We recently hosted a talk with Savills Malaysia. Greater KL’s office vacancy rates remain elevated at 25.4% in 2Q22. Impact is mostly felt in older grade B buildings as tenants relocate to grade A offices due to various incentives. Overall occupancy rates of retail malls continued to decline amidst the rising retail spaces and store closures. However, existing prime mall operators under our coverage should remain resilient, at least in the medium term. Manpower shortage remains a bottleneck for hospitality sector to operate at an optimal capacity to capitalise on the increasing demand and ADR. We increased our MAG10YR yield to 4.5% (from 4.25%) with new TPs for our REITs coverage. Keep NEUTRAL on the sector and cut IGB Commercial REIT from BUY to HOLD with a lower RM0.52 TP (from RM0.59) in view of the tough office market.

We recently hosted a talk with Savills Malaysia. The meeting was primarily focused on the real estate sector’s performance while delving into the recent updates on different property classes. Below are the key takeaways:

Bleak outlook, but offices still relevant. Notwithstanding the WFH trend driven by the pandemic, offices remain an important asset for many companies as it still serves as an ideal platform for collaborative work and social activities. Greater KL’s office vacancy rates remain elevated at 25.4% in 2Q22, but it saw a slight improvement from 27.3% in 2021. The impact is mostly felt in older grade B buildings as tenants are able to relocate to grade A offices without steep rental increment due to various incentives granted by landlords. Meanwhile, office gross asking rent in Greater KL has largely stayed flattish since 2020 at RM8.50 per sf (Figure#3).

Extensive malls pipeline in Klang Valley. Despite the retail boom in 1H22 following the transition to endemicity, the overall occupancy rate of retail malls continued to decline amidst the rising retail spaces and store closures (Figure#6). In 2022, a total NLA of 3.4m sqft came on stream, comprising Mitsui Shopping Park Lalaport, IOI City Mall Phase 2, Setia Ecohill Mall etc, alongside completion of another 3.3m sq ft in the pipeline for 2023. However, existing prime malls operators such as Sunway REIT, IGB REIT, Pavilion REIT under our coverage should remain resilient, premised on its established brand names and strategic location, at least in the medium term. Moreover, we gathered that new malls tend to take on greater risk than the established ones as landlords offer incentives to attract tenants.

Hotels not out of the woods yet. While enjoying steady increase in demand for hotel rooms due to lifting of travel restrictions, manpower shortage remains a pertinent challenge for the hospitality sector to operate at an optimal capacity. Coupled with the prolonged border closures of many countries, overall average occupancy rates for hotels in Greater KL remains well below pre-pandemic level (Figure#9). On a positive note, ADR for hotels has rebounded favourably, nearing 2019 levels (Figure#8).

Rising borrowing costs. As accessibility to loans is vital for the real estate market, the recent hike of OPR has elevated the borrowing cost, which may hamper new potential acquisitions. Though our economics team expects BNM to pause its OPR hike in Nov at 2.5% until end-year, the yield spread between M-REITs and the 10-year MGS (MAG10YR) is currently at c.2.2%, which has dipped slightly below -1SD with its 5-year mean of 2.86%. Hence, we take a prudent stance as we believe the narrowing yield spread will continue to deteriorate the appeal of M-REITs.

Valuation. To keep abreast with the current MAG10YR yield (now trading at 4.4%), we increase our assumption to 4.5% (from 4.25%) for all REITs under our coverage (except Sunway REIT which we revised in our recent company update). New TPs are shown in Figure#13.

Maintain NEUTRAL. We retain our neutral view on the sector while being selective on names that delivered commendable showing throughout 2022 and its ability to tide over a recessionary environment. We like Axis REIT for its robust track record and occupant tenancy in its diversified portfolio. For retail REITs, we favour Sunway REIT and IGB REIT for their strategically located prime retail malls and sturdy shopper footfall. Meanwhile, we downgrade IGB Commercial REIT from BUY to HOLD with a lower RM0.52 TP (from RM0.59) in view of the challenging outlook for office market.

Source: Hong Leong Investment Bank Research - 14 Oct 2022