The stakes were always going to be high for the first REIT listing in India; that a firm like Blackstone was the one taking the leap raised expectations even more.
No surprises then that the 47.50 billion-rupee ($690 million; €610 million) IPO of the Embassy REIT, which ended 2.57 times oversubscribed when it was opened for subscription mid-March, was met with widespread relief. The REIT’s debut on the Indian stock exchanges was also positive, with shares ending at 4.89 percent up – 314.6 rupees versus the 300 rupees issue price – at the end of the first day’s trade on the National Stock Exchange.
The cloud of uncertainty preceding the debut was not lost on Blackstone. But Chris Heady, chairman and head of Asia real estate at Blackstone, told PERE: “We knew that these assets – whether in a REIT or privately held – are of such high quality, that institutional investors in one form or another would be interested in investing in them, if given the chance.”
The scale of the Embassy Office Parks REIT, a joint venture between Blackstone and the Bangalore-based developer Embassy Group, is huge by most reckonings, with seven office parks and four office buildings portfolio spread over 32.7 million square feet of leasable area and a 95 percent occupancy as of December 31, 2018. This is one of the biggest institutionally held portfolios of office assets in India – and is also cited as the largest among comparable Asian office REITs. The company’s total enterprise value upon listing was estimated at around $3.9 billion, with a market capitalization of around $3.3 billion. PERE understands Blackstone’s stake is approximately 55 percent, amounting to $1.8 billion in value at IPO price.
“We knew that these assets – whether in a REIT or privately held – are of such high quality, that institutional investors in one form or another would be interested in investing in them, if given the chance.”
But more than the quality of the product, market anxiety was driven by external events and the likely response from investors. The rupee’s depreciation against the dollar last year – nearly 14 percent between April and October – and a rise in 10-year government bond yields in India to more than 8 percent in September were seen as dampeners that could delay the timing of the REIT. Not many IPOs have happened in India of late, either; only two primary market IPOs closed from January up until the REIT listing. The Realty Sensex – a barometer for the real estate industry – also dropped 10 percent over the last year, according to Samantak Das, chief economist and head of research and REIS, India, for JLL. This year has also carried a high degree of political uncertainty in the country amid the ongoing general elections.
When asked about the degree to which these short-term fluctuations were factored into the timing of the listing, senior managing director Tuhin Parikh, who is leading Blackstone’s real estate strategy in India, said: “Financial innovation in Indian markets rapidly deepens. Players are very sophisticated, so they embrace change very fast. If you go back in history, when India went through the leap of electronic trading or dematerialization of shares, it happened in a dramatically short period of time. We were clear that innovation would be accepted very quickly, if we worked along with the regulators and investors. Once we got a clear green light from international investors, we were not too worried about short-term fluctuations.”
The firm’s faith has paid off. Investors, both domestic and international, have endorsed the REIT so far. In the pre-listing fundraising exercise; funds of US-based Capital Group committed around $125 million as a strategic investor. According to one person familiar with the listing, this is the first time an Indian IPO has been able to sign up a strategic investors’ tranche, which essentially implies a six-month lock-in period for those investors once the REIT starts trading. Typically, IPOs have tended to receive interest only from anchor investors – another category of investors that can buy up to 30 percent of an IPO before it opens, per Securities and Exchange Board of India rules.
“Domestic money has no clue what a REIT product is. Some think it is equity, some believe debt, and some think it is like a fixed-deposit. Their response has been tremendous.”
For a country that has not seen a REIT-like product, the 3.09 times oversubscription by non-institutional investors was also noteworthy – with institutional investors 2.15 times oversubscribed.
“There was an expectation for institutions to be three times oversubscribed, but they had a mixed reaction to the REIT. Maybe it was due to the upcoming elections or them taking a view that they should wait for the REIT to list first and then buy units later,” said Shobhit Agarwal, managing director and chief executive at Mumbai-based investment manager Anarock Capital. “But the interesting aspect of the REIT is how the high-net-worth and retail investors have responded. Domestic money has no clue what a REIT product is. Some think it is equity, some believe debt, and some think it is like a fixed-deposit. Their response has been tremendous.”
