This article first appeared in Capital, The Edge Malaysia Weekly on February 13, 2023 - February 19, 2023

IN the past two decades, real estate investment trusts (REITs) have emerged as a popular and efficient way for investors to invest in quality large-scale commercial properties by paying only a fraction of their real estate prices. Besides affordability and liquidity, a stable income stream and attractive distribution yields are among the benefits of investing in listed REITs. But as central banks around the world keep hiking rates to tame intense inflationary pressures, can REITs still perform and be a good hedge against inflation?

It is a common assertion that REITs are likely to underperform when interest rates rise, but is that a misconception? Theoretically, higher interest rates would affect real estate values, and hence the performance of REITs. However, they do not necessarily lead to poor returns.

According to market experts whom The Edge spoke to, the rise or fall of interest rates does not directly dictate a REIT’s performance. Instead, it is more important to address the underlying factors that drive rates higher. Simply put, if higher interest rates are driven by stronger economic activities, REITs with good fundamentals will likely be able to overcome any negative impact caused by rising rates.

In January, Christine Lagarde, president of the European Central Bank, remarked that the reopening of China’s economy would likely add to global inflationary pressures with the ramping up of commodity consumption.

The US Federal Reserve policy, meanwhile, has been hawkish since last year, leading to market concerns over a possible recession.

Would China’s reopening boost global economic growth? Or would it lead to even higher borrowing costs and inflation, which would result in lower disposable incomes?

Malaysian REIT Managers Association chairman Datuk Philip Ho Yew Hong believes the retail sector should continue to see an improvement in 2023, although business and consumer confidence is expected to moderate on inflationary pressures, rising interest rates and an anticipated slowdown in the global economy.

“The high inflation in 2022 was essentially caused by cost-push factors arising from supply chain disruptions due to China’s closed borders and geopolitical events in Europe,” he says.

Ho, who is also the CEO of Pavilion REIT Management Sdn Bhd, opines that the reopening of China’s borders is expected to stimulate more economic activities, whether consumer spending, or business or investment activities. With an anticipated slowdown in developed economies such as the US, strong growth in China is crucial to cushion any global recession.

“We believe the reopening of China’s borders will be a positive catalyst for the REIT industry. The impact of higher interest costs will be mitigated by higher income contribution on the back of an expected improvement in business performance,” he says.

Axis REIT Managers Bhd CEO Leong Kit May acknowledges that many are cognisant that China’s re-opening is a double-edged sword. But given that the country just reopened its borders in early January, she thinks it is premature to say whether the reopening itself will lead to a substantial increase in inflation and interest rates.

“We are not too concerned about the macroeconomic environment as businesses are constantly faced with different economic headwinds over time. On our part, we will just endeavour to optimise our portfolio’s performance while offsetting ill impacts caused by economic headwinds through our prudent capital management,” she says.

Al-’Aqar Healthcare REIT and Al-Salm REIT CEO Raja Nazirin Shah Raja Mohamad insists that not only will the reopening of China not pose a threat to Malaysia or other nations, but it could also serve as a catalyst for the market to grow, ensuring that fund managers will continue to invest in the Asian market. “When the US is having problems with its economy, Asia will provide support for growth. It is expected that M-REITs (Malaysian REITs) with significant asset profiles located in the Asian region will continue to be favoured by fund managers as they provide stable and sustainable returns,” he says.

Both Al-’Aqar Healthcare REIT and Al-Salm REIT are managed by Damansara REIT Managers Sdn Bhd (a wholly-owned unit of Johor Corp) and supported by KPJ Healthcare Bhd.

KIP REIT managing director Datuk Eric Ong Kook Liong concurs that China’s decision to reopen its borders is a significant positive boost, at a time when domestic economic activities are projected to slow down amid rising recessionary fears globally.

“The reopening of the world’s second-largest economy would help to sustain Malaysia’s post-pandemic recovery, particularly on the tourism and FDI (foreign direct investment) front, which remains robust, and should provide positive long-term trade prospects for Malaysia,” he says.

Nevertheless, Ong is of the view that it would be prudent for the Chinese government to ensure a gradual reopening of the country’s economy to the world, whether by sector or province.

“This would allow careful observation of its impact on the world. We are closely monitoring the developments as any negative macroeconomic issues are likely to have a knock-on effect on the rest of the world,” he says.

Ong adds that the increase in bilateral trade relations is likely to bode well for Malaysia’s economy and lead to higher disposable income among families, thus benefiting M-REITs, in particular the hospitality and retail sectors.

Johari Shukri Jamil, the CEO of Hektar REIT — which owns community-focused shopping centres such as Subang Parade in Subang, Selangor, and Mahkota Parade in Melaka — remains cautiously optimistic about the retail outlook for 2023, given that inflationary pressures and cost-of-living issues continue to weigh on the economy. Moreover, there is concern that the government may not be able to provide further cash handouts and wage subsidies to further boost consumer spending due to tight fiscal constraints and the rising interest rate environment.

