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Embassy Office Parks REIT
Set to be Indias first listed Reit
The Embassy Office Parks REIT (Embassy) is an irrevocable trust and was registered with SEBI on August 3, 2017, as a real estate investment trust under Regulation 3(1) of the REIT Regulations. The Embassy REIT has been settled by the Embassy Sponsor. Subsequently, in August 2018, SEBI took on record the addition of the Blackstone Sponsor to the sponsors of the Embassy REIT. As of the date, the Embassy Sponsor and the Blackstone Sponsor are the sponsors of the Embassy REIT.
Embassy Office Parks Management Services Pvt. Ltd. (EOPMSPL) has been appointed as the Manager to the Embassy REIT. EOPMSPL is held by the Embassy Sponsor and certain entities forming part of the Blackstone Sponsor Group. Axis Trustee Services has been appointed as the Trustee to the Embassy REIT.
Embassy is the owner of a high quality office portfolio in India that serves as essential corporate infrastructure to multinational tenants and has significant embedded growth prospects. The companys portfolio comprises 7 best-in-class office parks and 4 prime city-canter office buildings totalling 32.7 m sq feet as of December 31, 2018, with strategic amenities, including two completed and two under-construction hotels totalling 1,096 keys, food courts, employee transportation and childcare facilities.
Of the total 32.7 m sq feet, around 60.5% is in Bengaluru, 16.2% is in Mumbai, 14.4% in Pune and rest 8.9% is in Noida.
India is the 6th largest and the fastest growing major economy in the world and has become a leading services hub for global corporate over the last 20 years. With low unemployment and accelerating wage growth pressure in the United States, Indias cost competitive services sector is expected to grow at 8.9% in FY2019. As the owner of one of Indias largest Grade A office portfolios, Embassy REIT is in a prime position to continue to capitalize on this growth story and the sustained demand from services sector tenants (72.2% of their tenant base) for Grade A office space.
As of December 31, 2018, the committed occupancy remained at 95% and the weighted average lease length was 7 years. The company has more than 160 marquee tenants comprising a mix of blue-chip multinational and Indian corporate, such as JP Morgan, DBS, Swiss Re, Google, McKinsey, IBM, L&T Technology Services and Nokia. Companys tenants are truly international with approximately 80.9% of gross rentals contracted with leading multinational corporations and approximately 43.4% of gross rentals from Fortune 500 companies. 49.4% of their gross rentals are derived from tenants in fast-growing technology sector, with the remainder well diversified across various industries including financial services, healthcare and telecommunications. In addition, they have a diverse tenant base, with their top 10 tenants contributing only approximately 42.3% of their Gross Rentals. The client-centric approach has led to an 80.9% tenant retention rate over the last 3 years and 9 months and significant tenant growth in the Portfolio.
72% of tenant base is from the services sector (key driver of Indias growth). The companys markets are also amongst the top-performing in India and account for 72.5% of total Grade A office stock and 76.9% of total absorption over the last 5 years and 3 months. Their assets have outperformed their markets with 940 bps higher committed occupancy as of March 31, 2018 and 270 bps higher rent CAGR over the last 5 years and 3 months due to their high quality and premium locations.
The company has a strong track record of delivering on-campus development projects on entitled land within the parks, having constructed 4.1 msf over the last 5 years and 9 months (96% leased). The company currently has 2.5 msf under construction. A 230-key Four Seasons hotel was completed recently and is expected to commence operations in the first half of 2019. Additionally, they have 5.4 msf of proposed developable area to provide for future tenant expansions and consolidations.
Over the last 3 years and 9 months ended Dec 18, through their disciplined operating and investment expertise, the company has
- Leased 6.8 m sq feet of total office space and achieved average re-leasing spreads of 48% on approximately 2.7 m sq feet of re-leased space;
- Achieved 80.9% tenant retention rate, with 7.7 m sq feet of office space renewed (including exercise of renewal options), without incurring material tenant improvement capital expenditure (TI capex);
- Demonstrated a 7.1% same-store rental CAGR across the portfolio assets and the portfolio investment over FY2016 to FY2018;
- Grown their portfolio by 3.1 m sq feet through strategic acquisitions and the continued build out of their office parks;
- Achieved a committed occupancy of 95% as of December 31, 2018 and maintained occupancy at greater than 93.4% at the end of the last 3 fiscal years; and
- Undertaken extensive renovation programs, including successful upgrades of 33 office lobbies and 7 food courts
As per the management, the market value of the portfolio as of December 31, 2018 as per the valuer is Rs.31480 crore. Embassy Reit has been given a long term rating of AAA by Icra. The outlook on the assigned rating is stable.
The Offer details
The units are offered at a lower price of Rs 299 and at higher price of Rs 300 each unit. Minimum application is for 800 units (i.e., Rs 2.4 lakh at higher price and Rs 2.39 lakh as lower price) and in multiples of 400 units thereafter. Total Issue size comprises 15.83 crore units which at higher price of Rs 300 per unit makes the issue size at Rs 4750 crore and at lower price band of Rs 299 per unit makes the issue size at Rs 4734.16 crore.
