Dear Valued Unitholder of Hektar REIT,

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 utmost pleasure to present to you Hektar REIT's Annual Report and its audited financial statements for the financial year ended 31 December 2013 (FY2013).

I am pleased to report that in 2013, our portfolio of assets has continued to record solid performance thereby resulting in another year of positive results for FY2013.

We have completed our detailed planning and embarked on asset enhancement initiatives (AEIs) on the Central Square and Landmark Central (collectively known as “Kedah Malls”), these malls were acquired in October 2012 and represent the latest addition to Hektar REIT's portfolio. We have also initiated and will continue to undertake more tenancy remixing and relocation exercises on both the Kedah Malls. There will be more national and international retail outlets to give both shopping malls enhanced shopping profiles and a fresher outlook. Central Square has been selected to be the first of our 2 Kedah Malls to go through the refurbishing and AEI because it is the older of the two malls. The repositioning and refurbishment measures are expected to complete by the third quarter of 2014. Upon completion of the AEI, we foresee Central Square's performance to soar benefiting from our application of proven international best practices in retail and neighborhood shopping mall design and management.

Please continue reading for a more detailed review of our activities throughout FY2013.

Operating environment

The Malaysian economy is poised to achieve its official target of 4.7% in 2013 and it is expected to further accelerate to 5.3% in 2014. This was the general consensus from among the economists polled by FocusEconomics, a provider of economic consensus forecast based in Barcelona, Spain. Better external demand originating from the recovering western economies and the stable Chinese economy would support the domestically fueled Malaysian economy to grow faster in 2014. In a separate report, the Ministry of Finance via its Economic Report 2013/2014, reported that domestic demand has powered the local economy in 2013 and is expected to continue to provide the engine of growth in 2014. The private sector is expected to lead the charge as the government consolidates its spending to contain its fiscal deficit and growing national debt. A better external demand would drive Malaysian exports fuelling demand for its manufacturing, resource based products and consumer electronics sectors. Notwithstanding the uncertainties surrounding the US quantitative easing (QE) in 2013, many analysts opined that Malaysia's strong fundamentals have helped cushion the capital outflow impact induced by the tapering of the QE.

Hektar REIT remains confident in its business model – owning and managing world class retail destinations for Malaysians. The overall business fundamentals are still positive to support our business plan. The capital flight influenced by the tapering of the QE that had impacted Malaysia's stock market and the public-sector belt tightening measures by the government have not severely dampened the domestic retail industry in 2013. The Malaysia Retailers Association (MRA) recently reported that they were expecting the Malaysian retail sales to maintain its growth pattern of 6.2% compared to the 5.5% growth rate recorded in 2012. The association predicted that Malaysian consumers would face tougher challenges predicting a slower retail growth of 6.0% for 2014. The pressure on the consumers' purchasing power is expected to come from the electricity tariff hike, higher borrowing cost and general increase in prices of goods and services.

Financial performance

Sustainable financial performance

For FY2013, gross revenue reached RM120 million, up approximately 16.5% from the previous year, while net property income (NPI) reached RM74 million, also up 16.3% from the preceding financial year ended 31 December 2012 (FY2012). Despite the challenge of rising cost, Hektar REIT generated Net Income of RM58.8 million, 0.5% higher than FY2012. Revenue growth was contributed by all our 5 malls. Realised Earnings Per Unit is 11.52 sen, 1.5% lower than 11.69 sen for FY2012.

Hektar REIT's assets have increased with the acquisition of the Kedah Malls and are now collectively valued at RM1.05 billion. As a result, Net Asset Value (NAV) has also increased to RM1.53 per unit despite the increases in the number of units in circulation from the rights issue to part finance the acquisition of the Kedah Malls.

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 1.4% increase in the valuation of the properties in FY2013 to RM1.05 billion (FY2012 RM1.03 billion) reflected the increase in the market value of the portfolio of properties owned by Hektar REIT. The portfolio's income-generating capability has improved further during the year 2013. The various planned AEI and all the tenant remixing exercises executed during the year have achieved the desired results as envisioned by the asset manager. Please read on for more details on our asset enhancement activities throughout the year.

Income Distribution and accounting policy

Hektar REIT announced a distribution per unit (DPU) of 10.50 sen for FY2013 maintaining the payout made in FY2012. As communicated at our previous unitholders general meeting in 2013, 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 for 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 noncash items, such as fair value adjustments (usually attributed to property value increases) and items under FRS 117, an accounting standard implemented in FY2010 (see the notes to the accounts for more details). As a result, the FY2013 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.

Positive track record

Hektar REIT has continuously recorded improvements in its performance numbers every year since its IPO in 2006. The stock market took cognizant of these records and has rewarded Hektar REIT unitholders with a fair valuation of the units in circulation. Despite the dilutive impact from the issuance of the 80.0 million new units to part finance the Kedah Malls acquisitions in 2012, Hektar REIT's unit price closed the year at RM1.50, an increase of approximately 2.7% from RM1.46 at the beginning of 2013.

