REITs: A defensive play for yield hungry investors

OVER the past month, most of the retail- and hospitality-based real estate investment trusts (REITs) had announced their quarterly results for the second quarter (Q2) period and the underlying picture is that these REITs are under pressure, brought about by the movement control order (MCO) as well as sluggish growth during the recovery MCO (RMCO) period.

Most of them were impacted by the rental waivers to their tenants, lower footfall and drop in tourism-related activities, which impacted the hospitality sector.

In terms of revenue, the Q2 period saw a decline of 30% quarter-on-quarter (q-o-q) and when compared with the previous year’s Q2 period, revenue was lower by 34% y-o-y. Only KIP saw a y-o-y increase in revenue, mainly due to new additional mall injected into the REITs at the end of July last year. For the first half of the year, as can be seen from Table 1, revenue for retail and hospitality REITs declined by 21% with individual REITs experienced a drop of between 12% and 32% y-o-y, with the exception of KIP REITs, which saw its topline rising by 14% y-o-y.

With the decline in the topline, realised net property income (RNPI) took a hit for all the REITs as the Q2 period saw RNPI dropped by between 10% and 99% or an average of 43% q-o-q while on a y-o-y basis, the Q2 period saw RNPI decline by up to 99% with an average decline of 50%.

Table 2 also shows the first half performance, as RNPI fell by 32.5% y-o-y.

With the exception of again KIP REIT, the other REITs saw RNPI decline by between 11% and 69%.

The significantly higher decline in RNPI basically reflects an environment whereby business was hit by a drop in revenue but cost remains very much intact.

Obviously, this also meant that the RNPI margin too have declined and on average, that only stood at 35.2% for the Q2 period, and for the H1 period at 40%.

RNPI declined by 11.2 percentage points (pps) and 8.3 pps on a y-o-y and q-o-q basis for the Q2 period and for the H1period, it was down by 6.8 pps as seen on Chart 1.



The consequent of a lower RNPI are indeed lower dividends. With a lower payout, yields on the REITs too have dropped, reflecting market perception that it may take a while before we see normal retail and hospitality landscape.

Based on the H1 period, most REITs have lowered their dividend payouts by between 10% and 69%.

Only KIP REITs saw an increase in payout by a modest 1% to 3.05 sen for the calendar half year period. Table 3 summarises dividends announced by the retail and hospitality REITs.

What lies ahead for retail and hospitality REITs?

All retail and hospitality REITs operators have turned cautious and are concern about the impact of RMCO, not only in the current Q3 period but even beyond as there are reasons to be vary about the future outlook.

This can be summarised in three main issues:

> Rental revisions

All REITs have tenancy agreements that are locked-in for a period of time. Some have revision clauses, mostly on a three-year cycle and as and when they are due, both the tenant and REITs would come to an agreement in the form of the revised rental rate, if any. In the past, this has always been on a rising upward trend but for the retail REITs now, the landscape for the industry has changed, resulting in either tenants not being able to renew their tenancy or seeking a lower rental amount due to the tougher business environment.

With MCO and RMCO, consumers have learned to shop online and the need to be patronising retail outlets have indeed reduced.

This can be seen from lower footfall, especially among premier malls.

For investors, the key would be to watch this space in the sense that whether the REITs is experiencing a reversal in rental revision, flat growth or is it still able to command a growth in rental revisions.

>Vacancy rates

Another key figure to watch is vacancy rate. Most of the retail and hospitality REITs have been enjoying healthy occupancy rates with some close to the 98-99% mark even. Smaller and less popular malls tend to have slightly lower occupancy rate but still healthy in the overall scheme of things. However, due to the Covid-19, RMCO and tough business conditions, some tenants are likely to call it quits and thus raising the vacancy rates of these malls. REITs would need to provide some sort of carrots for new tenants as to fill-up vacant space is going to be challenging, especially if rental rates are not competitive enough. In the commercial space, we are already hearing that some landlords are throwing in the “extras” just to attract new tenants and this goes beyond the traditional rental free period that we have seen during difficult times.

> Changes in long-term master lease contracts

Most REITs leased out vacancy spaces on an individual tenant basis, especially for buildings that are occupied by multiple tenants. However, there are also REITs that enter into what is referred to as Master Lease Agreements whereby the REITs itself receives a fixed payment terms for a defined period of time. While long term leases are generally long-term, there are occasions where circumstances may lead to a change in contracts entered into by a lessor and a lessee.

In the case of YTL Hospitality REITs (YTL REITs), Covid-19 has severely impacted its hospitality business due to travel restrictions imposed in most countries. Hence, the REITs took note of the lessees’ request to alter payment terms of future lease payments with a 50% reduction on lease payments for a period of 24 months starting from 1 July 2020 to 30 June 2022. The rental difference will be paid over a period of seven years or up to the expiry of the individual leases, whichever earlier.

In essence, according to YTL REITs, some 87% of the rental difference will be repaid within 4.5 years after the two-year adjustment period.

What does this mean for REITs holders? While it is understandable for REITs to play the hand-holding for its tenants during this difficult time, it comes at a price for unitholders. As it is, YTL REIT will see lower net property income by about half for at least in the next two financial years, before repayment of the lease reduction starts to kick-in again in financial year ended June 2023 onwards.

As can be seen from the 12.4% drop in the Bursa Malaysia REITs index year-to-date, the pandemic has really tested the underlying strength of REITs as a defensive and a dividend yield play. The y-o-y drop in dividends by most of the retail and hospitality REITs is a signal that all is not that well for the sector.

Nevertheless, at the same time, the worst could be behind us, especially now that the we are already coming to the end of the RMCO period while domestic interest rates are at record low. Hence, even with reduced yield, which now range between 2-4% on an annualized basis (derived from the 1H 2020 declared dividends), some of the REITs remain attractive for yield hungry investors, especially for a REIT like KIP which has shown sustained and consistent performance.

As for YTL REITs, the annualised yield is not reflective of the next two years’ expected yield due to the rental reduction for its leased assets.

Pankaj C. Kumar is a long-time investment analyst. The views expressed here are solely that of the writer’s.