In the past 2 months, investors have been selling off Hospitality Trusts (HTs) listed on SGX due to travel restrictions imposed by governments around the world to stem the spread of COVID-19. There are 6 HTs listed on SGX, namely:
- ARA US HT
- Ascott Residence Trust
- CDL HT
- Eagle HT
- Far East HT
- Frasers HT
While all hotels will suffer revenue decline due to the travel restrictions, not all HTs will be impacted by the same extent. One important factor affecting the impact on HTs is their operating models. Traditionally, hotels have been owned and operated by the same party, but there are increasingly more investors who wish to invest in hotels but might not have the expertise or time to manage them. Thus, hotels might be owned by one party but operated by another, with revenue-sharing agreements between them. If you buy into HTs, you are buying into the ownership of the hotels. The operating model adopted by the HT will affect how the revenue and/or profit are shared between the owners (i.e. HTs) and the operators (i.e. hotel chains like Mariott, Hilton, Accor, etc.).
Some of the major operating models are as follow:
- Owner Operated - The owner owns and operates the hotel, bears all costs and risks, and receives all profits. HTs usually do not adopt this model.
- Master Lease - This is the simplest model when the owner and operator are different parties. The owner leases the hotel property to the operator in return for a fixed rental fee. The operator bears all costs and risks of operating the hotel. The owner does not have any share in the profits from operating the hotel. Nevertheless, there are variants to this model in which the rental can be variable and pegged to a percentage of the hotel revenue and/or profit.
- Management Contract - In this model, the owner engages the operator to run the hotel. The operator receives a management fee which is pegged to a percentage of the hotel revenue and profit. The owner bears all costs and risks of operating the hotel and receives all profits after deducting the costs and management fee to the operator.
- Franchise - In this model, the owner runs the hotel using the franchisor's brand. The franchisor receives a franchise fee which is pegged to a percentage of the hotel revenue. The owner bears all costs and risks of operating the hotel and receives all profits after deducting the costs and franchise fee. A variant of this model is the owner outsources the operation of the hotel to an independent third-party operator. This arrangement is similar to a management contract, except that the third-party operator is not associated with the franchisor.
|Fig. 1: Various Hotel Operating Models|
Needless to say, given the severe travel disruptions currently in place, the master lease model (especially the fixed rental model) would have the least impact to the revenue received by the HTs. Let us look at the operating model adopted by each of the HTs. Do note that a lot of these information are sourced from the annual reports. For HTs whose financial years end in Dec, the FY2018 annual reports are the latest ones available.
ARA US HT
ARA US HT owns 41 hotels, of which 38 carry the brand of Hyatt and 3 carry the brand of Mariott. Fig. 2 below shows the operating model adopted.
|Fig. 2: ARA HT's Operating Model|
The figure shows that all of ARA US HT's hotels are franchised by Hyatt and Mariott and operated by independent third-party operators.
As explained in the section above, under the franchise model, all costs and risks are borne by ARA US HT, which is not a good thing during the current COVID-19 situation.
Ascott Residence Trust (ART)
ART owns 87 hotels and serviced residences. It recently merged with Ascendas HT to form the largest HT in Asia Pacific. ART adopts a combination of master leases and management contracts. Fig. 3 below shows the breakdown of gross profit from the various operating models in 4Q2019.
|Fig. 3: Breakdown of ART's Gross Profit in 4Q2019|
25% of the gross profit comes from master leases, while another 13% comes from management contracts with minimum guaranteed income.
Notwithstanding the above, there are fixed and variable rent components in the leases. ART disclosed that its operating lease receivable within 1 year of FY2018 is $70.3M. This is based on the fixed rent component in the leases. This amount represents only 14% of both the gross rental income and total revenue (rental and other income) in FY2018. In the worst case scenario whereby there is only fixed rental income, ART could see its revenue dropping by 86%.
CDL HT owns 16 hotels, 2 resorts and 1 retail mall across 8 countries. It has a combination of master leases, management contracts and owner-operated hotel. Fig. 4 below shows the operating model.
|Fig. 4: CDL HT's Operating Model|
Of the 19 properties, 13 are under master leases, 4 are under management contracts and 2 are owner-operated.
Although master leases form the majority of the hotels, they have fixed and variable rent components. Fig. 5 below compares the minimum and actual rental income received in FY2018.
|Fig. 5: Minimum & Actual Rental Income for Master Leases|
In total, the minimum rental income from all master-leased hotels forms only 49% of the actual rental income received in FY2018. As a percentage of total revenue, the minimum rental income constitutes only 35%. In the worst case scenario whereby there is only minimum rental income, CDL HT could see its revenue dropping by 65%.
Thus, although the majority of CDL HT's hotels are under master leases, the variable rent component in these master leases reduces the stability of income received by CDL HT in situations like COVID-19.
Eagle HT was listed on SGX recently. It owns 18 hotels in US, most of which carry the brands of IHG, Mariott and Hilton. The operating model appears similar to that of ARA US HT, i.e. franchise model.
