2011

Dear Valued Unitholder of Hektar REIT,

I am pleased to report that Hektar REIT has recorded another year of encouraging results in 2011. Hektar REIT’s portfolio of three retail malls have made solid contributions in delivering positive results for the financial year ended 31 December 2011 (FY2011).

Chairman's Letter to Unitholders from Hektar REIT's 2011 Annual Report.

I am pleased to report that Hektar REIT has recorded another year of encouraging results in 2011. Hektar REIT’s portfolio of three retail malls have made solid contributions in delivering positive results for the financial year ended 31 December 2011 (FY2011).

The prolonged economic uncertainties posed by the Eurozone’s soverign debt crisis and the slow US economic growth recovery has not significantly dampened the domestic retail industry in 2011. The local economy and specifically the domestic retail sector have shown their resiliency to external shocks. Malaysia Retailers Association (MRA) reported in their 3rd Quarter Malaysia Retail Industry Report that retailers still saw their sales rise by 6.8 percent in the first 9 months period of January-September 2011 amid the attractive discounts thrown in to lure shoppers. On quarter per quarter basis, the 7.0 percent 3rd quarter 2011 sales growth is lower than the 2nd quarter 2011 growth rate of 9.1 percent. Nonetheless, the members of the retailers’ association remained optimistic that in the 4th quarter 2011 will see sales rise by 10 percent as compared to the same period last year. The Malaysian economy has remained strong where its third quarter Gross Domestic Product (GDP) expanded at a higher rate of 5.8 percent from 4.3 percent growth in the second quarter. Bank Negara Malaysia (BNM) reported that the robust domestic demand was driven by strong household and business spending as well as higher public sector expenditures.

Given that Eurozone’s sovereign debt crisis is still persisting and the risk of further worsening economic condition remains high, we are cautiously optimistic in our plans moving forward. We are confident at maintaining positive results in the forthcoming year on the back of our tried and tested business model based on best practices and a focused commitment to our customers - the tenants and their shoppers.

We have a committed management team who is focused in ensuring effective and efficient execution of business plans made for the financial year. The encouraging FY2011 results are a testament to the sound foundation that Hektar REIT has developed throughout the years since its listing.

Financial performance

Solid financial performance

For the FY2011, gross revenue reached RM94.9 million, up approximately 4 percent from the previous year, while Net Property Income (NPI) reached RM58.3 million, also up 5 percent from the preceding financial year ended 31 December 2010 (FY2010). Net Income reached RM86.7 million, significantly higher by 121 percent over FY 2010 at the back of the RM 47.7 million gain on fair value adjustment on investment properties. Hektar REIT's realised net income edged up 1.9 percent to RM 38.9 million in FY 2011.

In summary, gross revenue was higher whilst costs of operation had remained under control despite the inflationary push in 2011 generated from the pull back of government fuel subsidies.

Following these results, the portfolio’s assets were revalued upwards and are now collectively valued at RM822 million. As a result, Hektar REIT’s Net Asset Value (NAV) has also increased to RM1.48 per unit.

Fair value adjustment

Fair value adjustment is a non-cash item and is part of the Financial Reporting Standards (FRS) guidelines adopted on the valuation adjustment for Hektar REIT’s property portfolio on an annual basis. Valuations are conducted by independent valuers whose reports are made objectively to determine the market value of a property at that time. Asset managers constantly look for ways to enhance or refurbish properties to improve their income generating potential and ultimately increasing their property values. The 9.3 percent increase in valuation of the properties in FY2011 to RM822 million fairly reflected the portfolio’s income-generating capability. The various planned asset enhancement and tenant remixing exercises during the year had achieved the desired results envisioned by the asset manager. Please read on for more details on our asset enhancement activities executed during the year.

Dividend payout & accounting policy

Hektar REIT announced a dividend per unit (DPU) of 10.50 sen for FY 2011, a 2 percent improvement as compared with the dividend payout made in FY2010.

