ARA Asset Management, also known as ARA, has launched its new initial public offering (IPO) called ARA Hospitality Trust, and I had written about this real estate investment trust (REIT) in an article a while ago. The REIT starts trading on 9 May (Thursday) at 2 p.m.
Apart from discussing the key highlights and investment merits, no discussion would be complete if the risks are not covered, as these may either make or break an investment. Here are four key risks relating to this upcoming IPO which investors need to take note of.
1. Short-term “rentals”
For REITs, their main draw is in securing recurring and regular revenue from tenants so as to be able to pay out 90% of their earnings as a dividend to unitholders. Depending on the type of property involved, leases may range from as short as six months (for retail) to as long as three years (industrial or commercial). However, for hotels, the “rentals” are significantly shorter as most people stay for just a few days or at most up to a week.
This is a significant risk for the REIT as they are unable to “lock in” their rentals due to the constant flow of people in and out of the hotels. Predictability is thus greatly reduced and the hotels need to also constantly spend on marketing, advertising and promotion in order to entice people to book a room with them.
2. B2C model for the REIT
Another notable risk for the REIT is that it deals mainly with individuals, in what is known as a Business-to-Consumer (B2C) model. Granted, some of these individuals may be corporate clients but it may only form a small proportion of the total guests staying in the hotel at any point in time. For REITs which deal with commercial or industrial properties, their tenants are usually corporations and the REIT operates on a Business-to-Business (B2B) business model.
The problem with a B2C model is that individuals are much more sensitive to economic conditions as compared to companies. If there is a sharp economic downturn, many people may hold back on spending and holidays as their jobs may get cut, or salaries slashed. This behaviour would directly negatively impact the REIT as they are in the business of managing hotel properties.
3. Hyatt’s brand name
A third risk is that all the hotels within the REIT’s portfolio are Hyatt-branded. This is known as concentration risk as any reputational hit to the Hyatt brand would result in a decline in demand for Hyatt hotel stays. Without having a large stable of hotel brands within its portfolio, the REIT would not be able to mitigate any revenue decline if there is a boycott of Hyatt-branded hotels for whatever reason.
4. Aimbridge as hotel manager
The last risk is that of Aimbridge as a hotel manager for the REIT’s portfolio of hotels. Though Aimbridge is large and renowned as a hotel manager in the US, it is still considered a third-party to ARA. To illustrate this point, if we look at other hospitality trusts listed on the SGX, they are usually managed by the REIT sponsor themselves rather than through a third-party.
An example is Ascendas Hospitality Trust (SGX: Q1P), which is managed by Ascendas Hospitality Fund Management Pte Ltd and Ascendas Hospitality Trust Management Pte Ltd, both of which are wholly-owned subsidiaries of Ascendas Limited. Another example is Frasers Hospitality Trust (SGX: ACV), which is managed by both Frasers Hospitality Asset Management Pte Ltd and Frasers Hospitality Trust Management Pte Ltd. Both these companies are wholly-owned subsidiaries of Frasers Property Limited (SGX: TQ5), which is the sponsor for the REIT.
The Foolish takeaway
Investors should note the four key risks above before deciding to invest in this REIT. Although this may be the first REIT to focus exclusively on US-based hotel assets and is also backed by a strong sponsor (ARA), investors need to be mindful of the risks relating to this asset class and decide accordingly.
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The information provided is for general information purposes only and is not intended to be personalized investment or financial advice. Motley Fool Singapore contributor Royston Yang does not own shares in any of the companies mentioned.