Ascott Residence Trust - DBS Research 2021-01-06: Risk-Sharing For Master Leases In France

ASCOTT RESIDENCE TRUST (SGX:HMN)

Ascott Residence Trust - Risk-Sharing For Master Leases In France

Gradual extension of France master leases in 2021 through a risk-sharing approach and variable formula.
New rental structure implies a drop of ~9.4% in Ascott Residence Trust (SGX:HMN)'s revenues on a pro forma FY19 basis.
Impact manageable at ~2.5% revenue loss on a worst case scenario.
Opportunity to infuse stability to portfolio through acquisitions within the broader lodging asset class.

Ascott Residence Trust announced the extension of master lease agreements for their assets in France. Most assets will be extended for a period of 3 years except for 4 assets which will be extended for a further 2 years (after a one-year extension in March 2020).
Alongside the extension of leases, the lease structure for all leases will be revised as shown below to include a variable rent component. We estimate Ascott Residence Trust's overall rents will drop by 9.4% (ranging +7% to -21% on an asset level) when compared to FY19 rent levels.
We estimate rental declines of ~-4.1% and ~-5.6% as the revised lease structure takes effect in 1Q and 2Q/3Q 2021 respectively with the full impact of the rent reset to be felt in 4Q21, when all the properties move over to the new lease structure.

The revised rental structure shifts from a fully fixed structure to one that has a mix of fixed (60%) and variable components (40%), pegged to 10.35% of underlying revenues.
The revised overall rent (based on FY19 level) is estimated to be ~26.8% of revenues, which is slightly lower than ~29% of revenues under the previous lease structure.
This is within the range of independent consultant HVS - fixed rent for operating leases in the market to be in the range of 15% to 31% of total revenues while variable rents within the range of 0% to 13% of total revenue.

Approximately 5m Euros worth of rent abatement was given to master lessees during the lock-down period(s) in Paris and France. This translates to ~3.4 months of rent based on total rental revenue in 2019.
At its peak, 12 of Ascott Residence Trust’s properties in France were temporarily closed. All assets are expected to have restarted operations by the end of last year.
Christie & Co estimates that the rent abatement in France is up to an equivalent of 8 months’ worth of rent holiday, putting Ascott Residence Trust’s abatement in the mid-range of the market.
While risk of rental abatement is likely one off, the change in lease structure will have a -1.1% impact on Ascott Residence Trust's distributable income and -0.8% impact on DPU.

The pandemic has taken a toll across all of Ascott Residence Trust’s geographical markets with France standing out as one of the first few markets where master leases were temporarily re-structured to variable rent terms due to the widespread closures. The timing of the master lease renewal is unfortunate, as we are still in a fragile period where COVID-19 cases in France remain high and domestic travel demand is uncertain in the near term due to provincial travel bans within the country.
That said, we believe that the roll-out of the vaccine inoculation this year should help alleviate uncertainty over time.
In the worst case scenario of zero variable rents, Ascott Residence Trust's rental loss will approximate 8m Euros (S$13m), equivalent to 2.5% of our full year revenue forecast in FY21 (S$527m), which is manageable and likely priced in in our view.

The change in lease structure can be seen as a form of “risk-sharing” with the Sponsor in the near term, and allows Ascott Residence Trust to participate in the property upcycle when operational conditions stabilise in the longer term.
That said, we estimate underlying revenues will have to be 10% higher than FY19 levels for Ascott Residence Trust to exceed previous rents in France. Ascott Residence Trust may be able to negotiate for better lease terms in FY23 at expiry of the master leases should the pace of recovery beat expectations.

The pandemic has been a watershed event for the hospitality sector, putting both historically resilient master lease assets and geographically diversified portfolios to the test. We believe that the approach the manager should take is to bring added stability to the REIT by broadening asset class types within the portfolio (i.e multi-family or rental housing properties), especially those that may have withstood the impact of the pandemic better.

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We believe that investors will likely look beyond this near-term hump in earnings and look forward to the overall rebound in operational metrics with potential upside from acquisitions in the medium term.

Geraldine WONG DBS Group Research | Derek TAN DBS Research | https://www.dbsvickers.com/ 2021-01-06

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