This article first appeared in Capital, The Edge Malaysia Weekly on May 15, 2023 - May 21, 2023
IT is commonly said that the real estate investment trust (REIT) sector will languish when interest rates rise. That is because the dividend yields they offer will be less attractive to income-seeking investors.
For instance, in the current interest rate environment, fixed deposits can offer returns as high as 4% per annum. Furthermore, higher interest rates may be a concern for investors as the borrowing costs for REITs will increase while the value of their properties may not appreciate in the near term, if not depreciate.
However, judging by the performance of the KL REIT Index, REITs don’t seem to have disappeared from investors’ radar screens despite the current sentiment that interest rates are possibly “higher for longer”.
“REITs have clearly outperformed in this declining market and will continue to offer moderate total returns in today’s uncertain market dynamics, even though the upside is limited by higher interest rates,” says UOB Kay Hian head of research Vincent Khoo.
Year to date, the KL REIT Index has gained 2.8% to 794.64 points. Over a one-year horizon, roughly since interest rates started to climb, it has declined just 1.61%.
On the other hand, the KL Financial Services Index has declined 6.97% over the past year and 5.47% year to date (YTD). This is despite the fact that financial services are supposed to benefit from the rise in interest rates.
Notably, the KL REIT Index has performed better than the FBM KLCI. The benchmark index has slipped 8.37% over the past year and 4.67% YTD.
Analysts opine that there is still appetite for REITs, especially those in the retail and hospitality segment, even with interest rates back to the pre-pandemic level of 3%.
“We are still positive on REITs despite the higher interest rate environment as the sector, particularly retail REITs, will continue to see an earnings recovery in 2023 on account of a recovery in tenant sales and positive rental reversion,” says MIDF Research analyst Jessica Low, adding that the earnings recovery is expected to offset the impact of higher borrowing costs.
Among the listed retail-centric REITs, the percentage of floating rate borrowings varies, ranging from 20.9% for CapitaLand Malaysia Trust to 92% for Hektar REIT based on their 2022 annual reports.
Low says her forecast average distribution yield of the REITs under her coverage stands at 5.3% for 2023, which she says is still attractive compared to other fixed-income instruments such as the 10-year Malaysian Government Securities.
Meanwhile, Rakuten Trade Sdn Bhd vice-president of equity research Thong Pak Leng concurs with Low. He says that while the overnight policy rate (OPR) hike has led to higher interest rates for bank deposits, he believes REITs, especially tourism-related ones such as retail and hospitality, will do well with the reopening of the economy and international borders.
“Retail and hospitality REITs still offer attractive yields of between 5% and 7%, which are far higher than banks’ fixed deposit rates. As such, we believe the appetite for REITs will still be there,” says Thong.
Nevertheless, the external headwinds give rise to concerns of a potential economic slowdown, if not a recession, which in turn will affect rental yields.
Not too long ago, when the Movement Control Order (MCO) and its various iterations were imposed to curb the spread of the Covid-19 virus, retail and commercial REITs were hit hard. Many of them had to provide their tenants with support in the form of rental rebates as their tenants were unable to operate for the most part due to the MCO.
Low says the rental income outlook for REITs remains stable in 2023 as people adjust to life after the pandemic. “The earnings of REITs are defensive as they collect rental income from property assets. Tenant sales for retail REITs were encouraging in 1Q2023 and the outlook for tenant sales remains, underpinned by shopping sprees in the festive seasons. Overall, we see that the worst is over for REITs and believe the sector will continue to recover in 2023.”
Looking at the REITs listed on Bursa Malaysia, it is worth noting that most of them currently have a 12-month dividend yield of more than 5%. Only two have dividend yields that are below 5% — Tower REIT and AME REIT.
But based on RHB Research’s FY2023 forecast dividend yield for AME REIT, which was listed about eight months ago, the yield stands at 5.9%. AME REIT’s portfolio comprises industrial properties and worker dormitories.
The REIT with the highest 12-month dividend yield is Hektar REIT at 11.85%. The retail-focused REIT has six neighbourhood malls in its portfolio, including Subang Parade.
Commercial REITs such as AmFirst REIT, Sentral REIT and UOA REIT have 12-month dividend yields between 7.5% and 7.95%.
Retail and industrial property owner KIP REIT’s yield is also high at 7.28%, while popular retail REITs such as Pavilion REIT, IGB REIT, Sunway REIT and KLCCP Stapled Group have 12-month yields of 5% to 6%.
Low’s top picks for the sector are IGB REIT and Sunway REIT, with a target price of RM1.86 and RM1.73 respectively. She prefers IGB REIT for its high occupancy rates of Mid Valley Megamall and The Gardens Mall, a shopping hotspot, which translates into a positive rental reversion.
Sunway REIT is a “buy” for Low as she expects the earnings of its retail and hotel divisions to remain solid in FY2023, which will support its earnings growth.
“The retail division of Sunway REIT will benefit from the recovery in consumer spending at malls while the hotel division will be supported by the reopening of borders and return of tourists,” she says.
On the other hand, UOB’s Khoo is neutral on the retail REIT segment as he believes the prospective dividend yields have fallen as share prices recover. He prefers industrial REITs and has a “buy” call on Axis REIT, with a target price of RM2.04.
Meanwhile, RHB Research’s top pick is newcomer AME REIT. The research house has a target price of RM1.38 as it sees the REIT’s acquisitions driving earnings growth in the medium to long term. It also likes Pavilion REIT (target price: RM1.57), which it says should benefit from the improving tourism industry, as well as its planned acquisition of Pavilion Bukit Jalil in 2Q2023, which makes it positive for the REIT’s long-term prospects.
Kenanga Research also has Pavilion REIT as its sector pick, with a target price of RM1.43, as it opines that it can potentially offer a total return of 15.8%.
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