Although economy is poised for recovery in 2021, negative concerns remain in few selective REIT segments, namely retail and hotel due to cautious consumer spending, elevated unemployment rate, absence of international tourists, and lower footfall in shopping malls (in light of social distancing). However, office and industrial segments are expected to remain stable, and will continue to stay defensive. As such, we maintain NEUTRAL on REITs as we acknowledge some segments (like retail and hotel) will take some time to recover. Our top picks are MQREIT (TP: RM0.96) and Axis REIT (TP: RM2.49).

Retail and hotel to recover gradually. Overall, the retail and hotel segment should see improving business activities in 2021, compared to last year. However, negative concerns remain, namely on: (i) cautious consumer spending, (ii) higher unemployment rate and (iii) absence of international tourists as borders will remain closed for tourism activity, and (iv) sluggish footfall in shopping malls from still rising Covid-19 daily cases domestically. While we note that recent vaccine news is positive for overall sentiment, the path to normalcy may take a while; our base case assumption is for c.20% of population to be vaccinated by end-2021.

Office and industrial to remain resilient. Although the long term outlook of office segment remains lacklustre (due to an unabated glut), it did quite well in 2020 relative to the retail and hotel segments. For 2021, we believe demand for office space will still be resilient as the economy recovers, and more employees will gradually be back to office and fewer on WFH. Meanwhile for industrial REIT, the segment has been steady all along despite the uncertainties and economic challenges from the pandemic and will continue its stability and growth trajectory in 2021.

OPR to remain low in 2021. While we have a conservative stance on the recovery of retail and hotel segment, we believe the current low level of OPR is supportive of REIT’s share price. Our economics team expects BNM to maintain OPR at the current low level thru 2021. An easing interest rate environment will result in lower borrowing costs for REITs to acquire future assets. Furthermore, we believe REITs will be able to benefit from some interest savings on floating rate borrowings, which in turn, help to support earnings growth.

Yield spread to remain lingering at current level. The yield spread between REITs in our coverage and the 10-year MGS (MAG10YR) is currently at 205bps which is largely around its 5-year mean (since 2016) of 170bps. For FY21, we do not foresee this swinging drastically from its historical average on the back of expectations of BNM maintaining OPR for the rest of 2021. As such, we maintain our MAG10YR assumption at 3.0% vs the current level of 2.58%, (FY20 average: 2.84%).

Maintain NEUTRAL. While the low interest rate environment typically bodes well for REIT stocks, we also acknowledge some segments in the REIT space (like retail and hotel) will take some time to recover. Furthermore, at the current level, the average yield for our stocks in coverage is decent at 5.2%. Our top picks are MQREIT (TP: RM0.96) and Axis REIT (TP: RM2.49) which offers a relatively higher degree of resiliency amid the pandemic.

Source: Hong Leong Investment Bank Research - 6 Jan 2021