Taking Cue From the NRP, We Expect to See a Reopening Recovery for Malls in Phase 3 (Sept-Oct) and Hotels in Phase 4 (Nov-Dec). We Take the Opportunity to Tweak Down IGB REIT, KLCCSS and Pavilion REIT Earnings Given Weaker Contribution in the Interim. Separately, We Believe the Office and Industrial Segments Will Continue to Remain Relatively Stable Amid the Pandemic. Maintain NEUTRAL on the Sector, With Axis REIT and Sentral REIT as Our Top Picks.

Retail and hotel. We take some cues from the National Recovery Plan (NRP, currently in Phase 1) to gauge the potential reopening timeline for retail and hotel segments of REITs. The eventual transition to Phase 3 (estimated Sept-Oct) will allow some degree of social activities which we reckon will possibly involve dine-ins and “leisure shopping”. As such, this phase of reopening will augur well for mall based REITs as we expect to see a significant leap in footfall when this happens due to “revenge spending”. Looking further ahead, the transition to Phase 4 (Nov-Dec) will allow interstate travel and see the reopening of hotels for domestic tourism. We expect pent up demand to “top the roof” as Malaysians would have been holiday deprived for almost a year by then. Despite our outlook on an eventual reopening down the road, the next 2-4 months will remain trying for malls and hotels.

Factoring FMCO impact. We take the opportunity to cut our FY21 earnings on IGB REIT, KLCCSS, and Pavilion REIT by c.6%-10% on expectation of weaker 2Q21 due to FMCO, as we see a drag from rental assistance, and potential flattish or negative rental reversion amid the crisis, in order to sustain malls occupancy.

Office. While oversupply issue continues to be a concern (+5.6% YoY, Figure #5), we feel office REITs can manage well during the FMCO, seeing occupancy remained stable in 1Q21 (-1% YoY, Figure #6), backed by the normal longer tenancy in office REITs (vs. retail REITs). On that note, we expect the demand for office space to remain stable for the rest of the year. We like Sentral REIT (TP: RM0.98) for its stable portfolio occupancy as well as attractive dividend yield of 8.5% (highest among REITs in our universe).

Industrial. We foresee industrial REITs to remain defensive amidst FMCO. This segment has been resilient with backing from exceptional growth of the e-commerce sector that was seen during the pandemic. We also see demand in industrial properties driven by the surge in e-commerce activity (projected to grow at 24% CAGR in the next 5 years), which has prompted more establishment of distribution centre by retailers and e-commerce players. Hence, we believe industrial REITs will continue its stability and growth trajectory in 2021 and we like Axis REIT (TP: RM2.54) as a leading player in industrial segment.

OPR to remain at 1.75%. Our economics team expects BNM to maintain OPR at 1.75% for the rest of 2021. While we feel retail and hotel segments are unlikely to recover intensely in the near term, we reckon the current low level of OPR would be favourable for REITs, with a lower borrowing costs for potential future acquisitions. Furthermore, the temporary increase in gearing limit set by SC to 60% (from 50%) until 31 Dec 2022 would allow REIT managers to manage their REIT’s debt and capital structure more efficiently.

Maintain NEUTRAL. We retain NEUTRAL on the sector, with Axis REIT (TP: RM2.54) being the top pick for its strong resiliency throughout the pandemic driven by increased popularity in industrial properties, high occupant tenancy in its diversified portfolio, and also, one of the few Shariah compliant REITs. We also like Sentral REIT (TP: RM0.98) for its high yields (8.5%) and potential valuation rerating following the listing of a sizable peer in the pipeline.

Source: Hong Leong Investment Bank Research - 8 Jul 2021