Of the total issue size, 2.92 crore units (Rs 876.26 crore at higher price band of Rs 300) is allocated to Strategic Investors. The net issue excluding strategic investors comprises 12.91 crore units (Rs 3860.8 crore at lower price band and Rs 3873.7 crore as higher price band). The strategic investors in the Embassy includes names such as American Funds Insurance Series New World Fund, American Funds Insurance Series Global Small Capitalization Fund, Capital Group New World Fund, New World Fund, Inc and SmallCap World Fund Inc.
The issue opens for subscription on 18 March and closes on 20 March, with anchor bid to open on 15 March. The units will be listed on the BSE and the NSE.
The IPO proceeds will be utilized for repayment of loans and debts of Rs 3710 crore, Rs 460 crore towards acquisition of the Embassy One Assets currently held by EODPL and rest for general corporate purposes.
Regulations regarding the fund
The investment objective of the Embassy REIT shall be to make investments as a real estate investment trust as permissible in terms of the REIT Regulations. The investment of the Embassy REIT shall only be in accordance with the REIT Regulations, including in such holding companies, special purpose vehicles or real estate properties (whether completed or otherwise), securities in India or transferable development rights as permitted under the REIT Regulations.
The principal investment objective of the Embassy REIT is to own, operate and invest in rent or income generating office real estate and related assets in India in accordance with the REIT Regulations. This includes
-Invest not less than 80% of the value of its assets in completed and rent and/ or income generating properties
-Not more than 20% of the value of its assets may only be invested in certain permitted forms of investments which include, among other things, under construction properties, completed but not rent generating properties, listed or unlisted debt of companies or body corporate in the real estate sector and specified securities, including unlisted equity shares of companies which derive not less than 75% of their operating income from real estate activity according to the audited accounts of the previous financial year;
-For projects implemented in stages, the portion of the project that is not completed and rent or income generating is required to be counted as an under-construction property; and
-Not less than 51% of the consolidated revenues of the Embassy REIT, and the Asset SPVs, other than gains arising from disposal of properties, must at all times arise from rental, leasing real estate assets or other income incidental to the leasing of such assets
The investments of the Embassy REIT shall be in accordance with the REIT Regulations, as amended from time to time, and the investment strategy. In accordance with the REIT Regulations, the Embassy REIT is not permitted to undertake any activity which is prohibited under the REIT Regulations. Subject to the restrictions and requirements of applicable law, the Embassy REIT may not carry on any other principal activity. Also REIT regulations also impose restrictions on certain investments including investments in vacant land, agricultural land or mortgages and assets located outside India.
The management expect to be the first listed REIT in India upon the listing of their units on the stock exchanges and believe that there is no other office portfolio of comparable scale, diversity and quality in India today.
While the portfolio is highly stabilized at 95% committed occupancy, Embassy REIT is well positioned to achieve further organic growth through a combination of contractual rent escalations, re-leasing at market rents (Embassy REIT estimates that the market rents of their properties are 33.6% above in-place rents), lease-up of vacant space and new construction within the portfolio to accommodate tenant expansion.
Portfolio revenue from operations is projected to grow by 55.8% over the projections period primarily due to these factors. The scale and quality of their business that has given them a market leading position, makes their properties the preferred office location in each of their respective submarkets and allows them to offer consolidation and expansion options for their tenants. This has enabled them to attract, retain and grow multinational tenants in their parks leading to tenant stickiness.
Net debt to Gross Asset Value (GAV) (Market value of the properties as per the valuation as on Dec 18) will be less than 15% post IPO proceeds.
Stable and long-term contracted rents, with 10%15% contractual escalations every 35 years, provide steady growth in earnings as projected by the management.
Conservative balance sheet, post utilization of IPO proceeds, provides significant flexibility for growth through value accretive Right of First Offer (ROFO) and third-party acquisitions.
The manager shall declare and distribute at least 90% of the Net Distributable Cash Flows (NDCF) of the Embassy REIT as distributions (REIT distributions) to the unit holders.
Such REIT distributions shall be declared and made not less than once every quarter in every Fiscal.
Further, in accordance with the REIT Regulations, REIT distributions shall be made no later than 15 days from the date of such declarations. The REIT distributions, when made, shall be made in Indian rupees.
