Business News

Saturday, 12 August 2017

Can REIT yields sustain?

WILL yields of Malaysian real estate investment trusts (REITS) come under pressure because of lower rents and rising interest rates? That depends on how the data is interpreted. There is some evidence that rentals of properties ranging from offices to factories are being renewed at lower rates as leases end although at the beginning of the year, the expectation was for an average 6.3% yield for the year.

REITS experts say the total returns should be calculated on their unit price gains together with the yield. For July, local REITS had an average yield of 5.801% versus 5.507% in January.

Conventional wisdom says that when interest rates rise, this is usually bad for REITS. This is because REITS pile on debt as they acquire assets, so when interest rates rise, their ability to service debt comes under pressure as they also have to pay 90% of their earnings as dividend.

But if interest rates are rising because of a growing economy, this may not necessarily affect REITS negatively because businesses will expand, offices will be rented out and people will spend their money. There is speculation that Bank Negara may have to raise the overnight policy rate some time next year on demand-pull inflation stemming from rising consumer sentiment.

Detractors, who believe that the economic outlook is still uncertain, say consumer sentiment is still down although the first quarter’s unexpected 5.6% growth spurt was in part supported by private consumption. Economists expect the second quarter’s economic data to show growth above 5% after the surge in exports in recent months.

Most Malaysian REITS, because they own malls and offices, have been affected, to a degree, by the glut in office space or the downcast consumer sentiment. There is still reason to be cautious with local REITS, and this can be seen from their unit price performance, which has been mixed on a year-to-date and one-year basis reflecting the local business conditions and consumer sentiments.

What is keeping select REIT unit prices up and performing better than the benchmark FBM KLCI could be the drop in the yield of benchmark 10-year Malaysian Government Securities, which stood at 3.976 from 4.463% at the end of November. This could have driven some investor interest back to Reits, which offer better yields. Indeed, Kenanga Research actually upgraded Reits to “overweight” from “neutral” in June.

Ultimately, REITS are about their underlying assets, which is property, where these are located and how well they are managed. If a particular REIT’s assets fulfill all three factors, there is no reason that yield cannot sustain even with all the daunting challenges.

Some are not jaguh kampung

Some Malaysian companies are not just jaguh kampung. That they can win jobs overseas goes to prove their capability to compete with high-calibre companies in the international arena – and that’s a good thing, not only for the companies themselves, but also Malaysia.

Take Scomi Engineering Bhd (SEB) (pic).

The company is reportedly in the final stages of sealing a deal for a monorail job in China. Competition for the project has been stiff, what with bidders such as China-based new energy vehicle maker BYD Co, Japan’s Hitachi Ltd and Canada’s Bombardier Inc.

Apparently, SEB is targeting more monorail projects in other countries.

What’s puzzling, though, is if SEB had the expertise and capabilities to compete and win projects overseas, how is it that the company had not been as actively involved in the local market?

After all, Malaysia is currently experiencing its own infrastructure boom, and there are many lucrative rail deals on the table, attracting various international companies, including China state-owned enterprises.

And surely, the criteria – technical or operational – set by the Malaysian Government for local projects is not beyond the capability of such a highly-experienced company as SEB to meet.

Or could it be that the politics of winning projects in Malaysia are just too much to handle for some?

Could it be that the tender process for local projects is actually not as “competitive” and “transparent” as it is often made to believe, and that some local players already know their chances in the bid and who are the favoured ones to win whichever portion of the cake?

SEB has thus far reportedly tendered for a total of RM3.3bil worth of works overseas, including monorail projects in Thailand and Turkey.

The company’s order book at present stands at RM1.9bil, comprising mainly monorail jobs in India and Brazil.

SEB is 72.3%-owned by Scomi Group Bhd, which used to be in the limelight during the reign of former premier Tun Abdullah Ahmad Badawi. His son Datuk Kamaluddin Abdullah co-founded Scomi and remains a substantial shareholder in the company, with about a 9% stake, even though he is not involved in the running of company or its subsidiaries.

Scomi fell off the radar screen of investors in 2009 after Abdullah stepped down.

Dealing with ringgit derivatives

THE one thing about free enterprise is the ability to conduct business that is unfettered by interference. Yes, there are rules that you must follow but when the market is a derivative of an asset, then the rules get blurred.

When Bank Negara announced that moves by the Singapore Stock Exchange (SGX) and Intercontinental Exchange in Singapore to offer ringgit futures were against foreign exchange administration (FEA) policy and rules, some were surprised that there were offshoots of a market that Bank Negara had tried hard to curtail.

The central bank went to great lengths in trying to contain and nullify the influence of the non-deliverable forward market on the ringgit in overseas markets. Volume of transactions in the NDF market abroad shrank after Bank Negara stepped in to close any loop holes in trading of the ringgit overseas.

Its most effective weapon was to control the flow of ringgit when it comes to the settlement of ringgit overseas.

It can do so because the ringgit is non-internationalised. That means, the ringgit has only value onshore but the reality is that through the wide and modern banking system, the ringgit can be made available for settlement through the web of banks that operate around the globe.

Bank Negara’s most effective way was to get the banks themselves to limit the use the ringgit when crossing out transactions for the ringgit abroad. It got a number of banks to agree not to provide ringgit liquidity offshore, and with the ringgit hard to come by, demand for derivatives in offshore market shrank.

Winning the battle against the futures markets abroad is one thing but the central bank knew it had to provide derivatives for hedging purposes onshore. How that is progressing is yet to be made clear by Bank Negara but the step-by-step approach is obviously leaving an arbitrage opportunity for SGX to provide ringgit futures in Singapore.

SGX has a number of Asean currencies in its suite of currency derivatives but the one thing is that volume for ringgit futures there is miniscule at the moment. Banks also know that Bank Negara can use the arm of legislation and punitive punishment when trading flouts Malaysia’s FEA that the central bank is trying to enforce. The best way to handle the spawn of derivative contracts in Singapore is to deepen the market onshore as quickly as possible to limit the recurrence of another market Bank Negara will have to deal with should it gain momentum.

Tags / Keywords: Sunway , Pavilion , IGB , real estate investment trusts , yields , rentals , price

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