Lead Story: Tougher conditions for M-REITs could be a buying opportunity

TheEdge Mon, Feb 26, 2018 02:00pm - 3 years ago


IT is not all doom and gloom for Malaysian real estate investment trusts (M-REITs) even as the world moves away from the low interest rate environment that helped make the investment class popular.

Bank Negara Malaysia, which hiked its key overnight policy rate by 25 basis points to 3.25% in January, could raise interest rates a second time this year if the economy grows a lot faster than expected, economists say. In general, higher interest rates make investments in risk-free assets like 10-year Malaysian Government Securities (MGS) more attractive than riskier investments that promise but do not guarantee stable dividend streams, such as REITs.

Alpha REIT Managers Sdn Bhd chairman Datuk Stewart LaBrooy agrees that the operating environment is getting tougher but continues to see room for industry growth.

“If the US continues to increase interest rates, we will possibly see another rise of 25bps in the middle of the year. It is my view that M-REITs will take a second rate increase in their stride.

“REITs will have to grow their portfolios accretively, control costs, improve occupancy and increase their dividend payments to counter the effect of rising 10-year MGS,” says LaBrooy, who is the former CEO of Axis REIT Managers Bhd, which manages Axis REIT.

Analysts at Maybank Investment Bank are even more bullish. While higher interest rates tend to negatively impact REITs, they see it opening up a good buying opportunity.

“With unit prices expected to adjust downward amid higher fixed income yields, we would position to accumulate the quality REITs on weaknesses in their unit prices,” Maybank IB says in a Dec 15 note.

It says the average distribution per unit (DPU) yield from REITs last year was higher than the average yield of 10-year MGS in the same period.

Last year, the 10-year MGS yield averaged 4% compared with 3.84% in 2016, while the net DPU yield of the M-REITs listed on Bursa Malaysia averaged 5.3%, which was lower than the 2016 yield of 5.31%. This resulted in yield spreads of M-REITs over the 10-year MGS being lower at 130bps versus 147bps in 2016.

Unit prices have fallen over the past 12 months for almost all the listed REITs, with declines of up to 18%.

There is also concern that higher borrowing costs could hit REITs that rely heavily on borrowings to finance portfolio expansion.

However, in a Jan 26 note, MIDF Research tells clients it sees a minimal impact on earnings per unit of the REITs under its coverage — with declines ranging from 0.2% to 2.1%.

“Although borrowing costs are expected to increase for REITs with high levels of floating rate loans, most of the REITs under our coverage [would] see [a] limited impact from a rate hike as 80% or more of their debts are based on fixed rates.

“Even Amanahraya REIT, which has 100% of its loans based on floating rates, is expected to see earnings impact limited to [a decline of] 2.1%,” the firm says.

Axis REIT Managers CEO Leong Kit May says Axis REIT has manageable debt levels as part of its prudent capital management strategy and has hedged and fixed more than one third of its debt at fixed profit rates.

“Net income is not solely attributable to the financing costs, thus the impact of a rising rate is limited and we do not foresee a severe impact on net income at this moment,” she tells The Edge.

She adds that Axis REIT has in recent years been focused on industrial assets and continues to make its mark as a space provider for industrial and warehousing needs. 

“This remains our ongoing acquisitions mandate for the future, bolstered by increased focus on industrial built-to-suit projects,” says Leong.
 

Tracking the REIT Index

The REIT Index, which was launched by Bursa Malaysia in October last year, peaked at 1,057.35 points on Dec 29. Unit prices of Sunway REIT, KLCC REIT, CapitaLand Malaysia Mall Trust and YTL Hospitality REIT all hit all-time highs on the same day. However, the index has been on the decline since then, falling to its lowest level of 931.85 points last Tuesday.

To LaBrooy, the index’s decline merely reflects tougher market conditions.

“The correction in the REIT Index was a result of a decline in the unit prices of the REITs [due to] market conditions — rising interest rates; overbuilding in the office and retail sectors in particular; the uncertainty of the impact of e-commerce on retail; the tight spreads that M-REITs were trading [to] a rising 10-year MGS; and reduced spending by the Malaysian public,” he tells The Edge.

A quick look at the 18 REITs listed on Bursa Malaysia shows that Sunway REIT — a diversified REIT with properties such as Sunway Pyramid Shopping Mall, Sunway Resort Hotel and Spa and Sunway Medical Centre in its portfolio — recorded the highest distribution yield at 7.85%, followed closely by Hektar REIT, a shopping mall REIT whose flagship is the Subang Parade mall in Subang Jaya.

MIDF’s top pick for the sector is Sunway REIT, it has a “buy” call and target price (TP) of RM1.90 per unit due to its positive earnings outlook, which is backed by positive rental reversion from Sunway Pyramid.

“We also have a ‘buy’ call on AmanahRaya REIT (TP: RM1.09) for its diversified asset base with exposure to education property. We also like IGB REIT (‘buy’; TP: RM1.73) for its ability to command positive rental reversion for its crown jewel, Mid Valley Megamall, and Axis REIT (‘buy’; TP: RM1.64) for its niche in industrial assets, which provides stable income,” the firm says.

LaBrooy opines that as markets turn volatile, investors will move their funds into REITs rather than bonds.

“REIT investors invest for the regular cash dividends that REITs provide them. They are net accumulators and they tend to be institutional investors like pension funds. It is interesting to note that the public portion of REIT ownership is still very small,” he says.

With recent measures announced by Bursa Malaysia to bring retail interest back to equities and the creation of the REIT Index in October last year, it will be interesting to see if interest in REITS does improve this year.
 






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