Multiple tailwinds likely to reverse REIT underperformance in markets

Stocks of listed real estate investment trusts (REITs) gained by as much as 11 per cent over the last two trading sessions after the government amended the rules for special economic zones (SEZs).

The notification allows identification of non-processing areas within an SEZ enabling asset owners to re-lease these areas once the process is completed.

Vacancies increased after tax benefits for new units in SEZs from March 2020 were withdrawn. 

Commercial real estate players, especially large asset owners such as Embassy, Mindspace, Brookfield and DLF, were bearing the brunt of vacancies in SEZ space even as the non-SEZ space was witnessing improving occupancy trends.

The amendment to SEZ rules will allow such asset owners to pursue need-based de-notification that would help improve the overall portfolio occupancy, say Murtuza Arsiwalla and Abhishek Khanna of Kotak Research.

Within the listed space, Embassy Office Parks REIT (Embassy) has the highest vacant areas within SEZs at 4.2 million square feet followed by Brookfield India Real Estate Trust (Brookfield), Mindspace Business Parks REIT (Mindspace) and the commercial arm of DLF, DLF Cyber City Developers or DCCDL.

In terms of SEZ share as a proportion of office portfolio, Brookfield has the highest exposure at 77 per cent, followed by Embassy at 60 per cent.

While the share of SEZ assets in office space for Mindspace at 56 per cent, it is the lowest for DCCDL at 46 per cent.

It is no surprise then that the stock of Brookfield has gained 11 per cent in two sessions followed by Embassy with gains of nearly 10 per cent.

Mindspace was up 2 per cent while DLF, which hit its 52-week high intraday, finished marginally lower over Wednesday’s close. 

Nexus Select Trust, which was listed in May this year, was flat over the last two sessions. 

In the September quarter, blended occupancies declined on a sequential basis on higher than expected expiries in information technology (IT) and IT-enabled services.

Brokerages expect occupancy levels to turn net positive over the next two or three quarters.

The listed REIT players have indicated that improved demand from global captive centres and Indian corporates is expected to outweigh the weak outlook from IT and ITES segments going ahead. 

Mohit Agrawal and Saatvik Shetty of IIFL Research expect FY25 to be a strong year for Office REITs, aided by improving demand, SEZ de-notification, return to office aiding occupancy levels with the best case in FY24 being flat occupancy levels year-on-year (Y-o-Y).

They, however, expect high interest rates to keep dividend per unit (DPU) growth in check for FY24 and FY25 while FY26 should see strong growth in DPU.

Office REITs have underperformed their residential and retail asset counterparts since the pandemic due to weak operating performance on account of work-from-home trends that was followed by vacancies in SEZ space.

Multiple tailwinds (SEZ denotification, return to work, demand from financial services/other corporates) should enable the REITs to reverse their sharp underperformance compared to the benchmarks, broader markets as well as their realty peers. 

Kotak Research expects a return to office, SEZ amendment to address vacancies, earnings and consequently unit performance going ahead.