Brookfield India REIT IPO – Too Many Questions

We looked at the Issue closely during its launch (03 Feb 2021 – 05 Feb 2021)

Brookfield’s India journey is interesting and started in 2013.

An international Private Equity attempted to bail out a capital-starved real estate entity by buying out its Corporate Parks (UNITECH). Eventually, it had to go through various legal and regulatory rigmaroles to get a majority stake. It struggled to complete construction of a substantial portion of the land-parcel and went on to lease it out to international tenants. Soon after, it clinched deals with other cash-strapped real estate builders and built a much touted “formidable” real estate portfolio.

The private equity firm’s year of reckoning finally came in 2020; when interest rates were at an abysmally low point – it was time to file for a REIT listing.

A rental yield even marginally higher than the risk-free rate today will attract several buyers and there is buzz around the listing already. Add to that, the gradually recovering real estate market, is an added attraction to investors who wish to diversify. After all Equity markets are at an all-time high too.

There is a little something though, that we seem to be missing.

Remember, the entity that holds the assets currently, is a private equity parent. The entities that will get partial or full exits include a US based Global Real Estate Fund of Brookfield (BSREP India Office Holdings III) and some group holding companies based out of Singapore. There are many other entities, the nature and shareholding structure of which are not known.

According to the DRHP, among the sellers of assets to the Brookfield REIT are other Brookfield entities viz.

• BSREP II India Office Holding Pte. Ltd
• Brookfield Asset Management Inc.
• Kairos Property Managers Pvt Ltd
• BSREP Moon C1. LP
• BSREP Moon C2. LP
• BSREP India Office Holdings III Pte. Ltd
• BSREP India Office Holdings Pte. Ltd

This is not even an exhaustive list of all entities that constitute the Brookfield Group. These, and other companies with similar names registered in Singapore highlight how complex the ownership and the corporate structure are. Creating a layered holding structure brings opacity, having similar names to these entities breeds confusion and moving of assets among these entities casts doubts.

For a PE fund, IPO is a form of ‘exit’ – the time at which it makes a killing as a reward for all that “patient investing”. Hypothetically, if they bought the underlying at ₹80 and can list at a valuation of ₹275, that is a text-book PE success. At 275 if the retail investor gets even an 8% yield, she/he will be happy to grab it.

But why are some entities of Brookfield looking for an exit? The Global Real Estate Fund will sell its stake in one of the properties.

Are they bailing out their US investors at the expense of the subscribers to the India REIT?

If the underlying assets being transferred to the India REIT are good, why are the Global Real Estate Fund investors being given an exit? And if so, could the India REIT also exit good properties after listing? If those underlying assets are not so good and hence, the global fund is exiting them, why are Indian investors being solicited into it? We can’t claim to understand this.

Only in Dec 2020, Embassy REIT raised funds through QIP in order to acquire an IT park in Bengaluru from a group entity, the sponsor to the REIT. While this could be a great asset in the heart of the Silicon Valley of India, such a transaction always casts doubt at the fairness of dealing.

One cannot help but chuckle at the timing of the Brookfield REIT IPO. The Budget for FY21-22 was announced on Feb 1^st and the IPO launched on 3^rd. And all the researchers, analysts and market observers were obviously busy covering the budget.

We did some cynical soul searching. After listing, what were to happen if the REIT manager acquired a commercial property with poor future cash flow prospects or sold one that had strong cash flow prospects?

Will investors check? How many check the underlying stocks of their mutual funds?

If they do check and do not approve of the transaction, what recourse do they have? One may argue that they can sell their shares. But what is to happen if this sell-off continues and the ₹275 per unit eventually falls to ₹200? The yield seeking investor will be left with a steep loss in capital.

You may scoff at our sky gazing and ask why would the price fall below the listing price? Uncovering of a bad asset could cause this, for starters. Another reason could be businesses unable to pay rent, or shut offices, hurting cash flows. After all, a low interest rate regime often encourages reckless debt acquisition and expansion by companies. While the economy is booming, this debt does not hurt because it can be covered by the higher profits from higher sales. But the onset of a slowdown in demand sets a chain reaction – slower demand means lower sales and lesser profits, the ability to pay interest and repay principal could be impaired.

Inability to pay up is an example of ‘tenant-risk’. But there are many more layers of risk to a REIT. Evolution of regulations for REITs could further boost or upset the sentiment. The properties owned by the REIT could be shared or freehold, each having its own set of pros and cons. The underlying assets could be owned or leased. The building could be owned but the land leased. The properties could be managed by the REIT manager or by a third party. Most of this information is either not available in public or buried in some corner of the internet that a layperson could never have access to.

Despite so many complications, what makes REITs attractive is that they make Real Estate liquid. But this liquidity comes at what cost? Many people profited from real estate before it crashed during the subprime crisis in the US. It doesn’t matter if you bought a real estate property at a high valuation if you manage it sell it at an even higher valuation. The chain could go on until it can’t. Liquidity seems to be a function of how long these REITs, along with various other AIFs, could keep passing on the assets to one another until they can’t.