Thinking about investing in a Real Estate Investment Trust (REIT)? Here's an interesting perspective

#1

Although REITs are quite popular globally, in India we don’t yet have a listed REIT. The IPO of the first Indian REIT - Embassy Office Parks is ongoing and if you are thinking of investing, then here’s an interesting perspective by Manoj Nagpal.

Many people requested me to give my views on the Embassy Office Parks REIT IPO

General Q was
With a rental yield of 8.25% (+ incr) and possible capital appreciation, this seems to be great buy. Should I buy?

I will try to decode the Embassy REIT IPO in this tweet thread (1/N)

— Nagpal Manoj (@NagpalManoj) March 19, 2019

1. When you buy a REIT, you become a unitholder in the REIT
2. REIT will be listed for trading. Post listing, You can sell/buy on the exchange (NSE)
3. Globally REITs trade at a discount to underlying
4. Embassy Office Parks owns commercial real estate (and some hotels)
(2/n)

— Nagpal Manoj (@NagpalManoj) March 19, 2019

5. Most of this commercial real estate is leased out to good cos like IBM, Cognizant etc
6. It owns around 32 mn sq ft. To give you a picture, It's like owning 60 x Express Towers
7. This commercial real estate is in Bangalore (60%), Mumbai, Pune, NOIDA
(3/n)

— Nagpal Manoj (@NagpalManoj) March 19, 2019

8. When you buy the REIT, effectively u become a part owner of these buildings
9. The value of this commercial real estate is around 31500 cr (independent valuation done by the co)
10. The IPO will sell it to you at a 20% discount! Why? (Just goodwill to you?)
(4/n)

— Nagpal Manoj (@NagpalManoj) March 19, 2019

11. Let's not look at a gift horse and count it's teeth?
12. Reality is real estate valuation in India is not real and just an estimate
12. 20% markdown to quoted prices is normal in Indian real estate
13. So don't assume and gloat that we are getting a discount in the IPO
(5/n)

— Nagpal Manoj (@NagpalManoj) March 19, 2019

14. So if we buy the Embassy Park REIT, we get
(a) Part ownership of this commercial real estate
(b) Already pre-leased to big cos
(c) Effectively we get rental yield from these cos
(d) Capital appr, if listed price reflects this
With me till here?
(6/n)

— Nagpal Manoj (@NagpalManoj) March 19, 2019

15. So hypothesis presented is
(a) Current rental yields are 8%+ in this portfolio
(b) This is lower than market. So u have upside
(c) As time goes by, rental agreements will renew at higher prices
(d) So u get more yield!
(e) Plus cap apprecition!
(7/n)

— Nagpal Manoj (@NagpalManoj) March 19, 2019

16. Before you invest in this REIT, you need to test this hypothesis and see if this is indeed the case
17. Also measure the risks to this hypothesis and then take a call
18. Rental yields in Bangalore have been increasing but other markets are flattish for last 5-6 yrs
(8/n)

— Nagpal Manoj (@NagpalManoj) March 19, 2019

19. Once u project the rental yields in the future, you need to deduct the management costs (maintaining the blg, property mgmt, repair costs)
20. Also deduct any interest payouts (loans taken earlier by co)
21. Reduce REIT management costs
22. And balance is what u get

(9/n)

— Nagpal Manoj (@NagpalManoj) March 19, 2019

22. Let's assume that the projected rent increases by the co will hold in the future (in the past they have missed estimates sometimes)
23. If that holds, then the Net discounted Cash flow will give a pre-tax yield of 7.5%-8.5% in the future before interest costs
(10/n)

— Nagpal Manoj (@NagpalManoj) March 19, 2019

24. Interest costs by the shareholder still needs to be reduced.
25. Most of the debt is on zero coupon bonds, but interest is still accrued
26. So you need to account for that
27. Interest costs can take away around 1.25%-1.75% of your rental yield
28. So build that in
(11/n)

— Nagpal Manoj (@NagpalManoj) March 19, 2019

29. So effectively, your net yield post of all expenses and all interest costs (assuming that the company projections hold) will be a bit lower between 6%-6.5%
30. We are still pre-tax here
31. This is just an estimate, you need to build your own estimate to decide
(12/n)

— Nagpal Manoj (@NagpalManoj) March 19, 2019

32. And there is some litigation on some of the properties too
33. At best this will be just a legal expense and at worst some of the value of the properties need to be discounted
34. So keep that risk in the back of your mind/calculations
(13/n)

— Nagpal Manoj (@NagpalManoj) March 19, 2019

35. For the sake of being conservative, build the downside case in your mode. This may give you around 5% yield
36. On an optimistic side, if rentals increase more than expected, then you can be closer to 8%+ yields
37. So it's evenly placed there.
Do ur own calculations
(14/n)

— Nagpal Manoj (@NagpalManoj) March 19, 2019

38. Now let's come to capital appreciation part
39. In an illiquid asset (the REIT has no intention to sell underlying assets), capital appr if any, in future will get reflected in the calculated quarterly NAV
40. And in effect part of this will be in listed prices on NSE
(15/n)

— Nagpal Manoj (@NagpalManoj) March 19, 2019

41. Take taxes also into consideration. REITs are almost a pass thru though some additional tax leakage will be there
And then take your decision to invest in the REIT
None of the above tweets are any kind of advise. Just my thoughts as some wanted to hear them
**End**
(16/16)

— Nagpal Manoj (@NagpalManoj) March 19, 2019
1 Like
#2

Is there a minimum lot size for REITs bought/sold on the exchange?

#3

Do you think it’s really much better for example than fixed deposits itself ? So it’s something like 8-8.25 % of yearly return ? Well that sounds really good, a bit better than safe deposits, but probablty worse than usual stocks and shares I would say.

#4

I think that REITs provide excellent opportunity for diversification of portfolio. Especially if you have market which is interesting from perspective of new constructions and business rentals, then there is huge probability of making some significant returns on your investment