Below are excerpts from a primer on REITS, property business trusts and stapled trusts written by Robson Lee, a partner at Gibson, Dunn and Crutcher, LLP. (More info at the end of article)

Despite the safeguards in the listing framework put in place by the SGX-ST, the case of EHT has illustrated that the continued success of a REIT, property BT or stapled trust which adopts a master lease arrangement will ultimately depend on the commitment and financial strength of the master lessees (who will typically be affiliates of the sponsor).

EHT is a stapled trust, comprising Eagle Hospitality Real Estate Investment Trust (“EHREIT”) and Eagle Hospitality Business Trust (“EHBT”), which made its debut on the Mainboard of the SGX-ST in May 2019 with an initial portfolio of 18 hotel properties.

EHREIT was established with the principal investment strategy of investing in income-producing real estate used primarily for hospitality and/or hospitality-related purposes while EHBT will initially remain dormant.

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EHT adopted a master lease arrangement under which affiliates of its sponsor (collectively, the “Master Lessees”), Urban Commons, would lease the hotels from EHREIT. The Master Lessees would in turn enter into (a) franchise agreements with various hotel franchisors to operate under their brands and (b) hotel management agreements with third-party hotel management companies to manage the day-to-day operations of each hotel.

Indications that things may be less than perfect surfaced shortly post-listing in October 2019 when an article appeared in the press that EHT had been served with a notice of default by the City of Long Beach in respect of one of its properties, The Queen Mary (a hotel operated aboard a historic British ocean liner which had been leased from the City of Long Beach), as a result of failure to make repairs. The same article also quoted a marine survey conducted in 2017 (the “2017 Marine Survey”) which alleged that The Queen Mary was in deteriorating condition and in need of substantial repairs (collectively, the “Queen Mary Allegations”).

The Queen Mary Allegations were swiftly disputed by EHT, which clarified that there was no default and that the supposed notice of default was merely a “formal request for information by the City”. EHT also called the 2017 Marine Survey’s estimate of the scope of work and costs “grossly inaccurate”. To substantiate its claims, EHT further relied on an independent structural engineer’s report by John A. Martin & Associates, Inc. (which was commissioned by Urban Commons prior to EHT’s listing) which concluded that The Queen Mary “remains in excellent structural condition”. Despite the assurances from EHT, the price of its stapled securities reportedly fell 14%.

In late 2019 to early 2020, EHT’s financial resources started to deplete due to the impact of Coronavirus Disease 2019 and various delinquencies by the Master Lessees.

Among others, the Master Lessees (a) breached the master lease agreements by failing to pay rent on time, (b) received notice of default from various hotel managers due to, among others, failure to provide and/or maintain sufficient working capital for the hotels’ operations and failure to pay management fees and (c) received notice of termination from various hotel managers due to failure to cure the default of maintaining sufficient working capital for the hotels’ operations.

During this period, EHT received a notice of default and acceleration in respect of a US$341 million loan it had taken out in connection with its listing.

In March 2020, EHT called for a voluntary suspension of trading. In April 2020, EHT established a special committee to safeguard value and conduct a strategic review. EHT subsequently appointed a financial adviser and implemented caretaker arrangements at the hotels which were the subject of the notice of termination by the relevant hotel managers.

In May 2020, the strategic review uncovered that the founders of Urban Commons (in their capacity as directors of various subsidiaries of EHREIT) had, on behalf of these subsidiaries, entered into certain interested person transactions which were prejudicial to the interests of EHT and its minority stapled securityholders. This discovery prompted their resignations from the board of directors of the manager of EHREIT (the “EHREIT Manager”) and the trustee-manager of EHBT (the “EHBT Trustee-Manager”).

In June 2020, EHT announced that an initial request for proposal (“RFP”) process conducted by its financial adviser was interrupted by Urban Commons’ entry into a letter of intent with Far East Consortium International Limited (“FECIL”) in relation to FECIL’s proposed acquisition of a 70% interest in each of the EHREIT Manager and the EHBT Trustee-Manager. Against this, the MAS and the Commercial Affairs Department of the Singapore Police Force commenced a joint investigation into current and former directors and officers responsible for managing in EHT in connection with suspected breach of disclosure requirements under the SFA.

Discussions with FECIL, however, collapsed and the trustee of EHREIT (the “EHREIT Trustee”) restarted the RFP process in late 2020, which culminated in the selection of SCCPRE Hospitality REIT Management Pte. Ltd. as the replacement manager of EHREIT (the “SCCPRE Proposal”). The SCCPRE Proposal was contingent on a number of resolutions being passed at an extraordinary general meeting (“EGM”) to be held on 30 December 2020. On or around the same period, EHT terminated the master lease agreements and the EHREIT Trustee also received a directive from the MAS to remove the EHREIT Manager.

On 30 December 2020, the EHREIT Manager was removed. However, not all the requisite resolutions for the SCCPRE Proposal were passed at the EGM held on the same day. In view of the absence of a replacement manager and inability to continue as a going concern because of the depletion of funds, EHT filed for insolvency protection under Chapter 11 of the United States Bankruptcy Code.

As at the time of writing of this primer, EHT has disposed 15 of its 18 hotel properties and also surrendered The Queen Mary back to the City of Long Beach. Stapled securityholders are, however, not expected to receive the sale proceeds as the cash is insufficient to repay all the claims on EHT.

The case of EHT has shown that the continued success of a REIT, property BT or stapled trust which adopts a master lease arrangement will ultimately depend on the commitment and financial strength of the master lessees.

Where a master lease arrangement is adopted, concentration risk is at its highest (given the lack of diversity in lessees) and the ability of the master lessees to keep up with timely rental payments becomes even more important.

"Where a master lease arrangement is adopted, concentration risk is at its highest (given the lack of diversity in lessees) and the ability of the master lessees to keep up with timely rental payments becomes even more important."
Rental income is ultimately the chief source of income for a REIT, property BT or stapled trust. As seen in the case of EHT, in certain cases, rental defaults could even result in the REIT, property BT or stapled trust defaulting on its debt obligations and ultimately wind up.

The case of EHT has also resulted in the public calling for the authorities to review the current disclosure regime.

In particular, it has been questioned if the rules should also require disclosure of the financials of a sponsor (especially if a master lease arrangement with the sponsor is adopted).

Where a master lease arrangement is adopted, valuations of the properties and financials presented in the prospectus would be based on the rental income received under such master lease arrangement.

For these figures to remain accurate, the master lessees need to be able to perform their end of the bargain. Requiring such disclosures would allow investors to better assess a sponsor’s financial strength.

Short of any amendment to the disclosure regime, issuers will do well to treat the required disclosures as the minimum standard and aim to go above and beyond in the interests of investors.

The full document can be accessed here.
The author: 
Robson Lee, Partner of Gibson, Dunn & Crutcher, LLP (This email address is being protected from spambots. You need JavaScript enabled to view it.)

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