Embassy Office Parks REIT (EMBASSY) Earnings Call Transcript & Summary

Good evening, everyone. A warm welcome to all for the Embassy REIT's Management Conference Call. [Operator Instructions] I would now like to introduce your host for today's conference, Ms. Sakshi Garg, Investor Relations Manager for Embassy REIT. Ma'am, you may begin.

Thank you. Good evening, everyone, and thanks for joining us to discuss the transaction Embassy REIT announced on April 6, 2024. You may wish to refer to the acquisition presentation, the press release and the extraordinary meeting notice relating to the transaction announcement. We have placed these relevant documents in the Investors section of our website at www.embassyofficeparks.com. As always, we would like to inform you that management may make certain comments on this call that you could deem forward-looking statements. Please be advised that the REIT's actual results or actual outcome of the proposed acquisition may differ from these statements. Embassy REIT does not guarantee these statements or results and is not obligated to update them at any time. Joining me today are Aravind Maiya, CEO; and Ritwik Bhattacharjee, our CIO. We'll run you through the proposed acquisition and fund raising plan, after which we will open the floor to questions. Over to you, Aravind.

Thank you, Sakshi. Good evening, and thank you all for joining us on the call today. We recently celebrated our fifth year anniversary as a listed REIT. On this occasion, we are very excited to announce a strategic acquisition, which will allow our entry into our fifth growth market and increase our portfolio to over 50 million square feet, positioning us as one of the largest office REITs globally. I want to highlight that Embassy REIT is at the cusp of delivering strong growth over the next few years. This will be led by an occupancy ramp up in our existing portfolio of 35.8 million square feet as well as our 6.9 million square feet active developments, out of which we have already pre-leased 73% of the next 2 years deliveries. With the continued business momentum and favorable market conditions, we believe this is the right time to raise additional to strengthen our balance sheet and give us the firepower and flexibility to finance our growth. Last Saturday, the independent directors of our investment and audit committees as well as the Board of the Manager to Embassy REIT approved the acquisition of Embassy Splendid TechZone, Chennai, for an enterprise value of INR 1,269 crores. And an institutional placement of up to INR 3,000 crores, subject to unitholder and other approvals. Let me hand over now to Ritwik to take us through the transaction details.

Thank you, Aravind. Good evening, everyone. I will keep my comments brief because this acquisition and the accompanying fundraise is quite self-explanatory. We view this transaction as a very compelling opportunity for the following reasons: ESTZ is a great asset. It's a 5 million square feet campus-style office park spread over approximately 26 acres. The asset is located at Pallavaram-Thoraipakkam Road, which is 15 minutes from Chennai International Airport. The 1.4 million square feet completed area is 95% leased to marquee multinational occupiers such as Wells Fargo and BNY Mellon, among others. Another 1.6 million square feet is currently under development. And already 26% pre-leased. An additional 2 million square feet of future development potential provides embedded growth. So second, Chennai is one of the fastest-growing office markets in India and recorded a gross absorption of 9.4 million square feet last year. Within Chennai, ESTZ is located in OMR 2, which is amongst the top performing submarkets in the city and accounts for over 20% of its gross absorption. The proposed transaction is accretive across all key financial metrics. We're buying the asset for an enterprise value of INR 1,269 crores, priced at a discount of 6.7% to the average of the 2 independent valuations, our price implies a stabilized NOI yield of 8.5% for the completed portion and 10% for the development portion. This compares favorably to our current trading yield of around 7.1%. The overall transaction is 2.9% NOI and DPU accretive and will not significantly impact NAV. The enterprise value of INR 1,269 crores includes 61% economic interest in the lease revenues and 100% interest in the property management business of the asset. We propose to raise external debt of approximately INR 400 crores and unit capital of INR 2,500 crores through an institutional placement subject to requisite approvals. We will use the total proceeds of INR 2,900 crores in the following manner: firstly, acquisition-specific proceeds. We will pay down approximately INR 800 crores of existing debt. We will refinance INR 400 crores of debt, and we will pay INR 43 crores to Embassy sponsor, which relates to the rental support. Second, there will be deleveraging proceeds, for which the balance INR 1,650 crores will be used to primarily delever the REIT's existing balance sheet. The deleveraging exercise will reduce our leverage from the current 30% at the REIT to 27% and provides us the flexibility for future growth. In summary, ESTZ adds over INR 89 crores of NOI and INR 69 crores of NDCF on a pro forma basis. We will achieve interest cost savings of over INR 130 crores through the external debt repayment. Together, this will result in a pro forma NDCF of over INR 200 crores to the REIT. Two other points. There is income support of INR 43 crores for Embassy sponsor, which is included in the consideration. We believe we have full visibility into this lease. However, there is a valuation adjustment should the binding lease agreement do not get executed prior to the acquisition completion. Then there will be a reduced consideration of -- that amounts to INR 11,085 crores without the rental support. Lastly, given this acquisition qualifies as a related party transaction under SEBI's regulations, we have followed applicable related party safeguards. Also, while the acquisition does not exceed the threshold requiring unitholder approval for related party transactions under the REIT regulations, we're seeking unitholder approval for the acquisition and institutional placement through an extraordinary meeting scheduled for April 29, 2024. Let's move to Q&A, please. Abhishek Agrawal, our CFO; and Amit Shetty, our Leasing Co-Head, who'll join us as well.

