Tag - commercial real estate

Do REITs deserve a place in your portfolio?


Real estate investment trusts are like mutual funds, where money is pooled from investors and units are allotted to them, which represent ownership in real estate assets. REITs invest in income-generating real estate properties. These income-generating real estate properties can be residential buildings where flats are rented, commercial office spaces, warehouses, hotels, shopping malls, airports, etc. In India, as of now, only commercial REITs are allowed to do business.

Speaking about India specific, a REIT will raise money from investors and either acquire a developed property or develop a property on its own. Later on, this property is rented to different tenants, which are predominantly corporate entities. The rent collected is then distributed to the unitholders after deducting all the necessary expenses.

Each REIT has a sponsor who acts as a trustee for the unitholders and owns the property on behalf of the unitholders. The day-to-day activities concerning the properties such as choosing the right tenant, negotiating the lease terms with the tenants, maintenance of the properties, etc are handled by a management team (REIT Manager) appointed by the sponsor.

Let’s look at some advantages of considering REITs as an investment:

  • Direct exposure to real estate requires a large amount of investment, whereas, REIT units are available at a low-ticket size. Over and above that, an investment through REIT provides diversification benefits, which is difficult to achieve by directly owning properties.
  • REITs are highly regulated and are required to distribute at least 90% of the net distributable cash flow to the unitholders. It is also mandatory for a REIT to have at least 80% of its portfolio invested in fully developed properties. This eliminates execution risk to a large extent.
  • The dividend distributed by the REIT is often tax-free in the hands of the unitholder. This may not always hold as it depends on the REITs ownership structure.
  • As REITs distribute more than 90% of their net distributable cash flow to the unitholders, a REIT acts as a hybrid instrument with regular dividend pay-out and capital gains due to share price change.
  • REITs also provide stability to your portfolio as a REIT’s stock price does not fluctuate much because it is valued based on the value of real estate assets it is owning, and real estate prices generally fluctuate less than stock prices.

Although there are no specific disadvantages of having a small exposure to a REIT, here are certain difficulties a REIT, as a business, can face, which will eventually affect the unit price and NDCF:

  • Recently in the COVID period, most companies chose work from home over going to the office. In such a situation, there can be lease cancellations or uncertainty about future lease renewals.
  • Any economic slowdown results in MNCs laying off employees and in the worst-case scenario, exiting the country. REITs lose business when office spaces are kept vacant for a long period.

These are larger economic issues that will be faced by any other business along with a REIT.

In India, we currently have 3 listed REITs and while the Nifty 50 index is down 6% year to date, the REITs are up from 8.5% to 10.5% for the same period. Investors’ interest has come back to REITs with the opening up of the economy and higher occupancy levels of the office spaces. The only limitation here is that of limited options as there are only 3 REITs and 1 International REIT Fund of Fund in India. This significantly limits the choices for investors.

Source: Tradingview

Disclaimer: “The views expressed are for information purposes only. The information provided herein should not be considered as investment advice or research recommendation. The users should rely on their own research and analysis and should consult their own investment advisors to determine the merit, risks, and suitability of the information provided.”

Excerpts of an interview with HDFC Chairman Mr Deepak Parekh published in Mint dated 4th September 2019

Dated: 6th September 2019

Update on Indian market: Nifty ended almost flat on Thursday (+0.03%). Within NIFTY stocks, top performers were Tata Motors (+8.1%), Coal India (+7.3%) and ONGC (+5.3%) and worst performers were HDFC (-2.8%), Indiabulls Housing (-2.3%) and ICICI Bank (-2.2%). Among the sectoral indices, best performers were Metal (+2.6%), Auto (+2.1%) and Media (+1.6%). Worst performing sectors were Realty (-1.8%), financial services (-1.2%) and Pvt Banks (-0.8%). RBI has mandated linking of housing and auto loan rates to the repo rate or other external benchmarks 1st October onward. Stock prices of HFCs (Housing Finance Companies) were down owing to the fear that HFCs will have to reduce their lending rates to remain competitive, effectively putting pressure on NIMs (Net Interest Margin). Auto stocks reacted positively to the same as lower borrowing costs to the customer can boost demand for vehicles.

Excerpts of an interview with HDFC Chairman Mr Deepak Parekh published in Mint dated 4th September 2019

·        In HDFC’s core business of housing finance, massive growth is seen in affordable housing. HDFC has launched a dozen projects in the last 3 months across Indian cities. Apartments that fit in the Pradhan Mantri Awas Yojana (PMAY) are selling fast. 70-80% is sold on the launch day.

