AL-SALAM REIT ANNUAL REPORT 2019

48 ANNUAL REPORT 2019 Market Report Summary AL-SALĀM REIT • 1. Economic Overview Global real GDP growth went sub-3% in 2Q-3Q 2019. The Global Composite Purchasing Managers Index (PMI) trend points to continued sub-3% global growth in 4Q 2019. Our analysis of 15 global economic, trade, financial and commodity indicators in terms of where they are now vs past recessions and slowdowns support the scenario of global growth slowdown (2020E: +2.8%; 2019E: +3.0%; 2018: +3.6%) with around 25% chance of recession. Global growth uncertainty remains elevated on several political and policy factors. World trade uncertainty remains as US protectionist trade policy resulted in trade frictions with major trading partners – not only China, but others (Europe, Asia, Latin America). US political and policy uncertainties are elevated amid on-going President Trump’s impeachment inquiry and US Presidential Election in Nov 2020. Geopolitical risks are spread out across Europe, Latin America, Middle East and Asia. There is also a question over major central banks’ effectiveness and options amid prolonged unconventional monetary policy. For Malaysia macro, we remain cautiously constructive as growth is expected to muddle along (2020E: +4.4%; 2019E: +4.5%). External uncertainties and downside risks, plus some overhangs in domestic policy (e.g. on going tax systems and incentives reviews) and politics, are contributing to cautious business conditions and consumer sentiment, in turn headwinds on consumption and especially capex. But monetary and fiscal policies are supportive of growth. We see another 25bps cut in Overnight Policy Rate (OPR) in 2020 after the 25bps cut in 2019. Budget 2020 is growth friendly e.g. slower pace of budget deficit/GDP ratio cut in 2020; higher Government procurement and capex spending; customized incentives and targeted allocations to boost private sector capex; additional major infrastructure projects. Meanwhile, approved manufacturing FDI from US and China surged in 2018 2019 as US China trade war triggered trade diversions and investment relocations. (Extracted from Maybank Economic Report 2019: Malaysia 2020 Outlooks and Lookouts) Private sector expenditure will remain the key growth driver in 2020, with private consumption and investment rising 6.9% and 2.1%, respectively. Private investment is expected to grow at a slower pace in 2019 and gain traction in 2020, following the resumption of infrastructure projects coupled with ongoing capital spending in the services and manufacturing sectors. Favourable private sector expenditure activity will offset the impact of lower public expenditure in 2019. However, economic growth is expected to rebound in 2020 with improvement in public corporations' capital outlays. Public sector expenditure is expected to rebound to positive growth of 0.8% in 2020 after registering 1.8% decline in 2019, largely driven by the acceleration of projects towards the tail-end of the Eleventh Malaysia Plan coupled with the revival of strategic projects. In line with the fiscal consolidation path, public consumption is projected to stay moderate at 1.5% in 2020, which is lower compared to 2% in 2019. (Extracted from The Edge Markets : Economic Report 2019/2020) 2. Malaysia REIT The sector has seen significant fluctuations of the MGS yields where the 10-year MGS yield fell to its 2019 YTD low of 3.19% in Aug 2019 (end-2018: 4.07%; 3M trailing average of 3.4%). However, in the light of sustained net DPU yields, the net yield spread has trended higher - ranging from 104bps to 195bps in 2019 YTD (end-2018: 128bps). In 2019 YTD, the sector was faced with: (i) 25bps OPR cut to 3.00% in May 2019; and (ii) potential exclusion of Malaysia bonds from FTSE Russell’s World Government Bond Index, which was first announced in Apr 2019. Elsewhere, as expected, asset acquisitions in 2019 YTD were limited - notably Sunway University & College Campus by SunREIT (Apr 2019) while Axis has again led the acquisition initiatives with a total of at least 9 small to mid-sized industrial properties to be acquired/developed in 2019-2020. We estimate M-REITs’ growths to be largely organic in 2019, via positive rental reversions and sustained occupancy rates, while there are M-REITs which would record full-year rental income contributions from assets that were acquired in 2019 (i.e. Axis, SunREIT, ALSREIT). Taking note from MKE’s expectation of an OPR cut in 2020 (-25bps to 2.75%), we expect direct earnings lift to M-REITs to be minimal (via easing of financing costs from variable rate debts). Nevertheless, a lower interest rate environment could encourage more acquisitions by M-REITs, which are generally financed by borrowings. We also expect 2020’s acquisition pipeline to remain subdued for now, only involving smaller size assets as anticipated major pipeline and developments could only take place from 2021 onwards, such as Lot 185, Lot 91, and City Point Podium by KLCCP and completion of Phase 2 development at Axis Mega Distribution Centre by Axis. Our 2020 forecasts have only imputed 4 industrial property development/acquisitions by Axis. Elsewhere, due to ongoing oversupply of retail and office space, particularly in the Klang Valley, we continue to favour prime malls with prominent locations and office and industrial assets with long-term tenants. We have penciled in >95% occupancy rates and positive rental eversions for the aforementioned assets. (Extracted from Maybank Economic Report 2019: Malaysia 2020 Outlooks and Lookouts)