[Operator Instructions] We have the first question from the line of [ Shrish Vaze ] from Moneylife.

My question pertains to the institutional placement at Embassy what we're doing. So in...

The line for the participant in the queue seems to have dropped. We will take the next question from the line of Kunal Tayal.

Just a couple of questions on the Chennai market from my side. One, if you could just talk through your assumptions on the leasing outlook for the under construction pipeline that you have, number one. And second, could you just refresh for us as to what are sort of the headline drivers of Chennai leasing market that you foresee? Is it expected to be GCC's story or a different set of events that would be sort of the drivers. I know that in the last 1 year, Chennai really come through the ranks in terms of leasing momentum. So which of these you would expect to continue? And what are the new ones that would come along the way?

Thanks, Kunal. Let me start on some of our assumptions, and then I'll hand it over to Amit Shetty, our Leasing Co-Head, to talk a bit on the market. From our point of view, as we said, 1.4 million completed, 95% leased and then there's 0.4 million, which is today under construction, but that is fully pre-leased. So in terms of the balance, there is around 6 blocks. Largely big picture, we've assumed that we will do a block each year, which we believe is very comfortable for us to lease over the next few years. That's what we have underwritten. But in terms of overall market, why don't I hand it over to Amit right now.

Thanks, Aravind. So Chennai has been a very strong performer on the leasing side. It's been the third largest city in the country from an absorption perspective last year, absorbing about gross -- grossly about 10.94 million square feet. And we are in the -- from a micro market perspective, we are positioned very, very well because 18% of all the leasing that's happened in Chennai is in the micro market that we are currently present. So we believe that it's truly a great story. And given the clientele and the ecosystem that we have in the park, I think it's truly exceptional to attract newer clientele as well.

Got it. Just one quick clarification. I thought you're saying that the under construction is 0.4 and all of that is leased out. I seem to -- I don't -- maybe I'm mistaken, but I thought I read 0.4 million or 1.6 million is being leased out so far.

Let me clarify. There's 1.4 million completed, which is 95% leased. Then there is one tower called Block 10, which is 0.4 million square feet, which is under construction today, which is fully pre-leased, subject to a binding document which Ritwik spoke about. Then there is another 3.2 million, which is at different stages of construction. Somewhere the structure has come; somewhere there's just podium, somewhere there is just land. So all put together is around 3.2 million.

Got it. And this is where you're saying 1 tower -- 1 block each year?

Yes, yes.

We have the next question from the line of Murtuza Arsiwalla from Kotak Securities.

Yes. You talked about the 8.5% cap rate and 10% for the proposed development. Can you help break that up? When I see that INR 1,269 crores of enterprise value for this acquisition, can you give us the breakup of that value between the subcategories? And we -- the way I picked up from the presentation is 1.4 million completed, 1.6 million under construction and 2 million future development. And also, if you could just give us some flavor on the underlying NOI, how much is coming from rentals, how much is coming from the property management fee for the 8.5% cap rate and the 10% cap rate that you stated?

So why don't I hand it over to Ritwik to give details on the valuation of split? And then second question, a little bit more clarity from you, but I'll come to it later. Ritwik, over to you.