·        Commercial real estate especially for IT back-office sector is also booming.

·        Real estate is in bad shape for homes that are larger and unaffordable.

·        The spiral down has continued after demonetization. The developers need help as without them there is no supply. There is a massive amount of unsold inventory and lack of fresh lending to the developers.

·        Regulators have to look at developers differently in terms of NPA recognition. Even if the developer is not able to build a phase due to demand shortage and is not able to repay the loan, he is sitting on the value in the form of land. When the demand picks up, the value will materialize.

·        50% of incomplete apartments need last-mile funding where 80%-90% work is complete. That should be done on an urgency basis. This will also boost confidence on the street. Currently, people prefer to buy a finished home rather than under-construction property as many people have booked under-construction flats and are still waiting. A solution could be a stressed asset fund initiated by National Housing Bank (NHB).

·        When IL&FS went down, it did not impact the Indian financial system. India has a strong financial base and a couple of players collapsing is not going to have a big impact.

·        Interest rate action helps in case of a slowdown but it is not the ultimate reason for the slowdown to go away. Self-confidence and confidence in buyers is required. India is a consumption-oriented economy and one or two-quarters slowdown is just part of the game. Even the auto industry has had phenomenal sales for many years and a slowdown for a few quarters will not have much impact.

·        The feeling is that slowdown will be short-lived. Good weather, upcoming festive season and easy availability of credit will cause spending.              

·        Consumption as a % of GDP is very low in India, less than half of China. So that has to grow. Even if there is a global slowdown, it is not so in India.

·        Ease of doing business in India has to improve. Large funds of billions of dollars have not yet invested long-term money in India. India specific funds have come in but global funds, sovereign wealth funds have just started looking at India. Still, massive amounts of investments can be expected from Australia, Canada and Japan. The sovereign wealth funds are underinvested in India but are looking at viable companies, good promoters and good track record.

Consensus estimates (Source: Marketscreener website):

·        The share price on 05-09-2019 was Rs 2,044/- per share. It was trading at a P/B of 4.2x/3.9x its book value per share estimates of Rs 479/521 for FY20E/FY21E respectively.

·        The consensus price target is at Rs 2,361/- implying P/B of 4.5x for FY21E BVPS of Rs 521.

Indiabulls Housing Finance 1QFY20 result update: Asset quality deteriorates sequentially.

Dated: 7th August 2019

  • Loan assets declined 10% YoY to Rs 1,131 bn. The decline is primarily due to efforts taken for reduction in the Commercial Real Estate (CRE) book.
  • NII at Rs 14,750 mn was 13% lower YoY. Pre-provisioning operating profits at 12,536 mn were 15% lower YoY.
  • Provisions were at Rs 1,476 mn compared to Rs 649 mn and Rs 1,645 mn in 1QFY19 and 4QFY19 respectively.
  • PAT at Rs 8,020 mn was lower by 24% YoY.
  • Asset Quality worsened sequentially from GNPAs and NNPAs of 0.88% and 0.69% respectively in 4QFY19 to 1.47% and 1.10% respectively in 1QFY20.

Management Commentary:

  • IBHFL reduced exposure to CRE loans amounting to Rs 60 bn in 1QFY20. Efforts to reduce CRE exposure is in anticipation of the proposed merger with Lakshmi Vilas Bank (LVB).
  • Management has guided to quarterly disbursements of Rs 100 bn from 2QFY20. Guidance for loan book growth for FY20E is in mid-teens.
  • Management expects spreads to remain stable in 300-325 bps range.
  • IBHFL recovered Rs 7 bn from Palais Royale in 1QFY20 against earlier guidance of Rs 2 bn. Against the recovery, Rs 4.5 bn was used to make additional voluntary provisions. Under ECL norms, companies cannot make floating provisions. Hence IBHFL has proactively classified certain accounts as Stage 3 (including Zee group, CCD group) and provided against them.

Consensus estimates (Source: Marketscreener website):

  • IBHFL closing price (as on 07-08-2019) was Rs 446/- per share. It was trading at a P/B of 1.1x/ 0.9x its book value per share estimates of Rs 417/ 493 for FY20E/ FY21E respectively. Consensus target price over next 12 months is Rs 910/- implying P/B of 1.85x for FY21E BV of Rs 493