Eagle Hospitality Trust, or EHT for short, is set to go public this week. The initial public offering (IPO) of Eagle Hospitality Trust comes hot on the heels of ARA US Hospitality Trust (SGX: XZL) which listed on 9 May 2019. Investors who want to get in on EHT’s IPO will have to submit their subscription for shares by 22 May 2019 at 12 noon.
With the subscription closing soon, here are three things that potential investors should consider before making an investment decision.
EHT is a pure-play US hospitality stapled trust that owns 18 hotels across eight states. It has set its IPO price at US$0.78 per stapled security, which translates to an indicative annualised yield of 8.2%.
The trust has a master lease structure, comprising a fixed rent and a variable rent portion that is dependent on the performance of the hotels. The fixed rent will represent 66.0% of EHT’s total rent projected for the year 2020. The trust managers expect its yield to increase to 8.4% based on its IPO price in 2020 due to the better operating performance expected at its properties.
Here are some things to note about the lease structure. The fixed rent portion provides EHT with visibility and stability and downside protection, while the variable rent portion gives the trust exposure to any upside from gross operating profit from the hotels.
The master leases have an initial term of 20 years from listing date with an option exercisable to extend the lease agreement.
Although management is forecasting better performance at its hotels for the second half of 2019 and the whole of 2020, I feel the future beyond that is far from certain. Only one of its hotels has a lease with annual escalation for the fixed portion of its contract. Therefore, EHT is highly susceptible to rental income volatility should the operating performances of its hotels deteriorate.
In my view, the long-term sustainability of the trust is uncertain, considering that more than 30% of its rental income is tied to the performance of the hotels. Income volatility has also been demonstrated in other hospitality trusts listed in Singapore such as CDL Hospitality Trust (SGX: J85) and Frasers Hospitality Trust (SGX: ACV), which have both seen distributions decline in recent years.
Another factor to consider is the growth potential of the trust. We have already discussed how EHT can grow organically. If the gross operating profit of its portfolio improves, EHT stands to benefit through the variable rent portion of its leases. But this is highly dependent on macroeconomic factors and could be quite volatile in the future.
Besides organic growth, does EHT have the potential for inorganic growth? Unfortunately, the answer here is not really.
Based on management estimates, the trust will have an approximate gearing of 38.0% at the time of listing. This puts it fairly close to the 45% regulatory cap imposed on REITs and stapled securities.
As such, I do not foresee it making any major debt-funded acquisitions that can materially improve its distributions to investors.
The third aspect to consider is whether the IPO price is reasonable. To gauge, I will compare the yield and price-to-book value metrics against similar trusts in the market.
Source: Author’s compilation of data from various sources
Based on a quick comparison between the other hospitality trusts listed in Singapore, Eagle Hospitality Trust has a higher distribution yield and a lower price-to-book ratio than most of its peers.
The Foolish Conclusion
Hospitality trusts can be an enticing proposition for investors who want exposure to a unique class of real estate. However, the nature of the leases and industry mean that rental income collected by hospitality trusts can fluctuate wildly. The fact that EHT has a variable rental income that is expected to contribute more than 30% of its total rental income in 2020 makes it all the more susceptible to income volatility.
Investors should also note EHT’s high leverage and 100% dividend payout commitment. This means the likelihood of debt-funded acquisitions that can drive growth will be low. Despite its relatively high yield, I prefer staying on the sidelines for now.
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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 contributor Jeremy Chia does not own shares in any of the companies mentioned.