Goola Warden Tue, Jun 14, 2022
Hospitality trusts listed on the SGX have experienced a challenging and sometimes turbulent 16 years since the IPOs of the initial trusts, Ascott Residence Trust (ART) in March 2006, and CDL Hospitality Trusts (CDLHT) in July of the same year.
Nothing quite impacted the hospitality sector more than Covid-19 pandemic. Travel stopped and most economies were in some form of lockdown for close to two years. This meant that occupancy rates for hotels dropped drastically to well below breakeven levels.
On May 13, Frasers Property (FPL) and Frasers Hospitality Trust’s (FHT) manager announced an offer by FPL and TCC Group for FHT at 70 cents to all of FHT’s minority security-holders to privatise the trust via a scheme of arrangement.
Earlier on Feb 22, City Developments (CDL) announced a distribution-in-specie (DIS) of CDLHT to CDL shareholders after a review of the group’s hotel operations. CDL and its hotel arm Millennium & Copthorne (M&C), which was once listed but privatised in 2019, are the sponsors of CDLHT. The DIS, which was completed on May 26, deconsolidates CDLHT from CDL, reduces CDL’s gearing and enables CDL to recognise an accounting gain of $467.5 million on a pro forma basis.
Although the response from FHT’s sponsor markedly differs from that of CDL, the challenges FHT faces are similar to the ones that CDLHT faces. In 2021, CDL had to write off close to $2 billion for its investment in Sincere Property, a Chinese developer. Since then, its management has been exploring ways to add value to CDL. The review of M&C and deconsolidation of CDLHT was one of them.
Too volatile for stable income?
REITs are passive instruments, required to provide a stable income for their investors. The S-REIT structure is such that the asset and property managers are external. The REIT just provides the conduit for pass through income.
Most hotel customers stay in their rooms for a couple of nights. Hence a characteristic of hotels is their short-term stays. “In general industrial and commercial REITs have longer lease terms (3-10 years) which mitigate short-term economic pressures. On the other hand hospitality trusts by nature have shorter duration stays (from daily to a couple of months) and thus are more exposed to short-term business swings making them more volatile among the REIT sub-segments,” notes Vijay Natarajan, head of real estate research at RHB Bank.
FHT won’t be the first or even second hospitality trust to potentially disappear from the SGX. In September 2019, OUE Hospitality Trust (OUEHT) was merged with OUE Commercial REIT in a scheme of arrangement. The rationale for the merger was to create a larger, diversified, more liquid S-REIT. “Post-merger, the portfolio of the enlarged entity will be more diversified, with seven properties across the office, retail and hospitality sectors. With reduced concentration risk associated with exposure to any single real estate asset class, the enlarged REIT will also be more resilient,” OUE C-REIT’s manager had said at the time.
To be sure, OUEHT was probably too small with just three assets in Singapore, the Mandarin Orchard (now Hilton Singapore Orchard), Mandarin Gallery, and Crowne Plaza Changi Airport (CPCA) to grow its distribution per security (DPS) through accretive acquisitions, attract institutional investors or make it to important indices such as the FTSE EPRA NAREIT Developed Index. Case in point: Although OUEHT’s manager had provided income support for OUEHT in its acquisition of CPCA, CPCA was still not able to meet the expected rental revenue after the income support expired.
Perhaps, a hint of the problems faced by hospitality trusts had appeared a lot earlier. In FY2013, Far East Hospitality Trust’s (FEHT) DPS was 5.64 cents, 3.1% below the forecast indicated in its 2012 IPO prospectus.
“For FY2013, the average occupancy was 86.4% or 1.6 pp above forecast. The average daily rate (ADR) of $191.9 was 10.8% below forecast, as a result of industry-wide challenges including price competition, subdued business travel spending and slower leisure traffic from some regional markets, due to the depreciation of their currencies,” FEHT’s manager had said at the time.
In addition to ADR, other important metrics that hospitality trust managers look at closely are the revenue per available room (RevPAR) and revenue per available unit (RevPAU).
Based on its portfolio, FEHT carries the least risk. It has a combination of long-stay serviced residences and shorter-stay hotels. And its portfolio is priced in Singapore dollars. Therefore, removing the added risk of overseas assets and hedging, and for investors, gauging the impact of different risk-free rates. In addition, the management of capital by its manager is sound, compared with Chinese S-REITs where nearly all the debt expires in the same month or year.
However, the biggest problem for FEHT lies with the vagaries of the hospitality sector. In FY2021, FEHT grew its DPS by 9.1% to 2.63 cents, but this was still painfully below its FY2014 level which was its first full year of DPS after IPO.
The breakeven point (BEP) is an occupancy rate of a hotel which depends on the ADR (average daily rate or the average revenue that a hotel receives for each occupied guest room per day), fixed costs and variable cost per room.
It is denoted by the formula: BEP rooms sold = Total fixed costs for the hotel ÷ selling price per unit — variable costs per unit.
