REITs under pressure as MGS yields rise

When we last wrote about real estate investment trusts (REITs) listed on Bursa Malaysia on June 7, we noted that unit prices have been remarkably resilient amid the global selldown in bonds and high yielding equities (including REITs) and could be exposed to catch down risks.

We posit that the risk premiums for REITs could have fallen too low. At that point, net yields ranged from as low as 4.4%, on average, for larger retail-focused REITs to roughly 6.1% for mixed commercial REITs.

Axis REIT, the only industrial-focused REIT on the local bourse, had a net yield of approximately 4.1%. Compared to the then benchmark 10-year Malaysian government securities (MGS) yield of roughly 3.5%, the implied spread ranged from as low as 0.6% to 2.6%.

Since then, unit prices have weakened, especially for the larger and more liquid trusts, which were also those offering the lowest yields. Excluding Al-Hadharah Boustead REIT, whose units are trading higher on the back of a privatisation offer from its parent company, all REITs with market capitalisation above RM1 billion have come under selling pressure — losing 6% to 16% of their values. Prices for the smaller, mixed commercial REITs, with their wider spread, have held up comparatively better.

Following the recent price correction, net yields for the four largest retail-focused REITs — Sunway REIT, Pavilion REIT, CapitaMall Malaysia Trust (CMMT) and IGB REIT — have improved to about 4.9% on average. Similarly, net yield for Axis REIT is now higher at 4.8% after its unit price fell 14% from the record high close of RM4.02 in May.

Despite the improved yields, investors may want to stay cautious. Over the last few weeks, yields for the 10-year MGS have also risen quite sharply, breaking above 3.9%, although still lagging the yield increases for the 10-year US Treasury notes, which have gone up by almost 1% since May.

The prevailing spread for REITs of 1%, on average, is not a big buffer if yields on the MGS continue to move higher. If true, there could be further downside risks for REITs.

CMMT looks to AEI to improve yields...

CMMT’s earnings results for the second quarter of 2013 (2Q13) were broadly in line with expectations. Revenue was up 4.4% year-on-year (y-o-y) to RM74.6 million. The trust has renewed about half of the leases which were due in the first half of 2013 (1H13) with a rental reversion of 7.9%, on average. Portfolio occupancy rate remains high at 98.8% at end-June.

Its latest acquisition, the East Coast Mall, registered the highest rental increase of 19.8% due, in part, to its low base. The Mines and Gurney Plaza too reported strong rental reversion of about 10% and 9% respectively. Only Sungei Wang Plaza saw weaker rentals as shopper traffic for the mall had been affected by ongoing MRT construction works in its vicinity.

The trust has some 43% and 28% of leases (in terms of rental revenue) up for renewal in 2014 and 2015 respectively. We expect rental rates to remain in an uptrend. But the pace of increase could be tempered by slower growth in consumer spending.

Domestic consumption has grown quite strongly over the last few years, fuelled by higher borrowings. However, with household debt at a high 83% of GDP, the room for additional leverage is narrowing rapidly. Higher interest rates — mirroring the expected global trend — would further crimp disposable incomes.

CMMT is focusing primarily on asset enhancement initiatives (AEI) to improve yields for its properties. The largest slice of capital spending is slated for the East Coast Mall, where works include conversion of some car park space into higher revenue generating retail area.

...while Axis REIT eyes yield accretive acquisitions

Similarly, 2Q13 earnings results for Axis REIT were broadly in line with expectations. Revenue was up 8.7% y-o-y to RM35.7 million, bolstered by contributions from newly acquired assets — the Emerson, Nilai in 3Q12 and Wisma Academy and The Annex in 4Q12 — as well as positive rental reversion. The trust registered 8.4% rental reversion, on average, for leases due in 1H13 that accounted for nearly 7% of total net lettable area.

Occupancy remains stable at 95.6%, including a low 15.7% occupancy for Axis Business Campus, which is undergoing major AEI. A new building block at the property is slated for completion by end-2014.

We estimate total distribution per unit (DPU) at roughly 18.5 sen for the current year — without taking into account any new acquisition — up from the 17.3 sen paid last year, excluding the 1.3 sen distribution from disposal gains. That will earn unitholders a net yield of 4.8%.

Axis REIT is currently negotiating the acquisition of several properties, which should be yield accretive in 2014 (assuming they are completed by end-2013). The purchase will be part funded by the issuance of some 90.8 million new units. Assuming its current gearing ratio is more or less maintained, we estimate DPU would rise to roughly 20 sen next year. That will up its net yield to 5.2% at the current price of RM3.46.

Daily FBM KLCI chart as at July 30, 2013 using Next VIEW Advisor Professional

Note: This report is brought to you by Asia Analytica Sdn Bhd, a licensed investment adviser. Please exercise your own judgment or seek professional advice for your specific investment needs. We are not responsible for your investment decisions. Our shareholders, directors and employees may have positions in any of the stocks mentioned.


This article first appeared in The Edge Financial Daily, on July 31, 2013.