Stock Market: DLF, Embassy REIT and Mindspace REIT – UBS on Office Real Estate

Understanding how global tech spending is likely to grow faster will increase demand for Indian offices. They expect India to remain the world’s preferred outsourcing destination over the medium term. They estimate an overall 20% shift to WFH by 2025.

1) UBS maintains buy rating on DLF, target raised to Rs 210 from Rs 195.

2)UBS upgrades Embassy REIT to neutral rating from sell rating, target raised to Rs 370 from Rs 330.

3)UBS maintains a neutral rating on Mindspace REIT, target Rs 324.

WFH impact + pipeline completions could drive vacancies up 640 bps by 2022E

The WFH trend, a result of the COVID-19 impact, is likely to continue with hybrid work policies (mix of office and WFH) even after the pandemic, driven by less commuting for employees and cost savings and flexibility for corporates. UBS published their interactive hybrid work impact model and estimated a 640 bps increase in vacancies by 2022 in the top six office markets, driven by hybrid work policies (360bp) and pipeline completions (280bp), based on supply deep dive. Increased vacancies would pressure rents, as most of supply is 'organised'/quality, but not all landlords would be equally impacted. UBS says that their 10 point framework suggests DLF and Embassy are better placed. Capital values should be positively supported by low interest rates.

Recovery in global IT spend & India outsourcing; quantifying the WFH impact

Given demand for Indian offices is more global than domestic and more from tech than other sectors, the consensus view that global tech spend is likely to grow faster versus pre pandemic is positive. UBS expects India to remain the world’s preferred outsourcing destination over the medium term. Hybrid work policies would dilute that meaningfully. They replicate their global real estate team's (link) WFH impact model for Indian offices. They estimate an overall 20% shift to WFH by 2025 (one day/week equivalent). This would be offset by increased desk space (for collaboration, social distancing, etc), implying a net 8% WFH impact on vacancies by 2025E (i.e., 145bp annual impact).

They built a framework to analyse the top 11 office landlords Rising vacancies would be much steeper in Noida, Hyderabad and Chennai than in Bengaluru, MMR and Gurgaon. Using PropEquity transaction based data, they analyse the top 11 landlords' sector exposure, competing supply, tail risk, concentration risk, market dominance, ecosystem/campus share and in-place rents and lay out a framework to rank them. DLF and Embassy fare better than most others in our analysis.

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Low rates can support asset valuations; REITs already pricing in low rates

Indian REITs have outperformed their global peers on potentially higher total returns and scarcity premium. However, on an excess total return over the 10-year Gsec (6- 8%), they are at 1-1.3x NAV, with global peers trading at 10-30% discounts to NAV.

(Authored by Rahul Kamdar)