2014

Dear Valued Unitholder of Hektar REIT,

2014 has drawn to a close and I wish to reflect and review this past year with you. As stated on our annual report last year, FY2014 was a busy year for us due to the asset enhancement initiatives (“AEI”) on Central Square Shopping Centre, Sungai Petani (“Central Square”). Now completed, Central Square boasts a fresh façade with distinctive mall features, with a more vibrant shopping ambience plus family-friendly features.

Chairman's Letter to Unitholders from Hektar REIT's 2014 Annual Report.

On behalf of the Board of Directors of Hektar Asset Management Sdn Bhd, the manager for Hektar Real Estate Investment Trust (“Hektar REIT”), it is my pleasure to present to you Hektar REIT’s Annual Report and its audited financial statements for the financial year ended 31 December 2014(“FY2014”).

2014 has drawn to a close and I wish to reflect and review this past year with you. As stated on our annual report last year, FY2014 was a busy year for us due to the asset enhancement initiatives (“AEI”) on Central Square Shopping Centre, Sungai Petani (“Central Square”). Now completed, Central Square boasts a fresh façade with distinctive mall features, with a more vibrant shopping ambience plus family-friendly features.

As for the rest of our shopping malls in the portfolio, we have also initiated and shall continue to undertake more AEIs and tenancy remixing exercises in order to maintain our competitiveness and appeal to shoppers.

Please continue reading for a more detailed review of all our activities throughout FY2014 in the latter paragraphs.

Operating environment

The Bank Negara Malaysia (“BNM”) reported in November 2014 that the country’s economy as measured by the Gross Domestic Products (“GDP”) had expanded by 5.6% in the third quarter of 2014, moderating from the robust 6.5% growth rate reported for the period between the month of April to June. Following from the bullish first half performance, Malaysian Institute Economic Research (“MIER”) had reported that the estimated GDP growth rate for 2014 would be slightly higher than 2013 at around 5.9%.

The Retail Group Malaysia in its quarterly industry report had indicated that the retail industry was expected to see overall retail growth rate of 6% for the entire of 2014 in comparison to the 2013 growth rate of 4.5%. The myriad of festivities in Malaysia are expected to contribute towards the strong retail sales throughout these periods.

However, the association had also noted that the retail industry would face tougher challenges in the second half of 2014 as the increased overnight policy rate may affect retail sales of big ticket items. Electricity tariff hike, the pull back of government subsidies and expenditures and general increase in prices shall add pressure to the local consumer purchasing power.

For 2015, analysts have generally predicted that the retail market is expected to temporarily soften with the implementation of the Goods and Services Tax (GST) on April 1. Notwithstanding, the retail industry may enjoy brisk sales in the first quarter stimulated by the consumer purchases avoiding the 6% tax.

The supply side of the industry has kept up with the rise in the retail space demand. During the first quarter of 2014, property consultant CH Williams Talhar and Wong Sdn Bhd had reported that Klang Valley will see the entry of several new and refurbished shopping malls with a total net lettable area of 5.0 million square feet adding to a total cumulative supply of 49 million square feet of net lettable area.

Financial performance

Sustainable financial performance

For FY2014, gross revenue reached RM122 million, up 1.5% from the previous year, while Net Property Income (NPI) reached RM73 million, slight drop of 1.1% from the preceding financial year ended 31 December 2013 (FY2013). Hektar REIT generated Net Income of RM50 million, 14.3% lower than FY2013. Realised Earnings per Unit is 11.05 sen, 4.1% lower than 11.52 sen for FY2013.

2014 saw an increase in the nation’s electricity tariff which has affected all of us; from businesses to individuals. Hektar REIT was not immune to this 17% hike. In addition to the electricity tariff hike, Bank Negara had also announced an increase of their overnight policy rate in July by 25 basis points which put pressure on our interest cost. The overall impact to our realised net income arising from these cost challenges was as much as RM1.8 million.

It has been a tough year operating in an environment of rising cost. There is now a new norm in doing business in general and we have to be flexible enough adjusting to these challenges in order to sustain our performance and track record.

