Opportunities in mispriced assets

M-REIT is due for a re-rating, especially commercial REITs which are under-priced vis-à-vis prices transacted in the secondary (physical) market. A re-rating will also be spurred by the impending listing of three mega REITs with combined assets of up to RM8 billion, which will add to the depth and liquidity of the sector. A 50-bps hike in the overnight policy rate in 2010 will have minimal impact on gross dividend yields, as M-REIT still provide sustainable yields of 7-8.7%. Maintain Overweight.

Mispriced REITs. M-REITs are trading at generous implied cap rate of 6%-10.8%, as most M-REITs trade at 5-39% discount to their NAVs (Table 2). This offers investors (especially individuals) “arbitrage” opportunities as shop offices and strata-titled offices around the Klang Valley were recently traded at gross rental yields of 5-6% p.a. in the secondary market. Recent primary market launches around the Kota Damansara area also reflect similar yield patterns.

Three mega listings in the pipeline. M-REIT asset size may double to RM18 billion by end-2010 with three impending listings – Sunway City REIT (up to RM4 billion in asset size), CapitaRetail Malaysia Trust (up to RM3 billion) and Malaysia’s first cross-border REIT, Qatar REIT (up to RM1 billion). To enhance the appeal of M-REIT, we understand the regulator currently favours creation of new REITs with market capitalisation of at least RM500 million on listing.

M&A activities abuzz again. M&A activities are picking up momentum in 2010 as capital market conditions are friendlier now. RM1 billion worth of assets will be acquired by three M-REITs – UOA REIT (RM500 million), Al-‘Aqar REIT (RM303 million) and AmanahRaya REIT (RM227 million) – this year and more are expected to follow suit. Axis REIT will be in the race to achieve its RM1b asset size target by end-2010. On the other hand, Atrium REIT, is a prime takeover candidate as it is undervalued and among the smallest M-REIT in asset size.

Minimal impact on dividend yields from rising interest rates. Our sensitivity analysis show that a 50-bps hike in interest rate (on M-REITs’ floating rate loans) will lead to a marginal decline in 2009’s distributable income – by up to just -4.5%. 57% of M-REITs’ loan facilities are long term with fixed rates. Hektar REIT, with its high debt-to-asset ratio of 43%, will be most affected. Still, it is only a 39-bps decline in gross dividend yields to 8.1%, still attractive (Table 6). Still attractive; Overweight. In 2009, M-REITs provided attractive gross dividend yields of 7.1-8.8% when compared to 12M cash deposit rates (2.75%), EPF dividend yield (5.65%), KLCI dividend yield (2.9%), and 10-yr government bond yield (4.2%). At current valuations, we believe the market has priced-in zero asset growth for 2010-11. Our top picks are AmanahRaya REIT (with FY10 gross dividend yield of 8.4%), Axis REIT (7.9%) and Quill Capita Trust (7.6%). We also like UOA REIT and Tower REIT for their long term value proposition and under-appreciated office values.

Quick overview of 2009

Stable and predictable returns. M-REITs emerged from 2008/2009 global crisis relatively unscathed. Except for a momentary scare in early 2009, M-REITs did not face any refinancing issue as banks were flush with liquidity and remained accommodative in lending. Despite a tough market, Axis REIT and Al-‘Aqar REIT managed to acquire new properties and grow their asset sizes in 2009 (Table 1).

M-REIT enjoyed net revaluation surplus. As highlighted in our sector report dated April 3, 2009, asset valuations of M-REITs have been conservative, with capitalisation rates kept relatively constant over the years. Al-‘Aqar REIT, AmFirst REIT, Axis REIT, Boustead Al-Hadharah REIT, Hektar REIT, Quill Capita Trust, and UOA REIT posted net revaluation surplus in 2009 (Table 1) despite challenging business environment. And none of M-REIT posted net revaluation deficit in 2009. This means M-REIT’s net rental income remained relatively resilient throughout 2009. As at end-2009, M-REITs still valued their assets at conservative cap rates of 6.0-9.2% in their balance sheets (cap rate is measured by net property income over the implied investment property value).


Arbitrage opportunity in 2010

Cap rates stayed low. Capital values of commercial properties in the physical market have stayed high and trended higher into 2010 just as we highlighted in our property sector report on Sept 24, 2009. Shopoffices and strata-titled offices around the Klang Valley were recently transacted at gross rental yields of 5-6% p.a. in the secondary market.

Recent primary market launches in Kota Damansara also reflect similar yield pattern. Strata-titled offices at the Strand in Kota Damansara (by Encorp) are selling above RM700psf in the primary market. Cap rates are therefore low at 5%-6.5% (compared to 6.5%-8% two to three years ago) as investors are willing to accept lower net rental yields as a consequence of low cash deposit rates and low mortgage rates.

Cap value will stay high throughout 2010. With cash deposit rates and effective lending rates likely to stay low for the next 12 months (our economist expects the overnight policy rate (OPR) to increase by just 50-75bps in 2010; inclusive of 25-bps increase in 1Q10), we anticipate capital values of commercial properties to remain firm. As such, we view REIT instruments as relatively defensive and attractive at current prices, supported by attractive gross dividend yields of 7-9%.

Arbitrage opportunity as M-REIT value lags the physical market. Despite the robust valuations experienced in the physical market, valuations for M-REIT have failed to rise in tandem with the physical market. As most M-REITs trade at significant discount to their NAVs (except Al-‘Aqar, Axis REIT and Boustead Al-Hadharah REIT), they trade at implied cap rates of 7.1-8.2% (Table 2). Al-‘Aqar has the lowest implied cap rate at 6.2% while Amanah Harta Tanah PNB trades at the highest implied cap rate at 11% (based on 2009’s net property income).

