We envisage a stable MGS yield for the remainder of 2018 with no further OPR hikes expected. The tax migration from GST to SST should be positive for purchasing power, benefiting retail REITs. Overwhelming retail and office space to worsen, however, REITs located in prime regions with long term tenancy will be able to maintain occupancy. We maintain NEUTRAL, with top picks including MQREIT (BUY, TP: RM1.29) and IGBREIT (BUY, TP: RM1.89).

Minimal risk on yield spread. Currently the MGS yield stands at 4.10%, stabilising from the high of 4.26% (May 2018) and we expect it to remain so for the rest of FY18. We do not expect any more OPR hike for 2018, after the hike in Jan. With GST abolished and stabilised fuel price, upside risk to inflation (and OPR hike) is minimal this year. Malaysia’s moderate yet strong growth is expected to remain resilient.

Consumption uptick. The “zerorisation” of GST is positive for consumer spending and we anticipate consumption to increase 8.5% YoY in 2H18 (1H18: 7% YoY). The Consumer Sentiment Index (CSI) hit 91 in 1Q18, its highest reading since the now defunct GST was implemented in Apr 2015. This augurs well for retail REITs via higher retail spending which is up 7.2% YoY (Jan-Apr 2018). The migration from GST to SST should be positive for purchasing power as the latter encapsulates a narrower range of goods and services.

Retail. 1Q18 total retail supply stood at 62.8m sqft, with incoming supply of c.15.5m sqft till 2020. The oversupply issue is expected to worsen while the rising of e commerce remains a long-term risk. However, major retail REITs under our coverage have promising occupancy rate in 2018 due to their prime location and catchment on the back of improved economic condition. Besides, we believe positive rental reversion is sustainable given the improvement in local consumption (zerorisation of GST) as well as active asset enhancement initiatives (AEI) by REITs.

Office. 1Q18 total office supply stood at 122.1m sqft with vacancy of 24.8%, and incoming supply of c.16.9m sqft is expected till 2020. We do not expect the oversupply issue to improve in the near term as (i) a majority of the incoming supply are built without pre-committed demand; and (ii) rental has largely remained stagnant due to availability of options. Hence, we prefer key buildings with sustainable rental reversion and long weighted average lease expiry (WALE) that are less prone to the challenging market.

Industrial. Industrial supply continues to increase in Selangor (2017: +39k units). New REIT guideline of allowing REITs to engage into property development is a catalyst for this sector, as shorter duration and lesser required capex for constructing industrial property vs acquisitions. Also, issue of securing tenants is well-mitigated as tenure of lease agreement for industrial property is usually long term.

Maintain NEUTRAL. We maintain NEUTRAL given the general oversupply situation but this should be offset by the appeal of REITs given the current uncertain equity markets. We leave our assumptions of 10-year MGS yield unchanged at 4.1%, and roll forward our valuation to FY19. To note, our valuation model is based on the targeted yield of 2-year historical average yield spread between dividend yield and 10- year MGS yield.

Top picks. (i) We like MQREIT (BUY, TP: RM1.29) given its sustainable attractive dividend yield of 8.0% (highest in our coverage), stable assets in prime locations with high occupancy rates and healthy WALE profiles. (ii) IGBREIT (BUY, TP: RM1.89)

due to its concentrated prime assets, sustainable positive tenant sales growths and rental reversions.

Source: Hong Leong Investment Bank Research - 12 Jul 2018