Yes. So effectively, you should think about it in 3 different phases, Murtuza, the first, the 8.5% pertains effectively to blocks 2, 3 and 9 and effectively also 10 as well, right, with rental support, right? So that's effectively what -- and the 8.5% really is a number that we did not take lightly simply because I think given where our precedent and transaction comps have priced out in sort of the private markets and just overall, we wanted to make sure that there is full value sort of reflected in that. The under construction portion of sort of 10% really then obviously pertains to doing this at sort of effective Chennai rents and then obviously taking 61% of that for the rest of the assets on a blended basis. And then -- but assuming the full financing cost, the construction cost of that because that's something that we have to bear the brunt on. So that number then obviously sort of comes in at that 10% range. So that's effectively the major area. And we think about it in the perspective of 2, 3, 9 and 10 as the major blocks and then obviously thinking about sort of rest of it under construction for the [indiscernible] cost. In just terms of split of values -- Murtuza, 2, 3, 9, 10 is around INR 910 crores and the balance fixed deposits is around, say, INR 359 crores, that's broadly distributed.

Sorry, just on the second one, I didn't get your question fully, sorry, Murtuza.

What I was trying to get a sense on was the NOI and the capital management split. So when I look at this -- broadly when I look at the in-place rental of about INR 69 crore which is through the points that you've given in your presentation, I get about INR 110 crore of rental revenue, which I understand only 60% belongs to us. So when you look at 8.5% on roughly about INR 900 crores -- that's roughly about INR 770 crores. So you see 8.5% on the INR 89 crore of NOI that you've given? Or is that on a number -- a more normalized number?

Yes. Okay, 2 things. One, it is on the INR 89 crores. The INR 89 crores includes 100% of the cash. The only moving piece is there is balance cost to be spent on Block 10 that is reduced, and I gave you the number of INR 910 crores value.

[Operator Instructions] We have the next question from the line of Naishi Shah from ICICI Lombard.

I just have a couple of questions. So based on my understanding, the currently constructed blocks, they are all SEZ properties. And the block #10 that is under construction, that is a -- that is also an SEZ, if I'm not wrong?

Yes, that's correct.

And considering that there's a lot of denotification and process in the other cities that we have assets in. Is there a specific reason why we're constructing these properties under SEZ? And is there demand for SEZ properties as of now considering the occupancy rates had gone down in other cities?

Sure. You want to finish off with your second question...

Sure. I can do that. I just wanted to understand a little more on the rental support of INR 42.9 crores. So is that -- is this something that the REIT will be paying to the Embassy group? Or how does it work?

Okay. Got it. So in terms of the first question, the current 1.8 million is fully SEZ. These are all new leases. It's weighted average lease expiry of another 14 years. So we are comfortable with that. In terms of the balance, 3.2 million square feet, we have assumed and underwritten the entire balance to be non-SEZ. So we have factored in the necessary GST costs in relation to construction. So to keep it short, we are assuming that every single lease henceforth will be in relation to a non-SEZ space. That's the way we've looked at it. The rent support is purely in relation to 0.4 million square feet pertaining to 1 tenant where construction is going on. So what we've done is because it's fully backed up by a tenant, we have valued this appropriately or accordingly in the valuation. And to the extent of the rent from the date of purchase until the expected rent commencement date, which is expected to be around November '25, that is going to be paid back by Embassy to us, and all of this is anyway will be done through escrow arrangement.

We have the next question from the line of [ Pallav Garg ] from Star Health Insurance.

So I quickly wanted you to give us some sense on the rent and occupancy building in other office dominated areas in the Chennai market? Just trying to get a sense on how OMR 2 is placed compared to other office markets?

Okay. I'll just request Amit to take the question, Pallav.

So Pallav, essentially, OMR 1 is the highest grossing in terms of rents. Rents are anywhere between INR 85 to about INR 100, right? The second most premium or the rent that we've seen is PTR Road, which is anywhere between INR 75 to about INR 85, INR 90. So that's the rental spread. And OMR 2 specifically is slightly lower than the PTR Road market, which is essentially closer to about INR 60 -- INR 50, INR 55 to INR 60 rental range.

Okay, sure. Sir, when we see the valuation report here, like I think on the Page 52, on the filing, which you have put up, which has total of 230 pages, there the current vacancy for peripheral Southwest, the region where OMR 2 property belongs to, that comes out among the highest. But our property per se is at a -- sitting at a very handsome occupancy rate. So our is the outstanding in the OMR 2? Is that understanding right?

Yes. If you see our strength, Pallav, is that we build business ecosystems, and that's the ethos that we've built this park also. And that's why we've commanded much better than the other parks in and around the vicinity.

