You will be able to compare the steady income of healthcare REITs with the variable income of hospitality REITs.
In 2020, when borders closed, hotel occupancy around the world collapsed within weeks. Hospitality REITs that depended on room revenue saw their income fall hard. In the same period, healthcare REITs that leased hospitals and nursing homes to operators on long leases kept collecting rent, because the leases said they would. Same pandemic, same stock exchange, completely different results.
The reason lies in how each kind of REIT is paid.
A healthcare REIT owns hospitals, nursing homes, medical centres or similar properties. In many cases it leases each property to a single operator, the company that runs the hospital or the nursing home, under a master lease. A master lease is one long lease covering a whole property, often for many years, under which the operator pays the REIT rent and usually takes on most of the running costs.
Master leases in healthcare commonly include rent reviews: a built-in increase each year, sometimes linked to inflation or to the operator's revenue, sometimes a fixed step. The lease terms are summarised in the annual report.
For the REIT, this produces steady, predictable income. Rent comes in whether the hospital is busy or quiet, because the operator has signed up to pay it. That is what carried healthcare REITs through 2020.
The steadiness depends entirely on the operator being able to pay. If the operator gets into financial trouble, the REIT may face a request to cut rent, a default, or the need to find a new operator for a specialised building, which is not easy. A hospital cannot be re-let to a shop.
And healthcare REITs are often concentrated. A REIT may lease most of its properties to one or two operators, sometimes a company related to its sponsor. Lesson 4.1, Sponsor, manager and trustee: who does what, showed why sponsor links matter. Here, the sponsor might also be the main tenant.
So for a healthcare REIT, read the operator as carefully as the property. What share of rent comes from the largest operator? How healthy are its finances? How much rent does it pay compared with the earnings it makes at the property? The annual report gives some of this, and listed operators publish their own results.
A hospitality REIT owns hotels and serviced residences. Its income moves with how many rooms are filled and at what price. When travel is strong, both rise. When travel stops, income can drop sharply and quickly, as 2020 showed.
Hotels also have high fixed costs: staff, maintenance, utilities. When revenue falls, those costs remain, so profit falls faster than revenue. If the REIT's income is based on the hotel's profit rather than its revenue, the swing is larger still.
Hospitality income follows tourism, business travel, events and exchange rates, which all change quickly. The Singapore Tourism Board publishes visitor arrival and hotel statistics, a good place to check the current picture.
Some hospitality REITs use master leases too, with the hotel operator or the sponsor as the lessee. These often combine a fixed rent with a variable rent linked to the hotel's revenue or profit.
With made-up figures, a hotel REIT has a master lease with S$20 million of fixed rent a year, plus variable rent. In a good year the variable rent is S$25 million, for S$45 million in total. In a bad year it falls to S$5 million, for S$25 million in total. Income falls by about 44%. A REIT with no fixed element, earning, say, S$40 million in a good year and S$10 million in a bad one, would see a 75% fall.
The fixed element does its job only if the lessee can pay it in a bad year. If the lessee is a sponsor company with a strong balance sheet, that helps. If it is a small operator, the fixed rent is only as strong as the operator.
Darren put one healthcare and one hospitality REIT side by side. The healthcare REIT earned almost all of its rent from fixed master leases with annual reviews, mostly from one operator. The hospitality REIT reported that roughly a third of its rent was fixed and the rest varied with hotel revenue. The first gave him steadiness with a single point of failure. The second gave him a share of a travel recovery, with income that could fall hard in a downturn.
Neither is better. They answer different needs in an income portfolio, which lesson 8.2, Spread income across sectors, sources and countries, picks up.
The annual report or results presentation usually states how rent is earned: under master leases or direct operation, with fixed and variable parts. In the activity you will find that split for one healthcare and one hospitality S-REIT, and it will tell you more about the next bad year than either REIT's yield does.
Compare how one healthcare and one hospitality S-REIT earn rent, noting the share of fixed versus variable income.
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