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DLF: Banking on REIT…

Nov 29, 2007

One of the investors’ main concerns from real estate and construction companies is the poor quality of disclosures and corporate governance practices. In these circumstances, investors view with circumspection the related party transactions carried on by these companies. One such case in point is DLF Assets Private Limited (DAL), a private company, which purchases assets from DLF Ltd. In this article, we undertake a brief analysis of the working of DAL and its potential listing as an REIT (real estate investment trust) in Singapore. DAL was incorporated as Lavonne Builders and Developers Private Limited in March 2006 and the name was subsequently changed to DLF Asset Private Limited in August 2006. The company was formed with an intention to acquire commercial and SEZ assets. While DLF as a corporate entity does not have any direct holding in DAL, the latter is promoted by the promoter group company of DLF and institutional investors like Lehman Brothers and D.E. Shaw.

Shareholders Nature
Kohinoor Real Estate Company Private company with unlimited liability
Madhur Housing and Development Company Private company with unlimited liability
Panchsheel Investment Company Private company with unlimited liability

Sale to DAL

Why this becomes important is because in 1HFY08, DLF sales to DAL accounted for 47% of total income (sales plus other income) of DLF. DLF is planning to list DLF Asset Limited as a Real Estate Investment Trust (REIT) in Singapore as DLF Offices Trust (DOT).

REITs are to real estate what mutual funds are to equities and debt. Plus, they come loaded with tax benefits. To get these benefits of income taxes, REITs are required to distribute 90% of their income, which is taxable in the hands of the investors. Like other corporations, REITs can be publicly or privately held. Public REITs may be listed on public stock exchanges like shares of common stock in other firms.

DLF, along with other developers, develops commercial and retail properties, leases it, and then sells the entire property with the future expected revenues at a particular capitalisation rate. The key here is determining the capitalisation rate which itself is a factor of location of the property, period of lease and the future price expectation of the property itself. Properties that are purchased by DAL from DLF are capitalised at 9%.

An example: DLF will be building the NTC mills in Mumbai and will be leasing it for rentals of Rs 112 per sqft. So annual rent per sqft is Rs 1,344. Suppose the NOI per square feet is Rs 1,200. This will be capitalised @ 9% giving value of Rs 13,333. NTC mills have an area of 1.8 msqft so the capitalised value of property is Rs 24,000 m. Like wise there will be many baskets of properties under DAL, which DAL will own and manage.

Capitalisation rate depends on net operating income (NOI) and market value of the underlying properties. To simplify, Capitalisation rate = NOI / market value of property.

DLF Sales to DAL
(Rs m) 1QFY08 2QFY08
  DLF DAL % Share DLF DAL % Share
Sales and other income 31,210 16,540 53% 33,492 13,870 41%
Profit before tax 21,268 9,840 46% 23,484 9,840 42%

How will DLF benefit from this?
We believe that the potential listing of DOT as a REIT in Singapore would be a big positive for the company going forward as it would improve the earnings visibility of sales in the commercial and SEZ segment. How? If DAL lists its REIT then DAL will raise money by listing its REIT and this will give it access to more funds to buy more properties from DLF and bring them under the existing REIT. Also, Singapore REIT regulations allow listed REIT to leverage its capital structure by raising debt. So this option is also available to the company. DLF has already formed a four-member audit committee, all of them are independent directors, to monitor the transactions with DAL. Secondly, in 2QFY08, the debtor’s balance stood at Rs 38.9 bn and a major chunk of this is due from DAL. After the listing of DOT, the debtors will be paid of in full, which will also increase the operating cash flows of DLF. This listing process of DOT is expected to be over by 1QCY08.

We are in the process of initiating our coverage on DLF.

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