Nexus Select Trust (Retail REIT) and Office REITs
(This
is for information purposes only. This should not be construed as a
recommendation or investment advice even though the author is a CFA Charterholder. Please consult your financial
adviser before taking any investment decision. Safe to assume the author has a vested
interest in stocks / investments discussed if any.)
(Update 12Jan2024 is available at the end of the blog)
Last Friday, Nexus Select Trust was listed on Indian stock exchanges. Nexus is a real investment trust or REIT exposed to retail sector in India through retail / shopping malls across India. (for simplicity, we shall refer this as Nexus).
This is India's first retail REIT and is different from REITs that are exposed to commercial real estate or office properties (CRE REIT or Office REIT). Nexus is backed by global investment firm Blackstone.
REITs (pronounced ‘reets’)
are companies that own and collect rent from commercial and residential
properties. The income from operations is distributed to the shareholders. A
REIT is a trust that owns, and in most cases, operates income-producing real
estate such as apartments, shopping centres, offices, data centres, hotels and logistics / warehouses.
Like stocks, REITs are listed and traded on stock exchanges. Of course, there are some unlisted REITs also.
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Read more on REITs:
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How different are Retail REITs from Office REITs
In the US, Japan, Canada, Singapore and Europe, there are various kinds of REITs, like, office, retail, warehouses, mortgages and residential.
Nexus Select Trust is India's first retail REIT. We have three other REITs, all of which are in the realm of office properties -- they are, Embassy Office Parks REIT, Mindspace Business Parks REIT and Brookfield India Real Estate Trust.
Nexus
receives rents from retail / entertainment stores that are housed in its malls across India. Nexus
focuses on retail malls, with 17 malls across India. Nexus
is not strictly comparable to other REITs, because Nexus is based on retail
malls, while others are based on commercial real estate or CRE.
Office / CRE REITs in India have big clients from information technology and finance sectors, most of these clients are global companies.
Nexus'
business model is comparable to Phoenix Mills, which has malls in Bombay and other cities. Nexus
gets a portion of its revenue (11.3 percent of store sales) from
sales of retail stores; in addition to fixed monthly rentals from these stores.
Nexus' offer document (red herring prospectus) claims it has no peers in India.
Valuation Metrics of REITs
Before investing in REITs, we need to understand how a REIT generates its cash flow: Some key factors to consider are:
-- how the rental income is generated
-- whether the income stream is sustainable in long term
-- what is the portfolio of properties a REIT owns
-- what is the quality of the properties
-- how is the demand for properties
-- is there any excess supply in the market
-- lease terms
-- quality of tenants
-- how are the overall economic conditions
-- are the properties located in growing areas
-- is the REIT acquiring any new properties
-- how often a REIT distributes its income / payout
We
should not compare price return of REITs with other stocks,
because REITs distribute their profits as income periodically to
REIT unitholders.
As mandated by India's capital market regulator, SEBI or Securities and Exchange Board of India, REITs have to pay out at least 90 percent of their net distributable cash flows to unitholders on a half-yearly basis.
We cannot value REITs based on traditional stock market metrics, like, price-earnings ratio, price to book value or price to sales ratio. We need to assess the valuation of REITs based on other metrics. Some of the metrics are discussed below.
1. Distribution yield
As stated above, REITs have to pay out at least 90 percent of their net distributable cash flows to unitholders on a half-yearly basis, as mandated by SEBI.
Distribution yield is calculated by dividing the actual distributions made by a REIT in a year to a unitholder with the current market price of the REIT. This is a pre-tax return for the unitholder as the income distribution is taxable in the hands of the unitholders.
A distribution yield provides a broad view of how much return one can expect from a REIT investment.
2. WALE
WALE or Weighted average lease expiry measures in how many years the existing leases of the tenants expire. For example, a WALE of six years means the properties leased will on average expire in six years before the tenants renegotiate for renewal at the end of the contract. In general, the higher the WALE, the better for unitholders.
3. Occupancy Rate
During turbulent times, a number of units in office or retail properties may remain vacant, as offices and merchant establishments may shut down their businesses.
Occupancy rate is calculated by dividing total occupied area (for which lease agreements have been signed) with total completed area (leasable area for which occupancy certificates have been received and construction has been completed)
Hence, it is important to know how much of the space in a property is occupied. An occupancy rate of 90 percent means out of the completed area, only 90 percent of the space is leased and is fetching rentals from clients. The remaining 10 percent space is not occupied by any tenants.
4. Net Asset Value or NAV
Net asset value is net worth of the REIT on a per unit basis. Net worth is calculated by subtracting total liabilities from the fair value of the REIT's assets. NAV represents the underlying market value of the REIT unit.
However, NAV often differs from the market price of a REIT -- a REIT often trades at a discount or premium to its NAV, depending on the demand and supply factors in the stock market.
Moreover, NAVs are declared only periodically, at quarterly intervals usually. But the price of a REIT is available in real time on all trading days.
5. Funds from operations (FFO)
Net profit of a REIT does not give a clear picture of the actual profitability. FFO is a better metric to understand the cash flows of a REIT. Broadly speaking, FFO is similar to cash flow from operations (CFO) of a business firm.
FFO is calculated by adding depreciation and amortisation to net profit; gain on sale of properties is reduced from net income and some other adjustments are made to arrive at FFO.
REITs and risks
A REIT unitholder typically can expect two sources of return from a REIT: one is the distribution yield from the income distributed by a REIT and second the price appreciation of the REIT in the stock market.
Over a period of three to five years, if the value of the properties increases in the market, the NAV of the REIT goes up and its price too may rise, all else being equal.
