New MREIT rules to provide more growth
We are mildly positive on these proposals as it allows MREITs more avenues for earnings growth in light of the low cap rate environment which makes it tough for MREITs to acquire assets from third parties, which are distribution per unit (DPU) accretive. Kenanga Research
KUALA LUMPUR: TheSecurities Commission Malaysia’s (SC) new guidelines on listed Malaysian Real Estate Investment Trusts (MREITs) are expected to be mildly positive by providing more growth opportunities.
New guidelines for MREITs were put forth by the SC last Thursday (March 15) with its main amendments being listed REITs are now able to undertake greenfield development and private lease arrangements where REITs may obtain real estate.
The research arm of Kenanga Investment Bank Bhd (Kenanga Research) saw that the main purpose of these new guidelines was to help facilitate growth of listed REITS by providing them with more avenues for earnings growth at cheaper entry levels.
“We are mildly positive on these proposals as it allows MREITs more avenues for earnings growth in light of the low cap rate environment which makes it tough for MREITs to acquire assets from third parties, which are distribution per unit (DPU) accretive.
“However, this proposal might not translate to strong earnings growth in the near term during the construction phase of between two to four years; while earnings and DPU yield accretion in the longer run is also dependent on the structure of the deal such as whether it is an asset NPI yields, a portfolio yields or a funding structure,” explained the research arm.
Additionally, MREITs embarking on greenfield projects mighty face leasing risk as pre-committed tenants may be tough to come by given the oversupply situations in the office and retail segments.
On the flip side, a single tenant model such as industrial ones could work as it would be easier to secure pre-committed tenants before construction.
That being said, the SC also introduced additional steps in their new guidelines to help minimise listed MREITs exposure to construction risk arising from development cost overruns and impact to earnings.
These additional steps are requirements that all greenfield development activities undertaken by listed REITs will require a fixed borrowing limit of 50 per cent of total assets, property development costs and real estate under construction limited to 15 per cent of total asset value (TAV), and a higher threshold for minimum investments in real estate and a recurring income of 75 per cent of TAV – an increase form 50 per cent in the old guidelines.
According to Kenanga Research, these requirements would increase safeguard of recurring income and dividend stability over the longer run.
They are also deemed to be fair considering that MREITs embarking on greenfield development will have higher construction cost.
While the new guidelines are a positive development, they are also unsurprising as the changes have been largely expected by the market due to stipulations made in SC’s Consultation paper back in 2016.
Due to this foresight, the new guidelines are not expected to affect share prices in the nearterm as several listed REITs have already begun Greenfield developments since SC’s consultation paper.
“Since the SC’s Consultation paper, and prior to this new Listed REIT guidelines; AXIS REIT (AXREIT) has embarked on two Greenfield developments, and Sunway REIT (SUNREIT) has one greenfield project, which is the development of the second phase of Sunway Carnival slated for completion by FY21, both upon seeking exemptions from the SC,” Kenanga Research shared.
While the measure will allow MREITS to capitalise on the current weak property market and secure bargain Greenfield opportunities, Kenanga Research guides that the situation may not be as straight forward.
“Although there is no impact to the REIT’s earnings as interest cost is capitalised, but such deals would have cash flow implications, which could affect DPU pay-out capabilities, especially for REITs with already flattish DPU.
“Additionally, MREITs embarking on Greenfield projects may face leasing risk as pre-committed tenants may be tough to come by given the oversupply situations in the office and retail segments.
“On the flip side, a single tenant model such as industrial could work as it would be easier to secure pre-committed tenants before construction,” they explained.
All things considered, Kenanga Research is maintaining their ‘Overweight’ call on the sector as they believe most MREITs’ fundamentals will remain intact in FY18 as they have consistently met expectations in FY17, save for AXREIT, KLCC and PAVREIT in 2Q17.
“Going forward, FY18 is expected to be a stable year with a small portion of leases expiring and unexciting reversions with mid-to-high single-digit reversions for retail MREITs assets under our coverage and low-tomid single-digit reversions for office and industrial assets.”