2018

Dear Unitholders,

Our portfolio is weathering the economic challenges, our financials are holding up and we are proud to announce a solid dividend again for the year.

CEO's Letter to Unitholders from Hektar REIT's 2018 Annual Report.

On behalf of the Board of Directors, I am pleased to present to you the achievements and activities of Hektar REIT for the year 2018. The past year has been one of challenges and renewal. In the previous annual report, I mentioned that Hektar was undergoing the process of adaptation. I am pleased to share that this process has progressed well and is continuing in a positive manner. Our portfolio is weathering the economic challenges, our financials are holding up and we are proud to announce a solid dividend again for the year.

Market overview

The retail sector continues to reflect the volatility of 2018 due to changing sentiment and the shifts in government policies. Malaysia recorded its first change of government in six decades. The installation of the Pakatan Harapan government saw the swift removal of the much-maligned Goods & Services Tax, resulting in a consumption mini-boom before the re-implementation of the Sales & Services Tax in September. Their maiden budget announced in November 2018 reflected the country’s new priorities in reorganising the finances and restructuring the economy. Significantly, the new government offers the prospect of hope that genuine reform may lay the foundations for developing a sustainable economy in the future.

The challenges within the retail industry and the overall economy remain in the spotlight for investors. The World Bank has lowered Malaysia’s economic growth projection to 4.7% for 2019 while the Malaysian Retail Chain Association targets retail sales growth of 5% in 2019. The subdued forecasts are in line with the sentiment of uncertainty arising from global macroeconomic trends. The challenges within the Eurozone, the prospect of a messy BREXIT and the US-China Trade War have all contributed to an atmosphere of volatility.

In general, the retail industry continues to undergo a structural change, with the inexorable growth of online retail spending shifting consumer consumption patterns. Coupled with the rise of social influencers, online retailing continues to impact certain categories of retailers. Overall, the new government policies and the realities of the new online economy have served to positively impact our management thinking and strategy going forward.

Hektar REIT continues to provide a stable dividend track record, paying more than 90% of its distributable income to unitholders

Commitment to timeless principles

Hektar remains committed to its goal to invest in and manage neighbourhood shopping centres in well-established market catchments. This has been our strategy since inception and continues to be relevant after 12 years. Our strategy is derived from timeless principles: the right location, the right sizing and the right tenant mix. The old mantra of ‘location, location, location’ remains a key principle in real estate. Three of our malls are “the only mall in town”, while the other three are the “leading malls in town”, usually in the best spot in the neighbourhood. The right size is important – none of our malls are too big or too small, instead, we think that they are just right – the “neighbourhood” size. Our malls’ NLA are around 500,000 square feet or less – this is an important distinction since at this size, our malls only need to focus on primary catchment trade areas within 15-minutes’ drive-time to attract the necessary traffic. This reduces the scope of competition since most of our neighbourhood malls are in built-up residential areas. The average age of our malls is 19 years old, reinforcing our focus on mature, established markets. Ultimately, creating the “right” tenant mix is the most important criteria of a successful mall. We invest significantly in getting the right tenant mix, ensuring an emphasis on “value and convenience” to the shopper and the need to provide basic “necessities” to the local community. In other words, we strive to make sure our tenant mix remains relevant to the local community.

These principles of the “right” location, sizing and tenant mix has resulted in a diversified mall portfolio. Hektar REIT’s portfolio spans 6 geographically distinct urban areas in 4 states. Each mall serves a market catchment population of at least 190,000. This diversification approach assumes that with good management, barring a major economic recession, the portfolio can continue to grow despite fluctuations in local markets.

For example, the Klang Valley is the largest contiguous market in Malaysia and offers the best prospects for growth in retail. It is also the most competitive market and arguably at its most saturated in years, with many new malls and new, inexperienced players entering the industry for the first time. Hektar has a mall in Selangor, namely Subang Parade. The Malaysia Shopping Malls Association (PPK) estimates that there are 165 malls in Selangor. On the other hand, Hektar also has a mall in Kulim, Segamat and Muar where each one is the “only” mall in town. Hektar’s malls in Melaka and Sungai Petani are considered to be the “leading malls” in their respective markets. So while there is intense competition around Subang Parade, the rest of Hektar REIT’s portfolio continues to grow in their respective markets, ensuring overall growth for the REIT.

Portfolio review

The portfolio performed adequately in 2018. We definitely believe we can improve our performance in the future. In general, the challenges in two of our markets were balanced out by growth in the remaining four markets.

