ANALYSIS : Embassy Office Parks REIT - Financials and Operations

[reeseb]

I wrote this analysis in an earlier thread on the REIT -

https://www.reddit.com/r/IndiaInvestments/comments/b07coh

For ease of reading, I am copying those comments, as well as a summary from another user.

/@odzr wrote this summary:

I spent a good 2 hours reading the document. 99% of the papers were boring as hell. But there are some interesting statistics in it related to commercial real estate.

The properties listed are all pretty good. 43% of the income is coming from one single IT parK. So, would that be a risk? I'd say it depends on your point of view. It's an IT park in Bangalore named Manyata. It employs around 1,50,000 people and its the second largest IT park in India. I googled about the park and the negatives being told are by employees fed up with the Bangalore traffic. They all have very good opinion of what's inside the park, but hates the place. Anyway, 95% of it is occupied. According to them, missing 5% is due to construction works and ongoing negotiations. The rent rate in Manyata is 43% below the market rate because many of the contracts were signed years ago. Once that get expires, they can renew the contract at a rate little higher than the market rate. From what I see, these Embassy offices are highly preferred compared to the competition and for the same reason, their rental CAGR is higher than the competition.

Only issue I found is that they own only 50% of some of the properties that are in their portfolio. The rest seems to be owned by Karnataka Congress minister, K J George.

The rental income is probably going to be around 7-9%, I think. There is no mention of that in the offer document even though they specified rental growth CAGR which is at around 5%.

In short, I'd put some money in it. The properties are all solid. Just not sure how the investors would deal with it after IPO.

(For the record, some of the properties that would become part of the REIT have part ownership from K J George and family. This in any case is standard operating procedure in many big real estate - Co-opt an influencer to help smooth the deal.)

Manyata is between 40 to 50% of the deal - in terms of size, revenue, market value, and projected cash distribution.

My longish analysis is below. The financials are sourced to the right documents. I spent a few hours scouring them. The comments on the operational structure are opinions and not necessarily facts.

Here are some of the salient details that I could gather. Both NSE and BSE have the information. BSE's site is easier to navigate. https://www.bseindia.com/markets/pu...dtype=1&status=F&IPONo=3904&startdt=3/18/2019

First off, I have not been able to find any official document on the number of units allotted to the sponsors. This is definitely very critical, but it is not there.

The typical 'notice' is here: https://www.bseindia.com/downloads/ipo/Embassy_Price Band Ad_120320191512.pdf

It clearly states the price band as 299 to 300 (Please don't ask me what this band achieves!)

We can assume the the price would be 300

The issue size is 12,95,56,000 - almost 13 crore units

The total number of units, post-issue - is specified as 771, 665, 343 - 77,16,65,343

A quick math suggests that about 16.8% of the units are offered to the public

Strategic investors (4 of them) have bought almost 3 crore units

Many anchor investors have also bought units - about 5.8 crore - just days after the strategic investors. (NSE has the info at: https://www.nseindia.com/content/ipo/ANCHOR_EMBASSY.zip

)

A quick math suggests that more than 50% of the IPO portion has been allocated already - and at a price of Rs 300 per unit

Net Distributable Cash Flow (NDCF) is a key parameter for REIT. At least 90% of this has to distributed to unitholders

The NCDF projections seem reasonably aggressive - they assume a good increase in rental value, etc. The projections for FY20 and FY21 are: 1910 cr and 2074 cr (page 337 of https://www.bseindia.com/downloads/ipo/Embassy_REIT_140320191050.pdf )

Assuming that this holds, the yield per unit would be about 8.26% in FY20. Does not seem bad

The minimum bid size is 800 units - so you are looking at a minimum of Rs 2.4 lacs. Additional bids are for 1.2 lacs each

There is an indication that the unit price is less than the 'net asset value' - almost 20% less. This gives an indication of the possible appreciation in value

The operational structure of the REIT seems to have concerns - at least to me.

Only some of the Embassy properties are part of the REIT. In Bangalore, Embassy Tech Village is a flagship and is not part of the REIT. Manyata - which is away from the clusters - is part of the REIT.

Manyata is > 40% of the value of the REIT. However the REIT would own Manyata in two ways - 64% directly and 36% via a holding company. The holding company structure may be less tax efficient - I need to check this out

There are lots of buying out of smaller (read politicians) partners - they would get units in the REIT

The manager of the REIT has a lot of leeway - expectedly. The Manager - Embassy Office Parks Management Services Private Limited - is very much controlled by the Embassy group.

My reading is that this REIT structure is closer to a typical company IPO (than a mutual fund AMC). There are lots of cross-holdings, promoter influence and definitely conflicts of interest. Basically the public investing in the REIT would be minority shareholders

Related party transactions are allowed and have to be voted by the unitholders if they exceed a threshold. While the related party would not vote, the two sponsors - Embassy and Blackstone - can scratch each other's back and vote in favour of the other's related party transactions

In short, this is as opaque as the typical real estate set-up. If you buy shares of a real estate firm, you are a minority shareholder and things can be done against your interests. However unlike a company, there are no protection for minority REIT shareholders.

Summary: The financials look good, the operational structure looks dicey

What do I plan to do - Watch the frenzy (or lack of it) on Monday and try to read up more on investor protection.

I wrote a longer analysis, with images in my blog. It has the main information as above, but a blog provides flexibility to add images https://srinivesh.in/blog/embassy-reit-should-you-invest/

 

[resjudicata]

@reeseb Thank you for this painstaking analysis. Even for those like me who are unlikely to invest in REITs, this is educational and informative.

 

[profmaliki]

@reeseb I'll give Indian REITs a read over the weekend, so my reviews both on the regulatory structure and this particular REIT will have to wait. Analysis looks deep enough, though.

 

[lostyoungadult]

@profmaliki Eagerly waiting for your analysis.

 

[innocentstar]

@profmaliki This is the first one

 

[straf]

@profmaliki RemindMe! 7 days

 

[lostyoungadult]

@reeseb Thanks so much, this is a really good analysis.

I wanted to buy into the IPO but stopped after reading this as well as some another analysis. I will wait to get it listed.

 

[boxankles]

@reeseb Rental income is 9% of the invested amount? I.e. in stock terms, dividend yield is 9%?

 

[reeseb]

@boxankles Actually the net cash for distribution is more than rental income. It includes dividends too. The calculation is complicated and I didn't put the details of it. But yes, the NDCF projection is close to 8% if you take 300 as the unit price.

You can roughly equate that with a dividend yield. In my view, it may be closer to a long term bond that pays interest every year - yearly income may be a higher part of the return than capital appreciation.

 

[roy32]

@reeseb Great analysis. Though it seems interesting to read and it suggests to offer decent returns, the operations end of it makes me think twice about it. Isn't it better for a small time investor to invest in a company like hdfc bank or Asian paints and call it a day rather taking a risk with this..

 

[reeseb]

@roy32 Yes, the operational part it poses some risks. There is also the novelty risk - this is the firs REIT. In the blog article I had expanded the recommendation, and has pretty much said that a normal (say equity or mf) investor can skip the IPO.

 

[lostsheep89]

@reeseb thanks .let me know what you finally decide.

 

[reeseb]

@lostsheep89 I have read more of the Corporate Governance. I still have some concerns on the operational model. But I am tending towards suppressing them against the 'financial greed'. I am likely to put in a bid for the minimum lot size.

 

[lostsheep89]

@reeseb good to know.i'm thinking of the same.