Saturday, January 11, 2014

MREITs - Lackluster Prospects in 2014 (Kenanga)

MREITs - Lackluster Prospects in 2014

Recently, bond yields rose to a high of 4.1% from 3.1% in mid-2013 driven mainly by the anticipation of the US Federal Reserve QE tapering. The reversal in bond yields has also caused MREITs spreads to expand. MREITs could be facing weaker rental reversions as tenants combat against rising cost issues (e.g. higher assessment rates, electricity hikes, consumer spending to plateau, competition costs) and office space gluts in the Klang Valley. Meanwhile, MREITs have suffered from a subdued acquisition environment which is expected to persist. We make no changes to our MREITs call and TPs since we have recently increased our yield spreads to reflect the aforesaid risks and the effects of bond yield reversals, which have also caused MREITs’ spreads to expand. Maintain UNDERWEIGHT on MREITs.


QE tapering a non-event, or so it seems. On18/12/13 at the US FOMC meeting, the US Fed decided to go ahead with the tapering of its bond purchases from USD85.0b per month to USD75.0b per month. This came as a negative surprise to us as the tapering started slightly earlier than expected. We had anticipated the tapering announcement to occur in March/April 2014 instead of December 2013. Nonetheless, prior the announcement, we had recently raised our 10-year MGS target to 4.15% to reflect the looming risk of QE tapering and had mentioned in our previous report that there is a possibility that the 10-year MGS may expand further to 4.4%-4.5% post QE tapering. However, markets’ reaction was milder than expected which we believe may be due to the US Fed choosing to recommit to low interest rates. We maintain our MGS outlook for now at 4.15%.

Strong rental reversions are unlikely in FY14. Next year’s organic growth ranges at 4.5%-7.0% for the MREITs under our coverage. SUNREIT’s organic growth is on the lower end at 4.5% due to the weaker hospitality and office segment, and lower contribution from SPP due to the accelerated refurbishment plan while AXREIT, CMMT, and KLCCSS have better organic growth rates of 5.6%, 6.5% and 7.0%. However, we believe organic growth via rental reversions and bottomline accretions may come under threat in FY14 for all MREITs under our coverage due to: (i) potential increase in assessment rates by DBKL which MREITs may pass partly or fully to tenants might affect other rental reversion opportunities, (ii) slower step-ups for office spaces due to the supply glut in the Klang Valley (iii) cost push effects of subsidy rationalization (e.g. electricity hikes, which will be borned directly by the tenants (iv) consumer spending expected to plateau in 2014. Coupled with the fact that retailers are facing increasing competition and looming GST implementation in Apr-2015, the REITs may have to accept weaker rental reversions in FY14 to maintain occupancy or ensure tenant’s sustainability.

Expect a quiet year for asset acquisitions due to the low cap rate environment (at present at 5%-6%) for both office/industrial and retail MREITs. This will limit growth prospects and share price performance, which hinges on new asset acquisitions.

Maintain UNDERWEIGHT on MREITs. We make no changes to calls and TPs for MREITs under our coverage since we had increased our yield spreads to reflect the: (i) potential hike in KL assessment rates for retail MREITs, (ii) possible weaker rental reversions as retail tenants are facing rising cost issues, and (iii) the effects of bond yield reversals, which have also caused MREITs spreads to expand. Our TP’s and CALLs are: KLCCSS (UP; TP: RM5.41), SUNREIT (UP; TP: RM1.19), CMMT (MP; TP: RM1.41), AXREIT (OP; TP: RM3.13). AXREIT is an exception as we expect investors to chase for the gains on disposal realized from sale of Axis Plaza.

