As markets turn sour, are REITs the sweeter choice?
By Gho Chee Yuan / The Edge Financial Daily   | October 5, 2015 : 10:58 AM MYT   

This article first appeared in The Edge Financial Daily, on October 5, 2015.

KUALA LUMPUR: The strong global and domestic headwinds that blasted the third quarter of the year and caused equity markets across the world to tumble have left investors jittery, with not much optimism left.

This may prompt investors to look for defensive stocks. One sector that may appear on the investors’ mind is real estate investment trusts (REITs), which have largely been posting resilient earnings and dividend yields that average some 6%, with some as high as 8%.

However, the REIT sector is not without its own problems. Besides the looming issue of weaker consumer sentiment, both office and retail REITs are facing a glut, a headache that may turn this category into earnings laggards going forward, as competition may push them to lower rentals.

Given all the negativity, are REITs still the safe haven they are purported to be?

It appears so as analysts said the majority of retail REITs have locked in their rental for the next three years, while their office peers usually have leases with 10 to 15 years’ tenure. Thus, earnings visibility is sustainable in the near to mid term.

“I think REITs are still relatively resilient compared to other sectors, as their rentals have been locked in for at least three years,” said RHB Research ( Valuation: 1.65, Fundamental: 1.40) analyst Loong Kok Wen.

She said the weaker consumer sentiment has little impact on REITs’ earnings as the income derived from the tenants’ revenue only makes up a small portion of their numbers.

“On that note, the rental income is sustainable and the downside risk is limited,” she said, though she expects slower growth in rental rate this year.

“Previously, the rental rate grew by 4%-5% a year. That could ease to 3%-4%,” she said, noting it will adversely impact mid-sized malls (500,000 to 600,000 sq ft) that are struggling to retain existing tenants and secure new ones.

“The big malls tend to have better bargaining powers, given their prime locations and high shopper traffic,” she told The Edge Financial Daily.

Echoing her thoughts, MIDF Amanah Research’s analyst Alan Lim sees occupancy rates for bigger shopping malls remaining stable.

“The bigger malls like Mid Valley Megamall, Pavilion Kuala Lumpur and Suria KLCC tend to have a long list of potential tenants. Should existing tenants move out, they can easily replace them with new ones as location still plays a major role in tenants’ decision-making,” he added.

According to a report by the National Property Information Centre, the Klang Valley has 230 shopping complexes offering 60.48 million sq ft of retail space as at the first quarter of 2015.

An estimated 60 million sq ft of new retail space is expected to enter the Greater KL market by 2017, while some 40 new malls will open by 2020. The retail space explosion is anticipated to cause a dilution and limit prime rental growth.

But Sunway Pyramid, the prime earnings driver for Sunway REIT ( Valuation: 1.00, Fundamental: 1.00), is unlikely to be affected as the Sunway Lagoon water theme park nearby draws crowds, according to Hong Leong Investment Bank Research analyst Abdul Hadi Manaf.

As for IGB REIT ( Valuation: 1.65, Fundamental: 2.80), Abdul Hadi said its two flagship malls — Mid Valley Megamall and The Gardens Mall — are performing well, with a 15% rental increase compared with its peers amid the poor market condition, as its tenants are making good profits.

Abdul Hadi said Pavilion REIT ( Valuation: 1.00, Fundamental: 2.80) is fairly stable and has very good quality assets, referring to the Pavilion Kuala Lumpur shopping mall and Pavilion Tower.

“They have a long queue of potential tenants wanting to get in. Hence, I do not see any risks for Pavilion REIT to impose rental reversion every year,” he said.

On Sept 18, Pavilion REIT announced that it is acquiring da:men retail mall from Global Oriental Bhd ( Valuation: 2.10, Fundamental: 2.20) for RM488 million cash, which is targeted to be completed early next year.

Abdul Hadi said post-acquisition, Pavilion REIT’s investment properties will jump from RM4.4 billion to RM4.9 billion while its geographical diversification will be extended to Subang Jaya.

“We remain cautious on the acquisition given plenty of mall supply in surrounding area and da:men has yet to commence operation,” he added.

As for the hotel and office sub-sector, its outlook remains challenging, according to an analyst, who declined to be named.

“The economy is slowing down and corporates are cutting down spending, especially expenditure on conferences and conventions.

“Food and beverages are the bread and butter for the hotel sub sector. With fewer conferences and conventions, REITs will face pressure,” he said.

Further, he did not foresee a strong spike in tourist arrivals and spending this year.

“Weaker ringgit may attract tourists here. But Thailand and Indonesia also see their currencies depreciating. Tourists may opt to go there too,” he noted.

Some dividend stocks like Berjaya Sports Toto Bhd (BToto) ( Valuation: 2.10, Fundamental: 1.30) also offer attractive yields, as high as 7%, among the highest, on Bursa Malaysia.

Even though its net profit for the first financial quarter ended July 31, 2015 dipped 7.5% on-year to RM72.5 million due to cooling sentiments, another analyst predicted the numbers forecast operator’s ticket sales will remain resilient, with 3% annual growth.

BToto’s estimated prize payout ratio is also less volatile compared to peers like Magnum Corp Sdn Bhd, given its wider spread of lotto and 4D games, he added.

The stock also appears attractive now as it has dipped to a multi-year low — it fell to RM2.95 on Aug 28 before easing to RM3.07 last Friday — and is trading at 12 times earnings multiple. The analyst has an “outperform” call with an unchanged target price of RM3.72 for the stock.