EAGLE HOSPITALITY TRUST: THE ONE THAT FLEW TOO FAR

Note: This is the long version of the article on Eagle Hospitality Trust.

By Mak Yuen Teen

When Chew Yi Hong and I released the 2019 Governance Index for Trusts (GIFT) in August last year, Eagle Hospitality Trust (EHT) had just landed on the Singapore Exchange (SGX) three months earlier. Since we only cover listed real estate investment trusts (REITs) and business trusts (BTs) which have published at least one annual report, EHT was not included in GIFT 2019.

However, we had our reservations about EHT and other foreign trusts more generally, as reflected in the following comments in our report:

“Before unitholders apply for units in a new listing,  including foreign ones, in what seems to be assumed to be a “sure-win” REITs sector, they may want to ask themselves why certain foreign trusts are listing in Singapore especially when the sponsor is not local and the assets are overseas….the REIT market in U.S. is much bigger, so the question is why are some REITs with U.S. assets seeking listing here rather than back home…we believe it is important for investors to understand what they are investing in under our disclosure-based caveat emptor regime.”

But we did not foresee that it will take less than a year after listing for the eagle to fall.

By now, most investors in REITs and business trusts (BTs) should be familiar with the externally managed model used by these trusts and how their unique features set them apart from other listed issuers which are companies. It was their unique governance and business risks, and the fact that they are subject to different regulations and rules – the Securities and Futures Act (SFA) and Code on Collective Investment Schemes (CCIS) for REITs, and Business Trusts Act (BTA) for BTs – that prompted us to launch GIFT in 2017 specifically for this group of issuers.

GIFT, through its “Main Index” and its “Merit and Demerit Items”, capture what we consider to be the key governance and business risk areas that investors should pay attention to. If we apply GIFT to assess EHT, it would not have fared well – even without the raft of problems that have now prompted a regulatory investigation. However, EHT is an outlier with features and problems that no governance index could fully capture, even though it has now prompted us to assess whether there is a need for further fine-tune it.

Rather than talking about the generic risks in EHT that also apply to other trusts, I will focus more specifically on what I see as particularly problematic for EHT.

The prospectus

I cannot help but start with the 890-page prospectus. It took me a considerable amount of time to analyse and understand it, and find the “Easter eggs” (which are really potholes). It was registered with the Monetary Authority of Singapore (MAS) on May 16, 2019, the public offer opened at 9 pm that same day, closed on May 22 at noon, and the stapled securities started trading on May 24 at 2 pm.

It doesn’t hold the record for the longest prospectus or offer document – Cromwell European REIT’s prospectus has an astounding 1066 pages. However, more disclosure does not necessarily mean greater transparency and EHT is a good example.

It is unlikely that many public investors would be able to digest what is in the prospectus and make a proper investment decision in such a time frame, and the 12-page product highlights sheet is in no way an adequate substitute and, in any case, repeatedly points the reader to the prospectus for more information.

Public investors would clearly have to rely a great deal on those who are responsible for regulating, approving and facilitating the listing of EHT – and of course those in charge of its governance and management.

The structure

The basic structure of EHT, which comprises an active REIT and a (dormant) business trust stapled together, is like other stapled trusts. However, EHT’s trust and ownership structures have additional features that further reduce transparency and increase governance risks.

Its structure involves layers of companies incorporated in Cayman Islands, Singapore and United States. While this may be due to the need to comply with both US and Singapore regulations and tax laws, it raises questions of extreme financial engineering and why it chose to list in Singapore in the first place. Such a structure must come with increased compliance and transactional costs.

The highly complex structure also increases governance risks because of the difficulty in regulating and exerting oversight and control over these various entities. We only have to see, for example, how the founders have been able to procure the master lessors, which are companies owned by EHT, to enter into non-disturbance agreements with master lessees (which they fully own) and hotel management companies that are not in the best interests of EHT.

EHT may not have been able to obtain special tax treatment for REITs in the U.S. with its structure because it appears that U.S. tax rules for REITs require that a master lessee  should be an “eligible independent contractor” which “neither owns more than 35 percent of the REIT nor is 35 percent of its equity owned by a person who is related directly or indirectly to the REIT” (Jonathan Talansky and Jade Newburn, “The Use of Master Leases in Commercial Real Estate Transactions”, The Practical Real Estate Lawyer, September 2019).   In EHT’s case, all the master lessees are wholly owned by the sponsors through other companies.

