Cover Story: Weathering the storm with REITs


  • We caution investors to be mindful of the fundamental factors, such as the outlook for the various property sub-sectors, valuation of the units, management quality and track record of the REITs. > Ng

  • I think Asia-Pacific REITs will continue to be an attractive asset class if you look past the near-term volatility moving up to the medium term.
    > Yong

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This article first appeared in The Edge Malaysia Weekly, on November 21 - 27, 2016.

 

The heightened market volatility does not show signs of easing anytime soon. Industry players are recommending real estate investment trusts as they offer stable and consistent returns. 

Donald Trump’s shocking win in the recent US presidential election heightened volatility in financial markets around the world. The uncertainties surrounding the president-elect’s policies, especially his stance on protectionism and free trade, are widely expected to prolong market volatility if they are implemented.

An analyst with a local investment bank says while the current market volatility may be a knee-jerk reaction to the election results, an economic slowdown may take place if the situation persists. This may cause stock prices in general to remain low for a long period of time and turn the spotlight on Malaysian real estate investment trusts (M-REITs). 

In the midst of the turbulence, this asset class is expected to continue providing consistent returns and offer some stability to investors. “When all the other sectors are down, REITs will not go down as much because they are not a high beta sector. When times are bad, people will look at REITs,” says the analyst.

“Local REITs will still offer yields of 5.5% to 6%, which provides stability to investors’ portfolios. It is always a safe-haven sector in volatile times.”  

A case in point, the FBM KLCI tumbled to a three-month low of 1,647.62 points on Nov 9, down 0.97% or 16.2 points from the previous day’s close. But REITs held steady, with the TR/GPR/APREA Composite REIT Index Malaysia only falling 0.19% or 0.59 points to 302.7033.

Unless Bank Negara Malaysia decides to change its monetary policy, Trump’s presidency will not have a direct impact on the M-REIT sector, says another market analyst. “People are perceiving more uncertainty under Trump’s presidency and this uncertainty will lead people to look at REITs. People started turning to REITs after the last overnight policy rate (OPR) cut. So, I believe they already have a strong position in the asset class.” 

An investment analyst that covers M-REITs says an economic slowdown caused by Trump’s policies and plans could prompt Bank Negara to cut the OPR further in an effort to stimulate the local economy. On July 13, the central bank unexpectedly lowered its key interest rate to 3% — its first cut since 2009. The move was in response to the increasing downside risks on the external front amid the low inflationary environment. 

If the OPR is cut to stimulate the local economy, it could help reduce the monthly loan payments to the banks, says Gavin Teoh, advisory and practice director at Standard Financial Adviser Sdn Bhd. This will eventually increase the attractiveness of M-REITs and fixed-income assets, such as bonds, which typically move in an inverse direction to interest rates. 

“But the previous situation of expecting interest rate hikes by the US Federal Reserve did affect the interest rates of other countries, and this has impacted REITs. At the moment, many find it hard to predict Trump’s economic agenda and the Fed’s next monetary policy move,” says Teoh.

Despite the market volatility, the Fed is expected to raise interest rates sometime next year. According to Rabobank Financial Markets Research’s Nov 11 report, prior to the US presidential election, there were concerns that a Trump victory could result in uncertainty and cause the central bank to delay its planned rate hike in December. 

However, this concern has clearly evaporated despite the heightened volatility, says Rabobank. “Markets around the world have rallied. Furthermore, the recent US jobless claims came in better than expected, so the labour market is still going strong. This makes Trump — or, better, potential market volatility in the wake of his election — the only factor that could prevent a Fed hike in December,” says the report.  

“It appears that the focus has shifted from December 2016 to 2017 as the market’s implied pace of the Fed’s tightening cycle has increased on the back of higher inflation expectations,” it adds. 

Independent financial planner K Gunasegaran, who is also founder and managing director of Wealth Street Sdn Bhd, says investors who are looking to preserve their wealth in the face of uncertainty and volatility in the equity markets should look at increasing their allocation to REITs. “If they are holding, say, 10% to 15% of their portfolio in the asset class, then they should increase it to about 30% as REITs give consistent payouts and are a good defensive asset class in volatile times. REITs are something investors should look at to mitigate risks when there is a financial storm,” he adds. 

Aw Choon Hui, deputy CEO of GYC Financial Advisory Pte Ltd in Singapore, has been a strong proponent of REITs. The company collaborated with Henderson Global Investors to launch a fund of global REITs in 2013 and also keep a REIT and infrastructure allocation in their clients’ portfolios. 

