M-REITs - Stirred by Volatile Bond Market

MREITs remain quiet on the asset acquisition front, which implies fewer exciting growth prospects as strong growth, and hence, share price performance hinges on new acquisitions. We also believe retail MREITs organic growth may also be under threat for retail MREITs due to higher A&P cost due to stiff competition, thus limiting tenants ability to keep up with higher rental rates, while the supply glut for office spaces in the Klang Valley may suppress organic growth. The potential announcement of GST in Budget 2014 may weigh down tenant’s future ability to keep-up with high rental rates post implementation, limiting MREITs strong rental reversions. We expect the effect of GST to be less detrimental on office/industrial REITs due to the longer lease periods and lower step up rates compared to heavier retail MREITs. The uncertainty in the bond market has caused us to take a conservative outlook on the 10-yr MGS, particularly with the upcoming US FOMC meeting in Dec-13. We downgrade our sector call to UNDERWEIGHT from NEUTRAL by virtue of our UNDERPERFORM call on KLCCSS and SUNREIT as it provides a limited total return of -0.2% and 0.6%. Our new TP’s and Calls are; KLCCSS (UP; TP: RM6.12), SUNREIT (UP; TP: RM1.36), AXREIT (MP; TP: RM3.41), and CMMT (MP; TP: RM1.60).
Lack of asset acquisitions = less exciting growth prospects. Till Sept-13, our MREITs universe has yet to see any asset acquisition, with the exception of SUNREIT which announced the completion of its acquisition of Sunway Medical Centre in 1QCY13. We believe this is highly due to the low cap rate environment of 5%-6% (vs. 7%-8% previously) which is a mismatch between MREITs asset NPI yields. AXREIT has yet to announce the acquisition of an estimated RM400.0m worth of assets under negotiation this year while CMMT is reviewing the acquisition of Tropicana Mall and office Tower worth RM550.0-650.0m (CMMT has obtained approvals for a potential placement). SUNREIT has been eyeing acquisitions from parent and third parties of up to RM7.0b over the next 3-4years, but nothing is firmed up as yet, while market talk of the REIT-ing of Suria KLCC or any potential assets by KLCC Stapled Group has been quiet suggesting fewer exciting growth prospects as MREITs will only be able to grow organically.
Retail organic growth under threat? We believe there maybe weaknesses with future organic growth rates for retail MREITs (6%-9% p.a.) such as CMMT and SUNREIT. Retailers are facing stiff competition, which has resulted in higher A&P costs and limit their ability to keep-up with rising rents brought about by the series of REIT-ing over the last few years. We will be monitoring the situation closely as we have yet to factor this impact into our earnings. As for office spaces, we do expect flattish organic growth due to the supply glut in the Klang Valley while industrial spaces are unlikely to capture any short term upswing in rates as leases are longer termed (5-10years).
GST in Budget 2014, indirectly impacting tenants and suppressing strong rental reversions. With Budget 2014 soon approaching this 25-Oct, our House Strategist anticipates the announcement of GST implementation by mid-2014 to early 2015. Should GST be implemented, the biggest impact of GST will be on tenants, thus limiting strong rental reversions for MREITs in the future. This may also nibble into our future earnings estimates post implementation as tenants operating costs are expected to increase. We believe the effects of GST will be less detrimental on office/industrial REITs, such as AXREIT, as their tenants are locked in for longer lease periods, and have lower step up rates compared to heavier retail REITs such as SUNREIT and CMMT, providing office/industrial REITs with more earnings resilience.
Expecting a volatile bond market until the end of this year. With the US Federal Reserve’s surprise announcement that they will not taper bond buying activity during the September meeting, tapering would most likely be postponed to end of FY13 based on consensus view. This may thus increase the volatility in the bond market as well as the 10-year MGS when we are approaching to US December FOMC meeting. Therefore, we are taking a conservative outlook on FY14E 10-year MGS due to the volatile bond yield environment, and pegging all our MREITs to a target FY14E 10-year MGS of 3.9% (3.5% previously).
Downgrade MREITs to UNDERWEIGHT from NEUTRAL by virtue of our UNDERPERFORM call on KLCCSS and SUNREIT as TP’s provides limited total returns of -0.2% and 0.6%. Our new TP’s and CALL’s are: KLCCSS (UP; TP: RM6.12), AXREIT (MP; TP: RM3.41), SUNREIT (UP; TP: RM1.36) and CMMT (MP; TP: RM1.60). 
Source: Kenanga