(Aug 7): Chong Kee Hiong, CEO of OUE Hospitality Trust (OUE-HT)’s manager, senses from his regular interaction with investors that the market is looking for an inflection point in the hotel sector. “More investors are looking into this segment and we are getting more enquiries, and the same group of investors is seeing other hospitality players. It’s a very macro picture for these investors,” Chong says. He was speaking at a results briefing on Aug 1.

The local hotel sector has been in a slump for years as a result of a surge in the supply of rooms that outpaced demand. At end-2016, there were 63,850 hotel rooms in Singapore, up 25% since end-2012. In 2013, visitor arrivals grew 7.1% y-o-y to 15.6 million. Visitor arrivals fell slightly to 15.1 million the following year, and then stayed flat at 15.2 million in 2015. Last year, visitor arrivals rebounded 7.8% to 16.4 million. The key metric tracked by hotel sector watchers is revenue per available room (RevPAR). For the sector, this has fallen steadily from $225 in 2012 to about $200 this year.

Now, the pace at which the stock of hotel rooms is growing has slowed significantly. This year, a further 2,559 rooms are likely to be added, representing growth of 4%. In 2018, only 1,127 rooms are expected to be added, representing growth of just 1.7%. In 2019, 1,248 rooms are expected to be added, equivalent to growth of 1.8%. Meanwhile, the pace of visitor arrivals is growing at a moderate pace. According to the Singapore Tourism Board, visitor arrivals for the first five months of this year were up 3.6% from the same period last year. For the full year, STB is forecasting growth of up to 2%, or 16.7 million arrivals.

So, how can investors gain exposure to an upcycle in the local hotel sector? There are a number of locally listed real estate investment trusts (REITs) that own hotels. However, only two of them are pure plays on the local hotel sector: OUE-HT and Far East Hospitality Trust. OUE-HT owns just two properties — Mandarin Orchard Singapore and Crowne Plaza Changi Airport (CPCA). It has 1,640 rooms in its portfolio. FE-HT is bigger, with a total of 2,830 rooms, of which 2,460 are hotel rooms and the remainder, serviced residence units. Its properties include Orchard Parade Hotel, Rendezvous Hotel & Gallery, and Oasia Hotel.

OUE-HT delivered solid numbers in 1HFY2017, helped by a full six months of contributions from CPCA as well as better performance from Mandarin Gallery. For 1HFY2017, the REIT reported a 19% rise in net property income (NPI) to $12.9 million, and a 24.3% rise in distribution per unit (DPU) to 2.51 cents.

One risk, however, is that income support for CPCA will expire in 3QFY2017. The hotel currently has an occupancy rate in the mid- 70% range. “Our target is about 80%. The opening of Terminal 4 should bring in more visitors to Singapore and [the hotel] should be a beneficiary,” Chong says, adding that CPCA opened in a relatively weak market and has taken some time to build up its occupancy rate. “Its performance was not as good as we expected, so we drew down on the income support, with total drawdown of $5.5 million out of $7.5 million. From 4QFY2017, there won’t be income support and we believe the CPCA number will be weaker.”

Religare is among the research houses bullish on OUE-HT, on the view that a pickup in occupancy at Mandarin Orchard and CPCA in 2018 will make up for the loss of income support. It is forecasting DPU of five cents for 2017 and 2018, which translates into forward yields of 6.4%.

On the other hand, FE-HT is something of a turnaround play. It listed in 2012, just as the hotel sector peaked. Its DPU has fallen some 33% since then, and it does not currently have any analyst coverage. Its units are now trading 30% below the IPO price and 26% below its net asset value of 90 cents per unit. Interestingly, FE-HT has a 30% stake in its parent’s development project, the 850-room Outpost and Village Sentosa, which is scheduled to be completed next year.

Havard Chi, a director at Quarz Capital Asia, figures that FE-HT’s DPU will trough this year at 3.9 cents, which translates into a yield of 5.8%. Last year, the REIT paid out a total DPU of 4.33 cents. For 1QFY2017, it reported a DPU of 0.93 cent. Chi figures that a recovery in the hotel sector will provide sufficient lift to FE-HT’s RevPAR to drive its DPU up by 40% in 2018.

It is probably worth mentioning at this point that hotel REITs are generally structured to earn a fixed rental component from their properties plus a percentage of revenue and NPI from those properties. That is because hotels are extremely cyclical and REITs need to limit the downside of their DPUs in order to be attractive to yield-oriented investors. For FE-HT, Chi figures that the fixed rental of its hotels alone would deliver a DPU of 2.8 cents, which translates into a yield of 4.1%.

