Pavilion REIT, Axis REIT, IGB REIT, Sentral REIT, Sunway REIT: A Resilient Asset Class; Keep OVERWEIGHT

• Maintain OVERWEIGHT; Top Pick: Pavilion REIT. We continue to like M-REITs as a reliable shelter for investors seeking defensive assets given the robust domestic spending, easing bond yields, and inorganic growth strategies across multiple REITs. We think the pros outweigh the cons, most notably from the expansion of the Sales & Service Tax (SST) which could potentially provide a downside risk to rental reversions, of which the REITs with strong asset quality should be relatively shielded from.
• The current dividend yield spread between the Bursa Malaysia REIT Index (KLREI) and 10-year Malaysia Government Securities (MGS10) is at +200bps or +0.5SD from the historical mean. The MGS10 yield has eased roughly 38bps YTD alongside the broadly lower bond yields globally – this is as central banks in the region continue to cut interest rates. Bank Negara Malaysia (BNM) has also followed suit yesterday with its first 25bps cut to the overnight policy rate (OPR) since 2023, which we think will be supportive of M-REITs as dividend yield plays.
• Earnings catalysts in 2H25. We expect multiple REITs to record a bump in earnings from ongoing acquisitions and renovations. AME REIT is expected to complete MYR148m worth of acquisitions, and Axis REIT should record healthy YoY earnings growth from the MYR644m worth of acquisitions completed in 2H24. IGB REIT’s ongoing acquisition of Mid Valley Southkey (MYR2.7bn) is a significant one as it allows the REIT to capture opportunities from the growing Iskandar Malaysia market. To a lesser extent, Pavilion REIT should also complete the acquisition of the two hotels – Pavilion Hotel KL and Banyan Tree KL for MYR480m – which provides positive operating synergies with its flagship mall, and Sentral REIT is expected to complete the acquisition of Arcoris Plaza for MYR70m as part of its strategy to diversify its asset mix. We also keep an eye out on any disposal opportunities for the vacant Wisma Sentral Inai which would help pare down its borrowing costs. Finally, Sunway REIT has completed the phase two refurbishment of Sunway Carnival Mall which should result in a strong pickup in average rental rates.
• Manageable downsides. In lieu of growth opportunities, we think this should help REITs to manage the potential downside risks from the expanded SST and new electricity tariff. While there is no clear guidance as of yet on the impact from the new cost pressures, we think REITs may delay the imposition of higher rental reversions for certain tenants to maintain positive relationships while they adjust to the new cost base, which would be more beneficial in the long run. Likewise, REITs in the past have delayed raising the service charge to tenants due to higher electricity tariff.
• Top Pick: Pavilion REIT. The REIT is expected to provide more attractive dividend yields compared to its closest peers, backed by its high occupancy rates which should provide solid earnings growth in the long term.

More upside from the current yield spread

Currently, the dividend yield spread between the KLREI and MGS10 is at +200bps, or +0.5SD from the historical mean. The MGS10 yield has eased roughly 38bps YTD alongside the broadly lower bond yields globally – this is as central banks in the region continue to cut interest rates. While the timing of interest rate cuts may be slower due to the increased inflationary risks globally – as referenced by US Federal Reserve Chair Jerome Powell saying that the central bank would have eased monetary policy by now if not for the US tariffs – we think a wider yield spread during this interest rate cut environment will be supportive of M-REITs as dividend yield plays. In this regard, BNM’s announcement yesterday to cut the OPR by 25bps (a first cut since May 2023) is a positive catalyst for M-REITs, with the MGS10 yield now at the lowest level since 2021 (c.4.4%).

Bigger retail REITs with inorganic growth should fare better

Consumer spending is likely to remain resilient, though unexciting, supported by a strong labour market, wage growth, and sustained government assistance for lower-income households. Additionally, tourism could be a key tailwind, with the government targeting 31.4m international tourist arrivals in 2025 (+25% YoY). In the first two months of the year, Malaysia recorded a strong 31% YoY increase in international visitors, supported by visa-free access for Chinese nationals. This should particularly benefit tourist-driven malls in the city centre, such as those under Pavilion REIT and KLCCP Stapled.

That said, Retail Group Malaysia now has a 3.1% retail sales growth forecast for FY25, lower from its previous 4.3% forecast, for the year attributed to which we believe is unlikely to drive strong variable rental income for REITs with high exposure to turnover rent structures. This is as consumers brace for potentially higher cost of living from policy measures such as the expected RON95 subsidy rationalisation, as well as businesses passing on the costs of the expanded SST and new electricity tariffs.

In this environment, we prefer retail REITs with high-quality assets, strong occupancy, and exposure to tourist footfall, which are better positioned to capture rental growth. Pavilion REIT is our Top Pick among the retail REITs, considering its compelling dividend yield relative to peers, direct exposure to the improving tourism outlook, and long-term growth prospects from Pavilion Bukit Jalil.