We have maintained a policy of paying out at least 90 percent of our distributable net income in four quarterly dividend payments throughout the year. We should clarify that distributable net income is net income excluding non-cash items, such as fair value adjustments (usually attributed to property value increases under FRS 140) and items under FRS 117, an accounting standard implemented in FY2010 (see the notes to the accounts for more details). As a result, the FY2011 distributable net income is lower than the net income. After paying 90 percent of the distributable net income, Hektar retains the remaining 10 percent for future asset enhancements of the properties and potential acquisitions of sold lots throughout the Hektar REIT portfolio.

Positive track record

In terms of revenue, NPI, EPU, NAV and asset value, Hektar has continuously recorded improvements every year since its initial public offering (IPO) at the end of 2006. The stock market took cognizant of these records and rewarded Hektar REIT’s unitholders with a fair valuation of the units in circulation. Throughout FY2011, the market price of Hektar REIT had consistently mirrored the NAV of Hektar REIT.

Refinancing in 2011

Following the last 25 basis points increase of the Overnight Policy Rate (OPR) in the month of May this year to 3 percent, the OPR rate has remained unchanged since. The Bank Negara Malaysia stance of maintaining the OPR is consistent with the general assessment of heightened uncertainties arising from the global developments that have created bigger downside risks to growth.

Hektar REIT’s financing is secured by Al-Murabahah overdraft facilities with 3 tranches worth RM150 million, RM15 million and RM184 million expiring in 2013, 2015 and 2016 respectively. Hektar REIT’s gearing ratio is 41.9 percent of gross asset value which is well within the 50 percent limit set by the authorities and the weighted average cost of financing as at the weighted average cost of financing as at end FY 2011 is 4.2 percent. The financing cost during FY2011 increased by 26 percent compared to FY2010 mainly due to the rise of the interest rate and borrowing level.

The first tranche of the debt of RM184 million had expired and was extended by another 5 years. Our bankers have again supported Hektar REIT and we are very thankful for their continuous faith in us.

Portfolio performance

Hektar REIT’s portfolio of assets consists of Subang Parade in Subang Jaya, Mahkota Parade in Melaka and Wetex Parade in Muar. Collectively, these properties serve a market catchment of 1.3 million Malaysians. As they are located in densely populated areas, the properties enjoy a relatively high loyalty rate from locals. More than 300 tenancies representing a spectrum of businesses from retail to entertainment are present in Hektar REIT’s properties.

The shopping centre experience

Hektar REIT’s motto is about “Creating The Places Where People Love to Shop” and the business model employs international standard best practices. Our team constantly researches and reviews best practices through training and conferences around the world. Consumers want the latest retails concepts and offerings, and therefore we are constantly on the lookout to bring in new retail formats to keep our centres relevant to customers.

One of Hektar REIT’s proven strategies for a differentiated retailer mix is to incubate new local retailers thus providing a differentiated experience for our shoppers. We have successfully introduced new retailing methods for our budding entrepreneurs in the form of the Retail Merchandising Unit (RMU) and Stand-Alone Counters (SAC).

The RMU is essentially a cart vehicle with a point-of-sale podium which we lease out for short periods to new retailers. The start-up costs for the new retailers are comparatively lower as the RMU is a ready-made store and display unit. We have set up RMUs at all our centres and have received encouraging responses, mainly from fashion and specialty / novelty retailers. The concentration of such units attracts traffic and ultimately, customers for the retailers.

Once proven to be successful, these new local retailers can then opt for larger and more permanent outlets, of which we offer the Stand-Alone Counter (SAC) and the Net Lettable Area (NLA) lots. The SACs are permanent counters set up in common area spaces which allow retailers more versatility to display their retail offerings without requiring high capital expenditure whilst, the NLA lots are the standard lots with the highest start-up capital.

An entrepreneur could grow along Hektar’s incubator system in the following manner: from RMU to SAC and finally to their own NLA lot. At each step of the way, the entrepreneur can refine their retailing concept with reduced start-up costs. When successful, the emerging retailer can invest further to expand the retailing concept for the full-fledged experience.

