Mindspace REIT: Should you invest in India’s 2nd REIT IPO?

After Embassy REIT got listed in 2019, K Raheja Corp’s Mindspace REIT, IPO is currently open. Should you invest?

Kumar Shankar Roy Jul 28, 2020

Mindspace REITFor those investors looking for direct commercial real estate exposure without the usually high investments involved, Real Estate Investment Trusts or REITs are a great option. The first REIT in India, from Embassy Office Parks, got listed in 2019. Now, we have the 2nd REIT getting listed with Mindspace Business Parks, managed by K Raheja Corp, whose Rs 4,500-crore IPO is open from July 27. The price band is Rs 274-275 and the minimum lot size is 200, indicating a minimum investment of about Rs 55,000. Let us take a detailed look at what makes this REIT different. Keep reading.

Basic terms of understanding

A REIT stands for Real Estate Investment Trust. A REIT is an entity that will own and operate commercial real estate. It pools in money from various stakeholders. Like ETFs (exchange-traded funds), REITs are traded on stock exchanges. To invest in REITs, you need to have a DEMAT account through which you can choose the IPO. A REIT distributes most of its income (minimum 90%) to the investors/unitholders.

REITs are governed by SEBI regulations, making this asset-class trustworthy. From an investor’s point of view, a REIT allows you to spend a small amount to have a stake in commercial real estate.

What is Mindspace REIT

Mindspace Business Parks REIT (Mindspace) owns an office portfolio located in four key office markets of India – Mumbai, Hyderabad, Pune and Chennai. The portfolio has a total leasable area of 29.5 million square feet (msf). According to C&W, the portfolio is one of the largest Grade-A office portfolios in India. The portfolio comprises 23.0 msf of completed area, 2.8 msf of under construction area and 3.6 msf of future development area, as of March 31, 2020.

Just for comparison, Embassy owns and operates a 33.3 msf portfolio of seven Grade A office parks and four city-center office buildings in Bengaluru, Mumbai, Pune and the National Capital Region (NCR). The portfolio comprises two completed (including the Four Seasons hotel at Embassy One), two under-construction hotels, and a 100MW solar park supplying renewable energy to park occupiers. One of the common factors in Embassy and Mindspace REITs is the presence of Blackstone as an investor (Blackstone is a minority investor in Mindspace).

The Mindspace REIT intends to use a combination of rent commencement from leased out space, which is contracted and has not generated rental income for the full year, contractual rent escalations, lease-up of vacant area, re-leasing at market rents and on-campus development of existing business parks to continue the growth of the portfolio.

FY20 trust revenue was Rs 1,766 crore. This indicates an average rent of Rs 52 per square feet. Profit after tax was Rs 514 crore.

One of the parameters on which a REIT is judged is Net operating income (NOI). This is all revenue from the property, minus all reasonably necessary operating expenses. As per ICICI Securities, the Mindspace REIT’s NOI is projected to grow 59.2% over the projection period (FY23 over FY20), primarily due to the above factors.

The total market value of the Mindspace portfolio, which comprises the market value of the portfolio and the facility management division, as of March 31, 2020, as per the valuer is Rs 23,675.1 crore.

Proposed post issue debt (external) is Rs 3,614 crore (about 15% of the market value).

Net Asset Value (NAV) on a fair value accounting basis (attributable to owners of Mindspace Business Parks Group as on March 31, 2020) is Rs 17,784.5 crore

As of March 31, 2020, the Mindspace trust had 172 tenants, with a weighted average lease expiry (WALE) of 5.8 years, compared to 7 years for Embassy.

The tenant base appears well-diversified with no single tenant contributing more than 7.7% of gross contracted rentals, as of March 31, 2020. In terms of gross contracted rentals, as of March 31, 2020, nearly 85% is attributable to MNCs. The tenant base comprises a mix of multinational and Indian corporates such as Accenture, Qualcomm, BA Continuum, JP Morgan, Amazon, Schlumberger, UBS, Capgemini, Facebook, Barclays and BNY Mellon. About 39.4% is Fortune 500 companies.

