Stable yields to support performance of REITs

PETALING JAYA: The outlook for Malaysian real estate investment trusts (REITs) is becoming more challenging even as yields remain stable amid rising unit prices, analysts say.

This is also despite the KL REIT Index gaining 0.9% against Bursa Malaysia’s benchmark FBM KLCI’s 8.2% loss over the five months to May.

Analysts said that the expanded Sales and Service Tax (SST), which will come into effect on July 1, would have an impact on REITs as it would require them to them to impose an 8% service tax (unless specific lessee exemption criteria are met), raising operating costs for tenants.

Revisions to Malaysia’s SST include targeted increases for non-essential goods and an expansion of the services tax to six new categories: leasing or rental services, construction, financial services, private healthcare, education, and beauty services.

While the aim of revising the SST is to broaden the tax base with minimal impact on the majority of Malaysian consumers, specific business sectors, particularly REITs and financial services, are expected to bear a more direct and potentially adverse impact, analysts said.

CGS International Research said while REITs with prime assets would remain resilient due to strong tenant profiles and footfall, weaker properties may face tenant attrition.

“In this regard, REITs with lower-quality portfolios may be compelled to provide rental support, which could weigh on earnings and distributions,” the research house said.

Maybank Investment Bank Research (Maybank IB Research) remained positive on REITs, with its top pick being Sunway-REIT.

The research house said retail and industrial REITs remained resilient, but office REITs face challenges despite long leases and stable occupancy.

It added that domestic REITs offer attractive average dividend yields of between 5.6% and 6.1% or a healthy spread of between 208 and 258 basis points against the 3.5% for current 10-year Malaysian Government Securities (MGS).

“We see room for spread compression should Bank Negara initiate an overnight policy rate cut in the second half of this year that would benefit REITs with higher floating-rate debt exposure,” Maybank IB Research said, adding that this would support valuation upside and lower financing costs for growth-oriented REITs.

It noted that the managements of various REITs maintained a cautiously optimistic outlook but flagged a few concerns such as the potential 8% service tax that could limit their ability to raise rents, as well as the potential increase in electricity tariffs and broader economic uncertainty such as subsidy rationalisation for RON95 petrol and international trade tensions.

MIDF Research, which downgraded REITs to “neutral” from “positive”, said most of the positives have been priced in.

“Going forward, we expect REITs to continue registering earnings growth. However, we expect moderate earnings growth going forward from a normalised base in 2024.

“Besides, the yields of REITs under our coverage tapered to 4.6% following the increase in unit prices of REITs recently,” the research house said.

It expects its top pick, Pavilion-REIT, with an unchanged target price of RM1.69, to see its earnings supported by a rental revision for Pavilion KL Mall, while Pavilion Bukit Jalil’s performance remains stable.

MIDF Research said that the KL REIT Index was resilient in the first five months of the year following a gain of 11.4% last year in comparison to the KLCI, as investors flocked to defensive investments.

However, the research house said the increase in unit prices have also narrowed the yield spread versus 10-year MGS, which makes them less attractive to investors.