We believe this incubator concept will prove useful in cultivating new retailing ideas over time and ultimately provide a differentiated retailing experience for our shoppers. Our retailers are our business partners and therefore, we strive to offer them an environment which closely meets their business requirements. This incubator service is one of the ways in which Hektar can attract new business partners over time.

Over the years, one of the shifts in retailing is the revitalisation of the shopping centre as a communal place. Shopping centres continue to emerge as a ‘favourite meeting place’ in this part of the world. Our overall strategy is focused on ensuring that Hektar REIT’s properties remain as prime points of communal gatherings.

Let us examine below our strategy in the context of our portfolio performance in 2011 below.

Subang Parade’s challenge & opportunity

Last year, we reported that a major strategy was formulated to counter the effect brought about by the entry of a new shopping centre opened across the street. We were of the view that the new shopping centre was complementary to what our Subang Parade had to offer. It therefore has generated positive impact to the existing retail mix in the general surrounding area. In some areas, the new centre did overlap and we did lose our co-anchor, Toys R Us. As a result, Subang Parade’s occupancy fell to 95 percent in FY2010, mainly due to the 20,000 sq ft of space vacated by the co-anchor.

Our management team found a solution to these challenges by introducing the cinema concept in Subang Parade. The main thrust behind the cinema is to substantially increase shopper traffic. A surge in shopper traffic is expected to trigger a cascading effect, which ultimately will result in an upward rental pressure among tenants, as well as attracting new tenants whom, before the cinema, are not keen to do business in Subang Parade. The entry of several international F&B chains like Carl’s Jr Charbroil Burgers, Starbucks, Subway Restaurant and Sunshine Kebab, located in close proximity to the cinema, and are paying relatively higher rental, is early evidence of this cascading effect.

The new cineplex offers 8-screens including the latest 3-D screens. Subang Parade is now the only shopping centre with a cineplex in the Subang Jaya City Centre. With the successful launch of MBO Cinemas in mid September 2011, the cinema concept has reinforced Subang Parade’s appeal as a ‘favourite meeting place’, serving a diverse array of retail offerings that include entertainment for young couples and teenagers.

Other than the development of a cineplex on the first floor, the year 2011 also saw Subang Parade going through other major asset enhancement programs. The management introduced a new food and beverage (F&B) space known as Market Place located on the lower ground floor in the month of October 2011.

This new retail area has enhanced Subang Parade’s F&B offering by another 10,000 square feet combining the local favorites such as JM Bariani House, Kafe Bawang Merah, Siam Express, Rosie, Noodle Express, Sisters Food & Beverages with western delectables such as pizza and pasta brought in by Ristorante Italiano Capriciossa.

Occupancy in Subang Parade has edged up to 99 percent in FY2011. Although the launching of the new initiatives mentioned earlier had only materialized in the latter part of FY2011, Subang Parade visitor traffic was positively impacted, up by 6 percent to 7.95 million visits in FY2011 when compared with the previous year. We are extremely delighted with the reception given by our shoppers and look forward to experience the positive impact on rental reversions in 2012.

Mahkota Parade’s revival

Mahkota Parade completed its refurbishment and was re-launched in May 2010. It enjoyed a full year of post refurbishment operation in 2011. I am pleased to report that the refurbishment has revived Mahkota Parade as the leading shopping centre destination in Melaka. The most encouraging support has come from retailers with new and large flagship stores opening in the centre. Mahkota Parade now boasts Melaka’s largest IT store with tenants from national and international chain occupying the second floor space (ie. All IT and Challenger IT Superstore). Other exciting tenancy mix initiatives lined up during FY 2011 were the entry of Al-Ikhsan, one of the nation’s largest sports store chains, L’Occitane (beauty products outlet), Bossini fashion store and the introduction of new Bonia and Carlo Rino flagship stores at the main entrance.

Mahkota Parade has enjoyed high occupancy rate of 95 percent in FY2011. While the 2009-2010 refurbishment periods had impacted visitor traffic negatively, I am pleased to report that Mahkota Parade had since recaptured the lost traffic in 2011. Traffic had increased by a healthy 14 percent to 8.17 million in 2011.

