With work from home ending, Reits have turned the corner. Will retail investors line up?

Neeraj Chopra worked incredibly hard and gave it his all to achieve his personal best throw of 89.45 metres. On any other occasion, that would have been enough to ensure a first-place finish. But as it turned out, Pakistan’s Arshad Nadeem clocked a monster throw of 92.97 metres, smashing the Olympic record and walking away with the gold medal.

Something similar is happening with Reits and the equity markets.

While improved office leasing is pushing Reits’ net operating incomes and distribution per unit (DPU) upwards, the raging bull run on Dalal Street has eclipsed the former’s performance.

Retail investors looking to take exposure to the real estate market are preferring stocks or thematic mutual funds over other options. Not without reason.

The Nifty Realty index has soared over 90% over the past year. Some individual stocks have delivered even more bombastic returns during the period, including Prestige Estates Projects Ltd (up 227%) and Sobha Ltd (207%).

However, it would be erroneous to compare hybrid fixed-income instruments such as Reits with stocks.

Reits derive cash flows from owned commercial realty assets as rental income, most of which is distributed among unitholders. Hence, the total return offered by a Reit is measured as a mix of regular distribution and capital appreciation of the units of the trust. In stocks, most of the price gain is from capital appreciation, especially at this juncture of the bull run, with dividends contributing marginally.

Reits became a talking point earlier this month when US-based Hindenburg Research alleged that since Madhavi Puri Buch was appointed chief of the Securities and Exchange Board of India (Sebi) in March 2022, the market regulator has implemented a raft of regulations on Reits. It alleged that the appointment of her husband, Dhaval Buch, as senior advisor to Blackstone Group benefited the asset manager, which has been a sponsor and stakeholder in many Reits.

How Reits work

A Reit is a trust that owns a pool of income-generating commercial real estate assets, such as office parks and shopping malls, held in a special purpose vehicle (SPV). It generates revenue by leasing out these properties and collecting rent from tenants.

Sebi regulations require at least 80% of a Reit’s assets to be completed and income-producing. In addition, Reits are mandated by the regulator to distribute at least 90% of their cash flow to unit holders. After deducting expenses, the remaining cash, known as net distributable cash flow (NDCF), is distributed to unit holders.

Although Sebi gave these trusts the green light in 2014, India has only three listed office Reits: Embassy REIT, Mindspace Business Parks REIT, and Brookfield India REIT. It also has one listed retail Reit: Nexus Select Trust.

Some of India’s top office parks and shopping malls are owned and managed by these Reits, including Downtown Powai in Mumbai; Embassy Tech Village, Bengaluru; Mindspace Madhapur in Hyderabad; Nexus Select Citywalk in Delhi; and Nexus Koramangala, in Bengaluru.

As per the Indian REITs Association (IRA), the four listed Reits collectively manage assets worth over ₹1.4 trillion, serving more than 240,000 unitholders. These Reits have distributed over ₹18,000 crore, with their market capitalization reaching the ₹1 trillion mark.

Analysts say Reits are a good diversification option for investors who are looking to get relatively stable cash flows. These instruments, which are ‘moderate risk, moderate return’, are not meant to replace the equity component of a portfolio.

Reits have faced their share of challenges in recent years, many of them pandemic-induced. But now, with the office market turning around and higher acceptance of the product, growth is on the anvil.

Stumbling blocks

Turn up in office or risk losing your job, IT firm Cognizant Technology Solutions warned defiant employees in April. The company has over 200,000 employees in India.

Cognizant’s problems epitomize a challenge faced by the industry as a whole since the covid pandemic—IT/ITes (IT-enabled services) firms, which are the largest occupiers of office space in the country, have been struggling to bring employees back to office. With employees working from home, over the last few years, many companies had given up office space, which hit Reits hard.

“All Reits faced the issue of exits. Tenants changed their business models and looked at hybrid structures. As a result, downsizing and recalibration happened until the March quarter of FY24. Occupancy numbers are slowly inching upwards and tenant exits are slowing down," said Preeti Chheda, executive committee member, Indian REITs Association.

Many tenants also didn’t want to continue in special economic zones (SEZ), which constitute a large part of most office REITs. “Vacancy levels were maximum in the SEZ spaces in Reit portfolios," said Chheda.

Aravind Maiya, CEO, Embassy REIT, said a Reit’s cash flows depend on occupancy. Pre-covid, Embassy REIT’s occupancy was at 95%, after which it dropped to 83%. Now, it has moved up to 85%.

