This article first appeared in The Edge Malaysia Weekly on May 15, 2017 - May 21, 2017

THE dividend and sustainability story of Malaysian real estate investment trusts (REITs) has been replaced by one of growth, thanks to investors shifting into risk-on mode amid expectation of improved earnings and global economic recovery.

Some analysts say this represents a good entry point for long-term investors looking for investments with recurring income and limited downside.

“I think any price weakness is a good time to accumulate REITs, whose performance is typically stable with limited downside to earnings compared with other sectors. This is due to their nature — they get tenants to take up space for at least one rental cycle [usually once every three years],” says UOB Kay Hian analyst Abdul Hadi Manaf.

Note that in the first quarter of the year alone, the FBM KLCI and FBM Small Cap Index rose 6% and 16.1% respectively while the 18 REITs listed on Bursa Malaysia saw an average return of only 2.7%. Year to date, the average capital gain in REITs stood at 2.1% compared with an 8.1% increase in the FBM KLCI and almost 20% surge in the Small Cap Index.

What is more obvious is the lower average volume seen for REITs despite an increase in trading activity on Bursa. Their three-month average volume declined about 20.2% from a six-month average of 850,793, highlighting the shift in investor interest. This was in sharp contrast to the 34.7% increase in three-month average volume on Bursa from 2.5 billion shares in the last six months.

According to Abdul Hadi, for REITs that focus on retail space, the rising number of malls, especially in the Klang Valley, poses a threat to rental and occupancy rates. “We know of a new mall that is offering tenants such ‘goodies’ as free promotions and lower service charges after just one rental cycle, which is not a good sign. Normally, after one rental cycle ends, tenants are expected to be able to stand on their own feet and accept a rental step-up,” he says.

He adds that IGB REIT, the owner of Mid Valley Megamall and The Gardens Mall, is one of the REITs listed on Bursa that has solid rental reversion and sales growth. “We believe it has the lowest earnings risk among its peers.”

As for the office segment, Abdul Hadi says he has yet to see any of the REITs covered by him revise downwards their average rental rate in order to compete in the current market. This is despite some financially troubled companies taking up smaller office space after downsizing their workforce.

“Mostly, the tenants are of high quality with long-term contracts. Maybe the worst is when rental reversion remains flat and tenants expect some asset enhancement, such as a toilet or lift upgrade, in return for staying on in the building.

“Nevertheless, some of the office buildings have experienced a downward rental reversion. This is the case for older office buildings with no certification like Grade A, Green Building Index or so forth, and lack access to public amenities,” says Abdul Hadi.

He points out that data from the National Property Information Centre shows that last year, the average occupancy rate of purpose-built offices declined to 76.8% from 81.2% in 2015.

However, despite the lower trading volume and increased competition in the retail and office space, the overall performance of REITs has trended upwards, albeit at a slower pace than that of cyclical sectors.

YTL Hospitality REIT has been one of the top performers so far, gaining 8.6% year to date, followed by MRCB-Quill REIT and IGB REIT, which rose 8.3% and 8.2% respectively. All three have a trailing 12-month dividend yield of 5% and above. The laggards include Pavilion REIT, KIP REIT, KLCCP Stapled Group, Al-Salam REIT, Al-’Aqar Healthcare REIT and CapitaLand Malaysia Mall Trust.

Maybank IB Research analyst Kevin Wong says in a report that MRCB-Quill REIT’s earnings growth in the first quarter of FY2017 was lifted by contribution from Menara Shell and sustained occupancy rate on its portfolio.

Fundsupermart.com senior research analyst Lee Tien Xiang opines that with the shift in investor interest to higher-risk assets, the price of some of the REITs has declined, offering better yields as a long-term investment.

He notes, however, that REIT investors, especially those who have experienced good capital gains in the last two years, need to adjust their expectation of returns from their investment.

For example, Pavilion REIT, which was a top performer with a capital gain of 28.7% last year, has seen the biggest decline so far this year, falling 5.9% to RM1.75 per unit. Meanwhile, KLCCP Stapled Group has lost 3.9% YTD compared with a gain of 23.4% last year.

YTL Hospitality REIT, MRCB-Quill and IGB REIT are among the few that have maintained their performance.

Last year, REITs enjoyed a capital gain of 15.5% but this is unlikely to happen this year, given the defensive nature of the sector and current risk-on environment.

“If you invest in REITs today and expect the same sort of capital gains seen in the last two years, that would be very difficult. With expectations of a global economic recovery and improved sentiments in Malaysia, the cyclical sectors are gaining momentum unlike REITs. While the dividend yield is still there, investors are looking for a growth story, which is why we are seeing diminishing interest in REITs,” Lee explains.

He says it would make good sense for conservative investors with a long-term horizon to look at REITs, as their average dividend yield would help offset the rise in inflation. Real interest rates fell into negative territory in March this year as inflation came in at 5.1%. In comparison, the average dividend yield of REITs was 5.5%.

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