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Saturday, March 24, 2018

MREITs take a real beating

MREITs take a real beating
Saturday, 24 Mar 2018
by thean lee cheng

Downtrend: At yesterday’s close, the fall of MREITs widened considerably year to date with CapitaLand Malaysia Mall Trust (CMMT) seeing a 40.2 decline, diversified Sunway REIT (13.09), PavREIT (9.85), AxisREIT (16.77) and IGB REIT (12.98).

Opinion is divided over the attractiveness of Malaysian real estate investment trusts (MREITs) even after the price of many of them had taken a pummelling.

But are the hefty yields that some of these REITs offer attractive enough for investors to bite in an environment of rising interest rates and sluggish retail performance?

At yesterday’s close, the fall of MREITs widened considerably year to date with CapitaLand Malaysia Mall Trust (CMMT) seeing a 40.2% decline, diversified Sunway REIT (13.09%), PavREIT (9.85%), AxisREIT (16.77%) and IGB REIT (12.98%).

These retail and commercial-centric REITs have fallen due to concerns about rising financing costs with the rise in interest rates and also worries over the oversupply of retail and office spaces in the country.

One broker thinks the correlation has more to do with the rise in government bond yields which puts pressure on MREITs to deliver better returns.

Kenanga senior equity analyst Marie Suwrna Vaz says: “We are comparing MREITs yield against bond yield. Because the share price of MREITs have fallen, the yields have risen, because of the inverse relationship.

“REIT yields are 5%-6% versus MGS yields’ 4%. So the spread between the two yields is about 2%.

“But because share prices have fallen, REIT yields have risen generally. That means you are getting a higher dividend at a lower price,” she explains.

One example is CMMT where yield is as high as 8%, representing a hefty 4% spread with MGS yields.

Vaz describes the sell-down as “(veering) into irrational territory driven by investor fears.”

“Yes, there is an oversupply of office and retail spaces, but we think landmark assets and quality MREIT managers will survive,” such as Pavilion Shopping Mall (PAVREIT), Mid Valley (IGBREIT), Sunway Pyramid (SunREIT) and Suria KLCC (KLCC).

These landmark retail assets “will prevail” over the oversupply situation. They also tend to have better than average occupancy of between 90% and 100% versus the market occupancy of about 80%, according to Vaz.

Each of the MREITs has its own unique issues.

The acquisition of Pavilion Elite has only just become unconditional and in conjunction with that acquisition, PAVREIT intends to make a 7.2% placement of 218 million shares, initially expected by the end of financial year 2017 or early 2018. Analysts believe this is likely to be postponed to the second or third quarter of this year.

Kenanga is also lowering the indicative placement issue price closer to the current RM1.40 from RM1.70, implying that PAVREIT would require additional borrowings to fund the placement, which increase borrowing costs.

It is also lowering AXREIT’s earnings by 11% for the 2018 financial year as the group’s second tranche placement has been pushed to the end of 2018. The placement is expected to pare down the group’s borrowings. AXREIT owns and invests in commercial, office and industrial real estate.

As for office REITs, MQREIT and KLCC have above average occupancy of between 95% and 100% versus the market’s 81% due to the long-term lease structure, Kenanga says.

Research houses Kenanga, Maybank and Am Investment Bank are generally positive about the Securities Commission’s revised guidelines, effective April 9, 2018, empowering REITs to go into greenfield property development and buy vacant land.

An industrial source says there is a bit of a twist here. Investors buy MREITs because of the defensive nature of the stocks. Now that they are allowed to go into property development, that defensive element is somewhat “diluted”.

They will now be allowed to take on the role of property developers, but having said that, only “a small percentage” of MREITs will be able to do that because of the huge outlay needed for this new but property-related business.

Putting aside the various guidelines by the Securities Commission for the time being, and taking a more global view, REITs are generally viewed as defensive creatures.

People buy REITs because they enable investors to own a tiny bit of that office, retail or industrial property, which on their own, the capital outlay would be too prohibitive for most investors. At the same time, as part of a tax deal, REITs distribute 90% of their income in the form of dividends.

By virtue of the fact they distribute so much of their income, REITs borrow money if they want to do anything, be it to enhance their buildings or whatever. REITs have to borrow money all the time, be it short or long term.

Rising interest rates

So REITs are relatively happy with a low interest rate environment. But this is expected to change. In January, Bank Negara raised the overnight policy rate (OPR) by 25 basis points to 3.25% from 3%. This was the first rate hike since July 10, 2014. The last action by the central bank was to cut it from 3.25% to 3% on July 13, 2016.

Research house Kenanga is of the view that OPR hikes have minimal effect on MREITs.

In a report, the house says in the borrowings of most MREITs, more than 70% are on fixed rates, except for Pavilion REIT (PAVREIT), MRCB-Quill REIT

image: (MQREIT) and Axis REIT (AXREIT), where less than 30% of their borrowings are on fixed rates.

Nonetheless, interest rates are due to rise and this expected to impact all and sundry over the longer term, as signalled by the US Federal Reserve mid-week when it lifted its benchmark overnight lending rate by a quarter of a percentage point to a range of 1.5% to 1.75%.

This is the sixth time the Federal Reserve raised rates since the policy-making Federal Open Market Committee began raising rates off near-zero in December 2015.

Still on the global front, the rise in interest rates will also result in rising bond yields.

The yields offered by REITs are benchmarked against bond yields. Therefore, as bond yields rise, REIT investors will want a premium of about 2% over and above bond yields.


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