What lies ahead for Embassy REIT amid the Covid-led crisis?

With lockdown measures in place to contain the spread of virus, many business activities have almost come to a standstill. Despite turbulent market conditions, Embassy Office Parks REIT, the Bengaluru-based office space developer, has delivered strong growth in the latest March quarter. Embassy REIT reported revenue growth of around 8 per cent y-o-y to ₹543 crore in the March quarter. This was mostly driven by strong leasing momentum and rental escalations.

While the company was able to maintain its revenue from office space, which contributes to 92 per cent of its revenue, its hospitality segment (contributing about 5 per cent to revenue) took a sharp hit due to Covid-19 induced travel restrictions. Though the impact of this segment to the overall revenues was minimal, disruptions to the hotel business will continue in the coming quarters, impacting revenue generation from this segment.

The net operating income grew 10 per cent to ₹461 crore during the same period.

The net operating margin was 85 per cent, an increase of 100 basis points y-o-y, partly due to lower operating expenses.

Embassy REIT reported a profit of ₹58 crore during the March quarter (versus a loss of ₹9.4 crore in the same period last year). The profit during the quarter was dragged down by impairment loss of ₹177 crore recognised for the company’s hospitality business due to slower than anticipated occupancy at the Four Seasons hotel (Bengaluru).

Tough times ahead

While Embassy REIT has strong balance sheet with moderate debt levels, it faces several headwinds going ahead.

For one, with many of its clients’ employees working from home, it could face a significant slowdown in demand. According to the management, leasing decisions will likely be deferred over the next few months while the corporate occupiers figure out long-term strategy (with respect to work from home). Therefore, the rental pre-commitments from corporates is likely to be impacted for the next 1-2 quarters.

Further, the company had halted construction activities on 2.6 million sq ft of new development as per government orders. The delivery timeline too is expected to be impacted with delay by 1-2 quarters.

The stock went down 1 per cent on Wednesday post the results, but has corrected 20 per cent since November last year due to uncertainties in the office demand offtake. That said, while the short-term environment is challenging, the fundamentals of the company remain strong. REIT’s debt to equity ratio is 0.17 times.

The recent rollback on dividend distribution tax works in investors’ favour, and Embassy REIT for the March quarter announced ₹6.89-distribution per unit (dividend, interest and amortisation of debt).

As on March 2020, Embassy REIT was able to maintain an occupancy rate of about 93 per cent. It has seven office parks and four office buildings in prime locations of Bengaluru, Pune and Noida. Over 40 per cent of the revenue is contributed by the top 10 clients. During the quarter, the company released 75,000 sq ft and renewed lease contracts for about 1,38,000 sq ft. It has also entered into new lease contract of 2.4 million sq ft to over 25 occupiers. The average lease tenure for the REIT is 5-9 years with 3-5 years as the initial commitment. It has contractual lease escalation of 15 per cent every three years.

Given the quality of Embassy’s clients’ and the location of its office properties, it was able to collect 92 per cent of its rent for the month of April. For May too, the collections have been healthy according to the management. It has also achieved 12-15 per cent contractual escalations on 1.6 million sq ft with over 20 occupiers.

Also, during the quarter, about 1.4 million sq ft was ready for occupancy (it has received the occupancy certificate), of which 62 per cent was already taken up by occupiers, but due to Covid-19, rent commencement may take time. This could impact the rental revenue for the company in the next two quarters. Embassy REIT has about 6 per cent of its overall portfolio consisting of occupiers directly affected by the virus. This includes hospitality, aviation, retail and co-working sectors and these could continue to see stress in terms of occupancy and collections in the coming quarters as well.