SINGAPORE (March 30): In our manifold coverage of Eagle Hospitality Trust (EHT) in print and online — see cover story “Saving Queen Mary” (Issue 906, Nov 4, 2019) — we had flagged issues with the REIT, including its inauspicious debut, portend by its under-subscribed retail tranche of its IPO.
On its first day of trading on May 24, 2019, Bank of America, which was one of the underwriting banks, sold more than four million units of EHT at 71 cents. Since then, EHT units have not seen light of day and things reached a nadir with its March 23 trading suspension. This is probably a necessary step as the REIT restructures its loans, says a boutique fund manager who has no holdings in EHT.
On March 19, EHT’s manager announced it was undertaking a strategic review. Yet, in a statement to the Singapore Exchange (SGX) on Nov 6, 2019, EHT’s manager said: “The REIT manager also wishes to dispel a rumour reported in The Edge article: There is no strategic review underway nor has any consideration of a strategic review been discussed with the board.”
In its trading suspension announcement on March 23, EHT’s manager announced that distributions were not going to be paid to unitholders as scheduled on March 30 and that it had received a notice of default and acceleration for a US$341 million ($493 million) loan from Bank of America on March 20. The loan needs to be repaid immediately. The reason for the default was because of the non-payment of rent by the master lessee under the master lease agreements in respect of certain properties in EHT’s portfolio. The master lessees are affiliates of Urban Commons, EHT’s sponsor.
According to the IPO prospectus, Urban Commons signed master lease agreements for the properties in EHT. Valuations of the properties — and hence the fundamental value of the trust — are based on the master leases. The master lease agreements were for 18 properties and each agreement came with a security deposit. Altogether, EHT should have security deposits of US$43.7 million.
On March 19, EHT’s manager revealed it had approximately US$28.7 million of security deposits and planned to draw down US$12.5 million. However, the master lessee is required to replenish the security deposits within seven days of any drawdown, EHT’s manager added.
EHT’s manager also said that the master lessee, which is assumed to be Urban Commons, was meant to provide US$15 million of security deposits by June 8 so that total security deposits would once again amount to US$43.7 million as stipulated by the prospectus.
Defaulting on ASAP loans
According to the prospectus, EHT had borrowings of US$508 million at IPO. Of the IPO loans, US$341 million was secured against subsidiaries of US Corp and the three ASAP property borrowers. The latter comprises Hilton Atlanta Northeast, Doubletree Salt Lake City and the Sheraton Denver Tech Center (properties with asterisk in table).
EHT owns six ASAP properties, called the ASAP6 (see table). The ASAP6 properties were from private equity funds managed by the Yuan family who have been major sellers of EHT from August onwards. In a November announcement, EHT’s manager said the Yuan family “were introduced by the sponsor (Urban Commons) to the placement agents during the bookbuilding process for the IPO and subscribed for stapled securities in the placement tranche”.
A further US$78 million of mortgage loans was secured against Renaissance Woodbridge, Hilton Houston Galleria Area and Crowne Plaza Dallas Near Galleria-Addison. These are also ASAP6 properties. EHT also has an US$89 million unsecured loan.
Problematic valuations
The prospectus stated that the purchase consideration paid by the ASAP6 Portfolio did not include the value of the master lease agreements by Urban Commons. However, the valuation of the portfolio by two valuers included master lease agreements. Ten of the REIT’s properties are on long leases of 20 years plus 20 while the remaining eight of the properties are on long leases of 20 years plus 14, all commencing on the date of the IPO.
In the prospectus, HVS, a US valuer, says an estimate of a hotel’s market value under a master lease is based on estimates of the asset’s 10- year annual rent.
In addition to the 10-year net rent cash flow forecast, the projected cash flow for year 10 is increased by an estimated growth rate to arrive at the new cash flow for year 11 and capitalised for the remaining term of the property tenure. HVS then applies a DCF rate to arrive at the total investment amount under the master lease arrangement.
Colliers was the second valuer for EHT’s assets. It says its valuations were based on the “proposed master lease structure as provided by the client”.
“Each property is subject to a master lease agreement with property taxes, property insurance and land rent borne by the master lessor, with the exception of Queen Mary where all costs are borne by lessee,” states the prospectus but without giving a valuation excluding master leases.
Yet, in the March 24 announcement, it appears that master lease rents did not happen for at least three of the ASAP6 properties and hence the default notice.
If the master lessee Urban Commons is unable to meet the master leases, the valuation of the REIT changes. As at Dec 31, 2019, the portfolio was valued at US$1,260.6 million, down 2.6% y-o-y. However, the speed of the collapse in EHT’s unit price to 14 US cents when its NAV per unit as at Dec 31 was 89 US cents, or US$779.1 million, suggests a more serious problem.
Some market watchers are wondering if the vendors of the ASAP6 portfolio — the Yuan family — are responsible for the master leases for the ASAP6 portfolio. So far, they have been net sellers of EHT units.
In the event of default
What happens when a master lessee fails to pay? In general, the owner of the property needs to find another tenant or master lessee.
“If the building was committed to a tenant on a long-term basis, there is no vacancy and the valuer will value it with 100% occupancy. If the tenant has now vacated, the valuer will [use] market rents to value,” suggests Alan Cheong, head of research at Savills. “If the previous rental agreement signed is in line with the market, there is no change in the valuation. But if the previous rental is higher than market, the valuer will use the current market rent to value and that would lead to a lower valuation,” he explains.
Consultants say that a case such as EHT is unlikely to materialise in Singapore. “Typically in Singapore, in a good tenancy agreement, the landlord will need the tenant to give ample notice if they need to vacate or if the tenant is unable to pay the rent, the landlord will have the power to ask the tenant to vacate and the security deposit forfeited (Since the tenancy is 20 years, the security deposit or Banker’s Guarantee should be substantial). Meanwhile, the landlord can still market the property within the notice period, minimising any void periods,” explains Christine Li, head of research for Singapore and Southeast Asia, Cushman & Wakefield.
“Technically, [valuation] treatment will be based on these assumptions with slightly more provision for voids/vacancy in the cash flow. There will likely be some adjustment for voids if all things remain constant but, on the other hand, the landlord could also get a better tenant with better rentals. There are many considerations in property valuations and we look at them on a case-by-case basis,” she suggests.
Clearly, the valuers of EHT’s portfolio did not take into account non-payment by the master lessee. In the event of default, the prospectus says that EHT, as master lessor, is entitled to terminate the master lease agreement which includes the non-payment of rent or other amounts, repudiation of lease by the master lessee, failure of the master lessee to comply with obligations imposed by lease and an insolvency event by the master lessee.
When asked on March 24 about the regulatory actions SGX could take on EHT, Tan Boon Gin, CEO of SGX RegCo, says: “This is something we are monitoring closely. It is premature for us to comment on that, though I would observe that the entire hospitality sector has been very badly hit by this [Covid-19] situation.”
While EHT is in the SGX coverage scheme, an irate EHT unitholder points out although analysts are required to have two updates, if an unusual situation such as a default occurs, they are obligated to issue a comment. “You have a moral obligation, if something like this happens to at least give an update to highlight the problem,” the unitholder says. “You can’t just pretend that nothing happened and analysts don’t update and give a view especially if they initiated a buy.”
In its strategic review, EHT’s manager did say it is preparing to identify selected assets for sale as part of a portfolio reconstitution plan. The best option would be to divest the entire portfolio, redeem gross loans as at Dec 31, 2019, of US$506.6 million, and return the remaining money to unitholders. But with a credit crunch happening in the US, finding buyers would be near impossible.
