Malaysia - REITs: A new contender in the ring of investments

REITs in the country have grown both in depth and breadth since 2005, with high-quality REITs being well positioned to maintain popularity as an attractive defensive asset during volatile times. REITs are now gaining prominence as the new ‘challenger’ in investment circles.

In the rat race to increase net worth, individuals are constantly on the lookout for opportunities to create wealth through investments.

With a projected growth of between five to six per cent for Malaysia in 2012, coupled with the rising disposable income of the country’s population and rapid urbanisation, investors are getting more savvy in terms of searching for investment options.

Many pursue unit trusts, stocks, commodities, fixed deposits, hedge funds and so on, injecting monies with an expectation of gain after a thorough analysis of these products.

In fact, it is generally well known that the biggest asset class the average Malaysian invests in his or her lifetime is in properties.

However, all that has changed with the introduction of a different form of investing indirectly in properties, called Real Estate Investment Trusts (REITs).

The introduction of REITs into Malaysia has brought a whole new dimension to the country’s investment circles, adding special focus to the country’s property sector apart from enhancing the economy.

Since its debut back in 2005, the number of REIT players here has been growing and gaining prominence as a safer option for investment.

According to the head of equities at HwangDBS Investment Management Bhd (HwangDBS IM), Gan Eng Peng, Malaysia REITs (M-REITs) have grown in depth and breadth since 2005, fuelling his belief that high-quality properties were well positioned to maintain their popularity as an attractive defensive asset during volatile times.

“Malaysia made its debut of REITs in the stock exchange when Axis-REIT was listed in 2005,” said Gan. “Back then, the underlying assets were less varied.

“For instance, the more prominent REITs such as Axis-REIT capitalises on a combination high grade office assets in prime locations and industrial space, whilst Starhill-REIT offers top notch retail and hospitality assets in prime locations.

“Businesses in such areas tend to lock-in longer leases due to the appeal of its location and growth potential. On the other hand, the more environment-sensitive hospitality assets offer an upside during economic growth.”

A whole new ball game

The legislation for REITs in Malaysia categorises them as a unit trust, with a mandatory external management structure and at least 50 per cent of the fund’s total asset value to be invested in real estate and/or single-purpose companies at all times.

Property development of the assets under management is prohibited, but REIT managers may enter into conditional forward purchase agreements.

REITs are exempted from income tax if at least 90 per cent of income is distributed within two months of a financial year’s closure. However, dividend yields are not specified in Malaysian REIT guidelines.

With all these unique rules set in stone, REITs were emerging as a significant asset class in their own right, affirmed the chairman of Malaysian REIT Managers Association (MRMA) as well as the chief executive officer of Axis REIT, Stewart LaBrooy.

“From humble beginnings when market capitalisation was at about RM300 million in 2005, it currently boasts a market capitalisation of RM12 billion.,” he revealed.

“With the listing of Pavilion REIT in December, this should rise to RM16 billion.”

With so much value attributed to these REITs, it might appear odd to some that Malaysian REITs were still in their ‘infancy stage’.

The head of Real Estate and Construction Ratings, RAM Rating Services Bhd (RAM Ratings), Shahina Azura Halip, opined that with only six years of experience, the Malaysian REIT industry was considered to still be relatively young with much potential going forward.

“Based on our observations, the local REIT sector has not been growing as fast as some of its counterparts in Asia, with some local REITs having the same portfolio of properties since listing,” she stressed. “REITs in Singapore, in the meantime, often make active acquisitions and have already expanded their portfolio of properties overseas.”

In fact, the size of the local REIT sector paled in comparison to the likes of Hong Kong and Singapore, highlighted Shahina.

Supporting this was HwangDBS’ Gan, who compared Malaysia to Hong Kong and stated that Hong Kong began listing REITs in its stock market in 2005 shortly before Malaysia did.

“With only eight REITs in their portfolio, they have built their market capitalisation to US$12 billion in total, comprising a wide range of underlying asset mix ranging from hospitality, retail, office space, healthcare to industrial,” he added.

“However, its average yield is lower than that of M-REIT — at approximately five per cent — due to its perceived lower risk underlying assets, being a more mature capital market and nation, as well as its obviously higher liquidity that facilitates trading of the shares.”

Gan further opined that it was unfair to compare REITs between countries as it was a localised industry, sharing certain traits with the respective property sectors.

