Investors in commercial real estate, including listed real estate investment trusts (Reits), are likely to see a fall in rental yields in the coming months as leases expire and pandemic fears depress fresh leasing.
There are three listed Reits in India—Embassy Office Parks, Mindspace Business Parks and Brookfield India Reit—that invest in grade-1 properties.
Since the pandemic outbreak in March 2020, vacancies at office properties have risen by 300 basis points (bps) to touch 16.6% in June 2021 and are expected to rise 200-300 bps this fiscal year, according to ICICI Securities. This is mainly due to the devastating second wave in April, which is expected to keep ‘work from home’ as the norm in the foreseeable future at many large firms that typically lease properties, according to industry watchers.
“In line with industry trends, there has been a rise in portfolio vacancy levels by 4-6% on a like-to-like basis for Embassy Reit, Mindspace Reit and DLF in FY21, while Brookfield Reit retained flattish occupancy levels in H2FY21. This was owing to exits by tenants for scheduled expiries and early exits as well. Heading into FY22E, the second covid wave may lead to a further rise in vacancy levels of 200-300bps in H1FY22,” ICICI Securities said in a 13 July report.
While green shoots began emerging in January with a pickup in leasing enquiries and large pre-leasing transactions, the second wave may delay the recovery in the office market further, the brokerage said.
While the Embassy Reit unit price is up 3.25% since 1 January, Mindspace Reit is down 11.86%, and Brookfield India Reit, which listed on 17 February, is down 3.3% from its issue price of ₹275. All three Reits have significant leases coming up for expiry in FY22. According to a 6 July report by Investec, the Brookfield Reit has around 14% of gross rentals expiring in FY22. Embassy has given guidance for 1.9 million sq. ft (msf) of upcoming expiries in FY22, comprising 6% of gross rentals of which 0.5 msf is likely to see renewal comprising 2% of revenue, the Investec report said, while the remaining 1.4 msf likely exits comprise 4% of revenue.
ICICI Securities noted that for the Mindspace Reit, overall portfolio occupancy fell by 350 bps quarter-on-quarter to 81.8% in Q4FY21 from 85.3%, with exits in Hyderabad and Airoli West assets. “With another 2.3 msf of expiries in FY22E, portfolio vacancy levels are at risk of increasing further heading into H1FY22E with a possible recovery from H2FY22E,” it said.
“The distributions are linked to the rental income you generate; so, there will be a direct impact if your vacancies go up. Corporates are trying to keep costs low, and so they are willing to give up space till the time they take a call on going back to office,” an analyst at a domestic broking firm said. “However, collection efficiency continues to be very high at 99% for Reits, which means existing tenants continue to pay rent entirely and rental rates haven’t fallen that much, so the impact is limited,” he added on condition of anonymity. To be sure, while the second wave soured recovery for office properties, Reit managers believe things will turn around from October-December.
“We are hearing strong sentiment from occupiers that they want to get people back to office, and that is likely to happen in Q4 of the calendar year, supported by vaccinations. We are also hearing about a strong hiring and business pipeline from our type of occupiers, specifically the IT services firms,” said Mike Holland, CEO of Embassy Office Parks.
“We also have a situation where the two-year forward supply is down by over 20%; so, less supply will be coming into the market. Once companies get back to offices, you will start to see demand for new office space picking up, and there will be less supply. So we are feeling pretty good on the medium- to long-term outlook for our type of product,” said Holland.
“Considering the current market landscape and available investment opportunities, Reits continue to be one of the favoured investment avenues given the comparatively resilient underlying cash flows. While the office landscape has transformed amid the pandemic, the segment is expected to emerge stronger in future. With a gradual lifting of lockdown restrictions and the government’s mass vaccinations drive, we can expect businesses to display an increased inclination towards co-working/flexible spaces to meet evolving real estate needs,” said Anshuman Magazine, chairman and CEO-India, South-East Asia, Middle East and Africa at real estate consultant CBRE.
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