M-REITs may be allowed to build own properties

MALAYSIAN real estate investment trusts (M-REITs) may soon be allowed to put as much as 15% of their total assets into development projects and vacant land for development and are already positioning themselves for the liberalisation that is slated for the end of the year, industry sources say.

It is understood that the Securities Commission Malaysia (SC), which has been in consultation with industry players on the move, will issue a public consultation paper as early as this month to gather feedback on the planned revision to the REIT guidelines.

Citing the Singapore experience, M-REIT managers have long lobbied to be allowed to build some of their own properties to enjoy development profits as it became harder for them to make yield-accretive acquisitions. Last year, the Monetary Authority of Singapore raised the ceiling for development assets to 25% of the REITs’ total value, up from 10%, which is the current Hong Kong threshold.

At present, M-REITs can refurbish, renovate or extend existing real estate in their investment portfolios but the rules prohibit property development or the acquisition of vacant land.

Generally, allowing REITs to undertake development projects means the funds will be exposed to construction risks such as the possibility of cost overruns and delays in completion. In Malaysia, where there is already an oversupply of commercial properties on the back of slowing demand, permitting REITs to develop new properties and scour for tenants will only heighten risks in the fairly stable sector.

The SC is said to be looking at liberalisation because investors today are better informed about REITs, which are subject to a high level of disclosure. It is learnt that under the liberalisation, M-REITs will need the approval of unit holders to do development projects or vacant land acquisition and disclose the risks they are taking as well, among other things.

In the meantime, investors will need to learn more fast because REIT managers are already planning their moves.

Last month, Sunway REIT bought 13,306 sq m of land from its sponsor Sunway Bhd to host the extension of Sunway Carnival Mall in Penang. The investment trust said it will ask for a waiver from the restrictions on property development and the purchase of vacant land.

A precedent was set for such a waiver in August 2012 when Al-’Aqar Healthcare REIT bought two tracts next to its KPJ Puteri Specialist Hospital in Johor. It is understood that the SC gave Al-’Aqar its blessing because sponsor KPJ Healthcare Bhd was handling the development while the vacant tracts would add value to unit holders in the future as they were earmarked for the hospital’s extension.

According to Axis REIT CEO Leong Kit May, the investment trust plans to convert the Axis Pre-Delivery & Inspection Centre into a distribution warehouse with roughly 92,903 sq m of net lettable area. The lease for the space with Konsortium Logistik Bhd, which had used it as a pre-delivery inspection centre for Proton cars, expired late last year.

Analysts, fund managers and industry insiders acknowledge the potential of newly built properties generating better yields. In fact, REIT executives have argued that the local market needs to keep up with its foreign counterparts, where investment trusts have been allowed to handle their own developments for years. Malaysia will thus be on a level playing field, they say.

“The ability to develop greenfield projects would enable M-REITs to attain more attractive returns due to an earlier stage of entry. In addition, M-REITs will accelerate the injection of potential assets, setting a new frontier for the industry,” Leong says.

Danny Wong Teck Meng, CEO of Areca Capital Sdn Bhd, is less sanguine about REITs taking on construction risks. To him, REITs are for passive income — essentially collecting rent.

“Even when there is a cap [on allowable developments to total portfolio], the issue is more about the exposure to the development. There are construction costs, there’s financing that needs to be taken and there is the potential risk of delays, which will then increase the total cost,” he says.

Bloomberg data shows that the combined market capitalisation of the 17 M-REITs was RM41.07 billion as at July 1, or an average of RM2.42 billion. By comparison, the 39 REITs listed on the Singapore Exchange had an average market cap of S$1.78 billion, bringing the total market value to S$67.51 billion.

In terms of valuation, it was one times book value or more for nine M-REITs. Only a quarter of the Singapore REITs were valued as much, although 8 out of 10 of them offered indicated yields of more than 5.5%. A market observer also notes that the big S-REITs tend to be more volatile than M-REITs in general.

S-REITs also tend to be highly leveraged. Bloomberg data shows that most of them held debts that was equal to more than 50% of their unit holders’ funds. Their Malaysian counterparts proved to be more prudent when it came to borrowings.

Still, of the five biggest M-REITs, two (Sunway REIT and CapitaLand Malaysia Malls Trust) already had gearing that hovered around the permitted 50% level.

It is understood that the SC also plans to cap gearing at 50% for M-REITs. At present, the 50% cap can be exceeded with unit holders’ approval.

This article first appeared in The Edge Malaysia on July 11, 2016. Subscribe here for your personal copy.