REITs ability to make distributions may be affected by several factors such as:
servicing of debt raised by the Embassy REIT;
cash flows received from Asset SPVs and the investment entity;
debt servicing requirements and other liabilities of the Asset SPVs and the investment entity;
compliance with loan agreements including restrictive covenants that stipulate we obtain consent from the lenders prior to making any dividend payments;
fluctuations in the working capital needs of the Asset SPVs and the Investment Entity;
ability of Asset SPVs and the investment entity to borrow funds and access capital markets;
the extent of lease concession, rent free periods, and incentives given to tenants to attract new tenants and/or retain existing tenants, if any;
restrictions contained in and any payments under any agreements entered into by our Asset SPVs and the investment entity, including agreements with hotel operators and development managers, including the Embassy sponsor or regulatory authorities from whom land is leased;
approval of certain hotel operators of the portfolio assets that have been granted the right to determine the share of the gross operating profit of the respective hotel, and the shareholders of the investment entity;
completing the development of our under construction assets within the anticipated timeline or as per the forecasted budget;
business and financial position of our Asset SPVs and the investment entity, including any operating losses incurred by the portfolio assets and portfolio Investment in any financial year;
applicable laws and regulations, which may restrict the payment of dividends by the Asset SPVs and the investment entity or other distributions;
payments of tax and other legal liabilities; and
discharging indemnity or other contractual obligations of the Asset SPVs and the investment entity under their respective underlying contracts or similar obligations including with development managers, including the Embassy sponsor or any fines, penalties levied by regulatory authorities.
Further, as non-cash expenditure, such as amortization and depreciation, are charged to the profit and loss account, the Asset SPVs or the investment entity may have surplus cash but no profit in the profit and loss account, and hence may not be able to declare dividends as per applicable regulations. In the event of the inability to declare such dividends, the Asset SPVs, the investment entity, the manager and the trustee may evaluate various options to make distributions to the unit holders and utilize such surplus cash.
Tax provisions applicable to Reit and on income distributed by Reit
The REIT will receive income in the form of dividends and interest from holding company or Special Purpose Vehicles (SPVs). Such interest income received or receivable by the REIT from the SPVs should be exempt from tax in the hands of the REIT. Further, dividend income received from holding company or the SPV, which is exempt from DDT under Section 115-O(7) is exempt from tax in the hands of the REIT under Section 10(23FC)(b) of the Act.
Any Dividend (interim or otherwise) declared, distributed or paid by a holding company or SPV to the REIT out of its current Income, should be exempt from dividend distribution tax.
Where the unit holder is a resident ordinary, the tax rate is applicable to the resident to the extent that the distribution takes the character of either interest or rental income and tax exempt for the balance distribution.
In case the REIT units are held as a capital asset by the unit holder, gains arising on sale of the REIT units will be liable to tax as under:
(i) Long-term capital gains exceeding INR 1 lakh on sale of units held for more than 36 months 10%
(plus applicable surcharge and cess) as per Section 112A of the Act; and
(ii) Short-term capital gains on sale of units held for up to 36 months 15% (plus applicable surcharge and cess) as per Section 111A of the Act.
The above rates of taxes are applicable on the basis that the transfer of REIT units has been subjected to STT.
Where the REIT distributes any income which is characterized as interest in terms of section 115UA (1) of the Act, the REIT will be required to withhold income-tax there from at the following rates:
10%, where the distributions are made to a resident unit holder as per section 194LBA (1) of the Act; and
5% (plus applicable surcharge and cess), where the distributions are made to a non-resident unit holder as per Section 194LBA (2) of the Act. If the non-resident unit holder is entitled to a lower tax rate on interest under the relevant DTAA, the REIT may withhold tax at such lower rate,
Where the REIT distributes any income which is characterized as rent in terms of section 115UA (1) of the Act, the REIT will be required to withhold income-tax there from at the following rates:
10%, where the distributions are made to a resident unit holder as per Section 194LBA (1) of the Act; and
At the rates in force, where the distributions are made to a non-resident unit holder as per section 194LBA(3) of the Act. If the non-resident unit holder is entitled to a lower tax rate on interest under the relevant DTAA, the REIT may withhold tax at such lower rate,
Any distributions made by the REIT to the following unit holders should not be subject to any withholding tax:
Category I and Category II Alternative Investment Funds as per Notification No 51 / 2015 issued by Central Board of Direct Taxes; and
Mutual funds referred to in section 10(23D) of the Act.
On sale of units
No withholding tax applies in respect of capital gains arising from transfer of units to a resident or a non-resident which is a foreign portfolio investor (FPI) registered with the SEBI.
Withholding tax may apply on capital gains arising to a non-resident who is not a FPI. Where such non-resident is entitled to benefits, including capital gains tax exemptions, under the applicable DTAA, it will have to furnish all the relevant documents or information to demonstrate his claim of taking DTAA benefits.
Returns to unit holders
Based on the projected cash flows given in the prospectus, management has given a broad guidance of yield for FY 2020 and for FY 2021. For FY 2020, the yield is guided around 8.25%, of which 50% will be distributed as interest income and rest 50% will be distributed as dividend. This 8.25% yield will be paid in 4 quarterly instalments.
Similarly for FY 2021, management expects yield to be 8.96% and distribution will be made in similar way that of FY 2020.
However, there is no guarantee of returns. Returns are not fixed and will vary depending on the actual cash-flows.