“Logically, reduced rentals mean reduced cash flows. While we had the (rental) escalations coming in, distribution remained flat and didn’t see growth. For distribution to grow, occupancy has to be high and the portfolio needs to grow as well," said Maiya.

Distribution per unit (DPU, which is dependent on cash flows earned) and price to net asset value (NAV) are two key metrics that investors consider while investing in Reits. Both have been underwhelming.

Reits have exhibited notable market price to net asset value (NAV) discounts, underlining the divergence between their stock market prices and the estimated value of their underlying real estate assets.

Currently, the discount to net asset value or NAV across Reits ranges between 3% to 20%, as per Avendus Wealth Management Research’s estimates.

But the tide is turning for Reits. “Occupancy is on the rise. Interest rates are turning favourable. Additionally, the government has allowed floor-by-floor denotification of SEZ units, which will provide flexibility in leasing the space. The trend of global capability centres (GCCs) expanding in India will help increase the demand for office spaces. Most of the issues that concerned Reits are behind us," said Shravan Sreenivasula, executive director-investment solutions, Avendus Wealth Management.

On the road to recovery

On the regulatory front, the Centre’s move last December to allow partial denotification of SEZs in IT and ITes parks has prompted Reits to denotify SEZ spaces. This is critical because most Reits faced vacancies in their SEZ spaces, as tenants exited due to higher compliance norms and few tax benefits.

The impact of denotification is already visible. Brookfield India REIT initiated conversion of 1.5 million sq. ft of SEZ space to non-processing areas across its properties. Around 0.6 million sq. ft at Candor Techspace, Kolkata, has been converted and leased to HDFC Bank. Office spaces at Gurugram and Noida are in the final stages of conversion.

Mindspace REIT and Embassy REIT, too, have been actively leasing office spaces as and when they are denotified.

In FY24, Brookfield India REIT recorded its strongest performance since its IPO in February 2021, led by a recovery in leasing demand and growth in net operating income (NOI), said CEO and managing director Alok Aggarwal.

“We expect significant growth in NOI, leading to increased distributions, with the dividend component of distributions improving to above 20% in the next 4-6 quarters. This underlying operational growth should, in turn, result in asset price appreciation," Aggarwal said.

The recent Q1 performance of Reits has also been encouraging, indicating a revival in the commercial real estate segment after the pandemic-triggered lows. With leasing improving, lower vacancy levels, and net operating income inching up, analysts believe that will translate to better distribution per unit.

Mindspace REIT’s Q1 net operating income rose 9.2% to ₹496 crore on a year-on-year (y-o-y) basis, while distribution grew 5% to ₹299 crore ( ₹5.04 per unit), the highest growth rate since listing.

“After staying flat the last two years, distribution was up 5% in Q1. Rentals were at ₹82 per sq. ft pre-covid; now, they are closer to ₹90 per sq. ft," said Ramesh Nair, CEO, Mindspace REIT. “From 7,900 unitholders during the IPO in 2020, we have 63,788 unitholders as of June, 9% of which are retail investors."

Similarly, Embassy REIT clocked an NOI of ₹757.5 crore, up 3% y-o-y, and net distributable cash flow of ₹531 crore, with distribution at ₹5.6/unit. During the quarter, it achieved gross leasing of 1.9 million sq ft, with global capability centres constituting a 70% share.

“Given the strong pre-leasing momentum and gradual filling up of SEZ vacancy over the next 12-18 months, we estimate FY25 DPU of ₹22.5/unit vs ₹21.3/unit in FY24 with a meaningful pick in FY26 DPU to ₹26.9/unit," ICICI Securities said in a note.

The increase in unitholders is meaningful for Reits, which are seeking greater acceptance from investors, particularly retail investors. Embassy REIT’s investors or unitholders have grown from 4,000 in 2019 (IPO launch) to over one lakh. Brookfield’s unitholders have grown from 7,914 in February 2021 to 45,482 as of August 2024.

New kid on the block

Nexus Select Trust, backed by Blackstone Group, is the youngest of the four listed Reits. It is also the only listed retail Reit.

Sector-specific issues such as occupancy, which have worried office Reits, haven’t been a concern for Nexus. It operates 17 malls in 14 cities, totalling 10 million sq. ft, and is planning to double its portfolio to 20 million sq. ft in five years with an acquisition-led growth strategy.

