Strong leasing activity to benefit Real Estate Investment Trusts

But slowdown in the US and rising interest rates could pose risks

With the calendar year expected to be a record one for commercial real estate, listed majors in the segment are set to be major beneficiaries.

The return-to-office trend has led to increase in leasing activity, higher occupancies, rising rental income and mark-to-market gains on renewals.

This will help real estate investment trusts (REITs) such as Embassy Office Parks REIT and Brookfield India Real Estate and Mindspace Business Parks REIT, which are a direct play on the upward trend in leasing of offices.

Property consultancy Knight Frank India highlighted that the commercial office sector hit a seven-quarter high in Q2 (September quarter) with transaction volumes at 16.1 million square feet across the top eight cities in India. The volumes, which grew by 29 per cent year-on-year (YoY), have exceeded the pre-pandemic average in 2019 by 6 per cent.

Bengaluru, the largest office market, accounted for 45 per cent of the leasing space, growing at 71 per cent over the year-ago quarter. In addition to the increase in new leasing activity, rentals have also increased in key markets with the metric up 13 per cent YoY in Bengaluru.

Given the year-to-date volumes of 40.6 million square feet — which has nearly doubled over the year-ago period — CY22 is expected to be a record year.

Canada-based real estate services and investment management company Colliers expects the current year to emerge as the best one in terms of office space leasing. Absorption is likely to be 50 million square feet across the top six cities. Leasing decisions, which were postponed during the last two years, are being taken now, leading to a spurt in demand.

In the near term, the Street will take cues from the September quarter results of REITs. Among the listed REITs, Brookfield’s net sales in Q2 of FY23 are expected to rise by 42 per cent YoY to Rs 308 crore.

Kotak Institutional Equities expects rentals of Rs 220 crore due to inclusion of the acquired asset Candor TechSpace N2, the largest office park in Noida. It has a gross leasable area of 4.5 million square feet. The asset was not in the base quarter as it was acquired in December last year. The company had an operational area of 14.2 million square feet as of June 2022 with occupancy levels remaining steady at 83 per cent.

Revenue growth (YoY) for Embassy and Mindspace are expected to be higher by 16-17 per cent each. Embassy, the largest REIT, has an operational area of 33.8 million square feet with occupancy of 87 per cent.

Nirmal Bang Research expects the company to lease out 1.5-1.8 million square feet in Q2, given the strong demand from captive centres and IT companies. The mark-to-market opportunity for new leasing and renewals is pegged at 47 per cent.

For Mindspace, revenue gains in the quarter will be led by increased hiring by IT companies and improving rental income as new office leasing and renewals come at 15 per cent mark-to-market uptick.

The company, which has an operational area of 24.4 million square feet, is expected to improve its asset base during the quarter with acquisitions in Hyderabad, expanding its lease space by 1.8 million square feet.

Kotak Institutional Equities has an add rating for the three listed REITs. It expects Embassy to see superior growth compared to Mindspace and Brookfield. HBSC, in an earlier report, indicated its preference for Embassy over Brookfield on potential mark-to-market gains and a higher share of under-construction properties.

Even as office leasing remains strong, brokerages such as JP Morgan highlight a few risks. Says Saurabh Kumar of the brokerage, “Guidance from most office developers is for 90 per cent-plus occupancy levels; however, that could be challenging, given the risk from a US slowdown and the risk on valuations from higher interest rates.”

The stocks of Embassy and Brookfield are down about 7-9 per cent each from their August highs with Mindspace faring a little better on the returns front.