Improving leasing trends to support and lay bricks of value for Reits

Grand Design: New SEZ rules and rising GCC leasing set to elevate occupancies and rentals, benefiting Reits and office-focused developers

With the quarter witnessing the highest quarterly gross leasing for a few listed players, coupled with expectations of rising demand for office space, it is positive for listed commercial developers as well as real estate investment trusts (Reits).
 

The recent rules on special economic zones (SEZs) and increasing lease activity by global capability centres (GCCs) are expected to boost both occupancies and rentals going ahead. This will not only benefit pure-play commercial asset owners such as the four listed Reits but also developers with significant office portfolios, such as DLF and Brigade Enterprises.
 

The immediate trigger for the stocks is the strong performance in the October-December quarter, as well as calendar year 2023 (CY23). The recovery in demand for office space has benefited Reits, as gross leasing saw an improvement in the quarter.

Both Embassy Reit and Brookfield Reit posted their highest-ever quarterly gross leasing since their initial public offering.

The worry for the sector has been a significant quantum of exits, largely due to slowdown concerns in the software and 

information technology-enabled services (ITeS). This has resulted in net leasing (new leases less exits) being in the negative.

However, while exits have continued, the pace of the same has reduced, and all major developers have reported net leasing to be in positive territory in the quarter.
 

Nuvama Research points out that in the third quarter of 2023-24, rentals saw an improving trend. Analysts Parvez Qazi 

and Vasudev Ganatra of the brokerage highlighted that rents have risen steadily for all office Reits on the back of healthy 

mark-to-market rates when rentals come up for renewals.
 

The analysts also expect the distribution per unit (DPU), which has witnessed a flat to declining trajectory over the past few quarters, to reverse going ahead. The lower DPUs were on account of lower occupancies over the past few quarters and were brought on by higher exits.
 

While not alarming, the brokerage has pointed out that the net debt to gross asset value ratio is rising slowly, as most Reits 

are in expansion mode. The higher leverage, given increased borrowing and higher interest rates, is, however, well below the regulatory cap of 49 per cent for all Reits.
 

The trend of higher rentals has been the case through 2023.

 

Elara Capital Research, citing real estate consultancy Knight Frank, points out that despite global volatility, India’s commercial real estate market was resilient in 2023, with office leasing rising by a notable 15 per cent year-on-year, resulting in the absorption of 59.6 million square feet (msf) in CY23 and within striking distance of historical highs.
 

This growth is predominantly led by employees returning to offices and the expansion of global companies’ operations in India. With the increase in transaction volumes, rentals also stabilised in various micro-markets.
 

Occupancies have also been steadily increasing across markets and are believed to be in the 57 per cent to 65 per cent range in the Reit portfolios, compared to 47 per cent to 55 per cent last year, says Knight Frank. A key trigger for the sector is the sharp rise in demand for leasing from GCCs. The second half of 2023 particularly witnessed the highest GCC leasing activity since 2020, reaching 12.4 msf.
 

Real estate services major Colliers India, in a recent report, said that over the next two years, GCCs are expected to lease 

45-50 msf of office space, accounting for 40 per cent of the total office demand across the top six cities. Improved business sentiment and a positive economic outlook are fostering heightened demand for office spaces in India, particularly signalling confidence among foreign-origin companies seeking to establish their capability centres in the country.
 

In addition to technology and banking, financial services and insurance sectors, the growing interest of occupiers from 

engineering and manufacturing and healthcare sectors is expected to diversify the GCC landscape further, says Arpit Mehrotra, managing director, office services, Colliers India.
 

The other trigger is new SEZ rules, which are expected to boost office demand.
 

In December last year, the SEZ rules were amended, allowing developers of IT/ITeS SEZs to designate portions of built-up areas as non-SEZ space, which is expected to alleviate concerns of rising vacancies after the removal of tax breaks for new SEZ units in March 2020.
 

While JM Financial Research and Nuvama Research have a ‘buy’ rating on the four listed Reits, what could act as a rerating trigger for Reits, according to the latter, is a potential interest rate cut over the next year.