Challenges for Reits

Volatile bond market, slowing consumer spending and moderating growth to affect performance in the quarters ahead

Petaling Jaya: It has been a good start to the year for Malaysia’s real estate investment trusts (Reits).

Having registered an average gain of 3.58% since the beginning of January, the asset class as a whole has outperformed Malaysia’s equity market, as the latter only managed to make a gain of 1.2% year-to-date.

The encouraging performance of the Reits thus far has coincided with the recent moderation of government bond yields, specifically that of the 10-year Malaysian government securities (MGS).

This is because the declining trend of the return on the 10-year MGS since early this month has progressively narrowed the yield spread between the two instruments and led to a mild recovery in investor interest in Reits.

“The decline in the 10-year MGS is welcome news as it improves the spread between Reit yields and the MGS, making Reits even more attractive,” Malaysian REIT Managers Association chairman Datuk Stewart LaBrooy told StarBiz.

Yields on the 10-year MGS averaged around 3.8% over the week compared with about 4.1% on Jan 2.

In general, a lower 10-year MGS yield will have less pressure on the unit prices of Reits.

According to Kenanga Research, Reits’ yields tend to require a premium of between 1.3 and 2.3 percentage points to the 10-year MGS to command attractive valuations, as the former are, after all, not “risk-free” instruments.

On average, the yield currently offered by Malaysian Reits stands at 6.5%, ranging from the lowest of 4.9% by KLCC Stapled Group (KLCCP) to the highest of 8.6% by Amanahraya REIT. This implies an average Reit yield spread of 2.7% against the 10-year MGS.

Return from Reits, which are secured against property rental income from offices, shops, factories or hotel operations, are also higher than the average fixed-deposit rate of around 3.1%.

And with disappointing corporate earnings amid a slowing economy and low crude oil prices, it is not surprising that investors would find Reits appealing for their stable income distribution.

But with the 10-year MGS yields expected to inch upwards in the months ahead, as foreign investors resume their selling of Malaysian bonds, Reits’ unit prices will likely come under pressure again and see their recent gains erased.

Most analysts expect Malaysia’s bond market to be volatile this year, given the uncertainties surrounding global crude oil prices and the timing of US interest rate hike.

“Although we are seeing an improvement in the 10-year MGS, the possibility of a US interest rate increase will put pressure on the Malaysian government bond yield curve,” LaBrooy points out.

As it stands, most analysts have a “neutral” outlook for the Malaysian Reit sector due to the lack of near-term catalysts.

Kenanga Research reckons that the current market conditions present investors a good opportunity to sell their Reits. The brokerage advises investors to “bottom fish” for Reits towards the middle of this year to reposition for a better prospect of the industry in the fourth quarter of 2015 when global crude oil prices and the 10-year MGS yields stabilise.

The performance of Malaysian Reits will also be impacted by the sluggish economic outlook. Growth in income distribution to Reit investors will therefore likely be feeble this year given the various challenges and uncertainties affecting the industry.

Securing new tenants as well as renewing existing tenants to boost occupancy rates at the office and industrial buildings under the Reit managers’ portfolio will likely be difficult this year, as the private sector is expected to scale down their business operations.

With ample office space and lower take-ups, rental rates will likely come under pressure.

Similarly, the outlook for the retail sector is also challenging, as the oncoming supply of 10 million sq ft of new retail space is expected to intensify competition and constrain rental rates and occupancy.

According to analysts, the implementation of the goods and services tax (GST) in April that is expected to cause a slowdown in domestic consumption and lower retail sales will also have a negative impact on Reits with exposure to shopping malls. This is because some managers have a higher proportion of turnover rent, which is charged based on the tenant’s monthly revenue, than fixed base rent. Such is the case of IGB REIT, which owns MidValley Megamall and The Gardens.

“Cost-push inflation led by subsidy rationalisation and the impending implementation of GST would negatively affect household disposable and retail spending. This could, in turn, pressure tenants’ sales performance and dampen rental reversion prospect, going forward,” Alliance Research said.

LaBrooy, however, notes that one positive aspect is that most Reitss have good long-term leases on their properties with good grade “A” tenants. This, he said, would help mitigate risks on Reits’ earnings.

Given the challenging outlook, market observers believe that acquisition of new assets by Malaysian Reits will be less aggressive this year, compared with previous years, and this could be another obstacle to income growth.

LaBrooy, however, is more optimistic about the prospects of new asset acquisition by the industry.

“The cooling of the property market in the last half of 2014 has meant that prices have come off their highs and are looking more attractive… I believe that we will see more (acquisitions) in 2015,” he said.

Reits have to grow their portfolio with yield accretive acquisitions to keep the upward momentum of their share prices and provide increasing distributions for their unitholders, and managers realise this, LaBrooy explains.

“Organic growth will only take you so far,” he adds.

The industry may be heading into some strong headwinds. But as most analysts put it, the period of uncertainly is unlikely going to last long for Reits before these instruments get back in the game again.

reit , labrooy , mgs