Assets and valuations the key factors for REITs

Despite being severely tested by uncertainty during MCO, REITs can still be considered by investors if OPR continues to go down next month


THE performance of real estate investment trusts (REITs) is set to be severely tested by the uncertainty caused to businesses by the extended Movement Control Order (MCO) to contain the Covid-19 pandemic.

Independent financial consultant and investment analyst Leong Hoe Kit said the Covid-19 pandemic and MCO will cause cashflow issues to the REIT sector.

This is especially true for REITs in the retail space and more so if they are highly geared, while REITs in the industrial sector may be less affected, Leong said.

“REITs are generally considered a defensive investment vehicle but this time around, with the storm caused by the Covid-19 pandemic and the extended MCO, there is no umbrella to hide under.

“This is because rental cashflows are no longer assured (due to rebates or discounts on rentals that may be given) while the REITs operating expenses and debt servicing continue to be incurred,” he told The Malaysian Reserve (TMR) last week.

In the current volatile market environment, Leong said REITs can still be considered by investors, especially if Bank Negara Malaysia (BNM) further cuts its Overnight Policy Rate (OPR) at the upcoming May Monetary Policy Committee meeting.

“Be very selective to the type or sector the REIT is servicing, with good sustainable rental yields and also preferably with low gearing levels,” he said.

In the near term, Leong noted that REITs are not too attractive given the concern over the sustainability of their dividend yields as a result of lower expected rental income.

“However, in the recent market sell-down in March, prices of REITs are cheaper and there could be pockets of opportunity if investors take on a much longer investment horizon.

“A further interest rate cut by BNM in May could also be a catalyst for REITs. The key is to be very selective,” he said.

Agreeing with Leong, RHB Investment Bank Bhd analyst Loong Kok Wen urged investors to be very selective and choose REITs that are sustainable and avoid smaller REITs which are likely to see some problems due to their high gearing levels.

In terms of recovery of the segments in the sector, Loong opined the industrial segment is expected to fare better compared to office and retail asset-based REITs.

“I believe industrials are less affected, so they will recover very fast as when the economic growth picks up. Over the longer run, the prospect is also better given the rising e-commerce trend for warehouses and storage,” she told TMR.

For REITs in the office space, the outlook is more difficult to predict as certain office buildings that have high exposure to the oil and gas tenants may take time to recover, she said, adding given the oversupply in a long-term structural issue and thus remain very sluggish even after the health crisis is over.

“For retail, I will stick with the very big malls like Mid Valley Megamall, The Gardens Mall, KLCC, Pavilion and Sunway. These malls I believe will recover faster compared to the other very new malls. I would give around two months for the malls to be back to normal,” she said.

MIDF Amanah Investment Bank Bhd analyst Jessica Low Jze Tieng said retail REITs have been the hardest hit by the pandemic and MCO as malls were only partially operating, only tenants in essential trade services are allowed to operate.

“Most of the mall operators have offered rent-waiver to tenants in non-essential trade services. That coupled with extremely low footfall will hurt the income of REITs,” she said in an email reply to TMR last Friday.

Low said the decision to invest in any REIT should be based on valuation. For REITs with depressed valuation after the recent heavy sell-down but holding quality assets and financial muscle to weather the storm, investors may consider it as an opportunity to bargain hunt, she said.

Low added that the near-term outlook for REITs, especially retail REITs, remains challenging.

“We are ‘Neutral’ on the sector as most of the REITs have been sold down as the negatives are largely priced in. Having said that, the downside risk to the sector is the extended MCO,” she said.

Loong, who is ‘Overweight’ on the sector, opined she would stick with those REITs that own quality assets.

“Even though retail REITs is hit, the quality or the value of the assets is still there. The recovery period for REITs that own good assets would likely be faster compared to some other malls. The larger malls will relatively do better than the smaller ones. My pick for the other sector is industrial REITs,” she said.

Loong and Leong like KLCC Stapled Group (KLCCP) and Axis REIT, with Loong having a ‘Buy’ call and target price (TP) of RM8.55 for KLCCP and TP of RM1.99 for Axis REIT.

KLCCP is favoured due to the group having a financially strong and steady anchor tenant namely Petronas, whereas, for Axis REIT, it is due to the resilience of the industrial segment.

Low’s top pick is Al-Aqar Health- care REIT (TP of RM1.52) due to its fixed rental income structure of the defensive healthcare industry which suggests a fairly stable dividend yield.