Occupancy for the portfolio declined to 92.1% in 2018 down from 95.1% in 2017. This is mainly attributed to changes in the tenant mix in Subang Parade and Segamat Central. Visitor traffic in the portfolio saw declines in three malls; the major drop was attributed again to Subang Parade’s changing tenant mix. The bright side is that our malls in Central Square and Kulim Central recorded visitor traffic increases of 18.4% and 81.8% respectively. Both have been refurbished in 2015 and 2017 respectively. Combined with our new acquisition in Segamat, Hektar portfolio traffic attracted 32 million visits in 2018.

The most compelling statistic was our rental reversions. For 2018, our portfolio rental reversions recorded a positive 5.4%, despite the changes occurring in our malls amidst an uncertain market. Subang Parade and Segamat Central reversions were flat and negative 9.8% respectively due to their changing tenant mixes, while the other four malls contributed positively. Kulim Central, the latest Hektar mall to receive a refurbishment in 2017, led the way with rental reversions of 16.4%, followed by Mahkota Parade with a positive 15.0%. This once again underlines the benefit of a diversified portfolio.

Our strategy is derived from timeless principles: the right location, the right sizing and the right tenant mix

Subang Parade

Subang Parade’s occupancy dipped to 88% while its traffic dropped 21%. This is largely because it was undergoing an asset enhancement and improvement of its tenant mix which included removing some of the older tenants. The closure of a mini-anchor also resulted in a drop of traffic, but this is expected to rebound once it is reopened. Finding the “right” tenant mix is part science, part art and staying flexible is key due to the complex behaviour of consumers and shopping trends. We decided to take a bit more time and be more selective in creating the “right” tenant mix. Subang Parade remains the leading mall in Subang Jaya, an iconic location for over 30 years and we intend to maintain its position.

Historically, after an acquisition, Hektar plans on average up to 4 years before executing an AEI or refurbishment. The reason is simple: Hektar takes the time to understand the consumers in each market. The analyses come in the form of primary market research including exit surveys, household surveys and focus groups as well as analyses of shopper spending patterns. Understanding the market is very important to create the “right” tenant mix. Aside from minor asset enhancements such as the introduction of MBO in 2011, Subang Parade’s last major refurbishment was done 12 years ago and it is therefore overdue. Our team won’t rush the job, though. We will plan carefully. Our current timeline is to complete the asset enhancement works through 2019.

Mahkota Parade

Mahkota Parade has enjoyed a good year in part due to new exciting retailers entering the market. New entrants in Mahkota Parade such as JD Sports and LOL have created an impact. Due to Mahkota Parade’s central location in the historical Melaka district, the mall enjoys domestic and international tourist traffic. Mahkota Parade enjoyed rental reversions of 15% in 2018, with occupancy reaching 96%.

Wetex Parade & Classic Hotel

The only mall in Muar enjoyed a relatively positive year with occupancy at 98.5% and rental reversions at 11.8%. Visitor traffic was relatively flat at 4.3 million, a decline of 2.3%. Wetex is popular as a destination to buy gold or jewellery in north-western Johor state: there are five jewellery and goldsmith shops in the mall alone.

Hektar relaunched Classic Hotel in a soft re-opening in December 2018. Classic Hotel is part of the Wetex Parade development purchased together in 2008. After the expiry of the 10-year lease from the previous operator, Hektar took over operations and spent RM8.6 million in refreshing the guest rooms and suites and revamping the airconditioning system. Classic Hotel is the largest hotel in Muar with the largest ballroom facilities. At the moment, some reconfiguration of space is being done to optimise the retail space area adjacent to Wetex Parade.

Central Square

Visitor traffic in Central Square climbed to 4.5 million visits in 2018, up 18.4%. The mall was refurbished in 2015 and continues to attract new tenants and customers. Occupancy is up to 96.9% and rental reversions remain strong at 11.5%. Central Square is regarded as the “leading mall” in Sungai Petani, owing to its positioning as the place to purchase IT & electronics and also features the only McDonald’s in town.

Kulim Central

The refurbishment of Kulim Central was completed in late 2017 and the revival in 2018 continues. Visitor traffic increased dramatically, reaching 4 million visits, up 81.8% from the previous year. The new NLA space has been taken up, with occupancy now running at 93.5%. New entrants such as Starbucks and Texas Chicken appeal to Kulim residents, known for its high-tech park featuring numerous multinational corporations.

Segamat Central

Hektar’s newest acquisition, Segamat Central is entering the first phase of the asset enhancement & refurbishment cycle. The anchors have been replaced with a new supermarket operator TF ValueMart and mini-anchor Mr. D.I.Y., opening to great fanfare in late 2018. Occupancy has dipped to 78.6% as management cleared out older tenants to pave the way for new, exciting middle-class brands. The market research exit survey results will be collated and further research will be carried out before a comprehensive asset enhancement & refurbishment plan is executed in the coming years.