How does a REIT make money

The primary source of operational revenue for the REIT is the rental income. There are also common area service charges. The office spaces are usually leased out for long periods. There are rent escalation clauses.

When leases are renewed, there is an opportunity to align the rent to the current market trends

The tenants provide a stable source of income.

At this point, it is difficult to understand what the impact of Covid-19 pandemic will be. Will it adversely affect the business, financial condition and reduce demand for commercial real estate, in future? There is no fixed answer for this.

How unit holders get returns

In a REIT, there is a yield part from net distributable cash and a capital appreciation part.

The yields in REITs are expected to be higher than bank FDs.

REIT manager charges

K Raheja Corp Investment Managers LLP (held by Ravi C Raheja and Neel C Raheja, as partners) has been appointed as the ‘Manager’ to Mindspace REIT.

Axis Trustee Services Ltd has been appointed as the ‘Trustee’ to Mindspace REIT.

In terms of manager charges/fees, Mindspace REIT is competitive. REIT management fees are 0.5% of Net Distributable Cash Flow (NDCF). Property management fees is 3.5% of total rent. There is no base fee, no acquisition fee and no divestment fee.

Mindspace Net Operating Income

How have REITs performed in market

We can see how Embassy REIT is performing. The Embassy IPO was priced at Rs 300. It currently trades at Rs 364 compared to its NAV per Unit of Rs 374.64 (as on March 31, 2020).

The Embassy REIT was trading over Rs 460 in March and then Covid-19 hit, which led to a fall in the market price of REIT unit.

Tax impact for investors

Capital gains in REITs held for less than three years are taxed at 15%. Capital gains held for longer than three years are taxed at 10%.

Dividends from REITs are tax-free in the hands of investors, if the REIT special purpose vehicle does not opt for the concessional 22% corporate tax rate on its income. Mindspace REIT has not opted for the concessional rate.

Interest and rent investors get from the REIT are taxed in the investor’s hands at the applicable slab rate.

A 92% of Mindspace REIT’s income will be distributed in the form of dividends and the balance 8% as interest.

Talking about Mindspace REIT, Sharad Mittal, CEO, Motilal Oswal Real Estate Fund says: “With ~80% of the portfolio comprising completed assets and a projected yield of 7-7.5% on the issue price, one can expect an overall return in the range of 11-12% by investing in this REIT.”

Cross asset comparison

REITs combine elements of debt and equity and provide a return of ~12-13% of which ~8% is fixed (based on the rental income) and balance accrues through growth in the asset value.

The listing of the REIT makes it a highly liquid product and makes it accessible to investors who can invest in rent yielding real estate with a small ticket size.

With the dividend exemption provided to distributions made by the REIT, this investment also becomes tax efficient in the hands of the investor.

Globally, REITs have provided returns commensurate with those provided by equities over a 10-15 years period with a large part of the return being less volatile compared to equities.

RupeeIQ take

There are pros as well as cons.

Firstly, the Mindspace REIT lacks geographic presence in Bangalore. If you want that, Embassy is your pick. If you think the Bangalore market is over-rated, then Mindspace is a good alternative to avoid Bangalore.

Secondly, a substantial majority of the Rs 4,500-crore REIT IPO is Offer For Sale (OFS). This money does not come into the REIT company.

Thirdly, the Mindspace REIT offers a portfolio with stable cash flows, strong growth potential and significant scale. It is Covid-19 which creates a problem. The complete extent of the pandemic’s impact on the business and operations for the quarter ending June 30, 2020 and FY21 is currently uncertain.

Fourthly and most importantly valuation, a fluid thing. The NAV of Mindspace REIT is Rs 320 and at Rs 275 IPO price you are getting a 14% discount to NAV.

Kumar Shankar Roy

Kumar Shankar Roy is contributing editor with RupeeIQ. Kumar is a financial journalist, with a functional experience of 15 years. He tracks mutual funds, insurance, pension, PMS, fixed income/debt and alternative investments markets closely. He has worked for The Times of India, The Hindu Business Line, Deccan Chronicle Group, DNA, and Value Research, among others, across different cities in India. He is deeply interested in marrying data insights with actionable opinion. He can be contacted at kumarsroy@rupeeiq.com.

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