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clock 12-09-2017
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Fears of Oversupply Limiting Appetite for REITs

Fears of oversupply in the commercial property market and sluggish retail sales are limiting investors' appetite for Malaysian real estate investment trusts (REITs), according to UOBKayHian Research.

The firm, in a report yesterday, kept its "market weight” rating on the sector, citing lack of near-term catalyst.

This is despite improved financial performance in the second quarter ended June 30 by the majority of REITs under its coverage.

"We still believe that the oversupply of office malls and retail space is far from over" it said. "However, we think that the niche office building and prime retail mall segments will remain resilient in the long term.”

For exposure to retail REITs, the firm advised its clients to buy IGB REIT with a target price of RM1.86.

"We believe it has the lowest earnings risk (due to solid rental reversion and highest retail sales) and an implied dividend yield of 5.2%" it said.

Meanwhile, the firm downgraded its call on MRCB-Quill REIT from a "buy” to a "hold”, following the REIT's recent price surge.

"We still like the company for its built-to-suit strategy which allows it to lock in tenants for a longer period and shields it from the office oversupply issue" it said.

After the series of acquisitions by its sponsor (Platinum Sentral and Menara Shell from MRCB), the next acquisition could be Menara Celcom in PJ Sentral which is slated for completion by end of this year.

"Hence we expect the acquisition exercise will take place in 2018 and earnings contribution will only kick-in in 2019" UOBKayHian said.

While the acquisition will result in improved earnings per unit for MRCB-Quill REIT, the firm expects its dividend per unit to remain flat in the near term due to the enlarged share base from a placement and/or share swap exercise to fund the acquisition.

The REIT sector reported "decent” core earnings growth during the second quarter ended June 30, UOBKayHian said.

"Apart from CapitaLand Malaysia Mall Trust (CMMT) and Pavilion REIT, all REITs under our coverage reported year-on-year growth in core net profit (excluding fair value gains) which averaged 7.4%" it said.

MRCB-Quill REIT posted the highest growth rate of 43.3% – thanks to maiden contribution from the newly-acquired Menara Shell.

In contrast, Pavilion REIT recorded a huge decline in net profit of 8.7% as earnings during the quarter were impacted by lower occupancy arising from a major tenant relocation exercise from Pavilion Mall to the Pavilion Elite extension.

UOBKayHian also noted that there were more acquisition exercises during the quarter, with the most notable one being from Pavilion REIT.

Pavilion REIT is proposing to buy the newly completed Pavilion Extension – a 10-storey mall located next to Pavilion Mall, together with extension connection and subway linkage – for RM580mil.

"Assuming the acquisition is completed by end-2017, we estimate Pavilion REIT's bottom line could improve by 15% in 2018.

"This is premised on the assumption that 241,929 sq ft of net lettable area at Pavilion Extension will be rented out at an average rate of RM18 per sq ft" UOBKayHian reckoned.

The house also assumed a 4.6% interest cost for the borrowing that Pavilion REIT will need to undertake. "We also estimated that 2018 earnings per unit will rise by 9%, while distribution per unit could grow by 7% post-completion of the acquisition" it added.

On the broader market, subdued retail sales in the mass market has led to flat rental reversion at mass retail malls.

"However, we gathered that prime retail malls, which cater to the niche market segment, were still doing well in the quarter, with tenant retail sales and rental reversion both growing in the mid-single-digits" it said.

It expects the performance of prime retail malls such as Suria KLCC and Pavilion Mall to recover by the end of the year, leading to better earnings visibility for KLCC Property Holdings Bhd Stapled Group and Pavilion REIT.



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