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Saturday, April 11, 2009

Malaysian REIT

Risks & EmergIng Trends

 M-REITs face 3 key risks in 2009-10: Refinancing, Recapitalisation and
Revaluation, as the domestic economy continues to weaken.

 If the economy worsens, we foresee M-REITs (in order of probability)
cutting dividend payouts, refinancing ST with LT loans, and engaging
in dividend reinvestment schemes, rights offers and asset disposal.

 However, the sector should remain resilient as M-REIT’s 9-13.7%
dividend yields have largely priced in zero acquisition growth and a 9-
35% drop in net property yields in 2009-10. Maintain Overweight.

M-REITs relatively resilient so far. Unlike REITs in other parts of the region,
M-REITs are much less susceptible to the risks of having little access to debt
capital, and requiring cash calls. M-REITs have also thus far been shielded by
their sheer simplicity, such as not having gearing and development limits (which
are imposed in Australia) and not having forex exposure (which is affecting
Singapore REITs).

Nevertheless, M-REITs still face 3 key challenges in 2009-
(i) Refinancing (higher interest costs),
(ii) Recapitalisation (strengthening
balance sheets ahead of possible turmoil), and
(iii) Revaluation (capital values have peaked in 2008, and lower rental reversions may lead to downward revaluations).

The magnitude of these risks depends very much on the health
of Malaysian economy and the banks, which we assess as moderate.
Refinancing risk comes in two forms:

(i) the inability to refinance short term
liabilities, and

(ii) if refinanced, at higher interest rates. M-REITs have debt-toasset
ratios of 11-41% (Dec ’08) with about RM1.24b of short term debt (54%
of total debt) due for refinancing in 2009. Relative to regional peers, Malaysia’s
financial system is still flush with liquidity. But there is an ongoing false
assumption that cheap money is always available, especially if liquidity

One foreign bank has cut off fresh loans to REITs (and property
developers) while others have increased credit spreads to compensate for
heightened business risk (thus offseting BNM’s 150bps cut in OPR since Nov
‘08). Overall, refinancing risk remains under control for M-REITs.
Recapitalisation risk hinges on refinancing risk. We may see equity raising
exercises by highly geared M-REITs that need to recapitalise balance sheets
and those wanting to position themselves for the next market recovery. A
common recapitalisation method in Singapore is rights offers (Saizen REIT
even threw in warrants) although it is dilutive in nature.

We think a dividend reinvestment scheme has longer term appeal, which may slowly gain popularity. But, asset disposal could be the last line of defence. Manageable revaluation risk. Steep upward rental reversions amid recent economic boom led to the asset bubbles in Singapore, which was also accentuated by lower cap rates used.

While capital values in Malaysia peaked in 2008, there was no asset bubble. Nonetheless, it is reasonable to anticipate downward rental reversions of 10-15% in 2009-10. In theory, the most
susceptible REITs to these three key challenges are (in order of susceptibility):
industrial (especially with export-oriented tenants), retail (in particular, high-end
retail) and office (especially those outside the CBD area) REITs.

Downside largely priced-in.
We believe the market has largely priced-in zero asset growth, lower rental reversions and a slowdown in rental collections (and perhaps some defaults) for 2009-10. M-REITs presently trade at 14-45% discount to NAV. With dividend yields of 9-13.7%, M-REITs have priced in net
property yield corrections of between 9-35% (see table on page 8), implying reasonable, sustainable dividend yields of 5.7-9.1% on a worst case basis. Our top picks among M-REITs are Quill Capita Trust and Axis REIT. We also like UOA REIT and Tower REIT for exposure to the office space segment. On the other hand, Starhill REIT is a prime takeover candidate.

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