The responses by retailers and the feedback from shoppers have been very encouraging. They provided us with validation that our refurbishment was the right move to revitalize our centre in Melaka and thus ensuring that Mahkota Parade remains as a leading shopping mall in the city centre of Melaka. We also welcome our new tenants as their brand strength will add to the vitality of our retail offering. I wish them the best of luck and look forward to strengthen our partnering relationship for years to come.

Wetex Parade’s Leading Position in Muar

Wetex Parade enjoyed another year of solid performance in 2011 with increasing rental rates whilst maintaining high occupancy rate of 99 percent. Since acquiring the shopping centre in May 2008, management has continuously implemented tenancy mix changes and improvements on the amenities. We are applying our best practices’ templates and localizing them to the Muar market. The culmination of our market research and introduction of best practices management have encouraged national retailers to venture into the Muar market for the first time. Wetex Parade’s rental reversions had recorded another year of overall positive increases in 2011 reflecting the aggressive tenancy mixing changes that were implemented during the year.

The Quadrix located on the fourth floor was launched late in 2010 as our introduction to Muar of the latest in retailing concept. New tenants were introduced upon the completion of our asset enhancement initiatives to embark on remodeling and refurbishing the top floor retail space. The Quadrix is now anchored by The Music Bank, a family-style karaoke centre while the rest of the floor features lifestyle retailers that include fashion, novelties and communication outlets.

Visitor traffic growth remained steady at 5.9 million visits. Wetex Parade with an NLA of around 155,921 square feet receives a high density of visits per square foot compared to other shopping centres, reflecting its position as the leading purpose-built shopping centre in Muar.

Preparing for difficult times ahead

Our shoppers visit our properties on a daily basis, our retailers are business partners for years and our buildings are expected to last generations. With this perspective, the management is committed to enhancing the values of these assets over the long term horizon. Whilst we aim to improve Hektar REIT’s portfolio value every year, we must be mindful that the economic cycles and investor sentiment may work against these objectives in the short term.

We expect 2012 to be a difficult year given the uncertain global economic outlook. Our domestic economy is not expected to be spared from these challenges and cautious retail environment is envisioned. We will seek to position ourselves in order to cope with adversities that may lie ahead whilst remaining alert to opportunities that may be presented by the vagaries of dampening economic cycle.

In the past, the focused strategy on neighborhood retail adopted by Hektar REIT has proven to be resilient during periods of economic downturn. Neighborhood retail focuses on primary catchment area where the management scans retailers that serve the need of the primary catchment area usually within 15 minutes driving distance. As an example, the targeted retailers are those that sell non-discretionary basic necessities, mid-tier food and beverages, groceries and prescriptions which are proven to be less affected during economic downturn. We therefore remain positive in our outlook for retail development in Malaysia as a source of growth for Hektar REIT.

Acquisition Update

It has always been Hektar REIT’s strategy to increase its portfolio with potentially yield accretive assets. In evaluating potential assets, we employ the following criteria before deciding whether or not to proceed:-

  1. The property yield of the target asset meets industry standard
  2. The offer price of the target asset reflects market value
  3. The target asset has the potential for improvement
  4. Dividend distribution to unitholders is not compromised post-acquisition

In late 2011, we identified two assets that fulfilled all the abovementioned criteria. The requisite announcement to regulators was made in early December 2011. The proposed acquisition of the two malls, both of which are located in the northern state of Kedah, is expected to be completed by the second quarter of 2012. We look forward to share with you more details of the proposed acquisition once we are permitted to do so by the regulators.

Acknowledgements

On behalf of the Board of Directors, I wish to thank our team at Hektar REIT for their commitment and dedication to their work. Our appreciation is also extended to our retailers, vendors and business partners. Your contributions and support ensure that Hektar REIT remains a defensible, safe investment for our investors.

Dato’ Jaafar bin Abdul Hamid
Chairman & Chief Executive Officer