BL Research Bureau

At a time when the real estate sector is in doldrums with the S&P BSE Realty index declining 4 per cent in the last year and 2 per cent in the last six months, Embassy Office Parks REIT (real estate investment trust) has given nearly 24 per cent return since its listing in April this year. Here’s why:

Stable commercial market

While the residential real estate sector continues to struggle, the commercial realty market in India seems robust with double-digit rental growth over the past year or so. Unlike the supply overhang in the residential market, the office market is seeing lack of availability of quality office spaces. This has worked to the advantage of Embassy Office Parks REIT which has about 33 million square feet of commercial assets. The REIT has been able to consistently maintain an occupancy rate of 93-94 per cent over the past few quarters across its key office markets in the country - Bengaluru, Mumbai and Pune. As of June 2019, nearly 1.4 million square feet of new projects (Bengaluru and Noida) are two quarters ahead of targeted delivery, as per the company’s report. This is driven by healthy demand.

The demand for office spaces is primarily driven by IT/ITeS and also sectors such as e-commerce and co-working spaces. Here, Embassy REIT is at an advantage as it has over 160 marquee clients, of which nearly half are IT and technology companies such as IBM, Cognizant and McAfee. The average lease tenure for the company is 5-9 years with 3-5 years as the initial commitment. In the June 2019 quarter, Embassy REIT let out 5.95 lakh sq ft of new leases. Of this, expansion by existing tenants accounted for 57 per cent of the office space taken up. Embassy REIT has contractual lease escalation of 15 per cent every three years.

Read: For Embassy REIT, stress in realty is a boon

The net absorption of office space in the commercial segment is expected to exceed 39 mn sq ft by 2020 on the back of strong supply pipeline and stable vacancy levels, according to a report by property consultant JLL. Embassy has planned to launch 4 million sq ft in the next four years. With the demand for office spaces expected to remain high, the company should be able to improve its client base and occupancy level.

For instance, infrastructure improvement such as the Metro system around Noida-Greater Noida expressway has aided the demand for office space. In the Embassy Oxygen project (tower II - 0.6 million sq ft) being developed in Noida and expected to be completed by Q3FY20, about 2.46 lakh sq ft is already let out to MetLife.

Large office portfolio helps

Embassy REIT has seven office parks and four office buildings in prime locations of Bengaluru, Pune and Noida. Over 40 per cent of the revenue is contributed by the top 10 clients. With most of the company’s clients from the IT/ITeS sector, there is an element of concentration risk. But the company has been able to maintain a healthy client retention rate of 81 per cent in the last three years, thanks to long-term lease contracts and quality client base.

The REIT also generates income from its amenities such as hotels, car parking, food, and facility maintenance.

In the June 2019 quarter, Embassy REIT reported revenue of ₹535 crore, an increase of 19 per cent from the year-ago period. Lease escalations contributed almost 60 per cent of the revenue, lease renewals contributed 30 per cent and amenities the rest. The net operating income margin stood at 85 per cent in the recent quarter, the same as in the year-ago period.

Though the commercial segments of other realty companies have performed well, the segment usually contributes less than 30-35 per cent of their revenue. Therefore, the margins of these companies have come under pressure due to the slowdown in the residential real estate segment which contributes over 60 per cent of their revenue. In the last six months, most realty stocks have delivered a lacklustre performance.