We reiterate our NEUTRAL sector call on REITs. We do not expect Bank Negara Malaysia (BNM) to cut its current overnight policy rate (OPR) of 3% during the year; hence, we do not foresee yield seekers flocking back to REITs in a major way. Meanwhile, the retail REIT sector is navigating the recent increase in the Sales and Service tax (SST), weak consumer spending on sustained elevated inflation and subsidy rationalisation, partially cushioned by the impending pay rise for civil servants, the deferment of luxury-goods tax and the return of international tourists. We prefer retail REITs with malls in strategic locations while being cautious on the office segment. Our top sector picks are KLCC (OP; TP: RM8.00) and PAVREIT (OP; TP: RM1.59).

1. Retail

Weak consumer spending. The retail REIT sector is navigating the recent increase in the SST to 8% (from 6%) and weak consumer spending on sustained elevated inflation that is unlikely to ease over the immediate term due to the implementation of fuel subsidy rationalisation. These are partly cushioned by the 13% pay rise for most civil servants in Dec 2024 that may partially restore their spending power, the deferment of luxury-goods tax and the return of international tourists.

Two more malls to open. While we are positive on REITs with malls in strategic locations, we are mindful of competition for footfall posed by new sizeable high-profile malls in an already highly saturated market. Two new malls within Kuala Lumpur with a collective retail space of c.1.5m sq.ft, i.e. Pavilion Damansara Heights (Phase 2) and 118 Mall are scheduled for opening this year and 2HCY25, respectively. These will be on the heels of the entry of the Exchange TRX and Pavilion Damansara Heights (Phase 1) malls in 2HCY23.

Mall occupancy rates maintained while rental rates improved marginally. 1QCY24 retail occupancy rates in shopping complexes came in at 77.6% (4QCY23: 76.4%) from a total retail space of 17.7m sqm. There was a marginal increase in rental rates of about 3% YoY among retail REITs under our coverage.

2. Office

More office spaces to hit the market. Five new office buildings are pending completion in 1HCY24 which will contribute another c.1.4m sq ft to Klang Valley’s existing cumulative office stock, two of which are located in KL City, namely Felcra Tower, and The Exchange TRX Office by Lendlease. These will be on the heels of the recent completion of four new office developments, namely Merdeka 118 tower, PNB 1194 office building, Aspire Tower, and Pavilion Damansara Heights Corporate Tower.

Office occupancy & rental rates fairly maintained. 1QCY24 occupancy rates stood at 72.0% (from 71.9% in the preceding quarter) from a total private office space of 18.7m sqm. We note on the growing demand for office spaces from high-growth sectors such as technology and finance. However, we believe that the market for office segment will continue to be under pressure from the sustained imbalance between supply and demand.

We reiterate our NEUTRAL sector call on REITs. We do not expect BNM to cut its current overnight OPR of 3% during the year and hence we do not foresee yield seekers flocking back to REITs in a major way. We downgrade our calls for CLMT to UNDERPERFORM (from MARKET PERFORM) and SUNREIT to MARKET PERFORM (from OUTPERFORM) as valuations have become rich after the run-up in their share prices.

Our top sector picks are: (i) KLCC given its vibrant Suria KLCC mall backed by the iconic Petronas Twin Towers that is a “mustsee” spot for domestic and international tourists; and (ii) PAVREIT given the strong tenant portfolio of its malls, especially international luxury brands and franchises of its upmarket Pavilion KL mall.

Source: Kenanga Research - 12 Jul 2024