Parikh finds the retail and high-net-worth investor demand encouraging, but not surprising. “Retail investors view real estate as an inflation hedge; they understand that intuitively. When they invest in fixed deposits, they understand it is a static product that depreciates over a period, and inflation will creep in. That is the reason why people buy real estate and gold in India. And this is the first time someone offered them a financial product that mimics that.”
Managing return expectations
Naturally, expected yield and total returns are crucial metrics for a financial product being introduced to investors. But given the lack of comparable products in the country, market observers are divided on what the best risk-adjusted returns for an Indian REIT should be.
A domestic retail investor would benchmark the dividend yield from the REIT against returns generated by mutual funds and the 10-year government bond yield. JLL’s Das said mutual funds are currently generating 10-12 percent gross returns, while the 10-year government bond yield is currently at 7.37 percent. In his view, the market expects the REIT to deliver anywhere between 12-14 percent gross returns – a “lucrative return for a retail investor with a 5-year holding period.”
“The possibility of growth is what makes a REIT different from a bond”
PERE understands the initial net yield of “Embassy Office REIT is 8.25 percent. According to people familiar with the portfolio, Blackstone and Embassy are betting the yield on three growth drivers, starting with the 3-4 percent annual contractual escalation in the leases. Then there is the mark-to-market upside: many of the historical leases in the REIT portfolio are believed to be 35 percent below market rent. Lastly, an upside is expected from the under-construction assets in the portfolio. “It is unconceivable this won’t be a 15 to 17 percent return product,” said one source familiar with the REIT.
Others are not as positive. One advisor highlighted how REITs end up diluting investors over time. And with rental markets peaking, a 7.5 percent cap rate on fully-stabilized assets, which is what the REIT’s portfolio is reportedly estimated at, is not justified. “It is like saying a Bangalore technology park is the same risk-return as a 10-year bond,” the advisor quipped. “It is a mis-sold product to retail investors.”
“The possibility of growth is what makes a REIT different from a bond,” Parikh said, responding to these concerns. “A REIT has embedded growth in it, which is usually inflation-linked, so the tenant has to pay higher rents over time, everything else being equal.”
Meanwhile, for international investors investing in India, currency losses from a falling rupee are the biggest drain on returns. Foreign managers are currently understood to underwrite a 2.5 percent currency loss. This would essentially mean a roughly 6 percent initial yield from the Embassy REIT.
Like in other markets, the REIT is expected to institutionalize real estate as an asset class in India – as a viable liquidity avenue as well as an exit channel for private equity managers operating in the country.
Blackstone, and many other global private equity firms, have been aggressively growing their commercial real estate portfolios in the country over the past few years, buoyed by positive office market fundamentals, and generally a greater push for transparency in the sector through recent regulations. In the last two years, total private equity investments inflow into Indian real estate was $8.6 billion, up from $5.4 billion in the previous two years, according to a research report published by Anarock Property Consultants. And commercial assets have become the top preference of private equity investors over the past four years, comprising more than 70 percent of the overall investment share in 2018, compared with just 33 percent in 2015. The report attributes this boost to less than a dollar per square foot rent, coupled with high demand and availability of exit options in the form of REITs.
Continued interest in India
“We have had high conviction around the office market in India for some time now, since making our first investment back in 2011,” Heady said. “Part of our investment thesis was that, over time, the market would become more institutional. We believed there would be more capital that would come to the market and so the Embassy REIT is a step in that direction.”
Some market analysts, however, also want to exercise caution given their experience with infrastructure investment trusts (InvITs) in India, which failed to generate momentum despite the initial hype. In May 2017, IRB InVIT Fund – the country’s first infrastructure trust – garnered strong investor endorsement with an IPO that was 8.5 times oversubscribed. However, since then, the product has reportedly been trading below its listed price.
The initial success of the REIT has nonetheless already prompted other firms to plan their own REIT debuts. According to a report in the Economic Times newspaper, at least five other firms are looking to raise as much as $10 billion via REITs over the next two years. A continued upward or stable trajectory for the office sector, without any major bumps, macroeconomic or domestic is crucial for this interest to be sustained and for investors to remain attracted to a product which today has just the one data point.