Does Frasers Hospitality Trust’s Latest S$236 Million Acquisition Make Sense?

On Monday, hospitality-asset owner Frasers Hospitality Trust (SGX: ACV) proposed to acquire the 5-star Sofitel Sydney Wentworth hotel for A$224.0 million (roughly S$235.7 million) from its sponsor Frasers Centrepoint Limited (SGX: TQ5). The acquisition is subject to approval from the trust’s unitholders.

The property, which is located in Sydney’s central business district, will help add exposure to the Australian market for Frasers Hospitality Trust. Currently, only 11.3% of the trust’s portfolio is based in Australia. Following the acquisition, the percentage will increase to 22.4%. You can see the changes to the geographic spread of the trust’s portfolio in the table below:

Frasers Hospitality Trust portfolio

Source: Frasers Hospitality Trust’s presentation

The acquisition price of A$224.0 million was derived from the average of two independent valuations done on the hotel. Together with the relevant fees and acquisition expenses, the trust is expected to cough up roughly A$241.5 million for the whole deal. In addition to using debt, Frasers Hospitality Trust is also “considering” the issuance of new stapled securities of itself in a private placement to help fund the purchase.

Interestingly, the deal will be structured as a purchase-and-leaseback agreement. Once Frasers Hospitality Trust acquires the property, Frasers Centrepoint would be entering into a 20-year master lease agreement with the trust.

Under the master lease agreement, Frasers Centrepoint would be paying a fixed annual rent of A$6.0 million to the trust. In addition, there’d also be a variable rent component which is based on 83% of the gross operating profit of the hotel in each fiscal year, minus the A$6.0 million in fixed rent. The variable rent part of the agreement would also include any other unutilised balance in the “furniture, furnishings and equipment (FF&E) reserve that is not carried forward the following fiscal year.”

With all the figures above, we can see that the purchase of the Sofitel Sydney Wentworth hotel will provide Frasers Hospitality Trust with a minimum rental payment of A$6.0 million per year, which equates to a rental yield of only 2.5% or thereabouts. The purchase would thus only be attractive to Frasers Hospitality Trust’s unitholders if the variable rent is significantly higher than the fixed rent portion.

Another area of concern would be the potential dilution of Frasers Hospitality Trust’s existing unitholders given the trust’s intention to undertake a private placement for the issue of new units to help pay for the hotel. Acquisitions that are made by a trust can benefit its unitholders only if it results in growth in important per-unit figures like its distribution per unit and net asset value per unit.

To that point, Frasers Hospitality Trust did state that the Sofitel Sydney Wentworth acquistiion “is expected to be accretive” to its distributions on a per stapled security basis. No figures are given yet, though further details can be found in the circular for the acquisition which will be issued in due course.

Foolish Summary

The master lease agreement that Frasers Hospitality Trust will be signing for in the event that its latest acquisition does go through can provide it with stable annual rental income.

But, the trust would need the hotel to turn in a solid operational performance in order to extract a reasonable yield from the purchase. Given that Sofitel Sydney Wentworth currently has an acceptable occupancy rate of about 87.6%, there is a good chance that the property would be able to produce a good variable rent for the trust.

Moreover, given Frasers Hospitality Trust’s gearing ratio of 38.4% currently, and its status as a trust with a credit rating (real estate investment trusts with a credit rating are allowed a gearing ratio of up to 60% under current regulations, though it must be noted that the Monetary Authority of Singapore is considering a single-tier gearing limit of 45% for all REITs), the trust still has flexibility when it comes to options for financing the acquisition.

Overall, the deal seems like a positive for the trust.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore writer Stanley Lim doesn’t own shares in any companies mentioned.