If EHT had listed in the U.S., there would almost certainly be numerous class action suits by now. Therefore, it is probably push factors rather than pull factors that brought it to Singapore.

With regard to ownership, the founders and CEO held their shares through special purpose vehicles (SPVs) which appear to be incorporated in offshore jurisdictions with low transparency, such as British Virgin Islands (at least one is, but the place of incorporation of the others is not disclosed and searches show they are not incorporated in Singapore).

The stake of one of the co-founders, Howard Wu, is held through three SPVs, while those of the other co-founder Taylor Woods and CEO Salvatore Takoushian are held through one individual SPV each. While they have given commitments in the prospectus on lock-up arrangements which appear very comprehensive, covering restrictions such as those relating to pledging and hedging, there really is no effective way to monitor adherence to these commitments. Further, with holdings through offshore SPVs, it would be more difficult to enforce claims against these holdings.

Key actors

Two men are particularly critical at EHT  – Wu and Woods, the co-founders and owners of the sponsor, Urban Commons (UC).

Although Wu and Woods are considered controlling unitholders in EHT, each only own 7.62% of the stapled securities. However, despite the relatively low ownership interest, Wu and Woods were until recently also chairman and deputy chairman of the board. They also indirectly own the managers of EHT, and through companies they own, are the master lessees for all 18 properties.

Since they fully own the managers and are the master lessees, their interests will clearly be more aligned to these roles, rather than with EHT and its other unitholders. With the externally managed model, they cannot be removed by unitholders despite their relatively small stakes. Only five REITs and BTs have given unitholders the right to endorse directors of the manager and require directors who do not receive such endorsement to resign. The recent resignation of Wu and Woods was due to pressure from the regulators or other personal considerations, not because of threat of removal by unitholders.

In theory, it is possible for unitholders to remove the manager given that the two co-founders only own 15.2% of the stapled securities and the CCIS requires the constituent document of a REIT to include a provision that the manager can be removed by a simple majority of unitholders.

However, in EHT’s case, when investor anger prompted talk of replacing the manager, it emerged that UC had entered into a non-binding proposal with Far East Consortium International (FECI) with a 90-day exclusivity period to sell the latter a 70 percent in the managers, apparently causing the special committee overseeing the restructuring to abandon other expressions of interest for appointment as a replacement manager.

I could not find anything in the risk factors disclosed in the prospectus that alludes to restrictions in appointing a new manager if there are enough unitholders voting to replace the current one. There is mention that if the current manager is replaced, EHT loses the right of first refusal to buy new properties from Wu and Woods – a right of first refusal which I am sure unitholders would refuse first!

Recent adverse events show the result of “agency problems” caused by the misalignment of interests. These include, for example, the two co-founders procuring the master lessors to extend the deadline for the provision of outstanding security deposits by the master lessees; the failure of the master lessees to pay outstanding security deposits by the deadline as required by the extension agreement; failure of the master lessees to pay rents to the master lessors for  EHT’s properties; master lessees failing to provide sufficient working capital for hotel operations and to pay hotel management fees and make funds available for hotel operating expenses; causing EHT to assume potential liabilities, including those under the further non-disturbance agreements; and numerous other defaults of the master lessees.

While some may argue that these problems cannot be anticipated, I beg to differ because the misalignment of interests was hiding in plain sight and there appears to be little thought given to necessary controls to mitigate the risks. The two co-founders were allowed to take the two key positions on the board and it is unclear whether the board put reasonable limits on their ability to make decisions on behalf of EHT without its prior approval.

Takoushian, the Executive Director (ED), CEO and President of the manager of the REIT and trustee-manager of the trust (managers), is also likely to be aligned to the co-founders. He was granted 10.256 million EHT stapled securities (or a 1.18% stake) worth nearly S$11 million based on the IPO price as part of his remuneration package, which came from the consideration paid to Wu and Woods for the 18 properties sold to EHT.

Trusts are generally highly dependent on sponsors. What is critical are the financial wherewithal and integrity of the sponsors. What due diligence did DBS Bank, as the issue manager for the listing, do with regards to this?

