Embassy REIT: Maintain ‘buy’, lower TP to Rs 380

4QFY21 taking total vacancy increased by 170bps q-o-q (370bps q-o-q on a same-store (SS) basis) to 11.1% (and 13% on a SS basis).

While collections remained steady, rental escalations continued, and vacancies increased by 370bps on a SS basis. We believe MPPL presents a dilemma, with an opportunity to lease at 100% higher rent at the cost of increased vacancies. Maintain ‘buy’, but lower TP to Rs 380 (from Rs 390).

The good: Rent collections for FY21 remained steady at 99.8%. Rental escalations have remained smooth in FY21, with c8.4msf of area achieving 13% escalation and there is still room for another 10% mark-to-market (MTM) on current market rent for these new rentals. EOP has simplified the holding structure of Manyata (MPPL) SPV, which has resulted in an improved share of distribution in the form of dividends, resulting in 78% of the distribution now being tax-free for unitholders vs 55% earlier. Two-year forward supply estimates by CBRE continue to come down, now at c89msf, of which EOP believes only 13msf is in comparable/competing markets.

The complex: Manyata—The crown jewels or crown of thorns. MPPL accounts for c36% of adjusted NOI. From almost a nil vacancy rate six quarters back, its vacancy rate has increased to 6.5%. Over FY22 and FY23, another 14% of the area leased is up for expiry. There is another 1msf (although c60% pre-committed) that is under construction and now likely to be completed by December 22 (earlier June 22). This implies a total area that will need to be leased over the next two years of upwards of 3msf. The expiring leases of legacy tenants had average rentals of Rs 40psfpm vs current market rentals of Rs 90psfpm, offering a 100% MTM opportunity for this part of the portfolio. MPPL was among the most sought after office locations and hence commanded rentals higher than the Bangalore average. The key challenge is whether to fill up fast at low rentals or wait to achieve market rentals for this marquee asset. We assume vacancy rates rise to c14% by FY23e for MPPL.

The ugly: 4QFY21 taking total vacancy increased by 170bps q-o-q (370bps q-o-q on a same-store (SS) basis) to 11.1% (and 13% on a SS basis). Further, the company has guided that out of 6% of rentals that are up for expiry, only 2% are likely to be renewed and the balance will have to be leased out fresh.