Changing Rates to Pose Challenges
MREITs are facing yet another bump in the road with DBKL recently announcing a hike in assessment rates, which could be as severe as 100%-300% depending on locations. This creates uncertainties for MREITs like KLCCSS, CMMT and SUNREIT as the hike in assessment rates in 1Q14 could present earnings risks; although the extent of the hike may be less severe than reported and will be determined by March 2014 post DBKL’s finalized hearings. We have increased our valuation yield spreads by +0.5ppt to account for this increased risk. To top it off, the 10-year MGS has crept up to 4.1% as of 30th October due to looming risk from QE tapering; hence, we increase our FY14E target 10-yr MGS to 4.15% (from 3.9%). We have downgraded our TPs by 4%-12% and our new CALLs/TPs are as followed; KLCCSS (UP; TP: RM5.41), SUNREIT (UP; TP: RM1.19), CMMT (MP; TP: RM1.41), AXREIT (MP; TP: RM3.28). Maintain UNDERWEIGHT on MREITs.
3Q13 results were within expectations. MREIT’s earnings and dividends were within our and market expectations. SUNREIT, CMMT, AXREIT recorded YoY RNI growth of 6%, 9% and 15%, respectively, while KLCCSS recorded significantly higher growth rates of 68% as the KLCC stapled structure became effective in 2Q13, which resulted in a lower tax structure and MI. QoQ, growth was flat at 0% for SUNREIT and weaker contributions from the hotel segment, while growth for AXREIT and CMMT were minimal at 4%. KLCCS RDI growth was at 11% on the back of higher management service and better retail contributions. (Refer overleaf for details).
Assessment rate hike, another dampener. KL assessment rates are currently 12% for commercial properties of the annual rental value, while the new proposed hike of assessment rates within KL have been said to range of up to 100%-300% depending on the different locations. The three months hearing by DBKL, which will be finalized by March 2014 could mean that the rate hike increase may not be as severe as initially proposed. This creates uncertainties for MREITs with exposures in KL as the potential hike in assessment rates in 1Q14 could present some earnings risks. While most REITs have a clause in their tenancy agreement to account for assessment/quit rent hikes, it is not a ‘set in stone’ policy, i.e. they may not be able to fully pass on the cost increases. We think that REITs may not be able to fully pass on the higher cost, especially under current situation whereby tenants are facing rising costs (e.g. electricity hikes and competition costs) as REITs tend to prioritize higher occupancy over rental reversions. Under our coverage, REITs that will be affected by the KL assessment rate hikes are KLCCSS, which has 100% exposure to KL, CMMT via Sungei Wang (26% of total NPI) and SUNREIT via Sunway Tower and Sunway Putra Place (7% of total NPI).
Rental reversions may be more muted from 1Q14 onwards. Rental reversion momentums for MREITs under our coverage due to: (i) potential increase in assessment rates by DBKL which will limit the tenants ability to pay higher rent as they may have to bear higher costs (more clarity in Mar-2014) which will affect KLCCSS, CMMT and SUNREIT, (ii) slower step-ups for office spaces due to the supply glut in the Klang Valley, which will affect AXREIT, (iii) cost-push effects of subsidy rationalization (e.g. electricity hikes) on tenants' costs, which will affect all MREITs. Coupled with the fact that retailers are facing increasing competition cost and looming GST implementation in Apr-2015, retail MREITs may have to accept weaker rental reversions in FY14 as they tend to prioritize occupancy.
Maintain UNDERWEIGHT on MREITs but with lower TPs. We have widened our valuation yield spreads to the 10-year MGS for MREITs with KL exposure by +0.5ppt from our current assumed yield spreads to take into account the growing earnings risks arising from DBKL’s proposed assessment hikes. AXREIT remains unaffected as the REIT has no exposure in KL. We have also increased our FY14E target 10-year MGS to 4.15% (from 3.9%) in light of increased chances of the US quantitative easing (QE) tapering happening by March/April CY14. As a result, we lower our all TPs by 4%-12% for those under our coverage and our new CALLs/TPs are as followed; KLCCSS (UP; TP: RM5.41), SUNREIT (UP; TP: RM1.19), CMMT (MP; TP: RM1.41), AXREIT (MP; TP: RM3.28). Our call for SUNREIT has been downgraded to UNDERPERFORM as our new TP provides 1% total returns.
Publish date: 02/12/13