“In our portfolio construction, we always include some component of listed properties, whether in the form of listed REITs or infrastructure assets. It helps to diversify and bring down the overall risk of a typical equity and fixed-income portfolio,” says Aw. 

“Global REITs provide fairly decent long run 3% to 4% yields, with slow and steady capital gains. The good REITs are yield accretive and can definitely benefit investors’ portfolios when held for the long term. Although some investors dislike the equity behaviour and market noise that REITs are subject to (being listed securities), in the long run, they are still subject to the supply and demand vagaries of the property market, economic and interest rate cycles just like hard property assets.” 

 

Local REITs

M-REITs have outperformed the FBM KLCI substantially over the last five years. From January 2012 to Oct 31 this year, they have given an average total return of 50.6% and an average dividend yield of 6.4%, according to Bloomberg. By comparison, the FBM KLCI’s dividend yield as at Nov 15 was only 3.13%.

Analysts attribute the good performance of local REITs in the last 12 months to recent and ongoing events, such as the OPR cut by Bank Negara, fallout from the Brexit referendum in the UK, global low-yield environment and uncertainties in the global economy. 

Malaysian REIT Managers Association (MRMA) chairman Datuk Jeffrey Ng says M-REITs have gained substantial traction among local investors over the last decade as a large portion of the free floats in local REITs are invested by domestic retail and institutional investors. “Typically, foreign unit holdings of M-REITs do not make up more than 20% of the units in circulation. Therefore, at least 80% of the units are held by Malaysian investors (including the sponsors).” 

He adds that M-REITs are highly sought after by long-term sovereign wealth funds and insurance funds that view the asset class as a yield-generating investment. 

Following an appreciation in unit prices over the last several months, the distribution yield between M-REITs and the 10-year Malaysian Government Securities (MGS) has compressed to 239 basis points (bps) as at Oct 31. Despite the narrower yield spread, Ng says there is still a yield uplift for REITs compared with the 10-year MGS and fixed deposit (FD) rates.

M-REITs were introduced in 2005 and Axis REIT was the first in the sector to be listed on Bursa Malaysia. At the time, the market capitalisation of the REITs was only RM356 million. Today, with 17 listed REITs, their market capitalisation stands at RM43 billion (as at Oct 31). 

There is a wide range of M-REITs available, from conventional and Islamic trusts to specialised and diversified ones. Specialised REITs focus on income-generating assets in specific sub-sectors such as retail malls, offices, industrial properties and hospitality venues while diversified REITs own a diverse portfolio of income-generating assets across several property sub-sectors.

REITs that specialise in offices include MRCB-Quill REIT and Tower REIT. IGB REIT specialises in retail properties, Al-‘Aqar Healthcare REIT specialises in healthcare facilities and YTL Hospitality REIT specialises in hospitality venues. Sunway REIT, CapitaLand Malaysia Mall REIT and AmanahRaya REIT are diversified REITs that focus on either retail, office or industrial properties. 

Ng says there is room for the sector to grow further and play a more prominent role in the capital market. “Compared with our neighbour, Singapore, the 39 REITs there have a total market capitalisation of S$66 billion — four times that of M-REITs.”

The financial fundamentals of M-REITs are expected to improve, he adds, be it at a slower pace as rental reversions are expected to grow at a slower pace in the current landscape. Additionally, the property market oversupply situation and macro-economic uncertainties are expected to further dampen the REITs’ operating environment. 

“Based on the prevailing unit prices of M-REITs at compressed distribution yields, we are of the view that market prices have rallied ahead of the REITs’ fundamentals, supported by the favourable low interest rate regime and uncertainties in the equity market. However, we caution investors to be mindful of the fundamental factors, such as the outlook for the various property sub-sectors, valuation of the units, management quality and track record of the REITs,” says Ng. 

Despite a potential OPR cut creating good opportunities for investors, there are challenges facing M-REITs. For one, they are facing a long-term threat of oversupply of office spaces, says Hong Leong Investment Bank analyst Lee Meng Horng. 

“Some of the office properties are not doing well in terms of occupancy rates. There are a lot of leases for big projects coming up, such as the Bukit Bintang City Centre (BBCC), Tun Razak Exchange’s (TRX) Bandar Malaysia and Sunway Velocity,” he says. 