Our portfolio rental reversions recorded a positive 5.4% in 2018

Operational efficiencies

One of the major initiatives touted last year included a comprehensive review of the portfolio energy usage. Planned initiatives which resulted in the revamp and replacement of the existing air-conditioning and mechanical ventilation systems (ACMV) and targeted reduction in CO2 usage. Other initiatives ranged from recalibration of operational settings to improvements in preventive maintenance measures. In 2018, these initiatives resulted in cost savings of RM2.6 million.

Financial review

Revenue reached RM135.1 million in 2018, up 7.6%. Operational expenses increased to RM56.4 million, up 8.9%. The resulting net property income reached approximately RM78.7 million, up 6.8%. The major new contributor in 2018 was the addition of Segamat Central, whose tenant mix is currently being reviewed.

Realised net income before tax reached approximately RM42.3 million, an increase of 5.3% from the previous year. Borrowing costs also climbed to RM25.3 million, up 9.1%, reflecting a gradual rise in rates.

Efforts continue to be made to improve operational efficiencies within the portfolio, including the expansion of energy and water efficiency strategies and upgrading of ageing equipment. Rationalisation of costs is a major theme for management in 2019, with each department within the organisation expected to review their operating cost structure and maximise income generating opportunities. Revenue maximisation initiatives such as car park day rates and valet, improving advertising income and other initiatives are being implemented at each mall.

Financing

Hektar REIT’s financing comprises Al-Murabahah overdraft facilities with a combination of term loan and floating rate facilities. In total, the facilities amount to RM563 million, providing Hektar REIT with a gearing ratio of 44.4%. Of this amount, RM15 million is a revolving credit facility renewable annually, RM30 million due in 2021 and the bulk of RM518 million due in 2024. The management is actively exploring a Medium Term Note programme to tap into the debt market.

Distribution

Hektar REIT has declared its fourth quarter DPU at 2.31 sen, capping off the year at a total of 9.01 sen per unit. This is a decline of 6% from the previous year, owing to increases in the aforementioned costs. In total, the distribution payout in 2018 is RM41.6 million, a slight increase of 2.8% due to the enlarged units base in 2017.

Hektar REIT continues to provide a stable dividend track record, paying more than 90% of its net income to unitholders. Collectively, Hektar REIT has paid more than RM452.6 million in dividends to unitholders since 2006.

Commitment to strategy

Hektar’s strategy of focusing on neighbourhood malls with the “right” location, sizing and tenant mix distinguishes it from other REITs. We will continue to create shopping centre environments around enriching experiences of consumers and retailers. We remain committed towards meeting the long term expectations of our shoppers, unitholders and staff.

Hektar REIT recently won Gold at the Asia Pacific Best of the Breeds REIT Awards 2018 held in conjunction with the 5th REITs Asia Pacific 2018 Conference in Singapore. The awards was organised and presented by The Pinnacle Group International. We remain humbled by international recognition of our team’s hard work.

Hektar’s strategy of focusing on neighbourhood malls with the “right” location, sizing and tenant mix distinguishes it from other REITs

Acquisitions

Hektar REIT’s acquisition “pipeline” consists of suitable candidates, generally neighbourhood malls of around 500,000 square feet in size and with mature catchments. Ideally, acquisition targets which are underserving their markets provide Hektar with opportunities to improve the mall via asset enhancement. However, Hektar will also consider investments in mature properties with a strong captive market catchment population of at least 150,000. The REIT is investing for the long term. We believe that ultimately, a ‘network’ of neighbourhood malls strategically located throughout Malaysia would serve as an ideal ‘platform’ for emerging brands.

Acknowledgments

We record our deepest appreciation to our former chairman, the late Mr. Michael Lim Hee Kiang, who passed away on 16 May 2018. Michael was a prominent lawyer with over three decades of experience in the legal profession. He served as Chairman of the Board from 2015 to 2018 and was a recognisable face within corporate Malaysia, sitting on several listed company boards. We remain grateful for his committed leadership, keen interest in the affairs of the company and wise counsel. He will be missed.

On behalf of the Board of Directors, I wish to extend my appreciation to the management team and staff for their hard work and diligence in 2018. We anticipate 2019 would require the team to work even harder, but we believe in creating a conducive and rewarding environment to encourage our employees to excel. We hope our unitholders, retailers and shoppers continue to retain their trust in Hektar REIT.

Dato’ Hisham bin Othman
Executive Director and Chief Executive Officer