We upgrade our NEUTRAL sector call to OVERWEIGHT on REITs for two reasons. Firstly, after conducting ground and channel checks, we share optimism with REITs operators in retail, hospitality assets in prime locations, and industrial assets in booming regions. Secondly, despite OPR seen to be flat, MGS yields are expected to fall further where the spread of sector yields over MGS is now entering attractive territory (exhibit 1). We recalibrate our target yields and valuations – having considered relative ability of individual REITs in coping with further rationalisation and the possibility of luxury tax – and find PAVREIT (OP, TP: RM1.66) and SUNREIT (OP, TP: RM1.77) emerging as our Top Picks in the sector, replacing previously KLCC (TP: RM8.38) due to share price action.

REITs have now emerged to be a sound consideration for yield-seeking and long-term investors with average yields of 5.5%-6.5% remaining the cream of the crop within our coverage supported by stable projected earnings growth. With this in mind, we are delighted to share our findings and thoughts on the key segments between REIT markets, being (i) retail; (ii) industrial; and (iii) office spaces.

Retail

On the retail lens, most REITs managers remain optimistic on the retail and hospitality landscape. This is mainly driven by the continuous influx of tourists and promising rental reversions. The Malaysian government is expecting to welcome 27m tourists in 2024 (from 20m in 2023). Notable assets in prime location are seeing stronger spillover from tourist arrivals such as Suria KLCC (KLCC), Pavilion KL (PAVREIT), and Sunway Hotels (SUNREIT).

During our excursions, we continue to get a sense that retail mall remains bustling, supported by tourist spendings particularly in prime locations. As we had gathered, Sunway Pyramid mall is also expanding its retail lettable space to meet the continuous strong demand in the Klang Valley retail market. Apart from Klang Valley, it is noteworthy that retail malls in Penang such as Gurney Plaza, Queensbay Mall (CLMT) and Sunway Carnival have been recording strong growth in rental revenue since the beginning of the year, given the robust business activities that stimulate retail spending in the northern part of Malaysia.

Though having a healthy growth in retail activities, retail-centric REITs are still closely monitoring the market for headwinds especially in light of proposed government policies such as further subsidy rationalization and the luxury tax which erodes affordability of premium offerings in upscale malls.

Industrial

The industrial sector appears to be doing well, translative of the expansion in Malaysia’s industrial production index (IPI) by 5.3% in July following a 5% growth in the preceding month along with GDP growth by 5.9% in the second quarter. Particularly in Johor, it is largely driven by the data centre investments with strong FDI inflows. Our industrial-centric coverage, AXREIT, is shown to be approaching near to full occupancy for its industrial assets secured by longer-leasing assets (average 8 years upon acquisition) under the group’s portfolio with double-digit rental reversion in its Johor asset which accounts for one third of its portfolio. Aside from that, non-industrial REIT such as CLMT has also demonstrated keen interest in expanding into the industrial sector as part of the group’s growth strategy.

Office

Despite the overall office sector continuing to experience oversupply in many areas, well integrated areas such as the KL Fringe, Bangsar South, and Petaling Jaya continue to see resilient demand thanks to higher affordability than KL city. Sentral REIT (SENTRAL; UNRATED), for example, is still seen to be enjoying high occupancy rate on most of its office buildings outside of KL city centre.

A cause to recalibrate. With the decline in MGS yield, we have refreshed the MGS yield in our valuation to 3.75% from 4.0% accordingly and take this opportunity to review our individual target yields for our coverage given that the abovementioned merits may be more favourable to certain REITs. We apply lower yield spread to asset owners with lower income risk or higher growth potential and vice versa. With our refreshed perspective, we call out CLMT and IGBREIT to be deserving of better valuations thanks to: (i) lower earnings risk on CLMT assets, and (ii) higher business stability in mid-range malls such as Mid Valley Megamall for IGBREIT. Our revised target yield and target price as per below:

MGS showing signs of ease. The 10-year Malaysian Government Securities (MGS) yield – a risk-free benchmark used by us as a valuation reference to impute the corresponding yield spreads in deriving our individual target prices, has come off from its peak of 4.57% in Oct 2022. Given continuous net foreign inflows into Malaysian bond market, coupled with the anticipation of Federal reserve rate cut later this month, MGS has declined to 3.75%. We expect it likely to further decline to around 3.6% which would still be fairly in line with historical averages pre-pandemic

Source: Kenanga Research - 16 Sept 2024