DBRS Confirms RioCan Real Estate Investment Trust at STA-2 (low)

DBRS has today confirmed the stability rating of RioCan Real Estate Investment Trust (RioCan or the Trust) at STA-2 (low). The confirmation takes into consideration the fact that RioCan has enhanced its liquidity position through recent financing activity, including the issuance of 10.3 million trust units for gross proceeds of $150 million, the issuance of $180 million of 8.33%, five-year senior unsecured debentures (Series L), and mortgage financings of $185 million. As a result, RioCan had ample liquidity of $492.4 million to fund upcoming capital commitments, including development expenditures of $112 million in 2009/2010 and debt maturities of $264.6 million for the remainder of 2009. DBRS notes that this amount includes the Series D senior unsecured debentures ($79.7 million) that mature on September 21, 2009. DBRS expects the Trust to repay this amount with cash on hand.

The Trust, however, continues to operate with an aggressive payout ratio of 118.8% for the 12 months ended June 30, 2009 (DBRS adjusted for maintenance capital expenditures and leasing costs); 112.1% including gains on sales of assets held for resale), which has been affected by slowing property disposition activity and fee income.

While this level of payout reduces the Trust’s financial flexibility, DBRS believes that this shortfall is manageable in the near term and expects that potential property acquisitions (management has indicated its intention to acquire approximately $200 million to $300 million in properties by the end of 2009), completed development/intensification projects and positive leasing activity forecast for 2010 could slowly improve the Trust’s financial flexibility and cash flow levels. In addition, DBRS expects fee income and gains from property disposition activity to recover in line with an improvement in broader economic conditions in 2010. DBRS does, however, view this source of cash flow as less predictable over the long term.

Going forward, DBRS believes that the Trust’s financial profile provides reasonable funding support to the current distribution until property disposition activity and cash flow growth recover in 2010. DBRS also believes that this concern is balanced by the following:

(1) Despite current broader economic conditions, the Trust continues to perform reasonably well and to benefit from the size and scale of its portfolio; good property locations in large urban Canadian markets; and a diverse mix of retail assets, including new-format retail (46% of leasable space), neighbourhood and community unenclosed shopping centres (27%), and dominant enclosed malls in smaller urban areas. The Trust also has a large tenant base, with many tenants that are focused on necessity-type products such as grocery, pharmacy and discount retail, which tend to be less sensitive to recessionary periods. As well, national and anchor tenants under long-term leases account for 84.6% of annualized rental revenue.

(2) The Trust has yet to show signs of any material weakness in operating performance and continues to achieve high occupancy levels (97.1% as at Q2 2009), high tenant retention rates (93.2%), and positive re-leasing activity with higher average rental rates (7%) on lease renewals, particularly in its western Canadian markets. The Trust has been fairly successful at re-leasing space affected by tenant disruptions/bankruptcies. To date, RioCan has re-leased 201,000 square feet (sq. ft.) of its total 454,000 sq. ft. affected by tenant disruptions/bankruptcies at slightly higher average rental rates ($22.72 per sq. ft. compared with $22.19 per sq. ft.) RioCan is expected to re-lease the remaining space by the end of the year. For the remainder of 2009, DBRS expects cash flow growth to continue to slow and continued pressure on the Trust’s smaller or lower-quality tenants due to the current challenging economic conditions. However, the Trust’s minimal lease maturities for the remainder of the year should continue to provide underlying support to cash flow.

(3) DBRS expects RioCan to maintain sound credit metrics, with reasonable debt levels (debt-to-gross book value assets 55.8% as at Q2 2009) and an EBITDA interest coverage (includes capitalized interest) in the 2.3 times range, which is reasonable for the business risk profile of the Trust.

Overall, DBRS believes that 2009 should represent the bottom of the cycle for retail fundamentals, as we expect the economy and consumer spending levels in Canada to stabilize and recover into 2010. If the Trust performs as we expect and maintains current operating metrics and acceptable levels of liquidity while improving its free cash flow position, the rating should remain at the current category. However, if the Trust’s credit metrics trend away from levels appropriate for the current environment and rating (i.e., below the EBITDA interest coverage range of 2.25 times) caused by weaker-than-expected operating performance, inadequate financial flexibility and/or a deeper/longer than expected economic downturn (which would erode the Trust’s capacity to manage its payout ratio), the rating would be pressured.

Notes:
All figures are in Canadian dollars unless otherwise noted.

The applicable methodology is Rating Real Estate, which can be found on our website under Methodologies.

This is a Corporate rating.