Far East HT
Far East HT owns 9 hotels and 4 serviced residences in Singapore. Fig. 6 below shows the operating model adopted.
|Fig. 6: Far East HT's Operating Model|
All their hotel and serviced residence properties are master leased to its sponsor, Far East Organisation and its related subsidiaries. Although Far East HT did not disclose the fixed and variable rent components of the master leases, it disclosed that its operating lease receivable within 1 year of FY2018 is $85.1M. This is based on the fixed rent in the master leases. This amount represents 93% of the rental income received from master leases and 75% of total revenue in FY2018. In the worst case scenario whereby there is only fixed rental income, Far East HT could see its revenue dropping by 25%.
Frasers HT owns 9 hotels and 6 serviced residences in 6 countries. 14 of the properties are under master leases and 1 is under management contract. Like all HTs, the master leases have fixed and variable rent components. Fig. 7 below shows the minimum and actual rental income received in FY2019.
|Fig. 7: Minimum & Actual Rental Income for Master Leases|
In total, the minimum rental income forms only 49% of the rental income received from master leases and 38% of total revenue in FY2019. In the worst case scenario whereby there is only minimum rental income, revenue can fall by 62%.
The table below summarises the operating models adopted by the various HTs listed on SGX. For HTs with master leases, the table also shows the minimum rental income from master leases as a percentage of their total revenue.
|Hospitality Trust||Operating Models||Min. Lease Rental
as % of Revenue
|ARA US HT||Franchises||Not Applicable|
|ART||Leases, Mgt Contracts||14%|
|CDL HT||Leases, Mgt Contracts & Owner-Operated||35%|
|Eagle HT||Franchises||Not Applicable|
|Far East HT||Leases||75%|
|Frasers HT||Leases, Mgt Contracts||38%|
Like most REITs, HTs have been well-liked by dividend investors. However, as this blog post shows, the revenue received by HTs is highly variable, depending on the operating model adopted. In theory, master leases provide the greatest stability compared to management contracts and franchises. However, most master leases of HTs have fixed and variable rent components. The higher the variable rent component, the more variable is the revenue stream. Dividend investors should really consider whether HTs should form part of their portfolios.
Although the segregation of roles and responsibilities between the owner (i.e. HT) and the operator through the various operating models splits the risks between them, it is ultimately a zero-sum game. When the hospitality industry faces a severe downturn like the current COVID-19 situation, neither the owner nor the operator wins. Even when the owner is relatively shielded at the expense of the operator via master leases with fixed rentals, investors need to check the credit risks of the operator. If the operator cannot pay the fixed rentals, the owner will also lose. Investors in hotel companies and HTs can only pray that the COVID-19 crisis is resolved quickly.
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Good write up, never seen others analyze hospitality REITs in this way. Given current condition, even with master lease with fixed rent, wouldn't owner give rental rebate/discount to operator? We have seen this especially in Retail REITs. So could the revenue drop may be higher than what you have estimate?ReplyDelete
The COVID-19 situation is quite unprecedented. We do not know whether the owner and operator will renegotiate and how each party will react. Also, take note that hotel leases have very long tenures, so the impact of a one-off event is smaller compared to retail leases which are much shorter.Delete
Agree, if we are investing long term with holding power, current situation actually give us a good opportunity to accumulate, especially for Hospitality REITDelete
I would suggest that investors check whether the fundamentals of the company have been damaged by COVID-19. If they are not, then this could be a good opportunity to accumulate stocks with good fundamentals.Delete
good piece. I suppose Far East really may ride out this better.ReplyDelete
Thks. Yes, Far East HT is in a better position to weather this storm.Delete
Good to see you back Chin Wai!ReplyDelete
Will you happen to know if the nature of the lease contracts for office and shopping / retail REITS employ a similar model? Where can we get this type of information?
My understanding is that office and retail leases are mostly fixed rentals.
You can check the operating lease commitments in the annual reports to have a gauge of the fixed rentals receivables.
Nice write up! I am wondering the safer play is to buy the franchisors (Marriott, International Hotel Group). They adopted an "asset light" strategy after the GFC. Looks like some of their assets ended up on SGX!ReplyDelete
Thks. Yes, it is possible that franchisors are in a better position than the owners in the current environment.Delete
EHT fell first. And is franchise model.ReplyDelete
I think what can be clearer is whether the reit is franchise, owner, masterlease or mgmt contract. If I read correctly, owner is bad if they operate as well. If they master lease out is best provided the renter don't go bust. Franchise is just to get the brand. The owner is still reit which sounds bad as they have to pay for the brand too.ReplyDelete
Sorry for the late reply.Delete
Yes, you are correct.
Hi Chin Wai,ReplyDelete
Great writeup. I arrived at similar conclusion to your analysis and bought into FHT using similar set of assumptions. Interestingly in the latest 2h 2020 result announcement, master lease is S$19,574k versus S$58,373k in the corresponding period last year. This work out to be around 33% of previous year's master lease a fall of 67% versus 62% previously anticipated.
Looking at the granular detail I note that hotel such as Westin is barely contributing anything in 2h 2020 contributing only RM 1.2M in revenue versus around S$2.5M expected based on your chart. Interestingly there wasnt any announcement on any rental deferment or waiver - may I ask could your base rental figure be inaccurate somewhat or something more sinister is at play.