Supporting actors

There are also questions surrounding some of the other directors and key management but I will focus on two in particular, Carl Stubbe, an independent director (ID) and Chairman of the Nominating and Remuneration Committee (NRC), and Cheah Zhou Yue, Joel, the then Senior Vice-President (SVP) of Finance (who was the most senior finance person in management at the IPO).

In the prospectus, it was disclosed on page 283 that Stubbe was appointed as an ID of the managers on April 16, 2019 and that he is currently the Senior Vice President, Investment Sales, Asia Hotels & Hospitality Group of Jones Lang LaSalle Property Consultants Pte Ltd (JLLPC).

JLLPC is an indirect subsidiary of Jones Lang LaSalle Inc. (JLL), which is listed on the New York Stock Exchange (NYSE). The shareholders of Singapore-incorporated JLLPC are two other JLL companies, one incorporated in Cook Islands and the other in Luxembourg.

Another JLL subsidiary, Jones Lang LaSalle Americas, Inc (JLLA), is the independent market research consultant for the IPO. Its role in the listing is pivotal. JLLA was mentioned seven times in the prospectus and “independent market research consultant” 50 times. It conducted the independent review of the hospitality sector and the hotel real estate market in the U.S. for the purpose of EHT’s listing. Its 189-page report, included in the prospectus, included a detailed asset overview and market positioning for all 18 hotels.

The analysis of the 18 properties painted a positive profile for each of them, and its overall summary of EHT’s portfolio is wholly bullish, with not a downside noted – I guess unsurprising for a market research report designed to support a successful listing. It said:

• “The subject portfolio is expected to benefit from its exposure to U.S. metropolitan statistical areas with a strong historical and projected economic growth trajectory.
• RevPAR [Revenue per Available Hotel Room] growth rates for the lodging markets in which the subject portfolio is located have been materially higher than the national average in recent years and are expected to remain strong in the near term.
• The subject portfolio is expected to benefit from its relatively high concentration of rooms in resort locations, which are expected to yield RevPAR growth during the next few years than most other location segments due to the concomitant impact of high barriers to entry and limited supply growth in the resort segment.
• The subject portfolio features a high share of rooms in the largest lodging markets in the U.S. as well as in the country’s most populous states; these markets generally benefit from higher RevPAR as well as greater liquidity than smaller U.S. markets.
• The subject portfolio is expected to benefit from its high share of rooms with full-service, branded positioning. Supply growth in the full-service segment is expected to continue to be muted in comparison to the select-service segment, allowing for potentially stronger RevPAR growth. Additionally, full-service hotels benefit from significant ancillary revenue and valuations that are typically marginally higher than their select-service counterparts.”

There is no disclosure of how much fees JLLA earned for its work but it would undoubtedly be very significant – more than significant enough to question whether Stubbe should be considered independent. But is not just a matter of the fees involved.

EHT is subject to the independence rules and guidelines in Regulations in the SFA, BTA and  the Code of Corporate Governance. In Stubbe’s case, the question is whether he has a business relationship with the managers which will affect his independence. Based on the strict letter of the Regulations and the Code, he can be deemed to be independent. This is because he is an employee of JLLPC in Singapore, while the business relationship was between U.S.-based JLLA and the managers.

However, based on the spirit of the Code and a more substantive approach to determining independence, Stubbe should have been deemed non-independent in my view.

The reality is that JLLA and JLLPC are fellow subsidiaries under JLL. The Asia-Pacific CEO of JLL, who also has responsibility for Singapore, sits on the global executive board of the ultimate parent, JLL. Stubbe at least indirectly reports to JLL’s Singapore and Asia-Pacific CEO.

In such a situation, it would be unrealistic to expect Stubbe to challenge the work of JLLA, which would be expected of him and the other IDs. According to the prospectus, Stubbe and the other IDs were appointed exactly a month before the IPO prospectus was registered. All the IDs would be expected to review the prospectus and question its contents if necessary.

However, according to Stubbe’s LinkedIn profile, he was actually appointed as an EHT ID in August 2018, well before the IPO – contrary to the date in the prospectus. What I find particularly troubling – and this is not something that was disclosed in the prospectus – is that his LinkedIn profile states that he joined JLLPC in May 2019, the same month that EHT was listed. Therefore, he would likely have been in discussions with JLLPC about joining them as an executive as he was serving on EHT’s board as an ID reviewing the JLLA report.