“That means it is difficult to compare a REIT from two different countries as each has its unique profile, potential and regulations amongst others. Furthermore, one should not take yield returns alone as an indication of performance.

“It should be a balance of yield, asset quality, and cost of financing, as high yielding REITs could also mean equally high financing costs or lower quality assets.”

Looking at local REIT players

To date, the country has 14 Malaysian REITs (M-REITs) with a total market capitalisation of RM12 billion, offering an average yield of seven per cent.

Of the 14 M-REITs, a few stand out by the very fact that they handle sector-specific properties in their portfolios.

These include Al-Aqar KPJ REIT (syariah-compliant focus on healthcare properties), Al-Hadharah Boustead REIT (touted to be the only Islamic plantation based REIT in the world), and Atrium REIT (with focus on logistics properties).

Some players that are fully-focused on retail are CMMT and Hektar REIT, with emphasis within the Klang Valley region.

Other well known REITs with mixed developments include Sunway REIT, Axis REIT, AmanahRaya REIT, Starhill REIT, Am­First REIT, Tower REIT, UOA REIT and Quill Capita Trust.

These companies see a mix of retail, office, industrial, hotel or education properties in their portfolios.

Why are REITs so popular?

As all investment options have their own risk-reward profile, REITs appealed to investors as it was safe to park money for stable returns in light of the current volatile market conditions.

“Commodities could have higher return, but risk is also higher, more volatile,” said RHB Research Institute Sdn Bhd’s analyst Loong Kok Wen. “REITs will only offer you resilient and stable yields, but steady and less volatile unit price appreciation over the long term.”

In the past global financial crisis, unit price of REITs was also affected as there was market fear on the potential depreciation of property assets which triggered the debt collateral threshold, commented Loong.

“However, there were no such cases. Dividend yield was even higher (less than 10 per cent) due to unit price compression.”

RAM Rating’s Shahina compared returns from REITs with that from properties, citing differences along the way.

“In the Malaysian scene, yields from REITs have been at least around seven per cent, which is higher relative to the current returns from fixed deposits – understandably so, given that fixed deposits have lower risks,” she noted.

“Meanwhile, returns from properties can be divided into rental yield and capital gains. Rental yields from landed properties range at two to four per cent, while rental yields from condominiums are typically at about four to seven per cent.

“Comparing purely on just rental returns from properties versus the yield from REITs, the latter is likely to offer better returns, depending on the types of properties being considered. Nevertheless, as mentioned earlier, investors of properties will also be able to derive returns in the form of capital gains.”

However, Shahina forewarned that on balance, investing in property directly would require high capital investment and high concentration risk, in addition to the the fact that investors would have to manage the property by themselves.

Gan from HwangDBS affirmed that a blanket generalisation for the sake of comparison would not be accurate.

“For one, all the assets (stocks, commodities, properties and so on) are of differing classes and their respective suitability should be based on the investor’s objective, risk appetites, time horizon and overall investment portfolio,” he justified.

“In addition to that, these different asset classes have their respective functions in every investor’s portfolio. Generally speaking, though REITs are considered defensive play within the equity asset class, their performance move in tandem with economic growth and business cycles.

“As such, investors should adopt a longer term view when investing in REITs.”

Sectoral preferences

As players continue to raise funds and acquire new assets, different classes of REITs were predicted to thrive over others.

LaBrooy believed that investors needed to decide on the asset class that they were most comfortable with, citing East Malaysians as an example.

“Investors from Sabah and Sarawak favour Boustead’ Al-Hadharah REIT as it is a plantation REIT and they understand that market very well,” he cited.

“The appeal has to lie with the investor. At the same time, they have to be aware of the trends in the property market and look at exposure to potential oversupply situations where rents could be affected and, as a result, so will the dividend payout,” forewarned LaBrooy.

“However, most Malaysian REITs have very strong tenant covenants with strong tenancies in place, lowering that risk.”

Both Loong from RHB Research and Gan from HwangDBS pegged retail REITs as their favourite, emphasising on the fact that consumption in Malaysia would remain high and relatively insulated from the rest of the world.

“Retail spending will be relatively more resilient compared with manufacturing and industrial activities, in view of slower economic growth ahead,” Loong added.

RAM Ratings’ Shahina further appended that the performance of the retail property sector was supported by domestic economic growth and tourist arrivals, although stiff competition and large incoming supply were moderating factors that were constantly being monitored.