Along with the increase in operating cost, 2014 was the year where Hektar REIT was busy with the implementation of its AEI. We spent about RM23 million to refurbish Central Square, which was more than 15 years old when we took over in late 2012. Refurbishment works were planned and executed with the intention of minimising disruption to mall operation. Despite our efforts to mitigate disruptions to business, it was inevitable that revenue would fall temporarily as refurbishment works were in progress. We had to temporarily close down some stand-alone counters and retail merchandising units to make way for the refurbishment. We also had to vacate certain tenants to make way for better tenants. Hence the temporary dip in revenue of Central Square, which had affected Hektar REIT’s overall profit. Our AEI is now completed and we look forward to an improved performance of Central Square in 2015 which should boost our bottom line.

Due to all the aforementioned challenges, our earnings took a hit. Earnings in FY2014 was 4.1% lower than FY2013. Despite the lower earnings, the Board has decided to distribute the same quantum of dividend as we did in FY2013, i.e. 10.5 sen per unit. So, in a nutshell, in FY2014, Hektar has protected its unitholders from the vagaries of rising costs.

As we move forward to 2015, we will be facing new challenges. Currently we are preparing for the implementation of GST in April 2015. The extent of the impact from introduction of GST to our financial performance is unknown yet at this juncture but we feel there will definitely be added challenges in maintaining the cost of operation.

In terms of performance improvement, aside from the usual strategy of continuous revitalisation of tenancy mix, we are also looking at acquisition of individual sold lots which were sold prior to Hektar’s ownership of the malls. This will help improve our tenancy remixing strategy as they are mostly situated at strategic areas.

In relation to the AEI – now that we have completed Central Square, we are looking at embarking on more AEI programs for our other malls in the portfolio. Our malls need to improve and continuously change to keep up with the times or risk being obsolete and irrelevant with our shoppers. We will make the necessary announcements in due course.

Fair value adjustment

Hektar REIT’s portfolio is now collectively valued at RM1.06 billion. The Net Asset Value (NAV) has also increased to RM1.55 per unit from RM1.53 per unit the previous year.

Fair value adjustment is a non-cash item and is part of the Malaysian Financial Reporting Standards (MFRS) 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.

In 2014, there was a minimal fair value gain of 1.3% due mainly to increasing operating cost, especially the electricity tariff hike. This led to lower net property income which in turn, impacted the market value of Hektar REIT’s malls.

We expect the market value of Hektar REIT’s properties to increase more substantially in 2015 arising from the completion of AEI in Central Square.

Income distribution and accounting policy

Hektar REIT announced a distribution per unit (DPU) of 10.50 sen for FY2014 maintaining the distribution made in FY2013. As communicated at our previous unitholders general meeting in 2014, we are committed to at least maintain the DPU rate of 10.5 sen. Since its initial public offering (IPO) in 2006, Hektar REIT has maintained its uninterrupted track record of making quarterly distributions to its unitholders.

We have maintained a policy of paying out at least 90% 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) and items under MFRS 117, an accounting standard implemented in FY2010 (see the notes to the accounts for more details). As a result, the FY2014 distributable net income is lower than the net income. After paying 90% of the distributable net income, Hektar REIT retains the remaining 10% for future asset enhancements of the properties and potential acquisitions of sold lots throughout the Hektar REIT portfolio.

Stable track record

Hektar REIT’s unit price closed the year at RM1.49, maintaining the opening price level in the beginning of 2014. Hektar REIT’s net asset value at 31 December 2014 stood at RM1.55 per unit.

If you have invested in Hektar REIT units in the beginning of 2014 at RM1.50 and remained a unitholder till the year end, you would have received four distributions totalling 10.5 sen per unit, representing a dividend yield of 7.0% (based on a closing price of RM1.49 on 31 December 2014). Your total return on Hektar REIT for FY2014 would be approximately 6.4%.

