SINGAPORE (May 6): ARA US Hospitality Trust is offering 377.8 million stapled securities at 88 US cents apiece in an IPO. Of this, 328.6 million stapled securities are reserved for placement. The public offering comprises 51.13 million stapled securities. The stapled securities comprise ARA US Hospitality Property Trust (ARA H-REIT), a real estate investment trust, and ARA US Hospitality Management Trust (ARA H-BT), a registered business trust.
The offering, coupled with the stapled securities taken up by cornerstone investors that include sponsor ARA Asset Management, Gordon Tang and DBS Bank, will raise US$498 million ($677.6 million). The public offering opened on May 2 and closes at noon on May 7.
The expected distribution yield for the forecast period, May to December 2019, is 8%, or at an annualised distribution per stapled security of 7.04 US cents each. The expected distribution yield growth of 2.1% for the forecast year FY2020 gives an expected total return of 10.1%, or a projected FY2020 yield of 8.2%, based on DPS of 7.2 cents. Aggregate leverage on listing is 33.4%, giving the manager of ARA US Hospitality Trust some debt headroom to implement an acquisition strategy for growth.
The IPO portfolio comprises 38 hotels with 4,950 rooms valued at US$719.5 million. Of these, 27 are upscale “select-service” hotels under the Hyatt Place brand and 11 are extended-stay hotels under the Hyatt House brand.
In a recent interview, Lee Jin Yong, CEO of ARA US Hospitality Trust’s manager, says his biggest challenge when meeting investors is to get people to understand “select service”. “The most challenging part is educating investors as to why this asset class is unique and special — because there is no context for it in Asia,” he says.
New asset class for local investors
Select-service hotels are those with reduced ancillary services, providing customers with just breakfast and an evening bar service, for example. Select-service hotels have fewer departments to manage and are more efficient to operate.
“The ancillary amenities are the biggest things we reduce. There is F&B [such as] complimentary breakfast and evening bar, geared towards the travel patterns of the US traveller. This concept is for the road warrior, not C-suite executives,” Lee says. “We eliminate the excessive cost structure in providing F&B so that we can shrink the overall labour requirement.”
Select-service hotels are usually focused on serving middle-class Americans, who are interested in modern facilities and clean, comfortable rooms. There are no meeting rooms, restaurants or room service. As a result, select-service hotels achieved a higher gross operating profit margin of 42.5% compared with 39.3% for full-service hotels in 2018.
“We’re shrinking the single-largest cost component [labour] and focusing on the most profitable cost — the rooms, which generate the largest profit margins of 75% to 80%,” Lee says. F&B profit margins are much lower, at 20% to 25%. “Of our total revenue, 95% is from the rooms,” Lee notes.
In select-service hotels, labour cost accounts for 22% of total cost compared with 50% in full-service hotels. As an industrialised economy, the US has a relatively expensive labour market. Moreover, the country has a “tipping” culture. Select-service hotels don’t have porters and staff who wait at the driveway to help with luggage and so on, which saves costs for both the hotel operators and customers.
“We don’t have servers, cooks, [kitchen] cleaning. The more focused cost structure allows these hotels to perform better in downturns,” Lee says.
Indeed, during the global financial crisis, ARA US Hospitality Trust’s select-service portfolio remained profitable. Revenues fell 16% and profit, 33%, and [operating] profit margins dropped from 28% before the GFC to 22% during the GFC. Margins rebounded to 26% in the first year after the GFC and to 29% in the second year after the GFC, Lee says. “For our portfolio, the profit margins are so [good], they can withstand shocks in demand and the portfolio will still be profitable,” he says.
Moreover, the hotel staff are not unionised. In the US, when labour becomes unionised, it becomes less flexible because of work contracts and work rules. For instance, a worker who does a specific job cannot really do something else in that organisation.
“None of our hotels are unionised because we’re in business-centric suburban locations and not city-centre locations,” Lee says. “Our hotels are designed around flexible labour. The staff who checks you in can pour you a drink.”
This flexibility allows the hotels to cut fixed costs in the event of a downturn, or even during the low season, when demand falls. Although the average occupancy is 77%, there are seasonal and geographical variations. The peak season is summer, with spring and autumn being good seasons. Winter is the low season.
“So, in a recession, occupancy shrinks and you need fewer housekeepers. Our hotels are able to have a more flexible cost structure with lower demand. A flexible cost structure allows for greater resilience,” Lee says. Full-service hotels may shrink housekeeping, but cannot stop running spas or restaurants because of what is expected of the brand.
No need for master lease or minimum-rent guarantee
In addition to introducing a new asset class in Singapore, ARA US Hospitality Trust differs from other hospitality trusts listed on the Singapore Exchange. For one thing, it does not have a master lease or minimum-rent guarantee. Secondly, in some of the SGX-listed stapled securities — hospitality trusts consist of a REIT that holds the properties and usually, a dormant business trust — the business trust portion stays dormant until it needs to be activated to actively manage the properties.
ARA US Hospitality Trust’s business trust is active and operates the portfolio in line with the stapled trust’s investment strategy.
The portfolio has a higher average occupancy rate (77%) compared with the national average of 60%. For business travellers, the rooms are sold through the Hyatt platform, and there are negotiated accounts for businesses that book a large number of rooms. In FY2018, the initial portfolio derived 46% of room nights from transient corporate demand, 36% from transient leisure, 16% from group bookings and 2% were on contract. Hyatt Place’s average length of stay is 2.5 days and Hyatt House’s is 13 days.
“As an investor, I understand volatility of cash flow, and [the need for a stable cash flow]. We want investors to benefit from full upside,” Lee says. And given that the GFC was likely the worst-case scenario, he appears confident that the portfolio can continue to perform.
Growth strategies include diversifying into other select-service hotels operated by names such Marriott and Hilton, and diversifying geography. Some 30% of the portfolio by rooms is in the northeast region of the US, and Lee is looking to gain a larger presence in southern US, which is home to some foreign auto brands such as Toyota, Mercedes and Porsche, and in the West Coast, which is home to the US tech titans.
ARA US Hospitality Trust has an efficient tax structure, and investors outside of the US will not need to pay a 30% withholding tax on the distributions. The trust manager will be fi ling a Form W-8 BEN-E so that security holders do not need to fi ll up forms, as is the case with the current US REITs listed on SGX.