If he was indeed appointed as an EHT ID in August 2018, I would hope he was not involved in any way in the decision to appoint JLLA as the independent market research consultant.

Further, on page 280 of the prospectus, under the listing of the REIT manager’s board, it says:

“As at the Latest Practicable Date, none of the REIT Manager Directors has any family relationship with or is related to one another, the  executive officers of the REIT Manager, any employees of the REIT Manager upon whose work Eagle Hospitality Trust is dependent on, or any person with an interest in not less than 5.0% of the shares in issue…”

Curiously, while it mentions other relationships covered in the Regulations and the Code, it does not mention the absence of a business relationship.

I am particularly amazed that, under such circumstances, Stubbe was appointed as Chairman of the NRC, which is supposed to assess the independence of directors.

However, prior to the IPO, there is no NC as such to assess independence. The independence of the directors stated in the prospectus is likely to be effectively determined by a combination of the managers of EHT (in essence the sponsors) and the issue manager.

Did the issue manager question the disclosures relating to Stubbe and whether he should be considered independent given his employment with JLLPC? Or were they satisfied that a director can still be considered independent under such circumstances?

Unfortunately, the assessment of independence has degenerated to such an extent here today that directors with extensive relationships which would clearly affect their independence can resort to using their work experience, professional qualifications, affiliations with professional bodies or reputable firms, and endorsement from the board and NC, to defend their independence.

In Stubbe’s case, it boils down to this: Is he in a position to say that JLLA’s work is unsatisfactory if he thought so?

The finance head who bailed out

Cheah was the 35 year-old SVP of Finance of the REIT Manager at the IPO. He was the most senior finance person at EHT, which did not have a CFO. Cheah left on June 30, 2019, just over a month after the listing. However, his resignation was only announced on December 6, 2019, which is a clear breach of the listing rules in my view. His resignation so soon after the IPO is a red flag, and material information to EHT investors. Was the Audit and Risk Committee and board not aware that the SVP of Finance had left?

EHT appointed a CFO, Fred Chee Kin Yuen, on June 29, 2019 but he lasted only about eight months, as he resigned in early March 2020. EHT does not have a full-time senior finance person since.

The background of Cheah raises some questions. His resignation announcement said he was appointed to EHT on September 25, 2018, so he was likely appointed around the time when the preparation for the IPO started. According to his bio, prior to joining EHT – between 2016 and 2017 – “he was with a proposed REIT manager and a proposed trustee-manager seeking potential listings of a REIT and business trust respectively, on the SGX-ST”. I did not find any announcement of his resignation from another REIT and BT, so presumably those proposed listings did not happen.

After Cheah left, he joined Elite Partners Capital (EPC) as Finance Director and oversaw the finance and treasury function of Elite UK Commercial Fund. He then became the CFO of Elite Commercial Trust (ECT) when it listed on SGX in January 2020.

There is a discrepancy between his bio in ECT’s prospectus (and EPC’s website) and EHT’s prospectus. His bio in the ECT prospectus said that he was working for a REIT and BT seeking proposed listings between December 2016 and September 2018, which is different from the period of 2016 and 2017 in EHT’s prospectus. Assuming his latest bio is correct, why did he mis-state his prior employment in the EHT prospectus?  Did the issue manager confirm his prior employment history?

Assuming his latest bio is accurate, Cheah joined EHT as soon as he left his previous employer, and then took flight about a month after its listing to join EPC before becoming ECT’s CFO. Wouldn’t this raise concerns about his dependability and the stability of the finance function at ECT now?

The issue managers for ECT are OCBC and UBS. Did they question the circumstances of his short tenure and sudden resignation from EHT? If he resigned a month after EHT’s listing, that’s surely something that the due diligence process should look into. Are they aware of the discrepancies in his bios and would that not be a concern?

The valuers

The acquisitions of the 18 properties by EHT are all interested person transactions (IPTs), since all 18 properties were owned by the two founders. As required by the CCIS in the case of IPTs, two independent valuations are required for each property, with one required to be commissioned independent by the trustee. In EHT’s case, the two valuers were appointed by the REIT trustee, DBS Trustee, and the trustee manager, which is owned by Wu and Woods.