“The office sector will certainly be less favourable in the coming years. While the retail sector is still relatively stable, I think the industrial sector will be the one people will be moving into due to the Securities Commission Malaysia’s liberalisation. The sector will be the top beneficiary and we do not see a supply and demand mismatch in terms of industrial space.” 

According to Maybank Investment Bank’s Aug 9 research report, among the M-REITs with significant office vacancies at the moment are Sunway REIT and Axis REIT. The Sunway Tower and Sunway Putra Tower, whose occupancy rates at end-March stood at 19% and 27% respectively, are still looking for tenants. Other notable assets with occupancy rates below 80% are Infinite Centre, Axis Business Park, Axis Vista and Axis Eureka. 

In the longer term, e-commerce may pose a strong threat to the retail sector, says Lee. “We cannot discount the threat to retail malls. It may take a long time, but the possibility is evident as seen in China’s retail space. It is not impossible that the same thing could happen in Malaysia.” 

He adds that M-REITs are also seeing a slower rental reversion than a few years ago, which may be attributed to slower consumer spending post-GST implementation. “However, we have seen a slight pickup in the past one or two quarters on consumer spending and sentiment.” 

While retail REITs have been traditionally viewed as a safe haven, Lee says this is only for prime malls at great locations, near full occupancy rate and highly rated leases, such as IGB REIT’s Mid Valley Megamall.

MIDF Research analyst Jessica Low concurs, saying that retail REITs with solid assets in prime locations can be viewed as safe-haven investments. Besides IGB REIT’s Mid Valley Megamall and The Gardens Mall, other malls that meet the criteria are KLCCP Stapled Group’s Suria KLCC, Pavilion REIT’s Pavilion Kuala Lumpur and Sunway REIT’s Sunway Pyramid. 

“The performance of the mentioned assets is expected to stay firm going forward due to the high footfall and occupancy rates. Thus, the rental reversions for the malls are expected to be remain in positive territory,” says Lee. 

What should investors look for when choosing an M-REIT? Lee says the most important thing to look at is its sustainability. 

“We value REITs based on yield and when we look at the yield, we look at sustainability — whether the dividend will be sustainable over the next two years. We are not so concerned about organic or inorganic growth. Growth is something extra. It must be sustainable first,” he adds, citing MRCB-Quill REIT, Pavilion REIT and KLCC REIT as the top picks. 

Low says investors should pick REITs based on the quality of the assets (rental growth and location), the extent of their exposure in the retail and office sectors and their yield. Currently, MIDF Research’s top pick is Sunway REIT as the performance of its flagship Sunway Pyramid is expected to remain stable going forward while its office division should see a recovery from a low base. 

 

Opportunity in Asia-Pacific

Wealth Street’s Gunasegaran says investors could look at Asia-Pacific REITs as they provide more consistency and better prospects. “Singapore REITs, for example, give better returns of about 6% to 9% and offer better consistency than M-REITs. That is why most of the Singapore retirees put a big chunk of their portfolio into REITs.”

In Malaysia, there are a few REIT funds that focus on Asia-Pacific, such as the RHB Asian Real Estate Fund, Manulife Investment Asia-Pacific REIT fund and AmAsia Pacific REITs Plus, which mostly invest in real estate securities and listed REITs in the region. 

AmFund Management Bhd’s (AmInvest) AmAsia Pacific REITs – MYR Class fund invests in listed REITs in Asia-Pacific, including Australia, Hong Kong, Japan, Malaysia, New Zealand, Singapore, South Korea, Taiwan and Thailand. It also diversifies its investments into REITs that focus on different sub-sectors such as residential, commercial and industrial properties. AmInvest’s equities fund manager Selina Yong says REITs in the region will continue to be an attractive asset class, especially for investors looking for good dividend yields. 

“If you look at the yield spreads [between REITs and 10-year MGS] across the region, Australia has been stable at 270bps, Singapore is at 460bps and Japan is at 340bps [prior to the US presidential election]. This means you still get a decent spread over the risk in those countries,” she says. 

“If investors are looking to benefit from the yield spreads, then increasing their allocation is something that could be considered. I think Asia-Pacific REITs will continue to be an attractive asset class if you look past the near-term volatility moving up to the medium term.” 

Yong says although equity markets are very unpredictable, AmInvest tries to look for growth in certain countries and certain property segments that outstrip inflation. This allows REIT managers to gain a profit over the operational cost. 

“The portfolio running yield currently ranges from 4.5% to 5%, and that changes slightly depending on market movements and cash levels. But it is lower than what it used to be at the fund inception, which was about 6%,” she says. 