At the end of 2014, Hektar REIT units had been traded at a spread of 287 basis points to the 10-year Malaysian Government Securities (MGS) yield. Previously, the spread against MGS yield was recorded at 282 basis points in 2013. The premium over the MGS yield had increased slightly (5 basis points) due to the reduction one 1 sen in Hektar REIT’s trading price since the opening price at 1 January 2014.

Financing in 2014

As mentioned earlier, the latest overnight policy rate hike of 25 basis points was implemented in July 2014. Nomura and Standard Chartered Global Research are both of the opinion that there will be another 25 basis points hike in the OPR by BNM in the third quarter of the 2015. The hike could push bond yields higher and reduce Hektar REIT’s distribution yield spread.

Hektar REIT’s financing is secured by Al-Murabahah overdraft facilities with 6 tranches worth RM184 million, RM150 million, RM15 million, RM87 million, RM65 million and RM30 million expiring in 2016, 2017, 2015, 2016/17, 2019 and 2018 respectively. Hektar REIT’s FY2014 gearing ratio had increased slightly to 41% (FY2013: 40%) of gross asset value which was well within the 50% limit set by the authorities whilst its weighted average cost of financing as at the year ended FY2014 was slightly up at 4.8% from 4.5% in FY2013.

As a strategy to manage the risk in the interest rate hike, Hektar REIT had increased its hedging to about 70% (FY2013: 40%) of its total borrowings of RM436 million via an Islamic Profit Rate Swap (“IPRS”) instrument. IPRS has an average fixed rate of 4.87%. The decision to increase our hedging has mitigated the risk of future interest rate fluctuation.

Our current weighted cost of debt is now 4.8%.

Portfolio performance

Hektar REIT’s portfolio consists of Subang Parade in Subang Jaya, Mahkota Parade in Melaka, Wetex Parade in Muar, Central Square in Sungai Petani and Landmark Central in Kulim. Collectively, these properties serve a market catchment of more than 2.0 million Malaysians. The shopping malls are located in relatively dense population catchment areas, and enjoy high loyalty rate from locals as well as increasing visitorships from all walks of life. As a result, more than 500 tenancies representing a spectrum from fashion to entertainment are present in Hektar REIT’s retail 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 around the world through various means.

Over the years, one of the shifts in retailing is the revitalisation of the shopping centre as a communal place. Visiting shopping centres has become a favourite past-time activity for Malaysians and shopping centres continue to emerge as a ‘favourite meeting place’ within communities. We are observing more urban dwellers in Malaysia spending their weekends in shopping malls. Our overall strategy is therefore focused on ensuring that Hektar REIT’s properties remain relevant. Let us examine our strategy in the context of our portfolio performance in 2014 below.

Subang Parade

Subang Parade is an award winning neighbourhood mall located in the heart of the thriving Subang Jaya commercial centre. The shopping mall is in proximity to an important commuter train station that links Subang Jaya to Kuala Lumpur. Subang Parade is in an enclave of several shopping centres that are located within short walking distance of each other.

Throughout its existence, Subang Parade has undergone several major refurbishment exercises and as testimony to the success of our past AEI, Subang Parade has for consecutive years recorded an almost full occupancy status with appealing selection of tenants. Shopper footfall was 9.5 million for FY2014 or an average of approximately 790,000 a month.

Subang Parade reported healthy positive rental reversions throughout FY2014. The average rental reversion at Subang Parade has remained healthy at 5% in FY2014. There were a total of 63 new and renewed leases with an aggregate of 169,643 square feet retail space affected. The upcoming year will present Subang Parade with more challenges in the form of higher aggregate of retail space expiring and due for renewals. However, we view this as an opportunity to turn things around for the better. To maintain an interesting tenancy mix, we took this time to review the relevancy of our existing tenants and explored the possibilities of creating new experiences for our shoppers.

We have secured the first Coffee Club outlet in Malaysia as well as having brought in the local favourite delicacy in the form of PappaRich. To top it off , Subang Parade also welcomed the presence of Hamleys during the year-end holiday period offering excitement to parents and children shopping for the best holiday presents that Hamleys could offer.