Take ARA US Hospitality Trust for example. At IPO, its breakeven point was around an occupancy rate of 40%. This is reasonable as the breakeven occupancy pre-Covid for the US is around 37.3%. Still, ARA US Hospitality Trust is the most stressed hospitality trust at present and could be a candidate for privatisation in the future as it divests its properties. For instance, ARA US Hospitality Trust announced the proposed divestment of Hyatt Place Chicago Itasco for US$7.75 million (compared to the acquisition price of US$11.4 million in the IPO portfolio), to lower gearing, and for general working capital.
Master leases
To mitigate the volatility of income, hospitality trusts have a minimum guaranteed income through master leases and similar agreements, along with a variable component to make up gross revenue. “The income volatility is to some extent mitigated by master leases with minimum guaranteed income contracts for some of the hospitality lease structures,” Natarajan notes.
Eu Chin Fen, CEO of FHT’s manager, acknowledges that the way the hospitality sector is structured is an issue and master leases are meant to lessen this volatility. “This business is more cyclical. But the reversionary to current economic performance conditions is faster because there is no locked-in tenancy. Obviously, without locked-in tenancy, there is less stability. It’s good to have a master lease arrangement to give us income stability, yet allows us to ride the upside if the economy outperforms,” she explains.
FHT’s master lease rents amounted to around $50 million to $56 million a year compared to its gross revenue of $140 million, with the variable component making up the rest. FHT’s cash flow was always positive, even in the depths of Covid when DPS fell drastically to around 1.4 cents a year.
Within the sector, FEHT relied heavily on master lease rents to support income during Covid. In FY2021 ended December, FEHT’s rental income from master leases was $68.17 million and total revenue was $83.2 million.
Based on size, liquidity, sponsor support, DPS and NAV growth, strategy and business model, it is no surprise that ART is the market leader in the hospitality trust sector. In FY2021, ART’s rental income from master leases and minimum guaranteed rents of $65.2 million was a fraction of its gross revenue of $394.4 million. This could show that a diversified portfolio both geographically and by asset class is more resilient.
Out of its gross revenue of $154.4 million in FY2021, CDLHT’s minimum master lease rents totalled approximately $43.7 million. This comprises $31 million for its Singapore hotels, NZ$6 million for its New Zealand hotels and EUR5.1 million for its hotels in Europe.
By and large, sponsors are meant to support their hospitality trusts during times of financial stress. Far East Organization (FEO) group of companies are the sponsors of FEHT, CDL and M&C are the sponsors for CDLHT, while CapitaLand Investment (CLI) is the sponsor of ART. CLI, CDL and FEO, which rank among the largest local real estate players and are cornerstones of Singapore Inc, are wholly reliable as master lessees. As sponsors, they are committed to supporting their REITs both financially with master leases, rent support if need be, and fundraising in the event of acquisitions.
When Eagle Hospitality Trust (EHT) was listed in early 2019, its sponsor, Urban Commons, was an unknown entity. While the portfolio of its 17 hotels and a ship were valued based on the master lease rents for 20 years from the sponsor, Urban Commons appeared to have had no intention of meeting these payments. As a result, EHT defaulted on its loans and was eventually suspended. It has yet to be delisted. Based on an update by the Monetary Authority of Singapore on April 27, investigations are still ongoing.
Stapled security structure
Hospitality trusts — with the exception of ARA US Hospitality Trust which is an outright business trust — are structured as a stapled security: The listed entity holds a REIT and a business trust. In most cases, the business trust used to be dormant and is only activated in the event that the properties in the hospitality trust need to be actively managed. FEHT’s business trust is the only one among the hospitality trusts which is still dormant.
In 2016, FHT activated its business trust to operate an acquisition, Novotel Melbourne which did not come with a master lease.
Up to 2019, ART was often referred to as Ascott REIT because it had little use for a business trust. In 2019, because of the acquisition of Ascendas Hospitality Trust (AHT), ART had to implement a business trust through a vote by its unitholders. When it was listed, AHT’s business trust had been activated to own and manage certain hotel properties. ART’s business trust was set up to facilitate the management of some of the former AHT’s hotels when it acquired AHT.
CDLHT comprises CDL Hospitality Real Estate Investment Trust (H-REIT) and CDL Hospitality Business Trust (HBT). HBT has been activated to act as the master lessee of CDLHT’s assets for those with no master lessee and can operate hotels or appoint professional hotel managers to manage these hotels. HBT currently acts as the master lessee for six of the properties held under H-REIT managed by third-party hotel management companies. These are W Hotel, Mercure Perth, Ibis Perth, Raffles Maldives Meradhoo, Hotel MyStays Asakusabashi and Hotel MyStays Kamata.
Whether the privatisation offer for FHT triggers further privatisation offers for this somewhat troublesome sub-sector remains to be seen