Shedding light on Hospitality REITs

An introduction to Hospitality REITs

Unlike Commercial REITs, Hospitality REITs including CDL H-Trust, OUE-H Trust and FEHT offer higher distribution yields in the range of 6%-7%+. This can be attributed to the volatile nature of the tourism industry, where investors would typically expect a higher return due to the shorter lease terms.

Source: reitdata.com

The types of accommodation can be broken down into two categories, namely the hotels for shorter-term stays while serviced apartments cater to longer-term corporate clientele. For the latter, a minimum stay of 7-days is enforced to ensure non-competition with hotels.

Does income support exist for Hospitality REITs?

Unlike office REITs, which mostly offer full disclosure of income support,  it appears that most of the Hospitality REITs have worked around it via master tenancy arrangements between the Landlord (S-REIT) and Sponsors. Under the agreement which usually lasts on a very long term of 15+15 or 20+20 years, the Sponsor will pay a fixed rent + variable rent component to the REIT. When reviewing the various IPO prospectuses, these two components contributed fairly equally (50/50 split) towards the rental income to the REIT.

Most of the operating expense is borne on the master lessee's end, which means that the income to the REIT is already net of operating expenses. This begs the question of the properties actual performance.

The fixed rent component varies across the REITs, and guarantees a 1.6%-3.8% of the purchase price. This is to say that if gross operating profit were to be zero, the REIT would still be able to get the minimum of the fixed rent, indicating some form of income guarantee from the Sponsor. 

After accounting for variable rent, these REITs clocked a net property yield of between 2.7%- 6.5%. A further review of current net income to REITs also showed that performance was pretty similar to forecast, where the same 50/50 split between fixed and variable income contribution was observed.

Why some REITs have both serviced apartments and hotels?

Serviced apartments and Hotels are essentially different assets that generate different yields. The former is usually valued on a cap rate of 3%-4% while the latter typically commands a 5%-6% cap rate. This can be explained by the less volatile/ more stable nature of serviced apartments which tie down travellers on extended stays rather than hotels which target high turnover customers which subjects their income to higher volatility.

As such, you will find that for Singapore property dominated Hospitality REITs, none would have serviced apartments as a standalone basket due to the lower yield, which could result in a need for income support to bump up DPU yield. This is exemplified by FEHT and Frasers Hospitality Trust, which have a mix of both serviced apartments and hotels.

While Ascott Residence Trust is a pure serviced apartment REIT, it is important to note that they have diversified their portfolio into other countries in Europe and SEA which offer higher yielding assets.

Putting aside the impending hike in interest rates, are Hospitality REITs a buy?

Yield hunting investors will definitely find favour in Hospitality REITs, which only lose out to Industrial REITs, That aside, it is also important to study historically how these REITs have managed to grow their earnings per unit vis-a-vis the other property sector REITs. 

I personally find the hospitality sector an interesting sector to invest in, given that income support may not be required given the ability to generate a higher yield in contrast to office assets. That being said, Frasers Hospitality Trust listed their REIT with 2 of their developments on income support, albeit a small amount to help tide over refurbishment and stabilisation of the assets.

Buy into REITs that are able to keep up with changing trends

Given the dynamics of the tourism and corporate occupier landscape, it is important that REITs are able to adapt their developments to tap the greatest earning potential. This would be possible via asset enhancements or inorganic growth through acquisition of prime assets to grow their yield.

Such initiatives could include changing the unit layout to capture demand for a different product (1 bedrooms instead of 2 or 3-bedrooms), particularly in the current business climate where corporations continue to cut back on expat spending and will see more lone travellers instead of families to oversee projects in the region. 

I'd be happy to hear your thoughts, so just leave me a comment and i will try to get back to you as soon as i can.

Benchmarking Your Real Estate Asset Returns

Benchmarking your asset return

As the saying goes “No pain, no gain,” likewise for property investments, the riskier the asset, the higher the yield one can expect to receive. In Singapore’s context, the attractiveness of each asset classes can be viewed in the following hierarchy:

The net yields presented above are based on broad level trends in each market and will differ across specific assets from time to time. Nonetheless, it offers us an idea as to how risky these assets are viewed in the local property scene (Lower Risk = Lower Return, vice versa).  Across the sectors, these yields have been shaped over time by factors including asset volatility and investor sentiments.

These yields also represent the typical net yield expectations of institutional investors such as REITs and private equity funds, where information on the cap rates being applied for property valuations are publicly available for the former. For reference, I have provided an excerpt below (boxed in red) from the CapitaMall Trust’s quarterly presentation slides.

As seen in the example above, the initial yield/cap rate attached to individual properties vary depending on a combination of factors comprising location (I.e. economic attractiveness and proximity to population catchment and transport nodes)  and nature of the development (mixed or single use).

Lastly, it is important to note that these are valuation based yields and it will certainly not represent the dividend you will get when buying into a REIT, which is determined by the REIT’s Distribution per Unit (DPU) and transacted Share Price.  Nonetheless, the cap rates applied by the different REIT types (i.e. Starhill Global – Office/Retail, Cambridge Industrial – Industrial etc) will offer investors a benchmark on net income to expect when making a property purchase.