Dewan Bandaraya Kuala Lumpur (DBKL) has frozen approvals for new applications to build shopping centres, offices, service apartments and luxury condominiums in the capital city following a directive from the Cabinet. We are long-term positive on this news as it helps to address the oversupply situation which bodes well for MREITs. In the near term, we believe it will inject some confidence back into the more resilient MREITs with landmark malls (i.e. IGBREIT, PAVREIT and KLCC) that have been mostly ignored by investors due to the perceived high incoming supply of retail space. Meanwhile, we expect minimal impact for office based MREITs in the near term as tenancies are mostly on a longer term basis (c. 5-15 years), allowing occupancy and rental rates for these assets to remain stable. We are of the view that retail-based MREITs such as IGBREIT, PAVREIT and KLCC with landmark malls will gain on positive share price sentiment as this ruling puts to rest investors’ concerns of the worsening impact of the oversupply issue. We also reiterate our OUTPERFORM call on MQREIT as we believe its share price has yet to perform on the perception of an office supply glut affecting the stock which is not the case due to its long term leases. We make no changes to earnings, and valuations. Maintain OVERWEIGHT.

News. It was reported in The Edge that Dewan Bandaraya Kuala Lumpur (DBKL) has frozen approvals for new applications to build shopping centres, offices, service apartments and luxury condominiums in the capital city following a directive from the Cabinet. Though the freeze came into effect on 1st Nov 17, its duration remains unclear. The move follows a study conducted by Bank Negara Malaysia, which indicates an excess in floor space in the four categories of buildings identified.

Long-term positive on the news as it alleviates fears of oversupply. We were surprised, but are long-term positive on this news as the government is helping to address the oversupply situation which bodes well for MREITs. Currently, most retail-based MREITs under our coverage have assets in Kuala Lumpur, namely; (i) KLCC (Suria KLCC), (ii) IGBREIT (Mid Valley and The Gardens mall), (iii) PAVREIT (Pavilion Shopping Mall and Intermark Mall), (iv) CMMT (Sungei Wang Plaza), and (v) SUNREIT with one retail asset in KL (Sunway Putra Mall contributing c.7% to portfolio NPI). Most of these assets have decent occupancy rates at >80% as most REITs tend to prioritise occupancy over reversions, while those with landmark malls tend to fare better in terms of occupancy (95-100%) and rental rates(e.g. IGBREIT, PAVREIT, KLCC).

A confidence boost for MREITs with landmark malls. We believe the resiliency of landmark malls has been largely ignored by investors due to the perceived high incoming supply of retail space, which is more of a threat to neighbourhood malls. In anticipation of incoming supply of retail space in coming years, we believe freezing new applications will alleviate the downside pressure to reversion rates in the longer run. We also believe it addresses investors’ fears of oversupplies, which may inject some confidence back into the more resilient landmark malls based MREIT such as Suria KLCC (KLCC), Pavilion Shopping Mall (PAVREIT), Mid Valley Megamall and The Gardens (IGBREIT) as expectations of downside pressure to rental rates have been alleviated to some extent.

Pavilion Bukit Jalil development not affected. Additionally, we understand that PAVREIT’s potential asset for injection, the Pavilion Bukit Jalil which it has First Right of Refusal will not be affected by this ruling. The asset is currently under construction, and is slated for completion by end CY19.

Minimal near term impact to office based MREITs due to its already stable asset profile on long term leases. We do not expect any significant impact to office-based MREITs under our coverage (i.e. KLCC, MQREIT)as tenancies are mostly on longterm leases (c. 5-15 years) vs. retail assets of 2-3 years, and as such occupancy and rental rates for these assets will remain stable. However, this should bode well for preserving rental rates in the longer run while also addressing investor’s long-term fears about future oversupply. SUNREIT’s office assets in KL are fairly insignificant and make up only 1.6% of top-line. AXREIT is not affected by this ruling as its office assets are mostly out of KL, while the remainder are industrial-based assets.

Main beneficiaries are IGBREIT, PAVREIT, KLCC and MQREIT. We expect positive share price sentiment for retail-based MREITs with landmark malls as it puts to rest investors’ concerns of the worsening impact of the oversupply issue. Occupancy and rental rates at landmark malls will be able to sustain an oversupply glut better as tenants prefer such malls in tough times due to stronger footfall compared to neighbourhood malls. We believe IGBREIT and PAVREIT stand to gain more from this ruling as a larger portion of its revenue is derived from landmark malls (100% and 85%, respectively), while 35% of KLCC’s revenue is derived from its retail component. Office-based MREITs (i.e. KLCC and MQREIT) will continue to remain stable due to the nature of its long term tenancies. However, this news further strengthens the likelihood of long -term rental rates being preserved, and as such reinforces our OUTPERFORM call on MQREIT as we believe its share price has suffered on the perception of an office supply glut.

Maintain OVERWEIGHT. We make no changes to MREITs’ earnings and valuations. However, this news reinforces our OUTPERFORM call for IGBREIT, PAVREIT and MQREIT as it lifts the negative perception surrounding the oversupply issue. MGS remains stable at current levels of 4.00%, while we do not expect significant fluctuations to the MGS assuming a US rate hike in December 17 as possibility of a hike would have already been priced in by the market. Having accounted for most downside risk for MREITs in previous quarters as well as our recent 4Q17 strategy (refer to MREITs report titled ‘Still Attractive, Riding on Stable MGS’ dated 4th October 2017), we believe MREITs’ earnings and valuations are firm at this juncture with most MREITs under our coverage warranting an OUTPERFORM call, save for KLCC and AXREIT. This is backed by stable gross dividends of 4.9-6.6%.

We do not expect a potential OPR hike to affect MREITs. The market has been speculating of a potential 25-50 bps hike in OPR rates over 2018, while the higher-than-expected 3Q17 GDP growth of 6.2% makes a hike seem more likely. However, we do not expect a significant impact to MREITs’ earnings as a large portion of their borrowings (>70%) are on fixed rates, save for PAVREIT (21%), MQREIT (21%) and AXREIT (37%). Even so, impact to earnings is minimal, as a 50bps hike to PAVREIT, MQREIT and AXREITs’ borrowings would only lower earnings by 1-2%, which is insignificant. Additionally, we do not expect an overly negative impact to the 10-year MGS resulting from an OPR hike as foreign holding of the MGS is high at c.45%, while a 25-50bps hike would likely affect shorter term MGS rates (i.e. 3, 5 and 7-year MGS) due to its lower yield instead of the 10-year MGS. We note that there has not been a strong correlation between the 10-year MGS yields and OPR hikes in the past, likely due to these reasons. Lastly, MREITs are highly institutionalised with most investors accumulating at IPO levels at low holding cost. Thus, a sharp selldown of MREITs is unlikely.

Risks to our call. Factors that may affect our call include: (i) worse-than-expected consumer spending, (ii) cost-push factors that result in weaker-than-expected rental reversions, (iii) U.S. Fed increasing interest rates in a more aggressive manner, (iv) weaker-than-expected occupancy rates, and (v) further decline in oil prices and weaker MYR, which may increase pressure on the 10-year MGS.

Source: Kenanga Research - 20 Nov 2017