Board REITs to ride office real estate recovery, absorption hits 8-qtr high

A severe third wave of the pandemic could reverse the ongoing upswing in REIT prices

The office real estate market is recovering from the disruption caused by the Covid-19 pandemic. According to JLL’s office market update released this week, net absorption of office space was 11.56 million square feet in the October-December quarter of 2021, the highest in the past eight quarters and up 86 per cent quarter-on-quarter. This augurs well for Real Estate Investment Trusts (REITs), which invest in commercial real estate (primarily office space).  

A REIT collects money from investors and invests it in a portfolio of real estate assets that yield rental income. Three REITs are listed on the exchanges currently: Embassy Office Parks, Mindspace Business Parks, and Brookfield India.

According to Vikaash Khdloya, deputy chief executive officer (CEO) and chief operating officer (COO), Embassy REIT, “Collectively, the three Indian REITs own around 88 million square feet (mn sq ft) of office space with a total operating area of 66.4 mn sq ft. This is 10 per cent of India’s 650 mn sq ft Grade-A office stock in the top metro cities.”

Multiple benefits

REITs allow retail investors to invest in best-in-class properties that would otherwise not be available to them owing to large ticket sizes. Investors are also able to spread their capital across multiple properties, something they wouldn’t be able to do on their own.

REITs also offer regular and stable income. “They can provide stable returns even in uncertain times. The properties that the REIT owns pay rental, which the REIT distributes to investors as dividend or interest,” says Piyush Gupta, managing director, capital market and investment services, Colliers India. He informs that listed REITs have provided an annualised distribution yield of 6-7 per cent, higher than the 2-4 per cent rental yield residential properties offer. In addition, they also offer the potential for capital gains.

Easy access

Towards the end of June 2021, the Securities and Exchange Board of India (Sebi) lowered the minimum investment amount in REITs from Rs 50,000 to Rs 10,000. It also revised the minimum lot size from 200 to one unit.

“This step brought REITs on a par with other equity instruments and enhanced their appeal among retail investors. As trading volumes rise, liquidity will improve, resulting in better price discovery,” says Gupta.

Diversify beyond debt

REITs can provide regular income to investors as they are mandated to distribute at least 90 per cent of the rental income they receive. More than 80 per cent of their investments must be in completed assets.    

Interest rates are likely to harden in the future, which would lead to a mark-to-market impact on medium and long duration bonds and bond funds. “In such an environment, investors may re-allocate a part of their fixed-income portfolio to REITs,” says Amit Gupta, fund manager, PMS, ICICI Securities.

However, REITs are not a perfect substitute for fixed-income instruments as their prices tend to fluctuate.

Vacancy and price risk  

The ongoing Covid-19 wave could affect office space absorption, at least in the short term. “The performance of REITs is linked to the absorption of office space. If vacancy increases, it could impact the distribution of income to unitholders,” says Gupta of Colliers India.

Another risk arises from fluctuation in market price. When sentiment in the commercial segment turns negative, prices of REITs head south, as has been witnessed over the past year. (However, some recovery is also evident over the past six months.) According to Gupta of Colliers India, prices of REITs can at times fluctuate due to general market-related factors also.  

Sticky inflation could make the rental yields from REITs less attractive, while rising interest rates could make the yields on shorter-term bonds more attractive.

Do the due diligence

Before investing, do the due diligence and select a well-managed entity. “Learn about the management team’s track record. Look for earnings growth, which comes from higher occupancy rates, rising rents, and lower costs. New business opportunities must also be available to the REIT,” says Gupta of ICICI Securities. Begin by investing 5-10 per cent of your portfolio in them.