Stock Fundamentals

Despite ‘work from home’, the stock of Embassy REIT is a good buy

Bavadharini KS | Updated on October 23, 2020 Published on October 23, 2020

Large client base, prime locations and steady rental collections are positives

 

The office real estate market in India is undergoing a challenging phase since the outbreak of Covid-19. According to a report by Knight Frank, a real estate consultant, the demand for office space declined by about 37 per cent y-o-y between January and June this year. Supply of office spaces, too, fell by 28 per cent y-o-y during the same period.

However, big corporates, especially from sectors such as IT/ITeS, banking and financial services, and e-commerce have continued their occupancy.

Hence, large players in the office segment with properties in favourable locations have been able to not only maintain rental collections but also achieve rental escalations in FY21.

Embassy Office Parks, one of the largest office space players, is a REIT (real estate investment trust) which has so far been able to withstand the headwinds in the market. It has a large client base, properties in prime locations and a strong balance sheet with a comfortable debt position.

The REIT has 11 commercial offices, and nearly 90 per cent of its properties are occupied and are generating income.

Considering its resilience, Embassy REIT could be a good alternative investment avenue for investors with an appetite for risk.

The REIT has distributed ₹24.39 per unit in FY20 and the yield (pre-tax) works out to around 7 per cent. It has been able to pay out ₹6 per unit to investors in the June quarter — at the same levels as in the few quarters preceding the Covid-19 outbreak.

While the stock touched ₹320 during the market lows in March, it has not moved up much, considering the uncertainties surrounding the office market in general. At the current market price, the REIT is trading at a discount to its NAV of ₹374 as on June 30, 2020.

Steady rental collections

During the September quarter of FY21, Embassy REIT was able to collect nearly 98 per cent of the rents (on 26.2 million sq ft of operational office space) from its tenants. It is an indication of stable and quality client base — about 160 companies, most of which are Fortune 500 firms, including Cognizant, IBM, Google and McAfee. This should keep the company in good stead.

Embassy REIT was also consistently able to maintain its occupancy at 92-93 per cent even during the lockdown period. Thus, the impact of Covid-19 to its overall portfolio (in terms of occupancy) has so far been only 6 per cent, according to the management. This includes companies from sectors such as aviation, hospitality, co-working and retail.

With restrictions across the country being slowly lifted, these companies, too, could come back.

Further, Embassy REIT’s average rent works out to ₹69 per sq ft per month (across its office properties) while the average market rent is ₹89 per sq ft per month.

The lower rentals clubbed with location advantages help Embassy retain/draw new clients.

Also, the average lease tenure is 5-9 years with an initial commitment of 3-5 years. The REIT is able to quickly renew contracts nearing expiry withexisting tenants or lease it to new tenants. For instance, in the June quarter of FY21, despite the pandemic, the REIT was able to lease/renew a portion of leases, about 0.4 million sq ft, which is about to expire in FY21 (total expiry of 1.9 million sq ft leases, accounting for 7 per cent of its portfolio ).

The company is in discussions to lease an additional 0.2 million sq ft in 1-2 quarters, according to the management.

The REIT also has contractual escalation every three years. For the September quarter, it was able to achieve about 11 per cent rental increase from 1.9 million sq ft of office properties.

Some challenges

While Embassy REIT has been able to maintain its rental collections as well as achieve good occupancy, the demand for office space could face a slowdown.

On the lease expiry front, about 1.3 million sq ft (of 1.9 million sq ft expiring in FY21) is likely to exit due to the impact of the virus, lockdown measures and cost pressure; though, according to the management, about 0.8 million sq ft is part of the normal occupier churn.

For under-construction properties (of about 2.7 million sq ft), the REIT could face two problems.

One, it could face delay in completion of projects by 2-3 quarters, as the construction activities are yet to pick up to their full capacity. However, construction activities as of the June quarter of FY21 is at nearly 80 per cent capacity.

Two, the rental pre-commitment could come under pressure. According to the management, Embassy anticipates leasing decisions to be deferred over the next 2-3 quarters while corporate occupiers figure out their strategy in terms of operations (work-from-home or otherwise).

Financials

Embassy’s overall revenue for the quarter ended June 2020 declined 4 per cent y-o-y to ₹516 crore, predominantly due to the impact of Covid-19 on the hospitality business.

The REIT’s net operating margin improved to 88 per cent, from 85 per cent during the same period last year, due to lower operating expenses. But its profit fell to ₹204 crore, down by 8 per cent y-o-y, mainly due to higher finance costs.

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Published on October 23, 2020
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