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Malaysia: Weathering the Financial Downturn
20 May 2009
Stewart LaBrooy, CEO/Executive Director, Axis REIT Managers, Malaysia
Do you invest solely in property in Malaysia?
Yes we do, experience in the region has shown that there are certain issues affecting cross border acquisitions and they can disappoint in terms of total returns. Cross border investments have the following risks: currency risk, repatriation of capital risks, title risk, political risk and the write down of investments due to currency volatility. With the flood of cheap funding available prior to the current global financial crisis , fund managers were acquiring assets very aggressively outside their home base -often in foreign currency and with scant regard to building a decent risk spread into the projected returns.
Over here in Malaysia we have always maintained that only once you have exhausted what you can buy in your own home country, then you possibly look outside; but even then, it is not always advisable to bring those assets into a local based portfolio. Only 14% of investment grade real estate is listed over here. We take the position that if an investor wants to have exposure to Malaysian property, he’d buy a Malaysian REIT and if he wanted to buy Thai property, he would go to Thailand and buy a REIT there.
Rather than cross border acquire, I would prefer to set up a REIT in those countries provided that there was REIT legislation in place. In doing so the taxation and flow of distributions are far more transparent and the risks are measurable. The yield should cater for the investment risk. In Asia the issue of ownership is an ongoing concern as many countries do not allow 100% foreign ownership (such as Thailand & Indonesia). In addition title security and short land leases make it very difficult to price assets- to us it just adds up to too much risk to bring into a fund’s profile.
We run a conservative fund and we have stuck to the traditional REIT model, not venturing to the more exotic and leveraged stapled models. As a result I think we have been fairly well ring-fenced in terms of our risk exposure.
How has the property sector been affected in Malaysia by the global financial crisis?
Malaysiafortunately has not been too badly affected, primarily because we weren’t in a property bubble. Values here have not moved as aggressively upwards as compared to Singapore, Australia or even the US. What we have had is a very gentle rise in valuations and as a result there has been no big assets write downs. Our own assets have been holding very well in terms of their valuation and banks have not been taking any write downs on their books.
Is there still plenty of liquidity in the market?
Yes, the market is extremely liquid and the banks are flush with cash. The central bank here has been extremely conservative in its policies in terms of allowing banks to aggressively market the exotic derivatives or hold them on their balance sheets. As a result, the banks here have not been subject to what went on in the States. They are very well capitalised right now.
We learned a big lesson in 1998 during the Asian financial crisis and I think that is why Asia as a whole is so resilient right now.
Singaporewas starting to show signs of a bubble prior to the crisis and as a result they have been quite badly affected – their REIT market at the end of last year was down 56 percent and it actually underperformed the STI, which is unusual. REIT Stocks started behaving more like equities rather than REITs. In order to grow, some Managers were revaluing their portfolios every quarter and gearing up against the gains to acquire more property. Cheap money meant that valuations were rich and cap rates were low.
Rentals in Singapore had also started to overtake Hong Kong in 2007 and that to me was a real danger sign.
With the exodus of the hedge funds and the downsizing (and closing) of Investment Banks, office space came under pressure and with it a fall in rentals and valuations.
Hong Kong however is a different market and has proven more resilient- they have China next door.
Do you think there need to be international standards for valuations?
We run a REIT and coming from an investment holding property company we are very close to the ground in terms of valuation. I think that international standards on valuations are definitely something we would welcome as it brings more transparency to the industry.
But after what happened with the rating agencies in the recent crisis, everyone gets carried away in a bull market and history repeats itself time and time again. In the process valuations are pushed up aggressively. Bubbles will always occur and with it sharp corrections.
Housing, for example, has to be affordable. If homes are being priced out of the ability for people to pay, as happened in the States, you’re going to get a collapse in values. So there has to be some rationale, assets can’t keep going up in price indefinitely
How exposed are you to tenant risk?
It is a concern for everyone in our industry. Many tenants are feeling the pinch but not as badly as we thought they would be. There seems to be a fair amount of resilience amongst companies in Malaysia right now. Inventory levels have been depleted badly, so much so that we are seeing a strong pickup in orders. Fortunately our export sector is not in the heavy industry category (like automotive, white goods and brown goods as well as heavy industry) but rather in the electronics sector which is currently very resilient. Coupled to that, we have a strong commodity sector (Oil and Gas and palm oil and rubber). So as a country we are fairly well positioned to ride this one out.
To what extent is political instability an issue for investors?
We have experienced a sea change in our political landscape since the general elections a year ago. In as much as there has been an increased representation of the opposition in parliament, the government of the day is running fine. Governance has improved tremendously and there have been many positive changes to the way we do business here in Malaysia since March last year. We have a new cabinet in place, which seems to be very keen on doing the right thing, and the stock market is reflecting a renewed confidence. I don’t think we have anywhere near the risk that we have in countries like Thailand for example.
Have FDI levels to Iskandar been affected by the global financial downturn?
Iskandar is reliant on foreign direct investment (FDI)to make it work. Although there has been some success I think things will slow down but the project as a whole is still very viable. When Singapore’s economy recovers, which it will, there will be a renewed interest in Iskandar for the relocation of some of the businesses from Singapore.
Plans for an excellent infrastructure in the Iskandar development is in place, much of which has commenced. It’s big plus is the fact that it is located right next to the second link to Singapore.
A lot of Singapore based businesses are already building new factories in Johor Bahru. The FDI’s are still coming in (Oil & Gas in particular) over the last couple of years – I was surprised myself because I visit there very often as we have got assets there.
Have any major projects been put on hold or been cancelled?