If the lease rentals are increased, lease agreements are renewed at higher rents and occupancy rates have improved; the improvement will show up in distribution yield as the REIT 's net profits rise and so are the cash flows to unitholders.
However, as we have seen during the COVID-19 Pandemic, as offices were shut down due to government lockdowns, the market value of office properties plummeted and so were the rental incomes from REITs.
Any changes in the economic outlook will pose risk for REITs, as we have seen during the Global Financial Crisis of 2008 and dotcom bubble of the 2000s.
Even consumption demand and changes in consumption patterns can affect REITs. If economic outlook for a country improves, it will have positive impact on REITs.
One big post-Pandemic change in work culture is 'work from home' or WFH trend. Several youngsters still prefer WFH even though businesses have been encouraging them to come to office.
For all practical purpose, the hybrid model of work (whereby some workers work from home and the remaining work from office) is here to stay as per the global trends currently.
This WFH trend has negatively impacted market values and rental incomes of REITs. Occupancy ratios of office properties in places, like, San Francisco have dipped below 70 percent according to media reports.
Even capricious tax policies can impede the overall development of REITs. Government
of India in the last four months changed taxation rules for REITs on the periodic income
distributed by them. This has adversely impacted the prices of listed REITs in India.
If a REIT makes new acquisitions via debt, it may impact the debt levels and interest coverage of the REIT.
If the prospects of a business district diminish, it will adversely impact the REIT's future.
Comparison of Listed REITs: Valuation matrix >
The above table compares the four listed REITs in India based on the valuation metrics discussed above.
Current market price, market cap, P/E ratio and P/BV are as on 19May2023. Net asset value, WALE, occupancy rate, total leasable area and gross asset value are as on 31Mar2023 (the latest available data).
In the case of Nexus Select Trust, the net
asset value, WALE, occupancy rate, total leasable area and gross asset
value are as on 31Dec2022 (the latest available data).
As shown above, WALE
is typically lower for retail mall segment (Nexus in the above table) compared to CRE / office properties.
To sum up
This is a brief analysis of the four listed REITs in India. Due to high taxation in India, REITs are not very attractive for small shareholders. For small investors, there are better alternatives from a simplicity and taxation point of view.
REITs are simple products, but the real estate is a very complicated sector in India. Dishonest politicians and bureaucrats hold a stranglehold on the real estate sector. Practically, it's still a controlled sector in India.
As we've have seen in the US, Singapore, South Korea and Europe, REITs offer immense potential for investors. Sadly, this is the not the case in India -- at least for now.
Small investors are better off focusing on sectors that benefit from real estate sector -- like, home improvement, domestic pipes, tiles, sanitaryware, paints, plywood, adhesives, paints, home lighting, furniture and others (in investing lexicon, this is referred to as 'Picks and Shovels' investing).
However, I hope some day in the future, the stranglehold of vested interests may be loosened and real estate sector overall may reach its full potential in future.
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P.S.: Even though the blog was written on 21May2023, the following updates are added after the blog was published.
Update 12Jan2024: The valuation of REITs looks like this as on 12Jan2024 >
Peer comparison as on 12Jan2024 >
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References:
ICICI Direct Research reports
Phoenix Mills report
Nexus Select Trust IPO
Embassy Office Parks REIT IPO
Mindspace Business Parks REIT IPO
Capitalmind article dated 05Dec2022 on REITs
Nifty REITs & InvITs Index
--
as on 31Mar2023, there are only seven REITs and InvITs in the index
(small market of REITs and InvITs in India) - namely, Embassy REIT,
Nexus Select Trust, Powergrid InvIT, Mindspace REIT, India Grid Trust, Brookfield REIT and
IRB InvIT
13Apr2023 NSE - NSE Indices Ltd, a subsidiary of National Stock Exchange (NSE), has
launched India’s first ever index on REITs and InvITs, named, Nifty REITs & InvITs Index - PDF of the index - The index has a base date of 01Jul2019, with a base value of 1,000 -
--
as on 31Mar2023, there are only six REITs and InvITs in the index
(small market of REITs and InvITs in India) - namely, Embassy REIT,
Powergrid InvIT, Mindspace REIT, India Grid Trust, Brookfield REIT and
IRB InvIT
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Additional data:
1. Peer comparison from Screener
2. Nareit Index: FTSE NAREIT U.S. Real Estate Index is the principal benchmark used to represent indirect investment in real estate. The index is compiled by the Washington, D.C.-based National Association of Real Estate Investment Trusts or NAREIT. The index's underlying shares are REITs. The index is updated in real time on all trading days. It is a market-cap weighted index of all REITs actively traded on the NYSE and American Stock Exchange. This index is investable.
3. NCREIF Property Index (NPI): NPI is an index representing privately-held commercial real estate. NPI is the benchmark for direct investment in commercial real estate. NCREIF Property Index is not investable. The NPI is based on “values” estimated (poorly) by appraisers -- the appraisals are quarterly updated, but on a delayed basis. In the NPI, the underlying are individual properties.
NCREIF (the National Council of Real Estate Investment Fiduciaries) is a Chicago-based not-for-profit US entity that focuses on collecting and disseminating data relating to private commercial real estate investments.
4. Compared to FTSE NAREIT Index, NCREIF Property Index (NPI) is less volatile, as the valuations of underlying properties of NPI are updated on a delayed basis.
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Disclosure: I've vested interested
in Indian stocks and other investments. It's safe to assume I've interest in the financial instruments / products discussed, if
any.
Disclaimer: The analysis and
opinion provided here are only for information purposes and should not be construed
as investment advice. Investors should consult their own financial advisers
before making any investments. The author is a CFA Charterholder with a vested
interest in financial markets.
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