Look -- not all supply and not all products are created ethos, right? And I think one of the reasons why we have the names that we do in the park and the reason why we will move to actually go out there. And I think this is important for, I think, everybody on this call and just for the market to understand. We are doing this for a very specific reason. I think the time -- there's clearly a boom. There is a GCC boom. There is a leasing boom, and we are looking -- Chennai as a market is growing. We are really looking to capitalize on this entire aspect by listening to what our tenants want. They're looking to lease more. They're looking to actually sort of take up more space. And I think if we don't act when -- and strike while the iron is hot, I think we'll sort of lose out to competition. But again, it's our assets -- the quality of our assets dictate the vacancy level and 95% pre-leased -- 95% occupied for the completed is a sign of that.

[Operator Instructions] we have the next question from the line of Girish Choudhary from Avendus Spark.

So if you can just let us know a bit more on the need to deleverage now, especially one, if you look at from an interest rate cycle, we are at peak levels and so why not go for growth? And also from a timing point of view, like why the overall deleveraging exercise currently?

Yes, that's a very good question. And I think part of the entire fundraising strategy for us was predicated around this. If you look at the majority of the process -- of the proceeds for the fundraising is going to be to delever. And the reason it's quite simple, as a REIT in India, we're a new structure. And while I think we've done an exemplary job managing our cost of capital, the fact is that the debt markets are quite shallow. We've raised money at leading rates. But I think what we want to do is just create a little bit of headroom that allows us to manage the balance sheet where 30% leverage in a new market is still quite a lot. And I think if we have the opportunity to take advantage of a rising stock price and make sure that the balance sheet remains clean, gives us the opportunity to continue having those -- that INR 135 crores of interest savings that allows us to just keep the development sort of clean and funded appropriately. That's why we just thought it would be a good sort of -- it's a prudent way to do it. This is no different from what other REITs do worldwide or when companies actually take advantage of capital markets to delever. So -- and there's no sort of real sort of science behind it. I think we just feel comfortable at slightly lower levels at this point, ingest the acquisition appropriately and make it accretive, which sort of dictates why we are out there in the market doing a placement at this point.

And just to add on while Ritwik covered it, you are aware that we are developing close to 7 million square feet in our portfolio. The expected spend on that is almost close to INR 4,000 crores, plus we will develop further in Chennai, and all of this will come from debt. So considering all of this, we thought it made sense to delever a bit.

And just one last point on this. I think for the market to consider. I think we've always operated in an elevated funding environment. And I don't necessarily think that if you look at the Fed doesn't seem to be any real rush to cut, right, at this point in time. So if you think of an elevated rate cycle over the next year and there's some refinancing risk, at least globally that's going to hit commercial real estate. We just want to stay ahead of that and keep the balance sheet sort of flexible.

Got it. Got it. And one more question on -- if I look at your NOI to walk for the transaction, right, which is like the incremental and the [ INR 203-odd ] crores. So there, I would just want to understand like why the incremental tax is not factored in for the interest cost savings?

To introduce Abhishek, our CFO. Abhishek, go ahead please.

Yes. Actually, what will happen is, yes, the -- actually, this transition will be that neutral from the interest rate perspective because the tax shield we will lose on the interest of outside debt, but we will get similar tax shield when the REIT infuses this amount to their savings.

So there won't be additional tax expense, just to keep it short?

No.

The next question is from the line of Praveen Choudhary from Morgan Stanley.

And congratulations for getting this deal done. Two quick questions for me. One is when you mentioned on Page #22, the accretion of 2.9%, this assumes the entire placement on top of the deal, right? It's not just that you're assuming the deal is done with equity of INR 13 billion raising? I just want to confirm that. And the second question I had was the maximum gearing that you're comfortable. You said 30%, going to 27%, but what is the percentage where you are comfortable if tomorrow, there is another deal that comes through and you have to gear yourself? Is it 35%, is it 40%?

Yes. Just taking the second question first, in terms of gearing. Praveen, any way, we have a cap that we will not cross 35% because that's the maximum number, which is approved by a unitholder. So that is anyway the cap we have, but we would probably be on the early side of 30% than the later side of 30%. That's broadly what I would say. And in terms of attrition, you are right, the 2.9% accretion factors in both the Chennai asset acquisition and the necessary cash inflow and the full funding of INR 2,500 crores in form of equity and refinancing. But just big picture split closed around 1% or 1.1% is pure accretion from the Chennai asset and the balance 1.8% accretion is coming from deleveraging.

Understand. And do you have for deleveraging assumed the debt to be refinanced at 8.3%, right? That's where the interest cost saving is happening. Would you be doing immediately? Or it's just an assumption here?

Yes. So we have the necessary ability to do it immediately, Praveen, in terms of the loan terms.

The next question is from the line of Kunal Lakhan from CLSA.

