We expect industrial REITs to remain strong on the back of growing e-commerce trends. Separately, retail and hotel REITs will recover with the transition to endemicity. Office REITs under our coverage are expected to remain stable backed by prime location and long tenancies. That said, to keep abreast with the increasing MAG10YR yield, we increase our assumption here to 4.25% (from 3.75%). The current yield spread between M-REITs and MAG10YR is narrowing and we believe this would diminish the appeal of M-REITs. Hence, we maintain NEUTRAL on the sector as we expect reopening sentiment to be balanced off by rising rate expectations. Top picks are Axis REIT (TP: RM2.08) and Sentral REIT (TP: RM0.99).

Retail and hotel. Riding on the endemic reopening (which entails no limitations on operating hours and capacity restrains of commercial and restaurant premises), we expect strong recovery continuing for both retail and hotel segments. We anticipate better retail footfall, occupancy recovery, and lesser rental rebates. Nevertheless, we remain sceptical on positive retail rental reversion, as we foresee it to remain flattish in an attempt to retain tenants. With the reopening of Malaysia’s borders (1 Apr), we expect a revival for the hotel segment, backed by pent up demand from tourists visitation. Hotel occupancy was already recovering since late-2021 (Figure #3) with the easing of domestic travel restrictions. Thus, with the added presence of international tourists now, we can expect hotel occupancy to further improve. That said, we like IGB REIT (BUY, TP: RM1.85) for its prime asset location and high occupancy.

Office. Despite development backlogs and delays faced during the pandemic, we still see the oversupply issue to linger in 2H22 with some easing to be expected in 2023- 2024 (Figure #4). While overall office occupancy continued its slow decline (Figure #5), office REITs under our coverage managed to maintain strong occupancy of above 80% throughout the pandemic, thanks to their prominent location, longer tenancy, and resilient rental reversion (especially for prime areas). The transition to endemicity should be a boon for occupancy as workers return to office. We are not utterly worried on the WFH-trend impacting the sector as the data from Google Mobility Report indicates that mobility to workplaces has almost returned to pre-pandemic levels. Within the office space, we like Sentral REIT (TP: RM0.99) for its stable portfolio occupancy as well as attractive dividend yield of 8.2% (highest among REITs in our universe).

Industrial. Industrial REITs have been exceptionally strong, backed by the robust growth of e-commerce which drove up the demand for logistics and fulfilment centres. Average price of industrial market rental rate continues to increase especially in the Shah Alam region (Figure #6) and we anticipate future positive rental reversion rates. Sunway REIT (BUY, TP: RM1.67) expressed its vision to actively pursue more opportunities within industrial properties, and we foresee more players to venture into it as well. We favour Axis REIT (TP: RM2.08) for its strong resiliency throughout the pandemic, driven by high occupant tenancy in its diversified portfolio, and also, one of the few Shariah compliant REITs.

OPR hike. YTD, BNM has raised the OPR by 50bps to 2.25% during May and Jul MPC meeting. Our economics team expects another 25bps rate hike in Sep, bringing the OPR to 2.50% by end-2022. The increase in OPR denotes a higher borrowing costs for REITs that may affect potential new acquisitions. The yield spread between M-REITs and the 10-year MGS (MAG10YR) is currently at 2.16%, which is close to -1SD with its 5-year mean of 2.76%. We believe the narrowing yield spread will diminish the appeal of M-REITs as interest rates increase.

Valuation. To keep abreast with the current MAG10YR yield, (now trading at 4.06%), we increase our assumption to 4.25% (from 3.75%; YTD average: 3.92%) for all REITs under our coverage. New TPs are shown in Figure #10.

Maintain NEUTRAL. We retain NEUTRAL on the sector, with Axis REIT (TP: RM2.08) 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: RM0.99) for its high yields (8.2%; highest under our coverage).

Source: Hong Leong Investment Bank Research - 19 Jul 2022