Signature’s global depth and breadth provides us with access to unique investment opportunities. We recently participated as an anchor investor in Embassy Office Parks REIT, the first-ever Indian REIT IPO and the largest REIT in Asia by square footage. This IPO marks a significant milestone for the Indian commercial property market, as the country continues to see the institutionalization of real estate as an asset class. We deployed this name into Signature High Income Fund, Signature Diversified Yield II Fund, Signature Emerging Markets Fund, Signature Dividend Fund, and Signature Global Dividend Fund.
I thought it would be helpful to outline the collaboration and research involved so that our clients may get a better understanding of how we utilize our scale to enhance our investment process.
If you’re curious about further commentary on the real estate sector, I was recently on BNN Bloomberg Market Call sharing my top picks.
Some of the most sophisticated global real estate experts in the world, including Brookfield Asset Management, GIC (Government of Singapore), and the Canada Pension Plan have been investing significantly in Indian commercial property for over a decade. Blackstone, one of the world’s largest and most respected investors, made its foray into India early as well, having established its initial presence in 2007 before beginning to acquire significant property assets with local partners. Blackstone’s global expertise highlights the importance of a functioning large, transparent REIT market, as it helps provide a liquid market for commercial property. Our view is that Blackstone saw the opportunity for developing a REIT market in India and that it was instrumental in the passing of India’s REIT legislation in 2014 and its subsequent implementation. Blackstone continues to invest private capital in real estate in India, and an established REIT market will be beneficial in providing potential exit opportunities for their private investments over time.
Embassy Office Parks is an office REIT focused on India’s largest markets. In 2011, Blackstone purchased a large stake in India’s second largest office park, Embassy Manyata in Bangalore. Blackstone chose to partner with Embassy, a long-standing real estate developer in India, in order to accumulate the portfolio that now comprises Embassy Office Parks. Blackstone began with Manyata and went on to amass a 30 million square foot portfolio of some of India’s highest-quality office properties.
Signature is one of the largest global REIT managers in Canada, with approximately $4 billion invested in the asset class. Due to our size and global relationships, we are often brought into early discussions on real estate investments and REIT structures. In 2018, we were one of the only institutions in Canada invited to consider investing as an anchor in Embassy Office Parks. Anchor investors are often large, well-respected investors who engage in ongoing dialogue with the company and its bankers to structure a successful IPO. The anchor investor will commit capital to the IPO before an official IPO launch. This usually signals to other investors that there is confidence in the deal. In Embassy’s case, because the market was not used to seeing an Indian REIT, securing an anchor investment was important.
Our real estate team knows enough about the asset class to understand that drivers of real estate returns can vary substantially by geography. India has a very different market and economy than our existing investment universe. Therefore, it was of paramount importance for us to collaborate with members of the Signature team who have expertise in India. We consulted with our utilities, financials and trading teams, who had been involved in Indian IPOs before, to understand the process of acting as an anchor investor and about IPO investing in India. We spoke with Goshen Benzaquen, a Portfolio Manager on our financials team, about the financing and liquidity situation within the Indian banking system. In the past year, for example, the non-bank lending channel in India was facing headwinds with the potential to put a strain on the sector’s liquidity. The country’s upcoming elections posed another potential risk to market confidence. Goshen, along with Matthew Strauss, head of Signature’s emerging markets team, helped us to understand the risks. Equipped with this knowledge, we were able to ask the right questions and focus on the right topics as we shared our views on potential pricing of the deal.
Signature has dedicated traders in Asia, as well as here in Toronto, who were in constant contact with the brokers who were putting the deal together. Investing in an IPO in India is not yet as seamless as it is in North America, so on the night of our investment our back-office team worked around the clock to ensure that the investment was executed as smoothly as possible.
Due diligence – on paper
Our “on-paper” research looked compelling. Embassy has some of the most attractive real estate assets in India, leased to large multinational players such as Google, Microsoft and JP Morgan. The company signs long-term leases with its tenants with rents that increase 10-15% every three to five years. Market rents, however, have been increasing at a faster pace. This means that when Embassy signs a new tenant, or re-leases an existing tenant at market rates, they have the ability to increase rents by more than 30%. Moreover, unlike many U.S. office properties, the tenant is responsible for the expenses, improvement and build-outs of the spaces, not the landlord, making the free cash flow profile that much more attractive. The company’s disclosure document shows that it has a very conservative balance sheet, with debt-to-assets in the mid-teens after the IPO. This compares to many Canadian REITs with debt in the 40%+ range. This balance sheet capacity could be used to fund further growth through development or acquisition for the REIT.
The pricing of the deal looked very compelling. Based on the company’s disclosure documents, Signature estimated that the IPO would list at approximately a 9% cap rate (yield on the price of the property) on some of the best properties in Mumbai and Bangalore. This compares to cap rates of similar assets between 4%-5% in major North American cities. With such a high initial yield and such high free cash flow growth potential, the investment case warranted a due diligence trip to India.
Due diligence – in India
I spent a week in India with the Blackstone and Embassy teams and visited the vast majority of their assets. I gained an appreciation for the strength and optimism around the office property market in India. On my trip, I met with the leading real estate owners, developers and brokers in India who were able to give me independent colour on the markets there. I spent time with financial analysts to better understand financial system liquidity. The reality is that India has evolved from a back-office tech center to a major international innovation hub for global companies, and Embassy’s major tenants are executing some of their most in-depth innovation out of those very campuses. Because of low labour costs, highly skilled tech talent, and ultra-low rents, companies continue expanding in India – and have capacity to pay higher rents, which is why rents keep growing. As a result of this strength, however, a lot of new office building supply is coming into the market. This is a risk we are monitoring but we believe, in the medium term, that supply will be absorbed by strong demand from tenants for high-quality buildings.
The sponsorship of Embassy is unrivaled. Blackstone is one of the most well-respected property investors in the world. My trip confirmed the significance that the Blackstone group places on fostering a successful Indian REIT market. I gained the understanding that Blackstone is very well aligned with shareholders in Embassy. This was reflected in the structure of its management contract as well as the ultra-healthy nature of its balance sheet. The strength of this company and this deal was important to them.
Collaboration is key
After my trip, I reconvened with my two colleagues on our global property team, Lee Goldman and Kate MacDonald. We also spoke with Goshen, who had travelled to India just before me to visit the Indian banks, and Matthew, who arrived in India to meet with India’s central bankers just after I left. We were all able to share ideas around the risks and opportunities in the country. Our final decision was to participate as a lead anchor investor in the deal. We are now one of the top shareholders in a world-class REIT, sponsored by a world-class company in a growing market.
There are three Portfolio Managers in our real estate group and we are often asked if that is a big enough team to be running a $4 billion global REIT portfolio. My answer is that it is not – it is the support of, and collaboration with, Signature’s 50-plus global sector specialists that allow us to effectively provide our clients global exposure. In all, more than 10 different people at Signature with diverse sets of expertise contributed their time and input into the Embassy investment. The power of collaboration is valuable.
Joshua Varghese is a Portfolio Manager at Signature. He does not have a material interest in the securities discussed herein; however, he is an investor in certain Signature funds which may hold these securities.
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