The two appointed valuers were Colliers International Consultancy & Valuation (Singapore) Pte Ltd (Colliers) and SG&R Singapore Pte Ltd, which is the Singapore entity of the international firm HVS (the HVS name was used in the prospectus). Colliers said that it used the Income (DCF) Approach, while HVS said it used the Income (DCF) Approach and Direct Sales Comparison Approach.

Clearly, since all the properties are in the U.S., there may be concerns as to whether these Singapore-based valuers would have the necessary knowledge to properly value them.

To allay concerns, the local registered valuer for Colliers who signed off on the 18 valuation reports said that he was “supported by a team of local valuers and research personnel across the geographic regions” where the properties are located. HVS did not say this but said that it had inspected all the properties.

It is interesting that the prospectus disclosed that the managers do not have the historical financial information for the six hotels under the ASAP6 Portfolio for the last three years – that is, years ended 31 December 2016, 2017 and 2018. In other words, the managers bought the six hotels under the ASAP6 portfolio without information about the income and cash flows for these hotels. The unaudited pro forma statements of comprehensive income and cash flows for the past three years in the prospectus did not include these six properties.

Without such historical financial information, how are the valuers to apply the Income Approach reliably for these six hotels?

The adopted valuation was the starting point for determining the consideration to be paid. For 16 out of the 18 hotels, HVS assigned a higher valuation than Colliers, with a median difference of 9.3%. The only two hotels for which HVS assigned a lower value are the two largest ones – Holiday Inn Resort Orlando Suites – Waterpark and the now infamous Queen Mary Long Beach. The adopted values used by EHT for the 18 acquisitions were the valuations produced by HVS, which was higher for 16 of the 18 properties. The consideration for each of the 18 hotels was then set at a discount from the adopted (HVS) valuations – the discount for the 18 hotels fell within a very narrow range of 12.25% to 12.50%.

As the consideration for each hotel was below the average of the two valuations, there was no need for trustee to provide a written confirmation that the acquisitions are on normal commercial terms and not prejudicial to the interests of the unitholders.

Did the issue manager and the trustee question the valuations?

Issue manager

DBS Bank played an extensive role in the listing, including being the sole financial adviser, issue manager, joint global coordinator, joint bookrunner and underwriter. Many of the issues I have raised earlier arguably fall within the responsibilities of the issue manager, including undertaking due diligence about the structure, sponsors, board and management.

With the problems that have recently emerged with all the properties within the EHT’s portfolio, some apparently dating back to May 2019, questions also arise about the due diligence done regarding the properties, master lease agreements, and hotel management arrangements.

In EHT’s case, the hotel managers are third-party companies, independent of EHT and its sponsors. Recent announcements suggest that there are disputes between most of the hotel managers and the master lessees, with a number of claims against the master lessees which EHT may ultimately become responsible for.

On page 36 of the prospectus, there is a footnote which says: “Prior to the listing or shortly after Listing, the USHI Portfolio Vendor or the Master Lessee of the Hotel, as the case may be, may replace this Hotel Manager. A new Hotel Manager will be appointed, which is expected to be an existing Hotel Manager of one or more properties in the Initial Portfolio and a larger and more established hotel management company.” This footnote applies to seven properties managed by Brighton Management, LLC.

No reason was given for the intended change in hotel manager for these properties.

I estimated the ratio of the average rental to acquisition price for the 12 hotels for which the past three years’ gross operating revenue and gross operating margin were available, using the rental income formula under the master lease agreement for each hotel disclosed in the prospectus. There was a hotel in Denver managed by another company that was a clear outlier in terms of high rental income but overall, there was nothing to suggest that the seven hotels managed by Brighton were generating lower rental income. When I compare the average gross operating margin for these seven hotels with the other five, they were consistently higher. The median for these seven was more than double than for the remaining five. There seems to be something different about these hotels.

But did the issue manager question about the proposed change to ensure that there were no underlying problems that need to be disclosed?

The trustee

As a stapled trust, EHT has a separate trustee for the REIT and a trustee-manager for the BT. The trustee has a rather limited and largely custodian role, while the trustee-manager has a more operational role. However, while the latter in theory has a more important governance role given its greater operational responsibilities, it does not have the independence of the trustee. In EHT’s case, the trustee-manager is owned by the Wu and Woods. In any event, the BT in EHT is dormant, so I will focus more on the trustee for the REIT, which is DBS Trustee Limited.