No. I think there are some delays with the second Penang Bridge, more political than anything else, but they will have to go ahead with it anyway because of contracts awarded. The difficult portion is the structures crossing the water which have already started.
There is a big push to put in place more transport infrastructure projects and many of these have commenced.
Do you think there will be an increase in Shariah compliant REITS?
I think Islamic Finance is definitely becoming more popular and Malaysia leads the world in products, legislation and services.
Islamic Finance was very robust and we can get access to re-financing quite easily, more so as we are Shariah compliant. One of the main advantages of us becoming an Islamic REIT was that now we actually have a much larger investment universe. For example in Malaysia there are several Shariah-based funds which could not invest in our Units before, but they are now accumulating stocks in the market which has helped our stock price. We had a low in December of $1 but we are back up to $1.43 - $1.50 and are now Shariah compliant.
Malaysiais unique because it is the only place in the world that has structured regulations for Shariah compliant REITs.
To be Shariah compliant Malaysia allows a 20 percent tolerance level of non- permissible activities (much higher than GCC countries of 5%) although we are currently floating around six or seven percent. Slowly we are bringing that down to below five so eventually we’ll try and go for GCC compliance.
However some REITs that exist have to ensure their compliance levels. Currently there are 3 out of 11 REITs in Malaysia that are Shariah compliant.
How transparent are the capital and property markets?
I think there has been a huge change in how we do things here in Malaysia. The big listed property companies are becoming being extremely innovative in the kind of products they are offering both in design and financing. Quality has also improved tremendously.
Malaysiahas probably the best property developers that can build townships (and fast) as well as infrastructure. This can and is enabling them to outbid the competition in the region. We have a strong presence in India, Vietnam and the Middle East.
There are a lot of skill sets here which are quite applicable to the needs of the region and we’re quite a low cost developer in terms of the fact we’re not expensive and salaries are nowhere near what they are in the UK or the US. So we can outbid a lot of projects on a global basis.
With regard to the transparency, the Securities Commission has come down really very hard on companies that do not comply with a lot of focus on corporate governance and disclosure. It has been a complete change around from five years ago. We have seen a big improvement in this area which says a lot for the way the Securities Commission is being run right now- they have done a very good job.
Malaysia is an emerging market – in what respect is it emerging?
We have a goal to have Developed Nation status by 2020. I think the key to succeeding in achieving Developed Nation status rests with us having a very strong educational system. We need to develop a pool of knowledge workers to stay on and work in our own country before we can actually move up the value chain. We need to develop a population that effectively earns much more than they currently do to drive up domestic consumption.
Innovation, transparency and governance are the building blocks and I think we are ahead of a lot of countries in ASEAN, barring of course Singapore and Hong Kong. I think we stand head and shoulders above many ASEAN nations in respect of what we have achieved in terms of infrastructure, governance, land laws and how people do business here. A big initiative taking place is to improve the speed of actually getting things done and with a relaxing of the equity conditions, we hope to be much more competitive regionally.
Government services are now being extensively computerised; for example recently it took me just one hour to get a new passport. Malaysia has invested heavily in changing how we do things over here and in some ways I believe that we may be ahead of developed nations now. It has taken a long time to get here but I think we are finally getting the systems that matter in place and it is getting a lot easier for businesses to manage their affairs right now.
Has this made it easier for foreign investors?
Malaysiais making it a lot easier for foreign investors now and in fact they are rolling out the red carpet. Recently the Government has announced a whole raft of incentives including the much criticised equity conditions. These have been relaxed - for example companies such as insurance companies; foreign majority ownership is not an issue anymore. They are giving licences out and with a view to attract more investors into the services sector where we see our future growth coming from. We can’t afford to be a low value add industrial nation forever, we have to move up the value chain. We see this coming for instance from becoming an Islamic Finance hub for the region, becoming a portal for all investments from Islamic countries into India, China etc.
What challenges and opportunities do you foresee over next 12 months?
I think it is going to be business as usual here in Asia. Opportunities will arise and we see possible asset purchases coming up in the next 12 months. Raising capital here is not an issue. There are even opportunities to buy in Singapore, for instance where asset values have fallen sharply and are definitely a lot more attractive now compared to 12 months ago. These values will bounce back with a sustained recovery which is targeted in Q4 2009.
Have you had to change your strategy in light of the global financial downturn?
No, going Shariah was a big strategic shift for us and we just completed the whole exercise in December. We are still adjusting to it but we’re finding that we’re getting some pretty good positives out of it. In terms of moving cross border, we have made a decision not to look at it because I think the risk factors are a deterrent. As a manager, we would rather set up joint ventures in countries where we can set up REITs and then take a share as the manager there and do the fund management business in that country. Maybe instead of physical properties REITs can get their cross border exposure through holding REIT units as it makes far more sense in terms of repatriation of profits and reduced risk.
Do you think the way to encourage cross border investment is through REITs?
It is. People have always said that you invest in two things; you invest in equities or you invest in property. When REITs came along you could buy physical through an equity instrument. But then people forgot that was what they were investing in and they expected REITs to perform as equity. You buy a house, or a commercial space for income. REITS offer you that portfolio diversification possibility
An investor of property can gain exposure to properties in UK or USA through investing in REITs and ride the property cycles in different parts of the world through these equities.
But I ask that they check what they are buying. Some listed REITs have become very complex instruments with very different risk profiles. I believe that buying into conservative funds is the best option. There is now a return to basics – investors are saying ‘Let’s go back to the simple, boring old REIT structures’.
Source: Cityscape Intelligence