If you have invested in Hektar REIT units in the beginning of 2013 at RM1.46 and remained a unitholder till the year end, you would have received four distributions totalling 10.5 sen per unit, representing a distribution yield of 7.0% (based on a closing price of RM1.50 on 31 December 2013) and capital gain on the unit price of 2.7% (based on the initial investment entry price at RM1.46). Your total return on Hektar REIT for FY2013 would be approximately 9.7%.

At the end of 2013, Hektar REIT units had been traded at a spread of 282 basis points to the 10-year Malaysian Government Securities (MGS) yield. Previously, the spread against MGS yield was recorded at 376 basis points in 2012. The premium over the MGS yield had reduced by 94 basis points mainly due to the increase of MGS yield by 75 basis points to 4.2%.

The overnight policy rate (OPR) rate has remained unchanged at 3.0% since the last 25 basis points hike in the month of May 2012. There were concerns that a hike in the OPR by Bank Negara Malaysia (“BNM”) could push bond yields higher and reduce the spread further. The BNM has so far resisted pressures to increase the OPR despite improvements in the outlook of the global economy. BNM has to tread carefully when raising interest rates at a time of price increases so as not to severely impact household incomes.

Financing in 2013

Hektar REIT's financing is secured by Al-Murabahah overdraft facilities with 4 tranches worth RM184 million, RM150 million, RM54.3 million and RM32.8 million expiring in 2016, 2018, 2016 and 2016 respectively. Hektar also has a term loan of RM15 million which is expiring in 2016. Hektar REIT's FY2013 gearing ratio had improved slightly to 40.2% (FY2012 42%) 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 FY2013 was maintained at 4.6%.

The hedging of about 42% of Hektar REIT's total borrowings of RM436 million via an Islamic Profit Rate Swap (“IPRS”) instrument is a mitigating factor against possible further interest rate hikes in the future. The 5-year IPRS rate is fixed at 4.85%.

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 1.9 million Malaysians. The shopping malls are located in relatively dense population catchment areas, and enjoys 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 trend 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 our strategy in the context of our portfolio performance in 2013 below.

Subang Parade's challenges & opportunity

This year, our flagship mall Subang Parade has reached its 25th anniversary milestone making it one of the oldest shopping centres in Malaysia, yet it remains the heart of the Subang Jaya community just like it had 25 years ago. Our customers that were born during the 80's have matured and we understand that 'growing' together with our customers is equally important as connecting with the generation that comes after. Interaction with customers and retailers is the key to maintaining Subang Parade's position in the market.

The management team is constantly on the lookout for brands and retailers that suit our profile and invests a lot in market research which tracks changes in demographics and market preference to make sure that our tenancy mix stays relevant. The information gathered from our observations, customer feedbacks, tenants' analysis and marketing programs help us to formulate strategies to make our shopping centres a better place every day for our customers to shop, unwind and dine. We appreciate customers' feedback and would like customers to know that – 'we are listening'.

Based on feedback, we have brought in new fashion trends, the latest in health and beauty, children enrichment centre, and more exciting F&Bs such as Pastryville and Komugi. Swensen's executed a major refurbishment initiative on their outlet and also introduced a new F&B concept. Traditionally famous for premium ice cream in a wide variety of flavours, it now offers an enhanced menu of American style favourite dishes too.

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. The shopping centre industry is ever changing, therefore as retailers and asset managers, we too need to evolve. Our management team has been working hard with our retailers to introduce the latest concepts and shop designs, sharing industry knowledge and encouraging tenants to stay relevant by increasing the benchmark.

Subang Parade is at a full occupancy. It also reported healthy rental reversions throughout 2013. The upcoming year will present Subang Parade with more challenges in the form of higher number of tenancy expiries and renewals. However, we view this as an opportunity to turn things around for the better. Exciting retailers with good potential may have approached us previously but we were not able to offer them a spot due to unavailability of space. This would be the perfect time to rearrange and spruce things up a little!

Mahkota Parade entrenched position

Located at the heart of Melaka city, Mahkota Parade was the first regional shopping mall when it was opened way back in 1994. It will be celebrating its 20th Anniversary in 2014. Mahkota Parade was positioned and is still one of the premier shopping destinations that are strategically located in the tourist belt of the historical city of Melaka. In this part of the city, there are a few shopping malls such as Dataran Pahlawan and Hatten City shopping complexes which, due to their proximity to one another, create a retail precinct popular with tourists in particular.

In FY2013, Mahkota Parade had recorded higher occupancy rate of 97.8% in comparison to 96.7% in FY2012. It has also enjoyed positive rental reversions throughout the financial year, thus entrenching Mahkota Parade's position as one of the favourite shopping destinations for the locals and foreigners in Melaka.

