After a pandemic-led lull of two years, demand for commercial spaces is rebounding strongly. With employees coming back in increasing numbers every week, leasing of prime office space is kicking into higher gear. For those looking to bet on the revival in realty, this could be a good entry point into listed real estate investment trusts (REITs).
REITs are a new investment avenue that pool money from retail and institutional investors to own and operate income-generating commercial assets. These allow even smaller investors to invest in Grade A office spaces at lower ticket sizes. Currently, three REITs are operational in India—Embassy Office Parks, Mindspace Business Parks and Brookfield India. REITs are mandated by SEBI to invest 80% of their portfolio into pre-leased assets.
These are further required to distribute 90% of the income to their investors, either in the form of dividends or interest, or both. These REITs faced the brunt of the shift to work-from-home environment in 2020 and 2021 when the pandemic was wreaking havoc. After record leasing absorption activity of 42 million sq ft in 2019, the last two years saw net absorption drop to 20 msf—a sharp 50% decline from 2019.
However, according to Cushman and Wakefield, 2022 has started on a bright note with net absorption across India’s top seven cities rising 65% y-o-y to 6 msf in January-March 2022 inspite of Omicron related disruptions. The absorption was driven by the infusion of new supply of 14 msf of which a significant portion was pre-committed. The quarter also saw pre-commitments of 3.2 msf for larger transaction sizes which augurs well for a recovery in the remainder of 2022. While the global surge in Omicron cases from December With India one of the more affordable office markets in the world, potential for growth is high.
Bet on REITs for play on realty revival 2021 onwards has temporarily delayed the recovery in office leasing by a quarter, analysts expect this trend to reverse from April. The improved pace of vaccinations across India, recall of employees to offices and gradual pick-up in international travel are likely to lead to uptick in office leasing. “We expect net absorption to rise from April 2022 onwards and estimate net absorption of 26.8 msf in 2022 and 30 msf in 2023,” observe analysts at ICICI Securities. Embassy Office Parks REIT, the first listed real estate investment trust, has doubled its leasing guidance to 5 million sq ft for 2022-23, on the back of new leases and backto-office shift for employees.
Analysts remain confident about potential for commercial realty given that India remains one of the more affordable office markets in the world. Average rentals for Grade A office markets in peripheral or suburban micro-markets in the country hovers around $ 1 (Rs.76) per sq ft per month. Further, India’s unique strength in terms of high quality pool of talent with over two million students in science, technology, engineering and mathematics graduating each year remains a big draw for MNCs.
And yet, employees’ costs in India are estimated to be only 20-25% of comparable cost for employees in the leasing company’s country of origin. Companies in the IT-ITES sector retain lead in office occupancy with 35-40% share. The aggressive growth and hiring plans of leading IT majors bodes well for office space absorption in the country. Further, co-working spaces that have emerged as another significant driver over 2018-21, will continue to see demand going ahead given the focus on cost optimisation by occupiers. “The need for office space will pick up as economic activity reverts to normal,” reckons Feroze Azeez, Deputy CEO, Anand Rathi Private Wealth.
Put together, the prospects appear bright for the listed REITs in the coming years, making them a good investment proposition. ICICI Securities analysts expect the three REITs to offer distribution yields of 6-7% over 2023-24 along with 3-17% capital appreciation. Embassy Office Parks REIT is the biggest of the three, with 33.6 msf of leasable office space in its portfolio. It also enjoys the highest occupancy with 87% of its assets ing rentals. Nearly 85% of its office space is in Bengaluru and Pune. Meanwhile, Mindspace Business Parks REIT has a committed occupancy of 84.6% as of December 2021 spanning 24.2 msf of completed office space. 81% of this office space is located in Mumbai and Hyderabad. Brookfield India REIT’s 14 msf of leasable space—largely in NCR and Kolkata—is 83% rented out. There is enough scope for occupancy rates to go up further for all three players.
However, there are some potential risks lying ahead. All three REITs have significant leases coming up for expiry in 2022-23. If renewals drop and vacancies rise amid further Covid-led disruptions, yields from REITs will be at risk. Further, the expected uptick in interest rates is a big risk, given its depreciative impact on asset values, warns Azeez. In this scenario, he reckons investors would be better off investing in a REIT that is newly set up rather than an existing REIT, as it will allow for capturing higher rental yields.
The minimum amount that a small investor can put in a REIT is Rs.50,000 during the IPO or equivalent to value of 200 units when buying on the exchanges. Any rental, dividend or interest income earned by the REIT is taxable in the hands of the investor at the applicable slab rate. The trust deducts tax (TDS) on such receivables at 10%. Meanwhile, capital gains arising from sale of REIT units are treated at par with equity in terms of the tax rates. Short-term gains are taxed at 15% and long term gains in excess of Rs.1 lakh in a year at 10%. However, the period of holding the asset, for classification as long term or short term, is that of debt and not equity (3 years).