AmInvest diversifies into REITs with assets such as childcare, energy, healthcare, large-scale logistics and data centres. The fund had a return of 18.44% over one year, 46.09% over three years and 99.95% over five years as at Sept 30. It is a leader in the Lipper Table’s Equity Sector Real Estate Asia-Pacific non-Islamic category.

AmInvest’s main markets are Australia, Japan and Singapore as they are the largest and most liquid REIT markets in Asia. In Australia, the fund focuses on the childcare segment, which has seen rising demand recently because the Australian government provides families with young children a subsidy, among others. 

“The thing about childcare centres is that they are a very fragmented asset class. Transactions may not be as liquid as office, retail and industrial properties, but that is where we see opportunities for growth,” says Yong. 

“We only have a couple of large institutional landlords, who have built up a scalable platform. And because they have balance sheet strength, they are able to grow the portfolios meaningfully, either through acquisitions or redevelopment of the sites.” 

While the segment has put off other institutional investors due to the barriers to entry and stringent regulations, it has not deterred AmInvest. “Institutional investors need to spend time on good working relationships with not only the childcare centre operators but also the local council. There is a lot more granularity in working these portfolios compared with an office portfolio,” says Yong. 

AmInvest’s fund also has prime office holdings in Sydney and Melbourne. The offices are attractive because there is less new supply coming into the market and the occupancy rate stands at 96% (from 95% two years ago). 

In Japan, AmInvest is focusing on offices in five wards in Tokyo, which also lacks new supply. Yong says the vacancy rate was only about 3.7% at end-September, compared with 3.9% the previous month. There was a slight decline in rental spaces, which caused redevelopment to take off. As a result, rental rates have increased 4.2% year on year. 

In Singapore, however, the economy is lacklustre, says Yong. “That is a function of its exposure to the global economy, which has inherently affected the demand for office, retail and industrial properties. It is unavoidable. The best that landlords can do is navigate the headwinds the best that they can.” 

Despite this, AmInvest does have a penchant for Singapore-listed REITs that have assets abroad. “The assets could be in India, Australia, China, Japan or even the US. These REITs offer high yields as well as better growth prospects as opposed to those whose assets are purely located in Singapore,” says Yong.

Singaporean data centres are an emerging sub-sector that AmInvest is looking into. Yong says the city state is an attractive location for data centres because it is in a natural disaster-free location, has a well-established network infrastructure and clear legal framework. The intensification of internet use is expected to create greater demand for these centres.

While volatility is anticipated to rise in the near term, AmInvest views the situation positively as it creates opportunities for the fund house to generate returns from its existing positions at far better valuations than three to six months ago or to establish a new position. 

 

 

Proposed guidelines

 

Malaysian REITs stand to offer stable and sustainable returns in the longer term because of the recently proposed liberalisation by the Securities Commission Malaysia (SC). On July 14, the SC released a consultation paper seeking public feedback on the proposed enhancements to the Guidelines on Real Estate Investment Trusts (REIT Guidelines), first introduced in 2005. 

Among its proposals, the new guidelines will allow REITs to acquire vacant land in addition to acquiring up to 15% of the total asset value of greenfield developments. This will give REITs more room to develop their own property instead of acquiring more expensive, readily yield-accretive assets.

“The SC’s liberalisation will give REITs more opportunity to acquire yield-accretive assets. Asset prices have been really high, so it has been very tough for REITs to acquire assets that are accretive to their portfolio. Therefore, if they are able to develop greenfield projects, the yield will be generally higher and more stable,” says a market analyst.

“However, it is subject to the construction cost, how the acquisition will be financed and a multitude of other factors. But it should be accretive in the longer term. If you invest in a REIT that is looking to acquire greenfield assets, then you should give yourself a two to three-year time horizon for it to be distribution per unit accretive.”

 

 

Asia-Pacific’s first REIT ETF

 

Singapore recently launched its first real estate investment trust (REIT) exchange-traded fund (ETF) — the Phillip SGX APAC Dividend Leaders REIT ETF — issued by Phillip Capital Management Ltd. Touted as the first of its kind in the region, the REIT ETF tracks the SGX APAC ex Japan Dividend Leaders REIT Index, which comprises 30 REITs across Asia-Pacific ex Japan, ranked according to the total dividends paid out in the preceding 12 months (REITs that paid out the most in dividends have the highest weighting).

