By Vivek AnanthInitial public offerings are coming thick and fast - we are five weeks into 2021 and on our fifth IPO. This time it is a Real Estate Investment Trust (REIT) IPO sponsored by Brookfield Management’s affiliate BSREP India Holdings V Pte. The properties under the REIT are managed by another Brookfield Management affiliate Brookprop Management Services.
A REIT houses cash generating real estate assets and has to distribute at least 90% of its cash flows to unitholders, according to SEBI’s regulations. Brookfield REIT will start distribution to unitholders after its first full quarter post listing.
The Brookfield REIT houses four large office campus parks in Mumbai, National Capital Region (Noida and Gurgaon) and Kolkata. Three of the four campuses are located inside Special Economic Zones. Brookfield REIT will use the proceeds of this IPO to repay or prepay some of its debt which as of September 30, 2020 was around Rs 5,626 crore.
There have been two other REIT IPOs in India in the past, Mindspace REIT and Embassy REIT. Both of these were backed by private equity firm Blackstone.
Issue proceeds to reduce debt
The Brookfield REIT is looking to raise up to Rs 3,800 crore through a fresh issue of units. It has already raised Rs 1,710 crore (62.18 million units) from anchor investors at Rs 275 per unit. The proceeds of this issue will be used to repay or prepay debt worth Rs 3,575 crore. This will help bring down the company’s total outstanding debt to 18.5% of its initial market value. The REIT regulations allow for debt up to 49% of market value.
According to REIT regulations, up to 75% of the issue can be reserved for institutional investors and up to 25% for non-institutional investors. The issue price is Rs 274-275 per unit and the minimum lot size is 200 units. The Brookfield REIT IPO is being issued at a discount to the portfolio’s NAV (Rs 311), and the dividend yield for investors is expected to be around 7.2 per cent for FY22. Embassy REIT has a yield of around 7.0-7.5 per cent. The REIT units will be listed on the National Stock Exchange and BSE.
The issue opened on February 3, 2021 and will close on February 5, 2021. On the second day of bidding, the REIT had garnered a subscription for 33% of the available 76.28 million units as of 2 PM. In case of an oversubscription, Brookfield REIT can retain up to 25% of the oversubscription amount against fresh units, according to the red herring prospectus.
Marquee clients with long leases in key business districts
The Brookfield REIT’s initial portfolio of assets comprises of four large format office parks with 14 million square feet developed area in Mumbai, Gurugram, Noida and Kolkata. Three of these four are housed inside SEZs, which gives it some stickiness in terms of tenancy. The initial portfolio assets are in key business districts in their respective cities.
Out of the 14 million square feet of initial portfolio assets, 10.3 million square feet is completed, 0.1 million square feet is under construction, and a further 3.7 million square feet of future developmental potential.
The REIT also has the right to acquire 8.3 million square feet of assets, and a right of first offer on another 6.7 million square feet, both owned by Brookfield Group companies. This will give it a chance to improve its yield to unitholders. Brookfield REIT also has plans to further acquire assets from other Brookfield Group companies in the future once they mature and stabilize.
Some of the marquee customers of Brookfield REIT’s initial portfolio assets are multi-national corporations like Barclays, Bank of America Continuum, RBS, Accenture, Tata Consultancy Services and Cognizant. It has a weighted-average lease expiry of 7.1 years, compared to 5.8 years of Mindspace REIT and 7.2 years of Embassy REIT.
Brookfield REIT also has built-in escalation clauses for lease rentals, and this it claims will help drive up its yield, along with addition of assets from the Brookfield Group portfolio. Additionally, the properties have lower vacancies than the surrounding peripheral areas.
Projected revenues indicate steady rise
The net operating income of the Brookfield REIT has grown to Rs 676.34 crore at the end of 2019-20 from Rs 590.24 crore in 2017-18. For the six months ended September 30, 2020 the net operating income was at Rs 344.7 crore.
Income from operating leases made up 61-62% of Brookfield REIT’s revenues from FY18-FY20. At the end of September 30, 2020, it was 67% of total revenues. Income from maintenance services made up 34-36% of total revenues from FY18-20, and at the end of September 30, 2020, the proportion of maintenance services was lower at around 30%.
The property manager has managed to collect 99%, 98% and 96% of the gross contracted rentals in October 2020, November 2020 and December 2020, despite the impact of the pandemic on the Indian economy due to lockdowns. There have been no waivers in rentals given by the property manager, except for the food and beverages tenants.
These are the projections of the income from lease rental, revenue from operations and net operating income (NOI) for FY21, FY22 and FY23, according to the red herring prospectus
These are the projected cash flows for FY21, FY22 and FY23:
Work from home risks loom
One of the key risks to the Brookfield REIT’s investment proposition is the era of work from home. One of its major clients TCS has publicly stated that it will move 75% of its employees to a work from home setting by 2025, and focus on R&D services in its campus. Considering that IT services companies operating out of large format office parks is the moat that Brookfield is selling through its REIT, the long-term sustainability of its yield is not clear. Large firms in particular may be seeing substantial savings costs in real-estate that make the tradeoffs with work from home worthwhile.
Three of the initial portfolio assets operate out of SEZs, and companies that operate out of these offices are eligible for income tax deductions. The export revenues from operating out of an SEZ are eligible for income tax deductions, which brings down their taxable income. What will happen if these deductions are no longer applicable in an environment where IT services companies are moving to flexible work from home settings is unclear.
The growth prospects of Brookfield REIT’s yield are also dependent on the general growth in the Indian and global economy. Any slowdown in growth of the global economy and the Indian economy will impact its rentals.
In the end, a REIT is a vehicle for large investors that are looking for a quasi-debt instrument for a yield play. The long-term leases that Brookfield REIT’s properties have with clients bodes well, but this comes with the risks of owning commercial properties. REITs as an investment vehicle is ideal for an investor who has the wherewithal to take such risks. It is not for the fainthearted.