Average distribution yield likely to be at healthy 6.3% this year
NEXT week should be interesting. On Thursday Bank Negara will hold its overnight policy rate meeting.
A day later, Donald Trump will lay claim to the White House.
It will be the Friday event and the subsequent “Trump tantrum” that will impact Malaysian real estate investment trusts (M-REITs) going forward.
Malaysian REIT Managers Association (MRMA) chairman Datuk Jeffrey Ng says M-REITs, and REITs in general, are dependent on interest rate direction and Trumponomics.
Bank Negara, on the other hand, has the wiggle room to remain accommodative and has “to balance” its monetary stance with the “prevailing economic landscape” and “to prioritise economic growth over tightening monetary policy,” Ng says in an email.
Other than interest rates being a huge factor in REITs, their performance is also reliant on the property market.
Despite the weaknesses in the sector – oversupply in retail and office space leading to a slower pace of rental reversions and rental rates – M-REITs have remained resilient, offering dividend yields of 5%-6% in the past year.
Although the property sector is expected to be challenging for the next 12 months, the average distribution yield is expected to remain healthy at 6.3% this year.
Kenanga Investment Bank Bhd’s equity research head Sarah Lim Fern Chieh says earnings from M-REITs are expected “to be stable for the next one to two years”.
Rising interest rates
As interest rates feature so prominently in REITs, the overall global trend of rising rates will impact this investment option.
Property consultancy Khong & Jaafar group managing director Elvin says REITs are “a darling in the investment world” because rates are low. KLCC as a destination. Tourists go there
Elvin says if one were a serious market observer, and had considered the effects of the 2013 taper tantrum, he or she would consider what may happen going forward. “Are we going to have the same thing? No. It will be worse than the same thing,” Elvin says.
Rates have started to move and are expected to do so more aggressively. The cycle is turning, Elvin says.
“REITs, in general, will move into a far more challenging period,” he says.
Ng is aware of the challenges ahead but is positive. He is of the view that any potential selldown is “likely to be less aggressive” as foreign unitholdings have dropped since the 2013 “taper tantrum” and the 2015 weakening of the ringgit following the 2014 oil price plunge.
Nonetheless, the expectations of a global interest rate (rise) will impact M-REITs “as seen in the retracement in unit prices in recent weeks,” Ng says.
REITs are valued for their defensive nature. Because REITs have to pay out at least 90% of their distributable income, they are a proxy for the Malaysian Government Securities (MGS).
An analyst who declined to be named says REIT investors are rewar-ded for taking a risk, hence the 2% dividend upside offered by M-REITs against the yield offered by MGS.
This spread is narrowing, however. Trump’s unexpected victory has triggered an exodus of funds from emerging markets back to the United States in recent weeks.
The prevailing 10-year MGS yield, 4.2% as at Dec 31, 2016, was higher than the 4.1% back in July 2013 during the “taper tantrum” from June 2013 to August 2013, says Ng.
He says the recent spike in 10-year MGS yields to 4.5% may persist a bit longer, but is expected to normalise to below 4.0% eventually. Bond prices move inversely with yields.
Homegrown retail issues
Introduced as an investment option more than 10 years ago, M-REITs grew from less than half a billion ringgit in market capitalisation in 2005 to RM44.2bil as at Dec 31, 2016, with most of the shareholding under pension and sovereign funds, insurance funds and their promoters. Foreign shareholding and individual investors are small. It is by virtue of their small foreign shareholding that gives M-REITs their stability.
Out of 17 counters comprising retail, office, hospitality and healthcare, retail is leading.
The existing space within purpose-built retail centres totalled 59.89 million sq ft with the average occupancy at 80.1% as at the third quarter of calendar year 2016.
Despite slowing consumption and tourist spending, the KLCC REIT which manages three assets around the Kuala Lumpur City Centre area, Pavilion REIT (Pav REIT) which manages KL Pavilion, among other assets, and IGB REIT, the owner of Mid Valley Mega Mall, are leading.
Kenanga research says Pav REIT is expected to inject the recently completed Pavilion extension, or Pavilion Elite which opened in November 2016, into its portfolio this year.
Its inclusion is expected to add 15.7% or RM66mil to Pav REIT’s gross rental income based on 250,000 sq ft of net lettable area (NLA), or 11.8% of Pav REIT’s total NLA on an assumed rental rate of RM22 per sq ft (psf) a month.
Despite issues on the oversupply of mall space and the entry of more retail malls, there is something to be said about the position and location of these assets.
Says Kenanga’s Sarah Lim: “You are seeing very few leases expiring. People will not divert from malls like Pavilion, Mid Valley or KLCC. You cannot look at retail REITs from the sectorial perspective only. It has to be combined with the asset location point of view as well.
“Where is your asset located? Will Mid Valley see fewer people? No. It is a one-stop centre and you can do everything there. It is in a wonderful sweet spot between Bangsar and the capital of Kuala Lumpur, along the Federal Highway.
“The same with KLCC as a destination. Tourists go there. As for Pavilion, it is surrounded by offices. Where do people eat? These are landmark malls.
“Can they push rates up a lot? No. But they will survive much better than the average malls. So, there are two parts to an asset, the occupancy rate and the rental rate.
“Owners always try to maintain their occupancy. They may keep rental stable but maintain occupancy,” she says.
Despite various challenges, Universiti Teknologi Mara professor of property investment Dr Ting Kien Hwa says REITs can work towards increasing income distribution by buying yield-accretive properties that do not dilute earnings and by increasing the NLA.
Sungai Wang, part of CapitaLand Malaysia Mall Trust , is one of Kuala Lumpur’s earliest malls. It converted parking space to retail space, says Ting.
Subang Summit, under AmFIRST REIT, was refurbished and increased retail space in preparation for competition with Pav REIT’s da:men Mall located nearby. Tenant mix is another tool REITs can use, he says.
But probably, more crucial than anything else is today’s rising trend in interest rates and Malaysia’s high corporate debt levels.
This twin evil has thrown the focus on the wisdom of capital management.
Because REITs distribute 90% or more of their income, they do not have huge cash reserves.
The rising interest rate environment means increasing volatility, so they have to manage this aspect,” says Ting.
It is no longer business as usual.
Owners and managers have to roll up their sleeves and push up the level of property management in a global sense. They must be astute, says .
“They cannot just clean the building. New ideas and expertise are needed.
“Every REIT has to have capital management, and not just property management in order to enhance yield. Capital management includes managing debts and making sure they are as low as possible.”
Even in a subdued economic environment, opportunities prevail, says Ng.
The restructuring of companies to strengthen their balance sheet will give rise to acquisitions and expectations will be more realistic, he says.