DBRS Confirms Calloway REIT at BBB with a Stable Trend

DBRS has today confirmed the Senior Unsecured Debentures rating of Calloway Real Estate Investment Trust (Calloway or the Trust) at BBB, with a Stable trend. The rating confirmation incorporates the defensive features of Calloway’s portfolio, which underpins the current rating category. These include the following:

(1) Calloway has the second largest retail portfolio in Canada, comprising approximately 22.8 million square feet (sq. ft.) of new-format unenclosed retail properties, many of which are anchored by Wal-Mart Canada (Wal-Mart, accounting for 26% of gross rental revenue).

(2) The Trust’s properties are also relatively new, with 70% of the portfolio developed since 2002, which minimizes capital requirements over the medium term.

(3) Calloway’s portfolio has a focus on discount-/value-oriented tenants, which are generally less sensitive to recessionary periods than discretionary or fashion-oriented tenants.

(4) Calloway has one of the sector’s longest lease profiles, with an average lease term to maturity of 9.0 years (Wal-Mart at 12.6 years).

These features are highlighted by the portfolio’s consistently high occupancy rates (close to or greater than 99%) and very low cash flow volatility, which have provided good protection from the challenging capital and real estate market conditions over the past couple of years.

Overall, the Trust’s portfolio continues to perform well and generate cash flow growth, driven by completed development projects and earn-outs from SmartCentres, positive releasing activity (an increase of 9.2% on average rental rates on 103,833 sq. ft. lease renewal space) and, to a lesser extent, property acquisitions. In addition, Calloway has been fairly successful at re-leasing the manageable amount of space left vacant by tenant bankruptcies or disruptions early in 2009 and in Q4 2008. Calloway is expected to experience further growth in cash flow for the remainder of 2010 and into 2011 as a result ofa full-year cash flow contribution from acquisitions and completed development projects and earn-outs in 2010 and 2011. These developments and earn-outs are expected to add approximately 609,005 sq. ft. of leasable space to the portfolio and more than $12.5 million in cash flow.

The rating confirmation also takes into consideration that Calloway has significantly lowered its cost of capital and improved its financial flexibility and liquidity position through financing activity over the past year, including the issuance of $325 million of senior unsecured debentures (Series C, D and E), new term mortgages and, more recently, a $60 million convertible debenture issue and $40 million of Trust units issued at $19.05 per unit. As a result, DBRS believes that Calloway has ample sources of capital to fund its capital commitments, totaling $383.2 million (excluding Series A debentures, which were repaid subsequent to Q1 2010), by the end of 2011. These commitments mainly include $66.6 million of committed development projects and earn-outs, $88.5 million of principal mortgage amortization and mezzanine loan advances of $59.7 million. Calloway’s available sources of capital include cash balances ($8.4 million), undrawn amounts on its credit facilities ($126 million), construction financing, up-financing of maturing mortgages and financing of unencumbered assets.

Going forward, Calloway’s debt levels are expected to remain reasonable, in the 55% to 60% range, and DBRS expects EBITDA interest coverage (including capitalized interest) to modestly improve from current levels with cash flow contributions from completed development and earn-outs. In addition, EBITDA interest coverage will likely benefit from the Trust’s lower cost of capital, which could make potential acquisitions and completed developments and earn-outs more accretive compared with last year. DBRS notes that Calloway’s minimal near-term lease maturities (1.2% of gross leasable area (GLA) in 2010 and 4.6% of GLA in 2011) will also provide underlying stability to cash flow and should limit the Trust’s exposure to the challenging economic environment.

Overall, DBRS believes Calloway’s credit profile will remain sound as we expect the economy and consumer spending levels in Canada to show further signs of recovery in 2010. If the Trust performs as we expect and maintains current operating metrics and acceptable levels of financial flexibility while improving its free cash flow position, the trend should remain Stable. 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 1.90 times (including capitalized interest)) 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 credit metrics), the rating and/or trend 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 (Real Estate) rating.