Jefferies Cuts Embassy, Mindspace REITs' Target Price Over Mixed Office Demand

Jefferies Financial Group Inc. has cut the target price of Mindspace Business Parks REIT and Embassy Office Parks REIT over mixed demand for offices.

The brokerage revised the target price of Embassy to Rs 338 from Rs 378 while maintaining its 'buy' rating. Mindspace's target price was slashed to Rs 324 from Rs 337, with a 'hold' rating.

The real estate investment trusts have been flat since March 2023, even as real estate indices grew over 30%. REIT valuations are near two-year lows as they trade at a 20% discount to independent valuations, higher than the average 11% discount, according to Jefferies' analysis on Thursday. However, yields are still 0.6% higher than 10-year G-Sec yields.

REITs haven't been able to keep up with the rally in residential developers as office demand concerns continue to persist. "Strong residential performance versus offices has created sharp market movement differences," Jefferies said. While there are "pockets of strength" in the office space, supplies are expected to drop as developers prefer residential spaces.

Post-result commentary from large office owners, data from consultants, and the takeaway from a property tour in the National Capital Region by Jefferies show that office leasing demand has weakened over the past year.

The bulk of demand that emerges from information technology companies has been weaker than usual as hiring and return to offices took a pause on cost concerns. Therefore, the management of REITs has not given any explicit guidance for fiscal 2024, citing a lack of demand visibility from the IT sector.

Demand is strong, but from companies with domestic clients, supported by resurgent private sector capital expenditure and full-scale work-from-office. These largely non-tech companies saw vacancies rise only 2% in the Mumbai Metropolitan Region and NCR, in comparison with a 6% rise pan-India in Grade-A office vacancy levels.

Embassy and Mindspace had net operating income growth of 11% and 15%, respectively, and the brokerage expects this double-digit growth to continue in FY24, partly due to the opening of new spaces.

However, distribution-per-unit growth trailed for Embassy and Mindspace at 0% and 3%, respectively. Jefferies expects little change in DPU growth for these companies this fiscal. The DPU reflects earnings per share for REIT investors.

Embassy shares have declined over 25% over a year, while Mindspace shares have fallen nearly 13% as compared with over 13.5% in the S&P BSE Sensex during the period.