REITS Sector - Minimal uplift even with potential liberalisation of withholding tax NEUTRAL

• Upcoming Budget 2013: Talk on the potential liberalisation of withholding tax for M-REITs by industry players has once again resurfaced in view of the impending Budget 2013, which is expected to be tabled on 28 September 2012. This, however, is not new as it was with industry expectations in previous budgets. 

• Withholding tax for M-REITs: As a recap, the current withholding tax comprises 10% each for resident individuals, nonresident individuals and non-resident institutional investors, and 25% for non-resident corporates. In comparison, Singapore levies a withholding tax of 10% on non-resident non-individuals, while individuals pay no tax. Note that non-resident corporate unit holders in Singapore are taxed at a much lower rate of 17% compared with Malaysia at 25%. On the other hand, Hong Kong has completely removed the withholding tax structure. 

• Minimal re-rating potential: Should the liberalisation of withholding tax materialises, we believe it will be a positive to the MREITs sector. However, we are of the view that impact on unit prices may not be too significant given the M-REITs’ lofty valuations. Any liberalisation will translate into M-REITs becoming more competitive to Singapore and Hong Kong.

• Limited room for yield compression: Unit prices of M-REITs have rallied and their outstanding performance has led to a significant yield compression, making them more expensive than S-REITs. Yield spread between the retail M-REITs and 10-year MGS has narrowed to 104bps whilst the yield spread for retail S-REITs and 10-year SGB is at 362bps. We expect yield compression to be limited given the lofty valuations. The larger market capitalised retail M-REITs are already trading below 5%. Under our retail M-REITs coverage, yields for PavREIT and CMMT are 4.6% and 4.4%, respectively, for FY12F. Having said this, yields in FY13F are projected to be at 5.4% and 4.7% for PavREIT and CMMT, respectively, underpinned by major rental reversions in FY13F-FY14F, which we believe would uphold healthy and higher rentals for the next three years. Nevertheless, we see potential re-rating catalysts in the near- to medium-term driven by:-

(1) PavREIT (FV: RM1.33/unit): Opening of Fashion Avenue (NLA: +5%) in September should boost earnings given the doubling of rentals compared to the previous anchor which occupied the space. Greater tangibility in earnings is expected from the anticipated acquisitions – Fahrenheit 88 (FY14), da:men mall in USJ (FY15) and Pavilion Extension (FY16). 

(2) CMMT (FV: RM1.68/unit): East Coast Mall is in a midst of asset maximisation and the probable conversion of car park space (NLA +23%) – which are the key re-rating catalysts. Furthermore, the recent asset enhancement initiatives at Gurney Plaza would further strengthen rental growth. CMMT has the ROFR on Queensbay Mall and an upcoming retail mall in Taman Melawati would drive future growth. 

(3) Al’Aqar Healthcare REIT (FV: RM1.39/unit): Future asset injection is backed by its sponsor which is building seven hospitals over the next three years. Additionally, Al’-Aqar is actively looking at acquiring third party acquisitions – in aged care and retirement villages in Australia. In this regard, we will not be surprised by any potential acquisition happening next year.

• M-REITs lofty valuations: Given the current elevated valuations for M-REITs, the primary valuation driver has to be value- accretive in order to take advantage of the high unit prices. However, we have yet to see any REIT embarking on any major acquisitions although we note that yields are lower or at parity to the cost of borrowing, at current levels.

• Latest addition – IGB REIT, bringing a total of 14  M-REITs:   PavREIT and CMMT were listed at 6.41% and 6.6%, respectively – which are substantially higher compared to IGB REIT at 5.1% and 5.37%, respectively, for FY12F and FY13F. This, we believe, has prompted IGB Corporation to accelerate its REITs plan, underpinned by M-REITs’ rich valuations. We value IGB REIT RM1.38/unit, projecting yield to compress to 4.6% and 4.9%, respectively, for FY12F and FY13F. This puts IGB REIT’s yield at parity to PavREIT and CMMT, which stands at 4.6% and 4.7%, respectively, for FY12F. Looking at the enterprise value/sf for FY12F, PavREIT (RM2,958/sf) is the most expensive given its premium status and location, followed by IGB REIT (RM2,312/sf) and CMMT (RM1,406/sf). There has been talk of KLCC Property embracing a similar structure. Listings of such large REITs can only enhance the sector, which could be progressively developed as a distinct asset class.

• Maintain NEUTRAL: Long-term growth of M-REITs remains positive and intact although growth in the near term remains limited. We maintain NEUTRAL on the sector with HOLD calls on PavREIT, CMMT and Al’Aqar until we see constructive acquisitions taking place.   

Source: AmeSecurities