Office and retail space oversupply 'far from over' — UOB Kay Hian

KUALA LUMPUR (Sept 6): The oversupply of office and retail space in Malaysia is “far from over”, according to UOB Kay Hian Securities (M) Sdn Bhd.

The latest remark by the bank-backed investment firm came as it maintained a “market weight” stance on the country’s real estate investment trust (REIT) landscape, “given the lack of compelling catalysts in the near term”.

“However, we think that the niche office building and prime retail mall segments will remain resilient in the long term,” UOB Kay Hian analyst Abdul Hadi Manaf wrote in a note to clients today.

At the same time, Abdul Hadi observed that the country’s retail sales in the mass market segment is “still soft” and “remained subdued” in the second quarter of this year (2Q17), leading to flat rental reversion at mass retail malls.

UOB Kay Hian’s observation on soft and subdued retail sales was parallel with the latest view by Retail Group Malaysia (RGM), a consulting firm specialising in retail research and shopping centre consultancy services.

Yesterday, RGM had, in its latest Malaysia Retail Industry Report (August 2017), lowered the country’s retail sales growth forecast to 3.7% in 2017, from 3.9% previously, following muted projections from retailers amid expectation of increase in the price of retail goods.

It was the second downward revision for the year by RGM. Retail sales were initially projected to grow by as much as 5% this year.

As for prime retail malls which is catering to the niche market segment, Abdul Hadi said “they were still doing well in 2Q17, with tenant retail sales and rental reversion both growing in the mid-single-digits.”

However, “temporary hiccups” persist at Pavilion in Bukit Bintang and Suria KLCC, which “continued to see year-on-year” declines in 2Q17, due to major tenant relocation exercises.

“Tenants at Pavilion have been gradually moving to Pavilion Elite since 3Q16 and the relocations should have been fully completed by 1H17 (first six months of 2017). On the other hand, the development of a men’s and women’s luxury precinct on Level 1 at Suria KLCC will only be completed by 4Q17,” he added.

Going forward, Abdul Hadi expects the performance of prime retail malls such as Suria KLCC and Pavilion to recover by end-2017, “thereby leading to better earnings visibility for KLCC Stapled Securities and Pavilion REIT.”

In reviewing the sector's quarterly performance, Abdul Hadi said core earnings — excluding fair value gains — generated by Malaysian REITs, grew 7.4% y-o-y in 2Q17, mainly driven by strong growth at MRCB-Quill REIT and Sunway REIT. But it was partially offset by the dent seen in Pavilion REIT’s net profit.

Noting that the REIT market dynamics has remained unchanged, Abdul Hadi observed that three firms under its sector coverage — Axis REIT, Sunway REIT and Pavilion REIT — have announced asset acquisition exercises.

Last month, Axis REIT announced it was adding to its portfolio, a building and two parcels of land in an industrial park in Kuantan for RM155 million.

As for Sunway REIT, it had in early August proposed to pay RM340 million in buying Sunway Clio Property, which include a four-star Sunway Clio Hotel, three-storey retail lots named Sunway Pyramid West, and a multi-storey car park.

Meanwhile, Pavilion REIT had on July 27 proposed to acquire the newly-completed Pavilion Extension, a 10-storey mall located right next to Pavilion Mall, together with the Extension-Connection and Subway Linkage, for RM580 million.

Describing the latest acquisition as “remarkable”, Abdul Hadi said Pavilion REIT’s bottom line could improve by 15% in 2018, assuming a net lettable area of 241,929 sq ft at Pavilion Extension will be rented out at an average rate of RM18 per sq ft.

For now, his top pick is IGB REIT, as he believes "it has the lowest earnings risk (due to solid rental reversion and highest retail sales) and an implied dividend yield of 5.2%".

"IGB REIT also posted resilient growth in 1H17, solely from organic growth at MidValley MegaMall and The Gardens Mall. It was also able to record a rental reversion of 5% during the quarter, with tenant sales reported in the high single-digits," Abdul Hadi added.

UOB also downgraded MRCB-Quill REIT from 'buy' to 'hold', given limited share price upside, following its share price increase.

"Having said that, 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," UOB said. — theedgemarkets.com

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