SINGAPORE (July 1): On May 24, Eagle Hospitality Trust made its debut on the Singa-pore Exchange and immediately fell below its offer price of 78 US cents. One of the underwriters sold more than four million units at 71 US cents each, brokers said. This transaction appears to have imposed a ceiling on the unit price.
In a stabilisation move, DBS Bank announced it purchased 7.99 million EHT units at 73 US cents to 78 US cents each on May 24, followed by a further four million units on May 27. Even before trading started, it turned out that the retail portion was not fully subscribed. EHT owns 18 properties: 17 full-service hotels and The Queen Mary, Long Beach (in California), which comprises a permanently berthed ship called the Queen Mary and an adjacent, mainly vacant, plot of land.
Based on the offer price of 78 US cents, the IPO yield was 8.2%. This translates into a distribution per stapled security — EHT comprises a real estate investment trust (REIT) that holds the properties and a dormant business trust — of 6.396 cents. The forecast DPS for the period from May 24 to Dec 31 is 4.27 US cents, to be paid on March 20, 2020. Subse-quent DPS will be paid semi-annually. In FY2020, the forecast DPS is 6.54 US cents. At EHT’s last traded price of 70.5 US cents, forecast yields are at 9.1% for this year and 9.27% for next year. The net asset value at IPO is 88 US cents, and EHT is now trading at just 0.8 times book value.
Soon after the IPO, an old press report was circulated, suggesting that the Queen Mary — a hotel that has 347 rooms, 84,125 sq ft of meeting space and a ballroom, bar, restaurant, fitness centre and three retail outlets — would require in excess of US$200 million ($270.8 million) to be refurbished. That amount is more than the higher of two valuations commissioned by EHT’s trustee and its sponsor Urban Commons (see table).
A marine survey report that ran in the LA Times and Press-Telegram in 2017 had indicated that the hull was in danger of collapse if US$233 million to US$289 million were not spent on the ship. Salvatore Takoushian, CEO of EHT’s manager, disagrees, pointing out that this amount includes moving the ship, and EHT and -Urban Commons have no plans to move it. EHT’s IPO prospectus has already said US$23 million was spent on refurbishing the Queen Mary.
Testing valuations
“We took corrosion away and put anti-corrosion paint and fortified the hull. The priority of the US$23 million was the structural integrity of the hull and anything related to safety, specifically fire, and we put in US$3 million to fortify the hull and this included divers and sonars,” Takoushian says. The proceeds that were left over were used to invest in other aspects of the ship, he adds.
“When our sponsor bought the ship, they gave asset enhancement initiatives to an engineering and consultancy firm and that AEI indicated that the cost to repair and fortify the hull of the ship was in the single-digit millions,” Takoushian says. “There are other things the sponsor and city [Long Beach] wanted to do. Ultimately, through reserves and advancement from the city, the sponsor and city put together a plan to invest US$23 million in the ship pre-IPO.”
According to the valuation report by Colliers, the Queen Mary was built in 1936, but has been permanently moored since 1998. The asset includes an adjacent 11.55-acre submerged site available for development and for which there are currently no plans. As such, it has been excluded from the valuation of The Queen Mary, Long Beach. The property is listed on the National Register of Historic Places.
Colliers values The Queen Mary, Long Beach at US$179.7 million, using discounted cash flow analysis with a discount rate of 8.75%, which is higher than the 8.25% and 8.5% for the other properties. In addition, for Colliers to arrive at its valuation, the implied yield is 6.8% based on 2020 stabilised net income.
HVS values the asset at US$159.4 million, which is the valuation used by EHT. The REIT acquired The Queen Mary, Long Beach at US$139 million. In addition to discounted cash flow, HVS uses the income (cap) method, where the asset’s capitalisation rate is 7%. The land lease, which includes the adjacent undeveloped site, which is now a carpark, is 66 years from 2016.
How robust are the valuations?
EHT’s total revenue comprises a master lease portion and a percentage of gross operating profit of the hotel. For the Queen Mary, the base rent is US$10.4 million and the variable rent is 8% of gross operating profit (the equivalent of net property income). According to the prospectus, a full-year contribution from The Queen Mary, Long Beach to NPI is US$12.45 million, or 15.9% of total NPI of US$78.33 million for the forecast period FY2020. This translates into an NPI yield of 7.8% for the property based on the valuation (see table). Of the projected NPI of US$78.33 million for FY2020, about US$58 million is from annual fixed rent.
