Tuesday, October 8, 2013

M-REIT: Too much retail space? (CIMB)

 Too much retail space?
Although there is an abundance of retail space in the Klang Valley, it has not affected the rental reversions of malls held by the REITs we cover. However, the continued arrival of new malls does suggest a worrying outlook post 2015.

 We retain our Neutral call on the M-REIT sector as the dividend yields of 5.1-5.5% for FY13-14 are not particularly attractive relative to the 3.98% yield for 10-year MGS. Furthermore, given our bullish view on the overall market, we believe that investors will shy away from defensive stocks such as REITs, preferring sectors that offer higher returns such as oil & gas and construction. Our preferred REIT is KLCCP due to the prime location of its assets (Petronas Twin Towers and Suria KLCC) while its property development projects would provide the REIT with key assets in the longer term.

What Happened
The Starbiz weekly published an article focusing on the oversupply of retail malls in the Klang Valley which have caused rental rates to be flat in recent times. This surprised us as most of the retail REITs under our coverage recently achieved positive rental reversions of 10-15%. The article did go on to highlight that the main story is not just oversupply but the disparity between the successful malls and the struggling ones. The successful malls are the likes of KLCC Property’s Suria KLCC and Pavilion REIT’s Pavilion, which thrive due to their status as the go-to destinations for fashion outlets. According to property valuer Henry Butcher's MD the oversupply and overbuilding situation is only apparent in the city and not in the smaller towns.

What We Think
We think that the oversupply of malls is not a major concern yet. However, by 2015, mall space will increase by 28%, which could affect the occupancy rates of even the malls that are doing well.

What You Should Do
We recommend that investors stop accumulating REITs as dividend yields are not attractive relative to the risk-free rate. In the longer term, the rental reversion outlook does not look bright given the mall glut which will depress future rental reversions.

Too much retail space?
During the weekend, Starbiz Weekly published an article on the current issues facing shopping mall space in the Klang Valley, i.e. retail space oversupply and retail spending though the article’s emphasis was on the former. The article cited statistics from the National Property Information Centre (Napic) which stated that the Klang Valley (inclusive of Selangor and Putrajaya) has a total of 59m sq ft of mall space. Another statistic by CBRE, which excludes arcades and retail space in older buildings on the outskirts of the Klang Valley, stated that there is 48m sq ft of mall space in Greater Kuala Lumpur. Comparatively, Singapore's shopping mall space stood at around 25m sq ft in December 2012.

The article highlighted that "retail rentals have not shot up but have only been maintained", which was a surprise. We do not concur though admittedly, our view is formed from observing the retail malls under the management of the REITs in our coverage. Recent rental reversions for the REITs’ retail space came in at a healthy 10-15% rate, implying that rentals have not been flat, as per the article. But the article did go on to highlight that the main story is not just oversupply but the disparity between the successful malls and the struggling ones. The successful malls are the likes of KLCC Property’s Suria KLCC and Pavilion REIT’s Pavilion, which thrive due to their status as the go-to destinations for fashion outlets. Other malls that are doing well include Mid Valley and The Gardens (both under IGB REIT), 1 Utama and Sunway Pyramid (Sunway REIT) which are all enjoying nearly full occupancy even as other malls struggle.

According to property valuer Henry Butcher's MD, Tan Hai Hsin, the oversupply and overbuilding situation is only apparent in the city and not in the smaller towns. He went on to state that there is more room for growth in retail sales which would support retail rental rates. RGM Retail Group expects retail sales in Malaysia to grow at a faster rate of 6.4% this year compared with 2012’s 5.5%, driven by continued robust domestic demand. Our economics team forecasts consumer spending growth of 7% in 2013 and 6.3% in 2014.

Interesting developments in the mall segment
Despite the continued rise in rental rates for prime retail space, there have been some interesting developments in this sub-segment of the property market. In August, ARA Asset Management Ltd, which is linked to Hong Kong tycoon Li Ka Shing, said that it would be divesting five neighbourhood malls in Malaysia, i.e. Aeon Bandaraya in Malacca, Klang Parade, Ipoh Parade, 1MK in Mont' Kiara and Citta Mall in Ara Damansara, totalling 2.7m sq ft in built-up area. ARA Asset Management said that it is divesting because the fund that the malls are parked under is winding up. ARA would like to retain management of the malls. According to the article, other Klang Valley malls that are up for sale include Tropicana City Mall and Encorp Strand Mall in Kota Damansara.

Although the article paints a gloomy picture with all these malls being up for sale, we beg to differ as malls are always being built and sold by developers as a means of recouping the capital and profiting from the sale of the malls. The buyers are usually REITs which would manage the mall and improve its rental yields by refurbishing the mall and improving its tenancy mix to attract more shoppers, i.e. business as usual. Indeed, by the end of it, the article did highlight all these factors.

We do highlight that given the number of malls that are up for sale, the lack of injection of assets into most of the REITs does raise an issue. We believe that the issue is mainly the pricing of these malls which has to be satisfactory to the REITs. REITs typically will go for acquisitions at a certain cap rate, usually around 6-7%, and will then refurbish the mall and improve the rental yields. Pricing boils down to what the buyer and seller are willing to accept and we think that mall owners and the REITs are looking at status quo currently.

The future, however, is worrying
Despite the glut of mall space, developers are continuing to build malls, adding 24.7m sq ft of mall space by 2016. This, in our view, is a worrying trend as the sheer amount of space will result in lower occupancy and depressed rental rates even for the successful malls held by the REITs in our coverage. Although we do expect the continued growth in retail spending to mitigate the oversupply issue, the new mall space is likely to result in a flattish rental outlook post 2015 when approximately 16.4m sq ft of new space is expected to come onstream.

Sunway REIT CEO interview
The Starbiz also published an interview with the CEO of Sunway REIT Management, Datuk Jeffrey Ng Tiong Lip. There were no surprises contained in the interview, as we have addressed all of the issues raised previously, such as Sunway REIT's relatively weak DPU outlook in 2014 as a result of the refurbishment on one of its malls, Sunway Putra Mall and a brief description of the RM300m refurbishment of the mall. The impact from the loss of income from Sunway Putra Mall, however, would be minimised through: 1) positive rental reversion for 54% of Sunway Pyramid's NLA in Sept 2013, 2) the expansion of Sunway Pyramid's NLA by 20k sq ft and the reconfiguration of 23k sq ft which is expected to boost rental rates when it is completed by the end of the year, and 3) the RM38.1m Asset Enhancement Initiatives (AEI) which was completed in the last financial year and is expected to provide an ROI of 15%. The CEO also shared our views with regards to the current mall situation, i.e. leading malls would continue to enjoy strong occupancy rate, while average performing malls occupancy and rental rates would be under pressure.

Source/Extract/Excerpts/来源/转贴/摘录: CIMB-Research,
Publish date: 07/10/13

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