Between income and distributions

**Krishna** (0:04)
In today's episode, we will break down two important stories. First, we will look at the results of India's three biggest listed REITs, and then we talk about if RBI can control the food prices. Welcome back to The Daily Brief show by Zerodha, where we cut through the noise to help you understand what's actually happening in the most important stories from business and markets. I'm your host Krishna, and today is Thursday, 11th June. Embassy REITs buildings earned about 15% more rent this past year than the year before. Those who own embassy, however, got about 10% more money. Now, somewhere on the way from the building to the bank account, roughly a third of the growth went missing. Now, this is fundamental to how a REIT works. Once you can understand why, you can read almost any REITs results. Now, we have spoken before about what a REIT actually is, but to recap, they are a way to own a slice of a large pile of rent-earning real estate listed on an exchange like a stock. Now, this piece is about something narrower. How does one actually read their results and what that tells us? Now, we regularly cover company results on The Daily Brief and rarely do we have the space to go beyond a few scattered observations. But even by those standards, doing justice to three REITs quarterly numbers is complicated. There are waterfalls of cash, dozens of leasing metrics and weird valuation models. An analyst could spend a week on any of them. Now we don't do that here. Instead, what we will do is look through a handful of lenses that we thought actually matter at the results of India's three biggest listed REITs. We'll look at Bangalore-focused embassy, which is the biggest of the lot, Mindspace, the fastest growing REIT this year, which also runs data centers, and Knowledge Reality Trust or KRT, the newest of the three.
Now, consider this a curious nerdy tour of how to read their results. Not a full-blown research report on the health of Indian office spaces. Now, at the moment, all of them are in a very good place. India is in the middle of an office boom driven by global firms setting up large captive offices here. Now demand for space runs well ahead of new supply. As the tide rises, everyone's results look strong. Now, this in itself presents an interesting question. However, how do three companies riding the same wave end up giving very different returns? For that, let's dive in. By law, a REIT has to hand most of its cash, which is around 90% of it, back to its owners. It can't retain earnings and reinvest them the way an Infosys or an HUL would. Now that rule makes a REIT's profit figure close to meaningless. What matters instead is the cash the properties throw off and how much of it survives the journey down to you. Instead, look at two numbers. The first is the income the buildings themselves generate. That is, rent minus the cost of running those buildings. This is their net operating income or NOI. Think of it as what the property earns before any financing or head office costs are involved. The second is what eventually lands in a unit holder's account, which is the distribution.
Between those two is a long staircase of deductions with cash leaking at every step. The biggest leak by far is the interest a reed pays on its debt. The busiest reeds leak the most cash as interest. A building under construction has to be financed well before it earns a single rupee of rent. Even when a new building just opens, it usually comes with rent-free move-in periods. Accounting rules meanwhile spread rent out evenly across the whole lease. So a reed's books may show income even where the building isn't yet collecting cash. Now, as a result, a reed's paper income can grow much faster than the cash it pays out, and it can stay that way for years. Now, this was embassy story this year. Its building's earnings grew much faster than its payouts. The difference came from its construction pipeline. It was building a large amount of space right now, each tower adding financing costs and paper rent today. Meanwhile, the real cash will only show up later. As its management says upfront, this gap will stick around for a couple of years. By the way, the complexity continues when the REIT starts releasing cash as well. Now, we won't get into the REITs here, but there are different ways in which a REIT can payout to you, each of which are taxed differently. So, the shape of a REIT's distribution, and not just its size, decides how much you walk away with after tax. Two REITs can advertise the same headline payout while leaving you with meaningfully different amounts. KRT, for instance, runs an unusually tax-friendly mix, making its payout a little more attractive than it first looks. So, when you compare REITs on yield, compare them after tax and not before.