Based on Charts 1 and 2 (on Page 27), the valuations for The Queen Mary, Long Beach and the rest of the portfolio appear to be in line with market rates.
All the 18 properties have master lease agreements with the sponsor comprising a fixed rent and variable rent. The master leases are for an initial period of 20 years from listing date, with an option exercisable by the master lessee to obtain an additional lease for 14 years for all properties located in California and 20 years for properties located elsewhere.
Takoushian believes there could be upside to the valuation of The Queen Mary, Long Beach. According to the prospectus, and confirmed by Takoushian, Urban Commons has started the planning and entitlement process for a large-scale retail and entertainment centre on the adjacent land to the Queen Mary that could provide EHT with rental income through a sub-lease arrangement with either the sponsor or a third-party developer. The costs for the development would be borne by either the sponsor or developer.
The income of The Queen Mary, Long Beach appears stable, as it is on a triple net lease, where the lessee (Urban Commons) pays for costs such as property taxes, land rent, insurance and utilities. A certain amount is put aside as reserves for AEIs and these reserves are a percentage of gross room revenue, or gross operating revenue. For some properties, the sponsor (which was also the vendor) placed part of the purchase consideration in an escrow account under the REIT’s trustee for future AEI expenses.
“The reserve for furniture, fixtures and equipment is 3% of revenue and, in 2019, revenues are [forecast] at US$78 million,” Takoushian says. “We have reserves set up — a triple net master lease [for The Queen Mary, Long Beach] that insulates the investors. [Master lease rent] payment to investors is after payment to the furniture, fittings and equipment reserve so it doesn’t take away from distributions.”
Takoushian says the Queen Mary is a popular place for weddings, and visitors touring the ship have to pay an entrance fee. “This asset is the No 1 tourist destination in Long Beach, generating significant revenue and sales tax for the local authorities. Visitors go to Long Beach for the Queen Mary.”
The Queen Mary’s occupancy rate for this year is likely to be 77.5%, according to the prospectus, and its average daily rate (ADR) and revenue per available room (RevPAR) are likely to be US$160.60 and US$124.45 respectively, higher than EHT’s overall portfolio.
The portfolio’s occupancy rate for the forecast period of May 1 to Dec 31, 2019 is 78.5%, with ADR of US$137.30 and RevPAR of US$107.70. As a comparison, ARA US Hospitality Trust’s occupancy rate for the forecast period of May 1 to Dec 31, 2019 is 78.8%, with ADR of US$129 and RevPAR of US$101.
Unknown sponsor and manager, familiar cornerstones
Ultimately, EHT’s manager and sponsor are new to local investors and there is genuine uncertainty surrounding the condition and valuation of the Queen Mary. The ship is mentioned under “risk factors” in the prospectus. “[She] is subject to damage associated with ships such as ordinary wear and tear,” the prospectus states. Other properties too could experience unforeseen maintenance or repair. “The experts’ [valuation] reports that the managers rely on as part of their due-diligence investigations of the properties are subject to uncertainties or limitations as to their scopes. Such undisclosed defects or deficiencies may require significant capital expenditures to rectify defects or deficiencies or may involve additional obligations to third parties, which may have a material adverse effect on EHT’s results of operations, earnings and cash flows,” the prospectus adds.
Despite local investors’ unfamiliarity with EHT, it managed to attract seasoned REIT investors as cornerstones. Gordon Tang; Gold Pot Developments, whose sole shareholder is Janet Yeo (Tang has power of attorney); Tong Jinquan and Qian Jianrong (executive chairman of CWG International [Chiwayland], which was privatised in 2018) subscribed to the placement tranche.
On June 26, two of EHT’s under-writing banks, UBS and Jefferies issued 56- and 44-page reports respectively. Both had “buy” recommendations, with a price target of between 85 US cents and US$1. EHT last traded at 70.5 cents.
Some market observers point to the lack of an institutional name for current price weakness. Whatever the case, to gain an investor following, EHT will need to deliver on its forecast DPS, and investors will not have long to wait. Its first quarterly results announcement will be in August.
