This article first appeared in The Edge Financial Daily on February 5, 2018

KUALA LUMPUR: Analysts expect Malaysian real estate investment trusts (M-REITs) to stay attractive as a low-risk investment option this year despite the oversupply of retail and office properties.

“We believe that REITs will still register reasonable growth this year based on efforts taken by asset managers, which include asset enhancement initiatives and adding more yield-accretive assets into their portfolios,” said MIDF analyst Ng Bei Shan.

Ng said there is “unwavering appetite” for new assets, with industrial REITs expected to be in the limelight.

“We believe that the appetite for industrial assets will still be healthy as REIT managers continue their quest to hunt for yield-accretive assets, and industrial assets generally provide relatively stable medium- to longer-term income,” she told The Edge Financial Daily.

However, she noted that the growth in industrial-centric REITs may not be specific to increased e-commerce activities alone, as these assets are widely ranged from warehouses to factories.

At the same time, industrial-centric REITs are not entirely immune to the imbalance between supply and demand as felt in the retail and office segments.

“There is a lack of supply [of industrial spaces], and the demand is definitely there. The problem is that it is tough for REITs to get tenants that fit. They might be supplying what the market does not want or need,” said an analyst with an investment bank.

But the mismatch can be resolved if they take on projects in a build-to-suit manner, the analyst said, adding that industrial-centric REITs generally lease to longer-term tenants which occupy 100% of the lettable areas at one time.

An example is Axis REIT, which recently announced its second greenfield project — a RM73.2 million build-to-suit manufacturing facility for its existing tenant Upeca Aerotech Sdn Bhd, to be completed by the end of this year.

Over the past year, risk of an oversupply has become a growing concern for office and retail-centric REITs, which make up the bulk of the asset value among the 18 listed REITs in Malaysia.

Curbing oversupply fears

A recent study by real estate services firm Nawawi Tie Leung Sdn Bhd showed retail properties’ occupancy rate in Kuala Lumpur at its five-year low of 86%. Office occupancy, meanwhile, stood at an average of 78% as at November 2017, Knight Frank Research statistics show.

Analysts concurred, but pointed out that the two different profiles have their own means to weather that risk.

“Yes, there is an oversupply [of retail units],” said another investment bank analyst. “That being said, the retail REIT is a two-tier market whereby those who have malls in strategic locations will be less adversely affected.”

Office-based M-REITs are beneficiaries of long leases too, just as with the industrial-based ones. On Nov 20, Kenanga Research analyst Marie Vaz said in a note that REITs such as KLCC Stapled Group and MCRB-Quill REIT (MQREIT) have leases ranging from five to 15 years, allowing for stable occupancy and rental rates.

Additionally, the recent freeze on new luxury property developments bodes well for REITs, said Vaz, as it helps alleviate downside pressure on reversion rates for malls, and preserve rental rates in office-based REITs in the longer run.

Vaz has an “outperform” call on office-centric MQREIT with a target price of RM1.38, as well as for retail-based IGB REIT and Pavilion REIT at RM1.87 and RM1.84 respectively. All three counters have not performed to date, amid perceived high incoming supply of retail and office spaces previously.

In the bigger picture, Bank Negara Malaysia on Jan 25 raised its overnight policy rate (OPR) by 25 basis points to 3.25%, the first hike it undertook since July 2014. In comparison, the average dividend yield for M-REITs over the trailing 12-month period stood at 5.61%.

One analyst thinks the rate hike’s impact on investors’ appetite towards M-REITs would be less, when compared with macro movements which have higher influence on Malaysian Government Securities (MGS) yields due to MGS’ foreign shareholding. MGS is the typical benchmark to compare returns against the riskier REITs.

“Apart from the trend of the ringgit, unless the [US] Federal Reserve does something unanticipated, it is likely that any interest rate hike would only bring a knee-jerk reaction, though it also depends on the quantum,” the analyst added.

Similarly, Kenanga’s Vaz pointed out that there has not been a strong correlation between the 10-year MGS yields and OPR hikes in the past.

The OPR hike is also inconsequential for M-REITs, Vaz added, as over 70% of their borrowings are on fixed rates, save for Pavilion REIT, MQREIT and Axis REIT. “Even so, impact on earnings is minimal, as a 50 basis points hike will only lower earnings by an insignificant 1% to 2%.”

Stock picks

AmInvestment Bank Research analyst Joshua Ng cautioned investors in a note that while REITs tend to underperform in a rising interest rate environment, the retail-based REITs may be hurt further by the rise of e-commerce.

His top pick is YTL Hospitality with a fair value of RM1.38, as the proxy to the vibrant hospitality industry in Australia — under the Marriott brand name — has over half of its net property income backed by master leases.

Meanwhile, MIDF’s Ng has selected diversified Sunway REIT as its top pick with a target price of RM1.91. It delivered the strongest earnings growth in the third quarter of 2017 among the REITs under coverage, she said.

While Sunway REIT’s retail net property income is on the rise, it also reopened Sunway Pyramid Hotel in the third quarter after refurbishment, while its industrial asset in Shah Alam has started to show earnings, she said.

With the lack of clear catalysts in the REIT sector this year, Ng believes navigating the sometimes murky waters may be easier if investors look further into the quality of assets, rather than stressing asset types.

Bursa Malaysia’s REIT Index — which was launched officially as the 11th Bursa Malaysia-calculated index last October — finished the year at its record high of 1,057.35 points on Dec 29, 2017.

It has been on the downtrend since, closing at 964.93 last Friday, with a combined market capitalisation of RM42 billion.