With the growing competition in the market, it is necessary for us to always be on our toes and strengthen our partnership with the retailers to achieve common success. Although Subang Parade is no longer the biggest mall in comparison to the other massive regional malls that have mushroomed in Klang Valley, Subang Parade has been able to maintain its patronage of loyal shoppers from the families and young couples segment. The mall offers shopping convenience and comfort for families. They would have the opportunity to enjoy its array of dining choices as well as spending time together catching up on the latest blockbuster movies.

Mahkota Parade

Located at the heart of the city of Melaka, Mahkota Parade was Melaka’s first regional shopping mall when it was opened way back in 1994. It celebrated its 20th anniversary in 2014. Mahkota Parade was positioned and is still one of Melaka’s premier shopping destinations as it is strategically located in the tourist belt of the historical city of Melaka. The city is inscribed on UNESCO’s World Heritage List as part of UNESCO’s preservation of historical sites across the globe. In this part of the city, there are other shopping malls such as Dataran Pahlawan and Hatten City shopping complexes which, due to their proximity to one another has created a vibrant, though highly competitive retail precinct.

In FY2014, Mahkota Parade had a slightly lower, but stable occupancy rate of 94.5% in comparison to 97.0% in FY2013. There were a total of 29 new and renewed leases with aggregate 200,532 square feet of retail space representing 41% of the net lettable area. There was a positive reversion of 1% in 2014.

In 2015 there will be 226,075 square feet of retail space representing 47% of the net lettable area that are expiring and due for renewal. We see this as an opportunity to improve our tenancy mix and rental rates.

In FY2014, we had embarked on the AEI of Mahkota Parade where the existing 4-screen cinema will increase to ten (10) screens, accommodating 1,680 seats. The cinema will commence operation by the second quarter of 2015. The 10-screen cinema will invigorate Mahkota Parade similar to the positive impact brought about by the introduction of an 8-screen cinemas to Subang Parade in 2012. The strategy is to further improve the visitor traffic to the second floor which we hope would consequently lead to improvement in the rental reversion on the surrounding retail areas in proximity to the cinema.

In 2014, the management has aggressively acquired several retails lots in Mahkota Parade which the previous building owner had sold to private individuals. The locations of these retail lots at the ground floor are strategic and command premium rental rates. The acquisitions are expected to be yield accretive as they are purchased in accordance to the guidelines set by the authorities.

Wetex Parade

Wetex Parade is an integrated retail complex located in the midst of Muar town’s commercial area. It enjoys a prominent position as a premier retail destination for the local community as Wetex Parade is the only purpose built shopping mall in the thriving town of Muar, which is Johor’s second biggest city after Johor Bahru.

In 2014, Wetex Parade recorded another year of healthy rental reversion whilst maintaining high occupancy rate of 98.3% (FY2013: 98.0%) reflecting its leading position in the local retail scene. The average rental reversion at Wetex Parade was healthy at 7.0% in FY2014 (FY2013: 6.0%). There were a total of 16 new and renewed leases with aggregate 103,516 square feet representing 65.0% (FY2013: 9.0%) of retail space which were affected.

Wetex Parade underwent a minor AEI in FY2014 to improve shoppers’ traffic to the top floor of the shopping mall. It also saw the entry of Popular Bookstore anchoring the fourth floor of the mall. These initiatives had resulted in an improved shopper footfall and retail offering for Wetex Parade.

Central Square, Sungai Petani

Central Square is situated in the middle of Sungai Petani town, which is located 35km north of the state of Penang. It is a thriving industrial township with a sizeable population of more than 400,000 residents. The township is also about 25km away from another growing industrial district known as Gurun, a heavy industry zone. Sungai Petani’s retail environment is quite competitive as the town boasts several shopping malls and hypermarkets. The latest entry being the Amanjaya Shopping Mall located about 20 minutes’ drive to the north of Central Square Shopping Centre.

Hektar REIT embarked on a major AEI in Central Square in 2014. The exercise involved upgrading of the exterior façade of the whole building and the major interior refurbishment work of the shopping mall. We have tried to minimise the impact of the refurbishment work to the operation of the shopping mall. Several retail lots, retail merchandising units or kiosks and stand-alone counters (SACs) were relocated and redesigned to make way for the implementation of our new retail concept once the enhancement works were completed. Inconvenience caused by renovation activities to the shoppers and retailers were able to be minimised.