Source: Maybank IB, Companies, Bloomberg


Undervalued commercial REITs. M-REITs are obviously under-priced especially commercial REITs like Quill Capita Trust, Amanah Raya REIT, Tower REIT, UOA REIT and Starhill REIT. Except for Axis REIT, the remaining 11 M-REITs presently trade at 0%-39% discount to NAV. We anticipate the valuation gap between M-REITs and the physical market to narrow over time with M-REITs units increasing in prices.


Growth engine re-started

M-REIT assets size may double to RM18 billion in 2010. Interest in M-REITs could be revived with the impending listing of Sunway City REIT (RM3 billion-RM4 billion asset size), CapitaRetail Malaysia Trust (RM2 billion-RM3 billion) and an Islamic Qatar REIT (RM0.6 billion-1.0 billion; set to be Malaysia’s first cross-border listing) (Table 3). The sector has been quiet since Atrium REIT’s listing in Mar 2007. Earlier plans to list Sunway City REIT and CapitaRetail Malaysia Trust in 2008 were shelved due to the global financial crisis.The market condition has since improved and is ready to absorb new issues in 2010.

2010 will be buzzing with M&A activities. M&A activities are set to pick up momentum in 2010 amid friendly capital market environment. UOA REIT, AmanahRaya REIT, and Al-‘Aqar REIT announced new plans to expand their asset sizes at the start of 2010 involving RM1,030m (in total) of new investments (Table 4), financed by a combination of borrowing and new units issuance. And, Axis REIT will be in the race to achieve its RM1b asset size target by end-2010.

Repositioning of Starhill REIT. Starhill REIT will reposition itself as a hospitality REIT as it looks to acquire hotel properties in Malaysia from its parent entity, YTL Corporation subsequent to its disposal of Lot 10 and Starhill Gallery upmarket retail malls to its sister entity – Starhill Global REIT, listed in Singapore. Among the hotels that could potentially be injected into Starhill REIT are award winning Pangkor Laut Resort (Perak), Majestic Hotel (Malacca), Vistana Hotel (business hotels located in Kuala Lumpur, Kuantan and Penang), Cameron Highlands Resort (Perak), and Tanjong Jara Resort (Terengganu).

Sector consolidation could materialise in 2010. Atrium REIT is a potential takeover target for two years now. It is the second smallest M-REIT with asset size of only RM162m and trades at 9% discount to its NAV. Our industry sources reveal that several parties have shown interest in the controlling stake in the past. Atrium REIT is potentially a good fit for Axis REIT which is an industrial / commercial REIT.

Rising interest rate has minimal impact

M-REITs have manageable gearings. Malaysian regulators set the statutory debt limit at 50% of asset value. As at Dec 31, 2009, M-REITs had manageable gearings with overall debt-to-asset ratios at 28% and ranging from 0-43% (see table below). This indicates M-REITs are in a comfortable position to weather an interest rate hike. It also signifies that M-REITs have the capacity to gear up for future yield accretive acquisitions.

Sensitivity analysis: Minimal impact. As highlighted earlier, our economist expects the OPR to increase by 50-75bps in 2010 (inclusive of 25 bps increase in 1Q10). We performed a sensitivity analysis using a 50-bps hike in interest rate on M-REIT’s floating rate loan. Based on 2009’s core earnings, the impact of a 50-bps increase in interest rate is minimal at 0% to -4.5% of core earnings. 57% of M-REITs’ loan facilities are long-term loans with fixed rates. Hektar REIT will be most affected with 4.5% decline in core earnings given its high debt-to-asset ratio of 43%. Even then, this represents only a 39-bps drop in gross dividend yields to 8.1%, which is still attractive (see Table 6).

AmanahRaya REIT unaffected. For stocks under our coverage, Axis REIT (47% of total debt with floating rate exposure), and Quill Capita Trust (4%) are expected to be marginally impacted (-0.2 to -1.7%) by a 50-bps increase in interest rate. On the other hand, AmanahRaya REIT has zero floating rate debt exposure and will not be impacted by any increase in interest rates in the short term.

Sector re-rating expected

Buy for arbitrage opportunity and attractive dividend yields. The M-REIT sector is due for a re-rating as most REITs are significantly under-priced vis-à-vis secondary market transactions in the physical market. M-REIT’s attraction is supported by high gross dividend yields of 6.9%-8.8% vis-à-vis other investments (Chart 1). And a sector rerating will be aided by the impending listing of three large REITs with combined asset size of up to RM8b which will provide the necessary liquidity and attraction to the sector.

Maintain Overweight on M-REITs. Our top M-REIT picks are: (i) AmanahRaya REIT for its defensive gross dividend yields which are supported by long-term leases and long dated borrowings, (ii) Axis REIT for its proven management strength and acquisition track record which justified its premium to NAV, and (iii) Quill Capita Trust for its exposure to the relatively resilient office segment, quality tenants and strong sponsor.

Based on our analysis, we believe UOA REIT and Tower REIT with their prime office buildings around Kuala Lumpur still offer attractive values in the long run. At current unit prices, UOA REIT and Tower REIT are trading at implied office values of RM531psf and RM523psf respectively whereas surrounding office spaces were transacted way above those values (eg. Wisma Genting – RM677psf, Menara Citibank – RM828psf, Kenanga International – RM700psf, and Menara Standard Chartered – RM952psf). From an M&A perspective, Atrium REIT is a prime takeover target.

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