Just wanted to get some numbers there. In terms of balance CapEx on Block 4, 1, 5 and 8, what would that amount be?

So all in, it will be close to INR 1,600 crores, including master plan for all future blocks, including what is today under construction. Including GST. Yes, including all costs.

This excludes Block 10?

Includes Block 10.

But block 10 would be very minimal of this...

It's around INR 135 crores.

INR 135 crores? Okay. So around INR 1,450-odd crores would be for block 4, 1 and 5 and 8...

No, it's 5, 6, 7, 8. Yes. So there's 4 blocks between 5 and 8. So including Block 10, there are 7 blocks. If you were to exclude Block 10, there are 6 blocks plus master plan.

Correct. Correct. And that's the portion which you have valued at INR 359 crores?

That's correct.

Okay. So just trying to get some numbers there. So if I look at the completed portfolio valued at about INR 910 crores, that includes Block 10, I'm assuming, right?

Yes, that's correct.

Sorry?

Yes, that's correct. That's correct.

So that's like 1.8 million square feet of portfolio valuing at INR 910 crores, which essentially is the valuation of about INR 5,055 per square feet and the ongoing and upcoming you valued at INR 359 crores. And if I add balance CapEx to this of INR 1,450 crores, the implied valuation for this would be about INR 5,653 crores. So just -- I'm just trying to reconcile some numbers there.

Sorry, INR 5653 crores you mean or you mean per square feet?

INR 5,653 per square feet, correct. Yes, so INR 359 cores plus INR 1,450 crores is about INR 1,800 crores divided by 1.2 million square feet, it's about INR 5653. So just -- is that understanding correct?

Let me put it this way. The completed blocks -- all your numbers were right, but just remember that we have only 61% rights. So when you factor for the 61% rights, it will come to around INR 9,000 per square feet. Similarly, for the 3.2 million square feet, there are already some cost spend, right? So if I were to remove the cost spend and were to value only the rights which we have, that comes to around [ INR 1,200 ] per square feet.

How much would be the cost spend on...

Cost spend is approximately around INR 120 crores.

Okay. Would that -- I mean that would still value -- it would not be very materially different, right, in terms of valuation?

So Kunal what we can do, I think we don't understand the way you have done it. It's better to just take this one-on-one where we can explain you better because we are not able to really see what you have done.

Fair enough. I'll take this offline.

The next question is from the line of Satinder Bedi from Eon Infotech Limited.

Okay. So carrying on with this last question. So this INR 910 crores, which is the cost attributed to 1.4 million built up and 0.4 million parking built up. So what part of this INR 910 crores is attributable to the 1.4 million already completed, please?

Yes, it's around INR 770 crores.

Okay. So for INR 770 crores for 61% of 1.43 million? Is that -- out about [ INR 8,800 ]. Is that a clear understanding?

Yes, that's correct.

Okay. And regarding this interest cost -- so this is the original question I had, but I couldn't understand when it is answered by Abhishek. So Abhishek, on this walk down [indiscernible] NDCF. So you said the interest cost savings has not been offset by the tax implication, okay? So why more -- tax implication of the interest cost savings is, if you could kindly help us understand?

So Satinder, what will happen is there will be an interest saving on the external debt at the SPV level. There will be additional debt, which will come in because the equity raise that we do, we will infuse that also into the SPV. And the REITs will also charge interest. So net-net, there will be no tax liability.

Okay. Okay. Okay. So there will be no tax there at all. Okay, okay -- okay. And one more query I had was your view is like on the cap rate of 8% for PCL given that other leading REITs like let's say CapitaLand for example Taramani would have typically been valued at 8.5%. So if 8% kind of...

8.5% of the completed Satinder. We're not at 8%, we're 8.5%. So I think it's very well in line with the market precedent. And I think if anything, slightly wider, given sort of where sort of markets have been. And I think we're not sort of private capital. We obviously have a fiduciary duty to shareholders as well. So I think we're very much -- and I think if you look at sort of precedent trades that have been done, that significantly sort of inside us.

Yes. Satinder, I think honestly, there are some [indiscernible] have happened, the few ones in Chennai at a much tighter cap rate than 8.5%.

So yes, okay. So I think I understand correct it. So actually, the valuation is, the valuer has valued it at 8%. And because of the 6.7% discount, I think we end up transacting at 8.5%, 8.6%. So maybe that's where it is...

Ladies and gentlemen, we will take that as a last question. On behalf of Embassy REIT, that concludes this conference. Thank you for joining us. You may now disconnect your lines.