Wednesday, 13 November 2013
THE latest earnings results for real estate investment trusts (REITs) for the third quarter (3Q) of 2013 were mostly within expectations, though this really is no surprise, and therefore offer few reasons for a rerating. Indeed, considering the relatively low yield spreads over prevailing risk-free Malaysian Government Securities (MGS) and expectations of rising interest rates, it may be some time before REITs regain their broad appeal.
For instance, the larger and most liquid REITs such as Axis REIT, CapitaMall Malaysia Trust (CMMT), Sunway REIT, IGB REIT and Pavilion REIT are currently giving investors net yields ranging from 4.9% to 5.5% for the current year and estimated to average roughly 5.3% for 2014.
Compared with the current yield of nearly 3.8% for the benchmark MGS, these REITs are offering a spread of just about 1.5%.
Relatively low premiums to risk-free investments
Rising yields on risk-free government bonds will attract funds away from riskier alternatives such as REITs and high yielding stocks.
The current yield spread of just 1.5% for REITs is not much buffer if yields on MGS are to rise further. Based on prevailing expectations, there is an odds-on chance of higher interest rates over the coming months. There are myriad reasons why this will happen, not least of which is the US Federal Reserve.
In fact, yields on the benchmark MGS rose as high as 4.14% at end-July after Fitch Ratings revised Malaysia’s outlook to negative from stable, coupled with heightened speculation of the Fed pulling back on its bond purchase programme in September.
The tapering by the Fed did not happen as it decided to wait on more data on the US economy before taking its foot off the gas. However, it is only a matter of time that it does. Current consensus expects tapering to happen in March 2014. Although stronger than expected US GDP growth in 3Q and labour market report, released last week, has given the market some pause.
While REITs are comparatively low-risk investments, they are not risk free. The retail sector is still doing quite well and registering positive rental reversion — at least for malls in prime locations — but the hospitality and office sectors are showing signs of cracks.
For example, Sunway REIT’s earnings are weighed down by underperforming hospitality assets. Turnover for the segment was down 12.5% year-on-year in the latest figures for its first quarter of 2014 financial year ending June, due to lower occupancy and slower corporate activities.
Its flagship asset, Sunway Pyramid shopping mall, is still doing well — registering rental reversion of 14.4% in the last quarter — although overall income from retail assets will be affected by the closure of Sunway Putra Mall.
Economic outlook could be more challenging in 2014
The economic outlook next year could be more challenging with both the government and consumers reining in spending and indebtedness amid rising costs, including interest costs. Rental rates are likely to come under pressure, burdened further by new supply of retail and office spaces coming into the market. Against this backdrop, organic income growth for REITs may slow.
Quill Capita Trust, for instance, reported a 1.4% drop in revenue for the first nine months of this year and a 2.3% decline in income for distribution over the same period.
This was due to lower portfolio occupancy and higher repair costs, which were partially offset by better rentals at some properties. The outlook going forward is muted on expectations of oversupply in the market.
Yield accretive acquisitions are tough to find
At the same time, acquisitions of yield accretive assets are also increasingly scarce on the back of rising property prices. None of the listed REITs have made any acquisitions so far this year. One of the last big acquisitions was Sunway REIT’s purchase of Sunway Medical Centre in December 2012.
CMMT recently aborted plans to acquire Tropicana City Mall and office tower, reportedly due to pricing. Sunway REIT too has been in prolonged negotiations to acquire an asset, which it had earlier targeted to be completed this year.
Looking ahead, IGB REIT is unlikely to expand its portfolio in the foreseeable future, although Pavilion REIT may acquire Farenheit88 sometime next year. Farenheit88 is unlikely to match the profitability of Pavilion KL mall.
Among the listed REITs, Axis REIT probably is the most likely to add to its portfolio within the next six months. It has identified a number of properties since late 2012 but has yet to finalise any. The trust has since narrowed its options down to four properties worth RM317 million. It has already secured approval to issue up to 90.8 million new units to fund the expansion.
Publish date: 13/11/13