Letter from... Malaysia

Nazatul Izma Abdullah reports

Malaysian real estate investment trusts (M-REITs) have obtained a fresh lease of life, thanks to new guidelines on REITs issued by the Securities Commission in January and attractive tax incentives. REITs are funds that invest primarily in real estate and pay out most of their rental income as dividends.

Although Malaysia was the first Asian country to develop a framework for property trust funds based on the Australian model in 1986, the sector did not take off as expected. There were many reasons: a restrictive regulatory structure, a dearth of tax incentives, and the fact that only subsidiary companies of financial institutions—which were short on professional real estate experience—were allowed to set up and manage these funds. The upshot: the three existing listed property trusts on the Malaysian stock exchange historically traded at sizeable discounts to their net tangible asset values and commanded scant investor interest.

Today, there is plenty of interest, stoked by several Malaysian public-listed companies with heavyweight real estate portfolios which have announced upcoming REITs. Notably, YTL Corporation will be REITing JW Marriott Hotel and its upmarket Kuala Lumpur malls—the Lot 10 Shopping Centre and Starhill Gallery—and there is speculation that KLCC Property Holdings may REIT its impressive portfolio, which includes the Petronas Twin Towers, the Suria KLCC mall, the Mandarin Oriental Hotel, the ExxonMobil and Maxis office buildings, and the Dayabumi retail-cum-office complex, which had a total net book value of RM5.91bn as of the end of 2003. Investment banker Sherilyn Foong lists at least 10 other potential M-REIT candidates in her book, Road to Riches with REITs.

Given that M-REITs are in their infancy, gross dividend yields are expected to be more attractive at about 6%-8% compared to REITs in more mature markets like Singapore and Japan. Registered valuer, Gurjit Singh, estimates that “Singapore is averaging 3.5% to 5.5% while Japan is lucky to have 3%”. In fact, the first M-REIT listed under the new guidelines—the Axis REIT—was offered to the public in July at a price of RM1.25 per unit for a yield of above 8%. “The yields are still attractive but may be short-lived as the M-REIT market matures,” notes Foong.

Malaysia still has to fine-tune its tax treatment of REITs to make M-REITS globally and regionally competitive. “International investors will invest if the yields are superior and the tax structure is cheaper—note that the tax structure is not as attractive as Singapore,” says Singh.

Singapore’s total tax exemption on REIT distributions to residents and 10% withholding tax for non-residents has been a major impetus for growth in S-REITs, which now make up about 2%-3% of Singaporean stock exchange market capitalisation. Malaysia, on the other hand, imposes a steep 28% withholding tax for non-residents, which may deter foreign investors. Domestic investors also get taxed, albeit at their own tax brackets, which is a far cry from no tax. “Permissible direct investments in S-REITs by CPF (Central Provident Fund or the state pension fund) contributors in Singapore have also contributed to growth,” explains Foong.

However, many expect the Malaysian tax regime for REITs to catch up with Singapore soon. Both Foong and Singh predict that further tax liberalisation should occur within the next 12 months or so.

Growth may also be hampered by limited top-quality REIT-able properties in Malaysia. To sustain globally-competitive dividend yields, REITs typically rely on a yield-accretive strategy, where they have to continuously purchase performance-grade investment properties with acceptable yields. “These may be few and far between in Malaysia, and would exist in the CBD (central business district) and urban areas of the Klang Valley and Penang,” says Singh. Foong explains that as M-REITs mature, the next phase of growth would probably be derived from cross-border acquisitions.

Nazatul Izma Abdullah is a freelance writer on business and finance issues, based in Malaysia.