unitholder as income from other sources (at maximum marginal rate of tax). On an average, EMBASSY and BIRET have 37-47% of their distribution as ROD; hence, their post-tax distribution yield could be impacted up to ~1.2-1.4ppt. This will be applicable from FY24.

DESH Bill critical for full recovery in occupancy levels: 

Listed REITs have a high exposure to SEZs, 60-87% of their portfolio; vacancy levels in the SEZ is ~60-87% of the total vacancy of listed REITs. Government was planning to bring in the DESH bill in the budget session. There could be delays and consequently, the REITs are asking govt to allow partial de-notification as part of the exiting SEZ law.

Stocks down 20% in six months; Analysts at IIFL Securities see a long road to recovery:

REITs have delivered a total annualised return of 7-13% since their respective listing timelines, driven by their recent under-performance. For FY23/24, analysts at IIFL Securities see REITs yielding 6-7.4%/ 6.6-8% pre-tax respectively. However, for FY24, post tax yields could be 5.3-6.4% assuming full tax on repayment of debt. REITs are currently trading at 14- 24% discount to NAV and offer an attractive entry point.

Analysts at IIFL Securities retain BUY rating EOP and ADD on M-REIT & BIRET, and await clarity or confirmation on tax changes.