REENA KAUR BHATT finds out more about the market’s appeal and growth potential with the help of Kristine Wong, Equity Research Analyst at CIMB Investment Bank.
What are REITs?
A REIT is a company that owns or finances income-producing properties. REITs are similar to unit trusts, where investors pool together their money and a manager decides which property to buy and/or sell. Returns are then provided to unitholders in the form of dividend payments from investment income such as rental, through capital appreciation from changes in market value as well as capital gains when a property is sold off at a profit.
Rent is usually the main source of income as a REIT holds many types of commercial real estate such as offices, shopping malls, factories and hotels.
Change for the better?
One of the key proposals tabled by the Securities Commission (SC) in July is to establish a 15% cap on a REIT’s total assets value for property development, acquisition of vacant land, as well as property under construction.
According to Kristine, investors stand to gain positively if these proposals fall through. It is not surprising that many are in favour of the proposed ruling as it will allow REITs to assume redevelopment of the assets on their own which gives them the opportunity to enhance earnings and return on investment (ROE) for their unit holders.
Conversely, under the current requirements, REITs that hold outdated properties would have to sell these assets back to their sponsors to be redeveloped before repurchasing them back. The potential downside to this proposed ruling, however, is that REITs may over-leverage in a bid to chase rapid growth, besides the possible exposure to development risk. Currently, REITs are capped to a leverage limit of 50%.
Nevertheless, most M-REITs still have plenty of headroom to maneuver as they are well under the 50% threshold. In addition, SC has also proposed to adopt a fixed leverage limit of 50% and REITs will not have the option to increase this figure by the way of obtaining approval from unit holders.
Sharing the insights of Dato’ Stewart LaBrooy, Executive Chairman of AREA Management Sdn Bhd who spoke during a REIT’s session hosted by CIMB recently, a cap of at least 25% (15% for development and 10% for enhancements) should be put in place as this will minimise the risk for unit holders.
Additionally, REITs should continue to hold the completed property for more than 5 years, instead of the current 2 years as the real property gains tax (RPGT) would be , markedly higher30% for a two-year tenure instead of the 5% for five years. If carried out correctly, the guideline could create higher value for unit holders as a developed asset could carry property net yields of 12-15% versus just buying over the asset at 6-7%.
An attractive investment option
What kind of returns do M-REITS offer and will it be an attractive investment option for traditional property investors who are looking to expand their portfolio?
Unlike traditional real estate, REITs are traded on the stock exchange. Investors can get the diversification that real estate provides without being fastened down on a long-term basis; REITs shares are very liquid as they can be easily bought and sold. Also, the pooled capital enables for the purchase of real estate that investors normally could not afford.
Its main appeal will be its no-fuss nature – real estate is far from passive; hence REITs are perfect for real estate investors who do not want to deal with tenants, maintenance of properties and handling payments such as quit rent and assessments fees.
If a REIT distributes at least 90% of their yearly income to unit holders, the company will then be exempted from income tax. However, unlike its Singaporean counterpart, Malaysian REITs do not enjoy a zero withholding tax for individual unitholders. Singapore only levies a withholding tax of 10% on distributions to non-resident non-individuals.
REIT investors can be Malaysians, foreigners, individuals, companies or collective investment vehicles; thus the REIT manager has to deduct withholding tax based on the profile of each investor upon declaring dividend distributions. Kristine shared that many industry players would like to see the local REITs market mimic Singapore’s system as it would encourage pensioners to place their funds in REITs for steady returns.
Things to Consider When Investing in REITs
REITs can generate high dividend yields with modest long-term capital appreciation. Kristine stresses that the quality of the assets is important, hence investors must do their homework and study factors such as the location and income generation of the REITs’ assets.
What’s Hot And What’s Not
According to Dato’ Stewart, for the retail segment, larger and integrated malls will continue to outperform their smaller, standalone counterparts. Hence, investors should also focus on retail REITs that offer visible growth and a clear acquisition pipeline.
Knight Frank’s 2H2016 Real Estate Highlights revealed that prime shopping centres listed under the property portfolio of KLCC Stapled REIT, IGB REIT, Sunway REIT and Pavilion REIT continued to record higher rental rates and gross revenue during the review period mainly from new and renewed leases.
Meanwhile, what with the incoming office supply, the office sector might be somewhat stagnant as it will continue to be a “tenant’s market”. Rental rates have not moved in tandem with the increase in commercial property prices. Nonetheless, Dato’ Stewart believes that the market is still hungry for Grade A offices and those located in prime areas of the city centre will continue to do well.
Industrial REITs show the most promise and is doing extremely well as the sector has remained robust even in ‘difficult times’. This is mainly because demand for industrial properties has far outpaced supply; currently, most tenants are demanding for new and high-quality industrial estates. Rental rates have been on the rise over the past two years with e-commerce driving the demand and supply of the industry; the rise of e-commerce in the past two years is driving the demand for much larger warehouses to be built. Besides that, retailers are also turning to logistics and are constructing massive distribution centres.
DISCLAIMER: The opinion stated in the article above is solely of Kristine Wong and is not in any form an endorsement or recommendation by iProperty.com. Readers are encouraged to seek independent advice prior to making any investments.
This article was first published in the iProperty.com Malaysia September 2016 Magazine. Get your copy from selected news stands or view the magazine online for free at www.iproperty.com.my/magazine. Better yet, order a discounted subscription by putting in your details in the form below!