Vacancy rate for offices still stood stubbornly high at 30%. With continued increase in office supplies, ageing/older office landlords are struggling to retain tenants while sustaining rental rates. For retail, the positive momentum for footfall and tenant sales should sustain moving into 2023, aided by impending festive and holiday seasons in 1H23. Rental reversion outlook for retail is expected to be favourable. That said, outlook for hotel owners remained cloudy as they face manpower shortage and sluggish recovery in the tourism sector while awaiting Chinese tourists arrival to catalyse the industry. Meanwhile, we believe the sequential rise in borrowing costs, arising from imminent rate hikes will not pose a material dent on REIT’s earnings. Despite the MAG10YR dipping to 4.0% and widening the yield spread, we maintain NEUTRAL on the sector due to the volatile macroeconomic environment. Top picks: Sunway REIT (TP: RM1.68), IGB REIT (TP: RM1.89) and Axis REIT (TP: RM1.99).

Office: struggles for old buildings. Post-pandemic, offices are still saddled by the oversupply woes with overall vacancy rate still stubbornly high at 30% as at 3Q22 (figure#2). Despite the economy being fully reopened with mobility to office back to pre-pandemic level (figure#4), the gradual recovery in demand is struggling to stomach new office supplies following the completion of several new buildings in Klang Valley. With the persistent glut, office owners are facing an uphill task to fill up their space with favourable rates. Unlike their newer counterparts which are able to provide the latest office requirements such as availability of high-speed internet and sustainability features, the older/ageing buildings landlords face challenges in retaining their tenants without decreasing asking rents (Cushman & Wakefield). From our groundchecks with managements of office REITs, rental reversion in 2023 for their office properties are mostly flattish with high potential of dipping into negative territory. Hence, we believe the rental upside for office-based REITs should stay dismal entering 2023. Unless signs of inflection point emerges (significant slowdown in new office supplies), we opine that there is limited rental upside for office REITs.

Retail: decent reversion outlook. According to landlords of prime malls under our coverage, footfall and tenant sales remained reasonably strong in 2H22 despite earlier concerns of interest rate hikes and inflationary pressure stifling consumer purchasing power. Notably, Pavilion REIT and IGB REIT beat our earnings forecasts with higher-than-expected rental income. Alongside Sunway REIT, their performance has bounced back to pre-pandemic level, if not surpassed. We believe the positive momentum should sustain moving into 2023, aided by the impending festive seasons in 1H23 (Chinese New Year and Hari Raya Aidilfitri). We were also guided that prime malls (Sunway Pyramid, Midvalley Megamall, Pavilion KL) are anticipated to fetch positive mid-single digit reversion in 2023. While we deem the reversion commendable in times of economic uncertainties, we caution the incoming supplies of of retail space in 2023 (i.e. The Exchange TRX, Pavilion Damansara Heights) may intensify competition and weigh on the industry occupancy rate.

Industrial: stable and steady. Unlike retail and office, industrial properties have proven its resilience throughout the pandemic, thanks to the substantial growth of e commerce activities which subsequently lifted the demand for logistics -related industrial properties. While the tailwinds arising from the pandemic are abating with e commerce activities moderating, taking cue from Axis REIT’s strong performance, we expect outlook for industrial properties to remain fairly stable on the back of (i) anticipated positive rental reversion in 2023, (ii) sustained transactional activities within the industrial space, and (iii) resumption of investment activities which had been previously put on hold due to the pandemic.

Source: Hong Leong Investment Bank Research - 4 Jan 2023