September 30, 2016, Friday Ronnie Teo
KUCHING: Analysts laud the Securities Commission’s (SC) consultation paper to revise its guidelines for Malaysian Real Estate Investment Trusts (M-REITs) seen as a positive step in the right direction.
The guidelines aims to enhance M-REITs’ growth by broadening the scope of permitted activities, improve governance to safeguard investors and maintain long-term sustainability, and increase efficiency by streamlining post listing requirements.
The main highlight is Proposal 1 for Property Development Activities, which essentially allows M-REITs to undertake greenfield development subject to the development not exceeding 15 per cent of the REITs enlarged total asset value (TAV) in aggregate, thus capping the exposure to development risk.
“All in, we are positive on Proposal 1,” highlighted researchers with Kenanga Investment Bank Bhd (Kenanga Research).
“Although there is no accretion to earnings in the near term, and is only earnings positive in the longer run, we expect news flow on greenfield development to bode well for share price sentiment and valuations.
“We view Proposal 1 positively as it allows REITs to grow earnings given limited opportunities for accretive acquisitions in the current low cap rate conditions.
Kenanga Research observed that current cap rates for retail assets range between four to six per cent, while the rate was between six to eight per cent for industrial assets.
“M-REITs would be able to own assets at lower capital outlays; essentially, the real return on investment on development cost will be better than buying already completed buildings, which are based on market value with lower asset financing cost.
“Additionally, there is the icing on the cake when the greenfield development is completed, arising from revaluation exercise to reflect market valuation, which will further boost their asset and book value without additional cash-outlay.
“This opens the door of opportunity for M-REITs’ earnings growth in the longer run and will help alleviate the burden of low cap rates plaguing the market currently, but the impact to earnings is expected to be neutral in the near term, and accretive only in the longer run post construction.”
It is also important to note that the new guideline stipulates that the REITs would have to hold the assets for a minimum of two years post development, making it unlikely for the REIT to take on development unnecessarily unless there is a clear demand for it.
“We believe industrial REITs would be the main beneficiary. Although all M-REITs would be able to benefit from Proposal 1 by gaining higher development cost yields, we believe industrial REITs may fare better as development cost for industrial assets may be cheaper than retail, while it would also be easier for industrial MREITs such as Axis REIT to find a pre-committed tenant as it can operate on fewer tenants or a single tenant basis,” it said.
“To note, retail M-REITs require multiple tenants and may not be able to secure a pre-commit during or before construction. As such, retail M-REITs have greater leasing risk, which we believe can be mitigated should the REITs have extensive tenant network to leverage on.”
The firm was all in positive on SC’s list of Proposals, as it expect news flow related primarily to Proposal 1 to 4 to bode well for share price sentiment and valuations, with minimal impact to earnings in the near term.
“Besides Proposal 1, Proposals 2 to 4 are expected to be beneficial to unitholders as it is catered towards facilitating earnings growth by increasing the scope of permitted activities by M-REITs, making it easier for them to secure tenants or minimise vacant space,” it added.
“Proposal 5 on unit buy-backs aims to lend stability to share price and is a form of returning cash to unitholders, while Proposal 6 will help limit balance sheet risks amidst increased exposure to property development.
“Proposals 7 to 10 are catered towards enhancing governance and transparency which we view positively as it will benefit shareholders as it aims to protect shareholders and ensures the sustainability of M-REITs without burdening the managers.
“Additionally, Proposal 11 (revaluation of assets) which is also targeted at enhancing governance, requires the REIT to revalue its assets once every financial year versus once in three years previously, which we view as neutral impact to unitholders.
“Although frequent asset valuations capture the assets current market value which is beneficial for transparency to unitholders, asset revaluations do incur additional costs, while volatile property market conditions may affect capital values of the assets, and may negatively impact the REITs gearing ratio,” it added.
Proposals 12 to 13 are geared towards streamlining post listing requirements allowing MREITs to be on par with other listed corporations, including the process for rights issuance which is currently longer and more arduous for M-REITs.
Other proposals include Proposal 14 (Property Management) will be beneficial to investors and managers as it aligns the interest of the REIT Manager with the property manager.
Proposal 15 (Internal Management) will be beneficial to investors as it forces the existing REIT manager to perform, while failure to do so will allow a ‘Change of the REIT Manager’ (Proposal 9), giving shareholders the option to remove the existing manager and allow the REIT to be managed by hiring executives to internally manage the REIT.
Lastly, Proposal 16 which limits the offer of unlisted REITs to Sophisticated Investors aims to protect investors that do not have privy access to information to invest in an unlisted REIT.