The index represents over 70% of the region’s REITs by total market capitalisation, taking into consideration their size, free-float market capitalisation and liquidity. Its total return over the 12 months ended July 29 was 19.97%, or a yield of 4.53%. The REIT ETF provides investors with transparent and low-cost access to a diverse portfolio of quality REITs, which offer sustainable dividend income.

Linus Lim, director and co-chief investment officer at Phillip Capital, says it is the right time to introduce the ETF to the market. “There is also strong investor demand, whether from institutions looking for dependable income or individual investors, in our exploratory conversations prior to starting this. On top of that, the Singapore Exchange has been slowly growing its presence for REITs in Asia. So, I think it is an opportune time to build an ETF out of REITs,” he says. 

He adds that the global ETF industry has grown possibly 10 times in the last six to seven years in terms of passive fund management. “I think there will be a similar growth pattern in Asia. Maybe not as fast, but it will grow steadily over time as people get more familiar with the concept of ETFs.”

As ETFs are still a new space in Singapore and Malaysia, Lim says efforts have to be made to educate retail investors on this asset class. “The first group of retail investors may not grasp much of the concept as there are not many ETFs in these two markets, except for those that are cross-listing from offshore fund managers. 

“It does not help that sophisticated investors who are investing on Wall Street have a tendency to compare the ETFs there with our homegrown ones. They are not the same. Therefore, we need to educate, or at least help to educate, retail investors.” 

In terms of returns, Lim is confident that the REIT ETF’s dividend-weighted strategy will enhance risk-adjusted returns above the traditional market capitalisation-weighted strategies. The ETF also aims to provide more diversification for investors in the REIT sector, he says. 

“Each REIT has a specific focus, such as industrial, retail or residential properties. Any risks will come from the individual sectors themselves,” says Lim.

“The REIT ETF is diversified across various sectors as the methodology picks quality REITs from the Asia-Pacific universe. Therefore, the end product encompasses REITs that hold high quality properties, have a large market cap, are liquid in the market and are able to pay out sustainable income compared with the rest of their peers.” 

For the Phillip SGX APAC Dividend Leaders REIT ETF, there is a 0.5% management fee as well as index licensing, trustee and auditor fees, among others. The total expense ratio of the ETF is capped at 0.65% of assets under management. 

Lim says although some people say Phillip Capital should be charging less, it actually compares favourably with the smart beta ETFs, which is what its REIT ETF is. “It is not a simple synthetic replication, but a physical replication. And we are using a different methodology, so we have to set up our own index. 

“Not all ETFs are the same. You cannot compare it with the US ETFs as it has a much larger scale, which allows it to charge lower fees. If we compare ourselves with similar niche type of strategies — those that focus on Asia or on a particular sector — then, our fees compare fairly with that space.”

 

 

Islamic M-REITs

 

Of the 17 listed REITs in Malaysia, only four are Islamic or invest in shariah-compliant real estate and other assets — Al-‘Aqar Healthcare REIT, KLCC Real Estate Investment Trust, Axis Real Estate Investment Trust and Al-Salam Investment Trust. 

Malaysian REIT Managers Association (MRMA) chairman Datuk Jeffrey Ng says while there is growing demand for Islamic M-REITs, there are some practical challenges in the formation and management of these REITs in the country. 

“Currently, Islamic REITs are allowed, at the point of establishment, to acquire real estate with tenants that carry out non-shariah-compliant activities, provided that the percentage of total rent is less than 20% of the Islamic REIT’s total turnover. However, the current requirement does not allow these REITs to accept new tenants or renew existing tenants whose activities are totally non-shariah-compliant. This will hinder the operations and the growth of the Islamic REITs,” he says. 

To encourage more Islamic REITs in the country, the Securities Commission Malaysia is proposing a five-year time frame to reduce the non-shariah-compliant income to 5%, under its proposed guidelines. While the move is welcomed by MRMA, Ng says it hopes the SC will consider extending the period to 10 years to give Islamic REITs more time to manage their tenancy mix. 

The world’s largest shariah-compliant REIT is the UAE-based Emirates REIT. It is the first regulated shariah-compliant REIT listed on Nasdaq Dubai. 

The company recently announced that an 18.3% valuation gain on the construction of its Jebel Ali School in Damac’s Akoya development helped to increase its total assets to US$773.1 million as at end-September, effectively overtaking Singapore’s Sabana Shari’ah Compliant Industrial REIT, at US$762 million.