OTHER POINTS

QE tapering a non-event, or so it seems. On 18/12/13, the US Fed decided to go ahead with the tapering of its bond purchases from USD85.0b per month to USD75.0b per month. This came as a negative surprise to us as the tapering was started slightly earlier than expected. We had anticipated the tapering announcement to occur in March/April 2014 instead of December 2013. WE had recently raised our 10-year MGS target to 4.15% to reflect the looming risk of QE tapering which we anticipated for 1Q14, and we expected the 10-year MGS to expand further to 4.4%-4.5% post QE tapering as we expected markets to react negatively to the news. However, shortly after the tapering announcement, markets seem to have reacted mildly to the news with the 10-year MGS increasing only 4.7bps from 4.062% to 4.11%, while the US T-Bills only increasing slightly from 2.89% to 2.92%. We believe the mild reaction to this news is due to the US Fed recommitting to low interest rates. We will be monitoring bond rates closely and in the meantime, we maintain our MGS outlook for now at 4.15%.

Yield reversals post QE tapering. As a result of the looming suspense of possible QE tapering previously, the 10-year MGS has been on the rise, and as such, so have MREITs yields. This is because MREITs tend to command a premium in terms of yield compared to the 10-year MGS. For KLCCSS, CMMT and SUNREIT, we had previously also widened the valuation yield spreads to the 10-year MGS for MREITs by +0.5ppt to take into account future risk of a potential downward earnings revision due to the increase in assessment rates, as well as, risk of weaker rental reversions as retail tenants are facing rising cost issues (e.g. competition, higher electricity rates). Therefore, we maintain their yield spreads at this juncture.

AXREIT disposal of Axis Plaza. AXREIT has recently announced disposal of Axis Plaza on 26/12/13 for a cash consideration of RM34m, of which management has decided to return net gains on disposal of RM11m to shareholders while the remaining RM23m will be used to pare down borrowings. As such, we have increased FY14 RNI and DPU up by +11% each to RM104.8m and 22.8sen. However, we have also increased AXREIT yield spread by +1.0ppt to +3.15ppt to the 10-year MGS to account for: (i) bond yield reversals and QE tapering have caused MREITs’ spreads to be on the uptrend again, (ii) loss of an income generator from the disposal of Axis Plaza, which accounts for 2% of its RNI on an annualized basis and (iii) increase in AXREITs spread is also to reflect office and industrial MREITs’ inclination to command higher spreads compared to retail REITs as retail REITs have stronger growth prospects due to their shorter term leases and more competitive business nature.

In fact, AXREIT’s spreads to 10-year MGS used to be 4.3ppt when the 10-year MGS was at 4.0% compared to a low of 2.0ppt spreads in CY13. Prior the sell down, AXREIT’s yield spreads were on par with other retail MREITs on the prospects of potential injection of more Johor industrial assets. However, we think the possibilities have faded given the sharp rises in asset valuations down south, which have caused severe yield compressions. As a result of the higher spread, our TP was then lowered slightly to RM3.13 (from RM3.28) despite the higher DPU from the disposal. However, we have since upgraded our call to OUTPERFORM from MARKET PERFORM, since our TP still provides a decent 14.5% total return as of 27/12/13 as FY14E yields look more compelling at 7.8% due to the gains on disposal. We believe investors will chase for the gains on disposal. However, post the payout to shareholders and in the absence of significant acquisitions, we may review our CALL/TP again.

Strong rental reversions are unlikely in FY14. Next year’s organic growth ranges at 4.5%-7.0% for the MREITs under our coverage. SUNREIT’s organic growth is on the lower end at 4.5% due to the weaker hospitality and office segment, and lower contribution from SPP due to the accelerated refurbishment plan while AXREIT, CMMT, and KLCCSS have better organic growth rates of 5.6%, 6.5% and 7.0%. MREITs under our coverage will strive to continue with AEIs which is meant to help preserve or improve future rental rates. However, we take the view that organic growth via rental reversions and bottom line accretions may come under threat in FY14 for all MREITs under our coverage due to: (i) potential increase in assessment rates by DBKL which MREITs may pass partly or fully to tenants might affect other rental reversion opportunities, (ii) slower step-ups for office spaces due to the supply glut in the Klang Valley (iii) cost push effects of subsidy rationalization (e.g. electricity hikes, which will be borne directly by the tenants) (iv) consumer spending expected to plateau in 2014. Coupled with the fact that retailers are facing increasing competition and looming GST implementation in Apr-2015, the REITs may have to accept weaker rental reversions in FY14 to maintain occupancy or ensure tenant’s sustainability.