We also favour REITs with inorganic growth opportunities such as IGB REIT with the acquisition of Mid Valley Southkey mall, and Sunway REIT’s clear target of reaching MYR14bn in assets under management by 2027 (from the current MYR10bn asset value). This should help to offset any potential slowdown in rental reversion growth as tenants adjust to the new cost base.

Emphasis on quality for offices

We remain cautious on the office REIT sector, given persistently low occupancy levels in KL, which hover around 70%, and an ongoing influx of new supply. The leasing environment remains soft, with limited new demand and a growing preference among tenants for newer, well-located Grade A buildings. According to Knight Frank, about one-third of KL’s office stock is now green-certified, and demand is increasingly coming from occupiers relocating from older buildings in favour of modern offices with better connectivity and sustainability features. In contrast, assets lacking these qualities continue to face leasing challenges and downward pressure on rents.

That said, within the office subsector, we favour Sentral REIT for its attractive and sustainable dividend yield. Its portfolio is anchored by high-quality, transit-oriented assets like Platinum Sentral and Menara Shell, which enjoy healthy demand. We view downside risk to occupancy as limited in the medium term, given most of its lease expiries involve long-standing tenants with high renewal prospects. Earnings visibility is further enhanced by a long-term lease at Menara CelcomDigi. In addition, Sentral REIT stands to benefit from any successful disposal of the vacant Wisma Sentral Inai, which would free up capital, lower financing costs, and further enhance distribution yields.

Stability for industrials

We maintain a positive outlook on industrial REITs, underpinned by stable lease structures and supportive long-term fundamentals. Most industrial REITs are backed by weighted average lease expiries of 4-5 years, offering earnings visibility and insulating them from near-term tariff risks. While momentum from the China Plus One strategy has moderated amid broader protectionist policies, Malaysia remains relatively well-positioned with a lower average tariff rate (25%) compared to regional peers like Vietnam (46%), Thailand (36%), and Indonesia (32%). On the domestic front, national initiatives such as the Johor-Singapore Special Economic Zone and the New Industrial Master Plan 2030 are set to attract sustained investment into industrial real estate.

In this context, we expect strong earnings growth from both Axis REIT and AME REIT over the next two years. AME REIT’s proposed and completed acquisitions across 2025 and early 2026 (worth MYR220m) will expand its total asset value by 31% to MYR931m, while still leaving its gearing ratio at a healthy 35% post-acquisitions. For Axis REIT, despite its largest-ever private placement in Oct 2024, we still expect a solid 8% DPU growth in FY25 on the back of the MYR719m in acquisitions completed in FY24. The placement has also helped to pare down its gearing to 33%, giving the REIT MYR1.7bn in acquisition headroom before hitting the 50% gearing limit.

Inorganic growth to mitigate potential downside risk

In lieu of the growth opportunities, we think this would help REITs to manage the downside risks from the expanded SST and new electricity tariff. While there is no clear guidance yet on the impact from the SST, we think REITs may delay the imposition of higher rental reversions for certain tenants to maintain positive relationships while they adjust to the new cost base, which would be more beneficial in the long run. Likewise, REITs in the past have delayed raising the service charge to tenants due to higher electricity tariffs. Previously, following the initial 14% electricity tariff hike announcement in Dec 2024, most retail REITs guided for a c.2% impact to earnings, but – as of writing – they have yet to determine the estimated impact from the newly announced (Jun 2025) tariff structure.

Meanwhile, we think the downside risks from the expanded SST for industrial and office REITs should be relatively minimal given their long-term master leases, as well as the fact that their tenants mostly comprise large multinational corporations that can better absorb cost increases arising from the new tax. Other assets with long-term tenancies that should be relatively shielded from the new tax include hypermarkets (Sunway REIT) and hotels (Pavilion REIT’s ongoing acquisitions), as rental reversions are typically pre-agreed upon before signing a master lease agreement.

Top Pick: Pavilion REIT

We like the REIT for its relatively more attractive dividend yield compared to peers, proxy to the improving tourism industry, and growth prospects from Pavilion Bukit Jalil. Pavilion Kuala Lumpur would be a key beneficiary of Visit Malaysia Year 2026, in our view, as tourists typically make up 30% of the mall’s footfall and spend more than local shoppers. Pavilion Bukit Jalil has also gradually improved since the acquisition in 2023, with the mall now recording a 90% occupancy rate and having more room for rental reversions from its lower base. The REIT’s struggling asset, Da Men Mall, should also begin to break even in 4Q25 once its new master lease with Easyhome International commences.

Figure 7: Debt structure for REITs

Figure 8: Earnings sensitivity to OPR cut

Figure 9: Occupancy rates of buildings of M-REITs

Figure 10: Valuations of M-REITs