Highlights

• We believe retail REITs will continue to outperform over office REITs given its pricing power and potentially higher rental income from positive rental revision.

• While GST will be dampener for retail REITs, we see no significant impact as the government has broadened the list of items in the zero rated and exempt supplies. Moreover, consumption is still expected to expand albeit at slower rate. We also of the view that any incremental cost arising from GST incurred by REIT operator will be passed to tenants.

• The supply glut for office space in Kuala Lumpur is far from over and upcoming mega projects will create further dent on the problem.

• We are neutral with positive bias on industrial REIT given its softer rental reversion and limited supply coming in the market. The only industrial REIT under our universe is Axis REIT, which is actively looking for opportunities in booming industrial sector in Johor.

• Acquisitions to be wrapped up in 2015 including Platinum Sentral by QCT and Sunway Hotel Georgetown by Sunway REIT (both 1QCY15) and we expect Pavilion REIT will execute the acquisition of Fahrenheit88 this year.

• We expect Bank Negara to maintain OPR at 3.25% throughout 2015, which is favourable to REIT sector.

Catalysts

• Strong rental revision for retail REITs underpinned by sustained consumption (albeit slow) theme in Malaysia.

• Long term rental contract for office REITs created sustainable source of income.

Risks

• Weaker consumer sentiment primarily due to continued subsidy rationalization and implementation of GST may hamper our rental reversion assumption for retail REITs.
• Supply glut for office space in Klang Valley may results in rental rates for office to grow at slower pace or stagnant.
• Aggressive monetary policy by BNM may cause interest rate to increase.
• REIT sector could underperform in a bullish market as investors would prefer stocks which give higher capital appreciation.
• Significant slowdown in economic activities will dampen rental reversion for industrial REIT, particularly Axis REIT
• Improvement in US economy which would lead to a rise in US interest rate.

Top Picks

• We maintain our BUY call for QCT (TP RM1.34) as we favour its acquisition of Platinum Sentral to be completed in early 2015.

We initiate our coverage on Axis REIT with HOLD recommendation (TP RM3.57; NEW) given its exposure on industrial properties unlike the other players of M-REITs which are either retail or office or combination of both.

For exposure in retail REIT in the longer term, we prefer Pavilion REIT (HOLD; TP RM1.47) banking on its proposed acquisition of Fahrenheit88. We also see potential yield accretion for IGB REIT (HOLD; TP RM1.23) on Valley SouthKey in Johor by its parent company.

Source: Hong Leong Investment Bank Research - 23 Jan 2015