Interest rate cut gives fillip for Malaysian REITs

Back home, it is clear the Securities Commission (SC) has a few achievements to be proud of this year.

PETALING JAYA: The overnight policy rate (OPR) rate cut, coupled with proposed measures for mature Malaysian real estate investment trusts (M-REITs) to diversify their investment options, such as embarking on property development, is giving a boost to the otherwise staid sector.

Property stocks including M-REITs enjoyed a brief run-up on Wednesday but remained muted yesterday, although interest in the latter group is expected to emerge following the issuance of a consultation paper by the Securities Commission (SC) on 16 proposals “to facilitate growth of the maturing M-REITs market”.

A key aspect of the proposed changes is to allow M-REITs to invest in a wider range of asset classes, one of which is to allow them to acquire vacant land and undertake property development.

Currently, apart from investments in existing yielding property, REITs in Malaysia are allowed a 10% cap on acquisitions of properties under construction.

This is due to the fact that REITs were not meant to carry construction risks, as their investors are typically yield seekers.

However, the SC’s proposal is to now set a 15% cap on M-REITs’ total asset value for property development, acquisition of vacant land as well as property under construction.

Despite the existing restrictions, a few M-REITs had in the past sought waivers from the regulator for the purchase of vacant land to extend their existing properties, such as Al-Aqar Healtcare REIT in 2012 when it bought land next to its KPJ hospital in Johor, and more recently, Sunway REITs’ purchase of land next to its Sunway Carnival Mall in Penang.

According to the SC, the move to liberalise the requirements on M-REITs will enable them to create more value for their investors.

Under the current requirements, M-REITs that hold old and outdated properties would have to sell these buildings back to their sponsors to be redeveloped, and then repurchase these properties later.

“Allowing M-REITs to undertake redevelopment of their old properties will enable them to enhance the property yield for the benefit of unit holders.

“Similarly, allowing M-REITs to acquire vacant land for purposes of developing new properties will enable them to grow their portfolio of income-generating real estate,” the SC said in the consultation paper.

However, it said the M-REITs that undertake property development must continue to hold the completed property for at least two years from the date of completion.

This, it said, was to ensure that the development activities were conducted purely to enhance its income-generating capacity.

The move to allow property development is not new in the region, as Singapore, which had an earlier 10% limit on property development for its REITs, raised it to 25% last year.

In Hong Kong, property development is limited to 10% of the gross asset value of the REIT.

Another major change proposed by the SC is a fixed leverage limit of 50% for M-REITs.

Currently, M-REITs are already subjected to a 50% limit on their debts, but this can be increased with the approval of unit holders via an ordinary resolution.

“With the current flexibility, there is a risk that an M-REIT may over-leverage in pursuit of rapid growth,” the SC said.

The regulator said the move to set a fixed leverage limit is to contain this risk as well as to ensure sustainable growth.

The consultation paper was issued yesterday, with feedback from the industry due by Sept 13, 2016, following which, the proposals will come into effect.

Meanwhile, following the cut in the OPR, some analysts have unsuprisingly turned more positive on M-REITs, which according to Hong Leong Investment Bank Research (HLIB Research) “is often the darling of equity investors during monetary easing”.

This is because of the REITs’ “stability and high-yielding nature”, pointed out HLIB Research, which has upgraded its rating on the sector to “overweight”, noting that the average M-REIT yield stands at 6.2%.

Affin Hwang Capital noted that “high-yielding sectors such as REITs and companies with high local debt” would be beneficiaries of the lower interest rates.

HLIB Research added that another catalyst for the sector was the enhancement of the guidelines by the SC to enable M-REITs to embark on greenfield development. This could lead to “potential acquisitions of quality assets (by M-REITs) to achieve growth as a softer property outlook presents such an opportunity”.

Analysts highlighted two other positive effects of the OPR cut on M-REITS.

One is that lower interest rates should lead to lower interest payments by REITs which typically gear up to buy their assets. And secondly, the OPR cut should translate into more savings and thus larger disposal incomes for consumers who could be spending more in retail malls, which is a key asset base of a number of M-REITS.

But HLIB Research pointed out that the lower interest rates are unlikely to lead to significant interest savings for M-REITs, as the majority of their borrowings are in fixed-rate loans.

CIMB Research, however, pointed out that it estimates that the OPR cut could see “consumers pocketing an extra RM2.1bil a year due to lower interest payments. Nonetheless, we believe that there will not be a spike in consumer spending in the near term, given the uncertain global economic backdrop.”

CIMB Research has maintained its “neutral” stance on the sector. Malaysia’s REIT market had a total market capitalisation of RM41.07bil as at June 30, 2016, accounting for 17 REITs, including four Islamic REITs.

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