“Another category is the industrial property sector, which is seen to be largely stable,” Shahina opined. “Falling back to RAM Ratings’ outlook for the various aforementioned sectors, we have a negative outlook on the office sectors in Kuala Lumpur and Selangor due to the oversupply situation and its adverse effects on occupancy and rental rates.

“While demand from the manufacturing sector may moderate in the current uncertain economic environment, demand from the logistics sector is expected to provide some support to demand for industrial properties. Supply of industrial properties has been largely stable.

“Meanwhile, the healthcare industry is viewed to be relatively stable and defensive, given that healthcare is a basic necessity. Elsewhere, the oil palm plantation sector has a stable outlook, underpinned by demand from countries with large populations and increasing consumption of vegetable oils.”

Creating awareness: How far are we?

It is a difficult task for managers to create awareness about REITs, especially within a society as diverse as Malaysia.

Language barriers, geography and different classes of wealth mentalities are among the few causes of hindrance seen in disseminating knowledge and understanding about REITs, its core concepts and its addendums over other equity asset classes.

“Generally speaking, Malaysian retail investors have a decent level of knowledge of equities as an asset class. However, when it comes to understanding the business fundamentals within the sub-sector of equities asset class such as REITs, more can be done to improve the knowledge of the general retail investors,” highlighted Gan from HwangDBS.

He went on to outline knowledge such as understanding the drivers behind the REITs industry, factors affecting the industry and its specific business sector, evaluating its potential and accessing its valuation could be handy in helping one make investment decision when it comes to investing in REITs.

One important game-changer is the MRMA, an association formed in May last year to represent the REIT sector. One of its main roles was to educate the public through seminars in association with banks and real estate companies.

LaBrooy as its chairman noted that the association had done much to create awareness in Sabah and Sarawak, with encouraging results to date.

‘We recently concluded a road show in Kota Kinabalu in the middle of the year, where we presented the REIT experi­ence to investors,” he gave as example.

“However, I believe that local investors in Sabah and Sarawak still have a preference of own­ing local property as they are familiar with the markets. It will take time for the retail investors to come around to the idea of investing in REITs and we are doing all we can to accelerate the process.”

On the other end of the spectrum, one also needs to scrutinise the managers of these REITs to determine the investment viability.

RAM Rating’s Shahina af­firmed that a REIT manager’s track record vis-à-vis managing the properties in its portfolio was an important considera­tion.

“This can be derived from the operational statistics of the properties, such as the histori­cal occupancy and rental rates. The ability for a REIT manager to maintain strong occupancy and rental rates is a reflection of its competence,” she noted.

“The REIT manager’s ability to continuously perform asset enhancements to the buildings should also be taken into consid­eration as this will enable the REIT to enjoy better rental rates upon enhancements, either in the form of a ‘fresher’ look, better utilisation of space or optimisation of vacant space.”

On a broader note, one should also assess the REIT manager’s strategies in managing the over­all portfolio of the REIT from the perspective of diversity in tenant mix, locations and types of leases, she added.

“A more diverse portfolio will reduce the REIT’s concen­tration risks to a particular segment. One should also take into consideration the REIT manager’s growth strategy for the REIT by assessing its acquisition criteria as well as funding strategy.”

Successful acquisitions of well-tenanted buildings would also give the REIT a boost in its rental income.

From a credit rating perspec­tive, said Shahina, acquisitions should not be at the sole expense of balance sheet; in this context, the debt level and debt-maturity profile of REITs were also as­sessed.

Future expectations

Bearing all this in mind, it is generally understood that Malaysian REITs still have a long way to go.

“We expect the M-REIT in­dustry to grow going forward as the industry gradually matures. The increasing awareness of REITs as an asset class through time will offer a wider range of investors and funding sources for REITs,” affirmed Shahina.

Gan from HwangDBS pro­jected trajectory returns in the next 12 months to be about about 10 per cent upside, consisting of five per cent in capital apprecia­tion and another five per cent for dividend returns.

LaBrooy was similarly op­timistic, hoping that foreign investors would be strongly at­tracted by how inexpensive our properties were when compared with our neighbours.

RHB Research’s Loong hoped that the guidelines and poli­cies on Malaysian REITs could be more liberalised to attract greater foreign participation in the future.

“Through this, it will also help to drive the entire prop­erty sector, encouraging more transactions and hence greater liquidity,” she concluded.

Ronnie Teo

Borneo Post

http://www.theborneopost.com/2011/11/20/reits-a-new-contender-in-the-ring-of-investments/

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