MREITs experienced a subdued acquisition environment in CY13 and 1QCY14 appears to be no different. Although we expect CY14 to be another quiet year, we do not discount the possibility of asset acquisitions by AXREIT and CMMT. Additionally, MREITs could be facing weaker rental reversions as tenants combat against rising costs (e.g. higher assessment rates, electricity hikes, consumer spending to plateau, competition costs) amid office space gluts in the Klang Valley. The US Fed implemented a third round of QE tapering on 19th Mar 2014, scaling bond purchases by another USD10b to USD55b a month. Nevertheless, we maintain our yield forecast at 4.15% as the 10-year MGS yield appeared to have plateaued at 4.1% the market has anticipated and priced in progressive tapering throughout CY14, in our view. Maintain NEUTRAL on MREITs. Our TPs and CALLs are: KLCCSS (UP; TP: RM5.93), SUNREIT (MP; TP: RM1.39), CMMT (MP; TP: RM1.47), AXREIT (UP; TP: RM3.17), and IGBREIT (OP; TP: RM1.25).

No asset acquisition in 1QCY14 due to low cap rate environment. There was no asset acquisition activity in CY13, and the first three months of CY14, due to the low cap rate environment. However, some MREITs are slightly more optimistic about acquisition prospects for this year. For instance, AXREIT is eyeing close to RM380m-RM400m worth of assets, which is likely to materialize with the acquisition of an industrial asset by 3Q14. To recap, AXREIT has yet to complete its placement exercise, which it recently (on 11th March 2014) requested for an extension until October 2014 (from April 2014). AXREIT plans to allot and issue 86.0m new units for a placement which is usually used to fund acquisitions. Another player, CMMT had extended the time frame for the listing approval by six months to April 2014, to issue 20% of its existing fund size, which may be for a potential acquisition. As a result of the low cap rate environment, we expect MREITs to focus on organic growth going forward.

A third round of QE tapering. The U.S. Federal Reserve on 19th March 2014 announced a third round of tapering by a further USD10b reduction in its monthly bond purchases, lowering its monthly bond buying to USD55b. We maintain our outlook that the US Fed will continue to taper bond purchases progressively over 2014 as US economics data has been showing signs of improvement. As for its effects on the 10-year MGS, we believe markets have priced in the effects of the bond tapering as bond yields have plateaued, at close to 4.10%. We make no changes to our target yield of 4.15% at this juncture and maintain a slightly conservative outlook as we expect tapering to continue throughout CY14.

Strong rental reversions may be more muted in the short-to-medium-term. The current environment poses various threats to MREITs such as: (i) potential increase in assessment rates by DBKL, which MREITs may pass on partly or fully to tenants which might affect other rental reversion opportunities, (ii) cost-push effects of subsidy rationalization (e.g. electricity hikes, which will be borne directly by the tenants), (iii) slower step-ups for office spaces due to the supply glut in the Klang Valley, (iv) consumer spending expected to plateau in 2014, (v) intense competition amongst retailers, (vi) additional supply of retail space in KL and Klang Valley in CY14, and (vii) looming GST implementation in Apr-2015. Taking all these into account, REITs may have to accept softer rental reversions in FY14 to maintain occupancy or ensure tenant’s sustainability.

Maintain MREITs at NEUTRAL. We maintain MREITs at NEUTRAL. We have upgraded our TPs marginally by 1.2%-12.8% after rolling forward our valuations by half a year as we enter 2QCY14. We have also reduced SUNREIT’s risk spread to encapsulate better earnings prospects from Sunway Putra Place’s contributions. MREITS under our coverage are currently trading close to the average historical yields of 5.7%-6.5%, except for IGBREIT, which is trading above-average historical yields of 5.5% at 6.4% currently. Since our last Sector Update (24/02/14), KLCC, AXREIT and CMMT’s share prices have rallied, accomplishing 4.6%-17.7% gains YTD. As a result, we downgrade KLCC to UP (from MP), and AXREIT to MP (from OP). Currently, IGBREIT is the most attractive, providing potential 16.9% total returns as the stock is a laggard at current price levels. We make no changes to our 10-year MGS valuation base of 4.15% and maintain a slightly conservative outlook as we expect the QE tapering to continue throughout CY14. Our TPs and CALLs are: KLCCSS (UP; TP: RM5.93), SUNREIT (MP; TP: RM1.39), CMMT (MP; TP: RM1.47), AXREIT (UP; TP: RM3.17), and IGBREIT (OP; TP: RM1.25).

Source: Kenanga