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:

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:

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

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

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

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%.

Conclusion

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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