SC’s proposed new guidelines will not impact REITs in the near to medium term

Real estate investment trust sector

Maintain neutral: Last Thursday, the Securities Commission Malaysia (SC) released several proposed enhancements to Malaysia’s guidelines on real estate investment trusts (REITs) seeking public feedback. One of the key proposals tabled is to establish a 15% cap on a REIT’s total asset value for property development, acquisition of vacant land, and property under construction.

Our preliminary discussions with the REIT players under our coverage revealed that most of them are supportive and positive towards this new potential ruling. This is because under the current requirements, REITs that hold outdated properties would have to sell these assets back to their sponsors to be redeveloped before repurchasing them back. Thus, the new ruling could allow the REITs to assume redevelopment of the assets on their own, which gives them the opportunity to enhance earnings and return on equity for their unit holders.

Under our coverage, we believe that Sunway REIT would benefit the most as it would be able to capitalise on the new ruling, should it go through, the swiftest as it can leverage on its sponsor, Sunway Bhd, which has both a property development and a construction arm. Meanwhile, we see a more neutral impact on IGB REIT as we understand that it will purely remain as a retail REIT and will not embark on any redevelopment projects in the medium term.

Currently, REITs are capped to a leverage limit of 50%. Thus, the risks pertaining to this new potential ruling would be that REITs may over-leverage in a bid to chase rapid growth. REITs may also now be exposed to development risk. That said, the REITs under our coverage still have plenty of headroom to manoeuvre given that most are well under the 50% threshold. Additionally, the SC has also proposed to adopt a fixed leverage limit of 50%, without the option for REITs to increase this by way of obtaining approval from unit holders.

Nonetheless, discussions are still in the preliminary stages, and we believe that these proposals would most likely require an extensive period of time to be approved. Thus, this would not impact the sector in the near to medium term. Our top pick of the sector is Axis REIT as we like its ongoing commitment to continuously inject assets into its portfolio, which serves as a rerating catalyst. — CIMB Investment Bank, July 17

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This article first appeared in The Edge Financial Daily, on July 19, 2016. Subscribe to The Edge Financial Daily here.