“Nonetheless, we feel that the consumer sector is expected to remain resilient due to subsidised fuel and electricity costs, low unemployment rate and access to consumer credit,” he says.

So, what should investors do in the M-REIT space? Should they include REITs in their equity portfolios this year? More importantly, are distribution yields being offered by the M-REITs attractive enough compared to banks’ interest rates and Malaysian government securities (MGS) yields now?

Ng Zhu Hann, founding CEO of boutique fund management house Tradeview Capital Sdn Bhd, highlights that in a low interest rate environment, REITs are usually quite attractive to investors. But when interest rates are rising, investors have more options for returns, including bonds, fixed deposits or government securities.

“Logically, it (a higher interest rate) would be less favourable for REITs. But as the unit prices of some REITs are coming off multi-year lows, any recovery at the macro level, including China, would be a boost to the sentiments of the sector,” he says.

While he acknowledges that there may be a sudden surge in demand and that the supply side will need time to cope with China’s complete reopening, Ng says demand will normalise after the initial surge and help create a spillover effect to countries regionally and businesses all around the world.

Those with the spare capacity and ability to cope with the reopening demand will benefit in the short term.

“Whatever inflationary pressure (there is) would likely be only temporary rather than structural. We have seen this globally and now we are witnessing inflation pressure tapering as well,” he says.

Further, during a time of volatility and uncertainty, with a lack of safer investment options, REITs can be a defensive investment asset class, especially when other segments like growth stocks are losing their allure.

In short, Ng believes China’s reopening has a stronger positive pull on REITs. And the right REIT in the right sector would make a good choice for investors seeking a balanced, diversified investment portfolio, he says.

“Some of the names we have owned and whose long-term prospects we continue to believe in include Atrium REIT and AME Elite REIT. Both are in the industrial space with bright prospects and stable track records of operating successful industrial parks and assets,” he points out.

Compared to fixed-deposit rates, which are around 4%, and MGS yields which are around 4.5%, M-REITs on average provided a distribution yield of 6.41% in 2022.

“Similarly, Singapore REITs, on average, also delivered 6.17% in the same period. This shows there are indeed some levels of stability and return for M-REITs,” says Ng, adding that a REIT should be viewed as a type of investment asset class rather than just a listed company. That’s because the function of a REIT is different from an ordinary listed company.

“The purpose and intent behind investing in REITs are different. People invest in REITs for stability and yield rather than for capital gain. There is little excitement there,” Ng points out.

“REITs are entities that hold and invest in recurring income-generating assets within a specific space. They are also required to distribute 90% of their net income (after deducting relevant expenses). You can think of REITs as akin to a professional property investment manager who invests, maintains and collects rent on your behalf. So, you should invest in REITs only if you are clear about the functions of a REIT and your investment goals,” he adds.

Maybank Investment Bank equity analyst Nur Farah Syifaa’ Mohamad Fu’ad expects earnings for M-REITs to normalise in FY2023 mainly from increased footfall at shopping malls and improved tourism activities. She remains selectively positive on REITs with industrial properties and prime malls where earnings will be supported by resilient rental income and sustained occupancy rates.

“We have a ‘buy’ call on Axis REIT, YTL REIT and Pavilion REIT. We are cautious on neighbourhood malls and multi-tenanted offices in the Klang Valley, which would be at higher risk of being negatively impacted by the oversupply of retail and office space,” says Nur Farah Syifaa’.

Meanwhile, she says, the impact of high interest rates will be more visible this year as compared to FY2022, as most M-REITs under Maybank IB’s coverage are still mainly funded by floating rate loans.

“The sector currently offers decent net distribution per unit (DPU) yields of 5.2% to 8.1% in calendar year 2023, primarily led by YTL REIT at 8.1%,” Nur Farah Syifaa’ observes.

REIT industry observer and author Chia Wan Chow notes that given how the unit prices of REITs have risen, their distribution yields may have dropped.

“Although the yields are not fantastic, I still think they are rather decent for investors with a low risk appetite. REITs are defensive in nature, and their yields are usually better than the banks’ interest rates,” he says.

Chia, who has written a book on investing in REITs, highlights that certain REITs with good quality assets are still trading below the pre-pandemic levels, although their yields have revisited the pre-Covid levels.

“If you are a high-net-worth individual, I think MGS could be a good option. Otherwise, M-REITs would be a better option. After all, you just need to put in a few hundred ringgit to invest in a property while collecting rent income,” Chia adds.

Read also:
Are the stars finally aligned for Tiong Nam’s warehouse REIT spin-off?
REITs capitalising on the great reopening of China

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