The prospectus explains that the “REIT Trustee… holds the assets of EHT-REIT on trust for the benefit of the holders of the EH-REIT Units, safeguards the rights and interests of the holders of EH-REIT Units and exercises all the powers of a trustee and the powers accompanying ownership of the properties in EH-REIT”. This makes it sound like a Guardian of the Galaxy.

However, in response to a Business Times article which questioned whether DBS Trustee could have done more for EHT unitholders, the trustee responded in a letter which appears more modest about its obligations: “The trustee’s obligation (in the context of Reits) applies to budget approval and compliance, reviewing financial reports, arrears reports and ensuring good title and insurance to assets. This is true of trustees in all real estate investment structures and was no different for Eagle Hospitality Real Estate Investment Trust (EH-Reit).”

There is clearly an “expectations gap” between investors and the trustee about its responsibilities. While the trustee is more than like the Merlion by the Singapore River, it is also difficult for it to be true guardians of unitholders’ interests.

There are duties imposed on the trustee that I am not sure that the trustee can fulfil in a substantive manner. For example, I had earlier alluded to the trustee having to provide a written confirmation that it is of the view that an acquisition which is an IPT that is made at a price  higher than the average of the two valuations, is on normal commercial terms and is not prejudicial to the interests of unitholders. This written confirmation is required where unitholders’ approval is not obtained. Is the trustee really in a position to provide a contrary view given its limited involvement and knowledge of specific properties?

Reporting accountants

KPMG LLP in Singapore were the reporting auditors for the profit forecast and profit projection, and for the unaudited pro forma consolidated financial information. With regard to the unaudited pro forma consolidated financial information, KPMG offer what could be described as a 67% opinion – a bit like Star-Lord in Guardians of the Galaxy having a 12% plan.

The reason why I say this is because there was historical information for only 12 out of the 18 hotels, and KPMG’s opinion on the pro forma income and cash flow information was therefore based on just 67% of the hotels.

However, it seems that none of those responsible for the listing of EHT had any concerns that six out of the 18 hotels that were injected into EHT were bought with no historical information about income or cash flows for the last three years. I could find no reasons given as to why the managers agreed to the acquisitions of the six hotels without such information – it was merely stated that the managers did not have the historical financial information.

SGX and MAS

SGX had “no comments” on the exclusion of the ASAP6 portfolio from the unaudited pro forma income and cash flow statements submitted for the purpose of the application for listing and “no further comments” that the unaudited pro forma income and cash flow information included in the prospectus excluded the ASAP6 portfolio.

However, in November 2019, SGX was suddenly concerned about the way the sale of these six hotels was conducted prior to the IPO. Frankly, that was about six months too late. These six properties were sold by ASAP Holdings to Wu and Woods prior to the IPO. ASAP6 is run by several Yuan family members, and its CEO Frank Yuan became EHT’s largest unitholder at its IPO with a 16.2 percent stake and started selling down his stake about five months after the listing. EHT said there was no legal requirement to disclose this relationship.

There was clearly something unusual about buying six hotels without information on income and cash flows for the last three years. Did anyone pause and consider the risks of EHT absorbing the six hotels without recent information about their performance?

After SGX said “no comments” on the lack of historical information for these hotels, everybody else just went along. The problems that have now emerged appear are not just with the six hotels. But the willingness to accept this, together with some of the other matters I have raised, show an over-enthusiasm for the listing which arguably led to blind spots.

Ultimately the decision to allow EHT to list rests with SGX and MAS. They have done well in making Singapore one of the key markets for the listing of REITs and BTs in Asia Pacific. However, along with credit must come responsibility when a poor listing lands on our market.

They have acted swiftly in this case to press those involved in its governance to step up, and have launched investigations and hopefully will take necessary action against those responsible for this debacle.

Other markets which have longer histories with REITs have gone through a collapse in confidence at some stage. We must make sure that EHT does not mark the beginning of the end of SGX as a preferred listing destination for REITs. If lessons are not learnt, that could be the outcome and it would be a real shame.