With successful completion of the AEI, we have enhanced the profile of Central Square to be on par with some of the newer shopping malls in Sungai Petani. Central Square now sports a new distinctive main entrance lobby that offers convenience for senior citizen and families with children. The car park basement floors were vastly improved with brighter lighting and improved directional signage. An automated car park payment system was also introduced.

The refurbishment exercise had presented us with a window of opportunities to rope in new national and international chain tenants to replace some of the less popular tenants. The mall now offers better array of food and beverage selections suitable for families and young couples looking to spend their time shopping and dining. The entertainment zone for Central Square is now relocated to the fourth and fifth floors. The top floor of the mall will be anchored by a bowling alley and a new 8-screen cinema. These new tenants will open for business in the early part of the second quarter of 2015.

In 2014, Central Square recorded healthy rental reversion with improved occupancy rate of 80.5% (FY2013:80.0%). Footfall has reduced by approximately 20% during the AEI period, but is expected to improve now that the AEI has completed.

Central Square also reported positive rental reversions throughout FY2014. The average rental reversion was at 37% in FY2014 (FY2013: 52.0%) despite being affected by the refurbishment work. There were a total of 8 new and renewed leases with an aggregate 59,997 square feet representing 20% of retail space that were affected.

Landmark Central, Kulim

Landmark is situated in Kulim town, which is regarded as the feeder to the successful Kulim Hi-Tech Park that resides many of the global technology companies such as Intel, Fuji, Ranbaxy and First Solar. Landmark Central is the only purpose built shopping mall in Kulim town serving the immediate catchment of more than 250,000 residents. The closest competitors are The Summit Bukit Mertajam and the new AEON Mall Bukit Mertajam Shopping Centre, located in the neighbouring Bukit Mertajam town. Landmark Central was officially launched in 2009 and since then Landmark Central has been a catalyst to the town attracting more commercial development towards the vicinity.

The occupancy rate for Landmark Central has improved at 97.8% (FY2013: 96.0%). Landmark Central also reported healthy rental reversions throughout FY2014. The average rental reversion was at 16.0% in FY2014 (FY2013: 23.0%). This is encouraging as retailers have come to expect more improvements to be introduced to the shopping mall. There were a total of 4 new and renewed leases with an aggregate 23,058 square feet representing 8% of retail space that were affected.

Potential for acquisitions update

There were no new acquisitions of shopping malls in 2014. In the period of compressed capitalization rate, our mode of expansion shall be opportunistic, targeting potentials that offer property yields that are yield accretive.

Nevertheless, during FY2014, we had aggressively acquired sold lots in Mahkota Parade and Central Square from the individual owners who had purchased the retail lots from the previous mall owners. At Central Square, we took advantage of the refurbishment project to also purchase back the sold lots which we foresee could add value and complement our enhancement effort made to our existing retail area. At Mahkota Parade, the purchases of the sold lots are part of our continuing exercise to acquire strategic retails lots that are yield accretive in the long run.

The acquisition of the retail lots in Central Square and Mahkota Parade were funded via internally generated fund and bank borrowings.

Moving into 2015 and beyond

In spite of the uncertainties in the external demand and consumer spending level for 2015, the Malaysian economy is still expected to remain strong generating an expected economic growth rate of 5.5%. Based on this healthy outlook, Hektar REIT needs to take a proactive stance towards other equally important challenges such as retaining and developing talents, especially in the leasing line as there have been so many new shopping centres that have opened up exciting job prospects. We must be on top of this critical business issue and constantly review our human resource strategy with a view of attracting the best talents the market have to offer whilst retaining our existing performers.

Acknowledgements

On behalf of the Board of Directors, I wish to thank our team 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 and preferred investment for our investors.

Dato’ Jaafar bin Abdul Hamid
Chairman & Chief Executive Officer