Following ARA US Hospitality’s footsteps, Eagle Hospitality Trust is the next pure play US Hospitality REIT to be listed in Singapore. The IPO prospectus has been fully registered with MAS last Thursday and here are my initial thoughts.
Here is a summary of the offering details:
- Offer Price: US$0.78 per share
- Placement Shares: 535,687,000 shares
- Public Shares: 44,871,000 shares
- Closing of Offering: 22 May 12 Noon
- Commencement of Trading: 24 May, 2pm
The IPO portfolio consists of 18 hotels, with an even split between Marriott, Hilton and IHG brands, with 1 hotel that is not branded. The portfolio comprise of Full Service hotels that are positioned largely in the upscale market, with certain Holiday Inns positioned in the upper midscale market.
The portfolio significantly concentrated within California, with almost half the portfolio in that state. This is probably because the Sponsor is based in California. The rest of the hotels are located in Utah, Colorado, Texas, Florida, Georgia, New York and New Jersey. Most of the properties are freehold except for the independent hotel which has about 64 years remaining on the lease.
Renovations have also been done quite recently for most properties between 2017-2019, as such there should not be significant major capex requirements in the next few years, at least for its conventional hotels.
A sinking asset?
Ging Wien from ProButterfly alerted me to the presence of a curious asset in the IPO Portfolio. The only independent hotel is the Queen Mary Long Beach, a ship that is moored permanently in Long Beach Harbour (pictured in my cover photo). The ship was converted into a hotel and has been a feature of Long Beach Harbour since 1967.
Interested to know more, I went down the Google rabbit hole and I came across a concerning article from local press Long Beach Post regarding the history and cost of the renovations at the property. One article led to another which combined to paint a troubled history of the property.
Apparently, the property has suffered from years of neglect and mismanagement. Previous lessees had suffered from financial troubles or were unable to come up with a viable plan to finance repairs. A survey of the property estimated the amount of repairs required to range from US$235 – 289m, 75% of which are deemed urgent. Sponsor Urban Commons has apparently disputed this figure.
When the sponsor signed a 66 year lease from the city for the property in 2016, US$23m was made available by the city to help fund repairs of the ship. There was also a commitment to fund future maintenance and repairs by the sponsor. Part of the plan was to redevelop the surrounding land into a development called Queen Mary Island to help fund maintenance works.
If you review the Prospectus, you will realise that the $23m has been spent as committed by the city. It has also not given any indication of the amount of potential capex the ship will need going forward.
Given that the $23m that was spent for repairs were over-budget, I think it is fair to assume that maintenance works for the asset will cost more than what it takes for a conventional hotel. With the Queen Mary Island development plans are still in their infancy, there is no catalyst to in sight to boost revenue in order to fund maintenance works.
The asset is currently valued at US$160m. If the survey is to be believed, it potentially needs up to US$289m of renovations, which is way more than its current valuation. To me, this creates a overhang that we have no idea what to expect.
Operational Statistics & Property Valuation
Portfolio occupancy rates and RevPAR has been on the rise, probably due to rejuvenation works at most of the properties in 2017-2018. That said, Revenue Generation Index (RGI), a measure of performance relative the portfolio’s immediate competitors, remains below 100. This means the properties are underperforming their immediate competitors. As such, it is difficult to affirm the projections for FY2019 and 2020, as they assume significant improvement in operational performance.
The adopted valuation of the properties is US$1.27b. 2 valuations were commissioned with Colliers valuing the properties at US$1.21b and HVS valuing the properties at US$1.27b. They were valued using the income method and using the terms of the master lease agreements for each property.
Master Lease agreements
Eagle Hospitality adopts a master leasing strategy to provide some stability in DPUs. The conventional hotels have a base rent and a variable component based on a percentage of GOR or GOP. These leases are on a gross basis.
The exception is the Queen Mary Long Beach, which has a much higher base rent with no variable rent. This lease is on a triple net basis.
Sponsor & Fee Structure
The Sponsor is Urban Commons LLC, a privately held property fund manager based in California. It was founded in 2008 by Taylor Woods and Howard Wu, who have extensive real estate experience.
The IPO Prospectus mentions they have more than US$1b in AUM, with another estimated US$800m of assets under various stages of entitlement and development. This means that the IPO will see most of their AUM being injected into the REIT.
Only 2 properties are listed as Right of First Refusal (ROFR) assets – Ramada Hialeah (Miami, Florida) and The Wagner at the Battery (New York City, New York). They were not part of the IPO portfolio as Ramada Hialeah is undergoing redevelopment while The Wagner was recently acquired.
Their management fee structure is as follows:
- Base Management fee – 10% of Distributable income
- Performance Management fee – 25% of y-o-y increase in DPU
- Acquisition fee – 0.75% from related parties, 1% from 3rd parties
- Divestment fee – 0.5% of divestment value
- Managers have committed to receiving their fees 100% in units. As such, there is financial engineering here to prop up yields.
The Cornerstone investors have committed to take up about 25% of the offering. These investors comprise of DBS Bank, DBS Bank (on behalf of wealth management clients), Gold Pot Developments Ltd (a family fund) and Mr Ji Qi (Founder of Huazhu Group and Co-Founder of Ctrip).
Good to see that DBS Bank supporting the IPO, but the rest of the cornerstone investors are individuals and not institutional funds.
Financial Highlights & Valuation
The prospectus interestingly only discloses the past distributable income for 12 properties (the USHI portfolio). As such, we are unable to see the past financial performance of the properties injected by Urban Commons founders (ASAP6 portfolio). It is a bit difficult to know past performance of the entire portfolio as a result.
The IPO has been priced at a discount to book, an act that by itself is interesting. Gearing stands at about 37.4%, which is kind of a high starting point.
Positives about the IPO
- Mostly branded portfolio – Being part of the IHG/Marriott/Hilton system allows the hotels to benefit from their scale in marketing and their respective loyalty programs.
- Positive outlook – While the US market is quite mature, the economic fundamentals in the US is still the strongest in the world and supportive of travel demand.
- Visible growth pipeline – Sponsor has 2 ROFR assets in the pipeline, with about US$800m of assets in development / entitlement.
- Discount to book – IPO is priced at discount to book, maybe thanks to some arm-twisting from DBS Bank.
What I don't like about the IPO
- Queen Mary-sized elephant in the room – The unknown potential cost for future maintenance works on the Queen Mary Long Beach will be an overhang on the REIT.
- Missing financials – ASAP6 portfolio is not included P&L disclosures
- Fairly high starting gearing – 37.4% seems like a fairly high gearing starting point, given that the REIT probably will be looking to grow post IPO.
- Private sponsor – Little is known about the sponsor. Given the bulk of their AUM is being injected into the REIT, I’m not sure how big and steady the Sponsor is.
- Complex tax and leasing structure – The group is structured in a complicated manner for tax avoidance reasons. These tax rules can changed anytime which may affect further distributions
- High Base / Performance management fee – 10% / 25% fees seem high.
Overall, I just can’t find myself getting past the potential headaches related to the Queen Mary Long Beach. That factor alone would have prevented me from investing in the REIT. Couple that with the other unknowns and risks discussed above, I will definitely avoid this REIT until there is sufficient track record or discount to book.
If you missed my previous article
SingTel FY2019 results highlights