Looking overseas for yield The largest of the locally listed hotel REITs is CDL Hospitality Trusts, which owns hotels such as Orchard Hotel, M Hotel and Grand Copthorne Waterfront in Singapore. However, this REIT has significant exposure to Australia, New Zealand, Japan and the Maldives. And, it is continuing to expand overseas. This year, CDL-HT acquired the 165-room The Lowry Hotel in Manchester at £318,000 ($567,395) per key, and the 337-room Pullman Hotel Munich at €280,000 ($452,051) per key.

“We have diversified and expanded to Europe. Part of the reason is the deal flow is so much greater there compared with Asia,” says Vincent Yeo, CEO of CDL-HT’s manager. The way Yeo tells it, REITs such as CDL-HT have to venture overseas in order to find assets to enhance their yields. In Singapore, three- and four-star hotels tend to be valued at around $900,000 a key, and offer yields of only 4% to 5%.

With the acquisitions CDL-HT has made overseas, its Singapore properties accounted for 62.5% of its portfolio as at June 30. The Singapore properties contributed 58% to CDL-HT’s total NPI in 1HFY2017. Still, the REIT will benefit from any upcycle in the local hotel sector. In fact, Yeo says there have been signs of an improvement in demand.

“The good news is that there seems to be slightly more corporate activity,” he says, referring to CDL-HT’s hotels in Singapore. “In the last quarter and the quarter ahead, there is some indication on the ground that there is more corporate activity. We have some visibility a couple of months out and it is encouraging so far.” For 1H2017, CDL-HT reported an 8.8% rise in NPI to $70.8 million, and a 4.7% decline in DPU to 4.1 cents, because of the dilutive effect of a recent rights issue.

OCBC Investment Research sees CDL-HT benefiting from improved contributions from its hotel in New Zealand as well as its recent acquisitions. However, it has a “hold” recommendation on the stock, and is advising investors to look for a lower entry price.

On the other hand, RHB has a “buy” call on CDL-HT, on the expectation of a recovery in the hotel sector next year. “Despite recent overseas acquisitions, CDL-HT remains one of the best proxies to the expected rebound in Singapore hotel RevPARs. It is our preferred pick among the hospitality REITs too,” the research house says in a report. RHB is forecasting DPU of 10 cents for CDL-HT in 2017 and 2018. “The stock offers forward yields of 6.3% and 6.6% for 2017 and 2018 respectively, which we deem as attractive,” RHB says.

Some uncertainties While malls around the world are being disrupted by online retailers, hotels have been hit by the growing popularity of Airbnb, which enables people to rent their homes — or even just their couch — to travellers. Yeo of CDL-HT says Airbnb has not had any discernible impact on demand for hotel rooms in Singapore. He also points out that some cities around the world are beginning to impose restrictions and penalties on the letting out of residential properties to tourists. For instance, London is looking into the idea of imposing additional taxes on people who rent out their properties for short stays.

Yet, it seems unlikely that some variation of the current Airbnb model will not continue to exist in the future. Singapore recently took a step towards allowing residential property to be rented out for shorter periods of time, by lowering the minimum lease period from six months to three. According to Chong, who is a Member of Parliament for the Bishan Toa Payoh GRC, the government is getting feedback from a public consultation on the issue. “One way is to have purpose-built Airbnb places,” he says.

A more immediate concern for investors in hospitality REITs is whether anything will delay the expected improvement of the demand- supply dynamics in the local hotel sector. While some investors are already scoping out potential plays on the turnaround, the managers of some locally listed hotel REITs have been more circumspect in their expectations. Among them is OUE-HT, which recently stated: “The increased rooms supply in Singapore had created a highly competitive market environment and this would likely persist as more supply is expected in 2H2017 before tapering in 2018.”

Yeo of CDL-HT is also somewhat cautious on calling for an immediate recovery. “We still need to digest that block of supply coming up at the end of the third and fourth quarters. I think sometime next year, it is possible to expect some improvement in overall RevPAR.” RHB is forecasting a 3% to 5% rebound in RevPAR for 2018 and 2019. For 2017, RHB actually sees RevPAR falling a further 2% to 3%.

Nevertheless, with the tide showing signs of turning and hotel REITs having been ignored by investors for years, this could be the time to begin hunting for opportunity in the sector.

Hotel sector hitting inflection point: Time to check into hospitality REITs

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