Assessment rate hikes may not be as severe, but still a threat to retail MREITs. In late November, various articles cited that Dewan Bandaraya Kuala Lumpur would be hiking assessment rates in Kuala Lumpur, which raised objections from various parties on the significant hike. KL assessment rates for commercial and residential properties are currently 12% and 6% of the annual rental value, which is the projected rental income as assessed by DBKL. DBKL’s proposed hike in assessment rates have been said to range from 20%-30% to 100%-300% depending on locations in KL, which have triggered heated objection from residents due to the sharp increase in the valuations of properties. As a result, DBKL has proposed a three months hearing period for objections, which will be finalized by March 2014 suggesting that the rate hike increases may not be as severe as initially proposed. As such, any changes as a result of the hearing will be adjusted accordingly. However, on 20/12/13, DBKL announced that they may reduce the assessment rates to 4% and 10% for residential and commercial properties respectively, from the current 6% and 12%. While it appears to be a minor positive, the overall impact on MREITs remains negative. This is because the estimated rents used to calculate assessment rates are now significantly higher, i.e. net impact will still be higher than 2013 assessment amount. For now, we make no changes to our earnings until further information is available. Currently, assessment/quit rent rates make-up 2%-3% of MREITs Gross Rental Income (GRI). MREITs under our coverage that will be affected by the hike in assessment rates are KLCCSS, which has 100% exposure to KL properties, CMMT, via Sungei Wang (26% of total NPI) and SUNREIT via Sunway Tower and Sunway Putra Place (7% of total NPI).

To pass on costs or not? While there are tenancy clauses to pass on higher assessment cost to tenants, it is not fixed in stone. This means that the landlord or the REIT may partly or fully pass on the cost to tenants, depending on market conditions or the ability of tenants to absorb cost. If the REIT chooses to pass on this cost to tenants, the hike in rental rates will not translate to better returns for the REIT and limits other potential rental reversions opportunities (which would have typically translated to bottom-line accretions for the REITs), particularly as we take the view that consumer spending may weaken in 2014.

Expect a quiet year for asset acquisitions due to the low cap rate environment (at present at 5%-6%) for both office/industrial and retail MREITs. This will limit growth prospects and share price performance, which hinges on new asset acquisitions. Recent events such the potential assessment rate hikes may make it tougher for MREITs to conduct acquisitions as increased valuations would put downward pressure on cap rates. While we do not discount that there may be some acquisitions from the MREITs under our coverage, we think it the likelihood is low. AXREIT previously highlighted that it was eyeing RM380m-RM400m worth of assets in CY13 from its private equity group which it has yet to acquire. Furthermore, it has yet to complete its placement exercise which it was given an extension until April 2014 to allot and issue new units for a placement which is usually used to fund acquisitions. CMMT has also extended the time for the listing approval by six months to April 2014, to issue 20% of its existing fund size, which may be for a potential acquisition. However, with a low cap rate environment, finding yield accretive assets may be tough at this juncture.

Maintain UNDERWEIGHT on MREITs. We maintain our CALLs and TP’s for all MREITs under our coverage since we have recently (Sector Report on 2/12/13) increased our yield spreads to reflect the: (i) potential hike in KL assessment rates, (ii) weaker rental reversions as retail tenants are facing rising cost issues, and (iii) the effects of bond yield reversals, which have also caused MREITs’ spreads to expand. Our TP’s and CALLs are: KLCCSS (UP; TP: RM5.41), SUNREIT (UP; TP: RM1.19), CMMT (MP; TP: RM1.41), AXREIT (OP; TP: RM3.13).


Source/Extract/Excerpts/来源/转贴/摘录: Kenanga-Research,
Publish date:07/01/14

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