Highlights

• Volatile MGS. The M-REIT yield is becoming less attractive at current level given that the yield spread relative to 10-year MGS has narrowed to a low of 0.95% recently compared to about 2% at the beginning of 2016. MGS is now trading at around 4.2% compared to 3.6% previously.

• Monetary easing bias no longer. With recent economic data painting a clearer sky moving forward, investor interest in the defensive REIT space will certainly cool off. 3Q GDP number came in stronger QoQ suggests that economic conditions have bottomed and the likelihood of more monetary easing policy from BNM has tapered off.

• Improved global yield environment. US treasury yields have risen after the presidential election putting upward pressure on emerging market bond yield. With more rate hike likely to be introduced by the Fed coupled with the tendency of negative interest rate policy reversal by Japan and Euro, we think that the yield environment shall continue to improve.

• Cautious underlying outlook. Slower rental reversion on the back of lower same store sales growth shared by retail REIT manager adhering to the cautious outlook view. Furthermore, coupled with the major influx of supply in both retail and office spaces would put downward pressure on rent and take up rate. However, we reckon that those existing superior assets in the prime areas and township would continue to stay relevant.

• Revised REIT guidelines come into play. The new REIT guideline is expected to come into force by early 2017 after industry consultation. We believe the revision will make REIT a more dynamic and attractive investment vehicle. Besides allowing for green field development, private leases, property management and potential M&A activities will spice up this traditionally stable space.

Catalysts

• Potential acquisition of quality assets to achieve growth as opportunity arises from softer property outlook.

• Regulatory intervention in limiting the supply for office/mall.

• The proposed changes of REIT guideline to facilitate growth.

Risks

• (1) Prolonged erosion in consumer sentiment; (2) Failure to execute the planned asset injections and strategy; and (3) Significant slowdown in macroeconomic activities.

Ratings

• NEUTRAL

• Downgrade to NEUTRAL given that M-REIT yield is less attractive at current level while all the external factors are largely priced in. While we believe REITs are still stable with sustainable yields, we are turning neutral on its outlook in view of the softer rental reversion and challenging operating environment.

• We revise our assumption of 10-year MGS yield to 4% from 3.5% previously and valuations are based on 1-year historical average yield spread.

Top Picks

• Maintain BUY on MQREIT (TP: RM1.33 ) given its sustainable attractive dividend yield c.7% and stable assets.

• Maintain BUY on PREIT (TP: RM1.84 ) for its income growth potential in FY17 and visible injection pipeline. However we are wary of the potential downward biased caused by potential injection of less desirable assets.

Source: Hong Leong Investment Bank Research - 9 Jan 2017