Nexus Reit currently has five shopping malls in various stages of acquisition. Its current portfolio is 97.4% occupied (as of June). For FY25, the Reit has given a distribution guidance of ₹8.7 per unit, which adds up to a little over ₹1,300 crore, up from the ₹1,070 crore ( ₹7.09/unit) it gave out in FY24. In Q1, it clocked an NDCF of ₹325 crore.

“We are on course to meet this guidance," said Nexus executive director and CEO Dalip Sehgal.

In August, Blackstone Group sold 315.5 million units in Nexus Select Trust for about ₹4,354 crore in a block deal. For FY25, it has given a 9% NOI growth guidance of ₹1,760 crore.

“We are looking at doubling not just the area, but also in terms of a substantial NOI increase. While our core model is acquisition, if we enter a market where there is no buyout opportunity, we may look at a greenfield asset along with a developer," said Sehgal.

Nexus has strong credentials for delivering inorganic growth through acquisitions of stabilized assets and the turnaround of underperforming assets, according to ICICI Securities. “We estimate Nexus’ NOI CAGR of 10.4% over FY24–26 to ₹1900 crore," the brokerage said in a July note.

On the anvil: SM Reits

Suresh Poddar, who works in a financial services firm in Kuwait City, said he is waiting for the Reit market in India to mature and deepen further. In the last three years, Poddar has invested in commercial real estate assets sold by fractional platforms hBits Proptech and Strata Property Management.

“A Reit is a good product if one wants to diversify their real estate portfolio. But there are only four listed Reits now and it’s still at a nascent stage. Broader Indian retail investors still treat Reits as any other stock. Once more Reits are listed and the market expands, I will certainly consider investing," he said.

In March, Sebi issued regulations to amend the Reit Regulations–2014, establishing guidelines for creation of Small and Medium Real Estate Investment Trusts, or SM Reits. These are real estate investment trusts with an asset base of ₹50 crore to ₹500 crore. (The minimum asset size for Reits is ₹500 crore.)

Unlike mainstream Reits, which can only hold commercial properties, SM Reits can hold any type of property except vacant land, thereby opening the door to housing projects as well.

In August, Property Share became the first fractional real estate platform to secure an SM Reit licence from Sebi. More such platforms are expected to get a licence.

Unlike Reits, which so far have relied a lot on institutional investors, SM Reits will make real estate accessible to retail investors under a regulated regime.

While SM Reits will not directly compete with Reits, analysts said the common denominator between the two would be retail investors. Traditional Reits are trying to bring in more retail investors, while the SM Reit model would largely thrive on them.

This is why the Budget’s announcement on the shortening of the holding period of units in Reits from 36 to 12 months to qualify for long-term capital gains tax is a big positive from a retail investor’s perspective.

IRA’s Chheda said it will bring short-term investors and liquidity into Reits. More buy-sell activity or trading will happen, unlike with a three-year holding period.

Growth plans

Blackstone Group is working with its developer partners, Bengaluru’s Sattva Group and Pune’s Panchshil Realty, for a listing of their combined assets of 35-40 million sq. ft to form a mega Reit.

India has nearly 400 million sq. ft of Reit-worthy office space, almost four times the size of the four listed Reits, setting the stage for future listings, as per analyst estimates, which will lead to the growth of the product.

“More office Reits will happen. Certain platforms have been set up to build good commercial real estate," said Gaurav Karnik, partner and real estate national leader at EY, an advisory. “Once they reach a certain scale, they will REIT it. In two-three years, we will see at least one-two Reit launches happening."

Chheda said that for Reits to grow further, more changes are needed. For instance, the Reserve Bank of India (RBI) does not allow banks to lend to Reits—individual special purpose vehicles under Reits can borrow funds, but the Reit itself cannot do so.

However, existing office Reits, too, have seen a gradual turnaround and are eyeing expansion, both organically and via acquisitions, to grow. Earlier this year, Brookfield India REIT acquired Bharti Enterprises’ 50% stake in four commercial properties at an enterprise value of ₹6,000 crore.

Mindspace REIT will invest nearly ₹3,500 crore over the next three-four years across projects. It has 9.5 million sq. ft of vacant, under-construction and future development space, which will translate to an NOI of ₹800 crore in three-four years.

Embassy REIT has guided for 10% and 7% growth in NOI and distribution, respectively, in FY25. It has 8.6 million sq. ft of office space in its development pipeline, which will add nearly ₹1,000 crore to its NOI in four years. It also expects occupancy to go up from 85% to 88% in FY25.

“The product has started gaining quite a bit of acceptance. Now, it is [time] for us to deliver growth, which we are confident about," said Embassy REIT’s Maiya.