Mahkota Parade boasts a stable of quality international and national brand tenants. Kaison and Popular Bookstore are Mahkota Parade's latest mini anchors. Kaison is a new home décor outlet that is expected to further complement and reinforce Mahkota Parade's well-balanced retail mix offerings.

For 2014, the next AEI in the pipeline for Mahkota Parade is in respect of the proposed refurbishment of the existing four (4) screens cinema to ten (10) screens with the ability to accommodate about 1,680 seats in total. We are expecting the cinema project to be completed and fully operational by the first quarter of 2015. It is expected that the 10-screens cinema offering would invigorate Mahkota Parade similar to the positive impact brought about by MBO 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 close to the cinema.

Wetex Parade's leading position in Muar

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 Muar. In 2013, Wetex Parade recorded another year of healthy rental reversion whilst maintaining high occupancy rate of 96.8% reflecting its leading position in the local retail scene. In 2013, one of our anchor tenants, The Store went through a major refurbishment exercise which resulted in an improved retail offering and experience for their customers whilst enhancing their presence in Wetex Parade.

There is a prevailing misconception that international retailers will not succeed in smaller towns by virtue of lower purchasing power amongst shoppers. Hektar has proven this to be untrue when Hektar has successfully introduced numerous national and international chains like Hush Puppies, Polo Haus, Sushi King and Baskin Robbins. Hektar has revolutionised this mindset and is poised to replicate this strategy in the Kedah Malls.

The Kedah malls – Central Square and Landmark Central

The acquisition of the two Kedah malls was completed in October 2012. Both malls are located in major catchment areas in Sungai Petani and Kulim. The investments in the Kedah Malls fit into our investment strategy of acquiring assets with opportunities for value creation via our AEIs.

Sungai Petani town is located 35km north of the state of Penang. It is a thriving township with a sizeable population of more than 400,000 residents. The township is also surrounded by growing industrial districts such 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.

Kulim town 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 competitor is The Summit Bukit Mertajam, 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.

Hektar REIT is bringing its experience of managing neighbourhood malls to the two Kedah Malls. Even the best shopping malls require continuous attention to remain relevant. Planning the retail mix therefore, is one of the key factors in successfully managing shopping malls. 2013 was a busy year for the team as we execute the plans for the transformation of the Kedah Malls in our quest for better property yields in the medium to long term period.

Armed with our experience in applying international best practices in designing and managing retail mix for shopping malls, our motivation will be to ensure that the Kedah Malls remain relevant to the shoppers. The upgrading of the exterior façade and the interior refurbishment work of the shopping mall shall enhance the profile of Central Square to be on par with some of the newer shopping malls in Sungai Petani.

As planned, the AEI at Central Square have begun on the ground and we expect to complete the refurbishment work by third quarter of FY2014. The AEI is progressing smoothly and impact on the daily operations of the mall has been minimised. The refurbishment exercise presented us with a window of opportunities to rope in new national and international chain tenants to replace some of the less popular existing tenants. We are excited on the progress of the transformation of Central Square and look forward to update you further on the outcome soon.

Landmark Central is our next focus for AEI projects once Central Square fully completes its redevelopment. In the meantime, we wasted no time in improving the tenant mix. Rental reversions throughout FY2013 have been very encouraging at double digit levels in expectation of better things to come for Landmark Central. The occupancy rate for Landmark Central has improved from 76.7% as at the acquisition date to 93.7% by the end of FY2013.

Hektar REIT is also mindful of its responsibilities to nurture and develop budding entrepreneurs who have good retail ideas that can provide unique shopping experiences for our shoppers. We have an incubator system which is one of the ways in which Hektar REIT can attract new business partners over time.

Our incubator system involves the usage of the Retail Merchandising Unit (RMU) or push carts and the larger sized Stand-Alone Counters (SAC). These retailing methods are relatively cheaper to rent compared to renting larger more permanent retail outlets. Hence, budding entrepreneurs require smaller start-up capital to promote their retailing ideas which if proven successful, would enable them to expand their concept for the full-fledged experience. We will introduce this at our Kedah Malls too.

Potential for acquisitions update

There were no new major acquisitions in 2013 as we were focusing our efforts on the two Kedah Malls. Notwithstanding, we will continue to explore other acquisition potentials as the opportunity arises. In the period of compressed capitalisation rate, our mode of expansion shall be opportunistic, targeting potentials that offer property yields that are yield accretive.

Unique to REIT, any future proposed acquisition would require external fundings like additional issuance of REIT units and/or borrowings. This is because at least 90% of all internally generated funds are distributed to unitholders to enjoy tax incentives provided specifically for REITs. Based on Hektar REIT's current trading price range, which remains above NAV and combined with access to affordable bank financing, we are confident of our ability to finance yield-accretive acquisitions moving forward.

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.