DBRS Confirms RioCan REIT at BBB (high) with a Stable Trend

DBRS has today confirmed the Senior Unsecured Debentures of RioCan Real Estate Investment Trust (RioCan or the Trust) at BBB (high), with a Stable trend. The confirmation takes into consideration the fact that RioCan continues to perform well and has benefited from a recovering retail leasing environment, favourable refinancing activity, a resumption of property acquisitions in Canada and expansion into new markets, including the northeastern United States and Texas. The Trust continues to achieve high occupancy levels (97.0% as at Q2 2010), high tenant retention rates (93.2%), and positive re-leasing activity with higher average rental rates (+10.3%) over expiring rents on 924,000 square feet (sq. ft.) of lease renewals.

The Trust also continues to achieve meaningful portfolio growth through property acquisitions and recently formed joint ventures with Cedar Shopping Centers Inc. (Cedar) and Inland Western Retail REIT (Inland Western). To date, RioCan has acquired 1.04 million sq. ft. at an average cap rate of approximately 8.5% from Cedar and has 916,917 sq. ft. of pending acquisitions from Inland Western at an average cap rate of 7.7%. Overall, these predominantly grocery store-anchored properties complement RioCan’s existing portfolio with good occupancy levels (mid- to high 90% range) and quality tenants, such as Giant Food Supermarkets.

In the near term, DBRS expects that higher capitalization rates in the United States (7.5% to 8%) than in Canada (6.5% to 7%) and the availability of suitable retail properties will continue to be a source of motivation for the Trust to build out its U.S. operating platform. Overall, DBRS views RioCan’s expansion into the United States as slightly positive for the credit rating, given that the Trust has mitigated some of the risks of entering into a new market by forming joint ventures with experienced partners that have local expertise and an operating track record.

DBRS also expects diversification benefits by reducing the Trust’s geographic exposure to Ontario markets (accounts for 57% of annualized rental revenue) over the medium term. In terms of financial profile, RioCan has enhanced its financial flexibility position through substantial capital raises in 2009 ($261 million of equity and $330 million in unsecured debentures), which has supported portfolio growth. In addition, RioCan continues to have good access to the capital markets and had ample liquidity of $326.2 million to fund upcoming capital commitments, including development expenditures of $46.2 million and debt maturities of $162.5 million before the end of 2010. RioCan’s debt maturity profile is well-staggered over the next five years, which limits its exposure to refinancing and interest rate risk. DBRS expects RioCan to continue to achieve interest expense savings on upcoming debt maturities (debt maturities in 2010 have a weighted average interest rate of 7.17% compared with recent financing rates done at below 5%).

The Trust, however, continues to operate with an aggressive payout ratio of 126.7% for the 12 months ended June 30, 2010 (DBRS adjusted for maintenance capital expenditures and leasing costs). DBRS notes that RioCan has an active dividend reinvestment plan (DRIP), which partially supports the payout ratio. While this level of payout reduces the Trust’s financial flexibility, DBRS believes that this shortfall is manageable in the near term and expects cash flow growth to continue, driven by recent property acquisitions (including $233 million under contract that are scheduled for completion in Q3/Q4 of 2010), completed development/intensification projects and positive leasing activity forecasted for 2010. As a result, DBRS expects EBITDA interest coverage to improve and to also benefit from interest expense savings on debt refinancing. Going forward, DBRS expects RioCan to maintain sound credit metrics with reasonable debt levels in the 55% to 60% range based on gross book value of assets 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 expects the economy and consumer spending levels in Canada to continue to recover into 2011. 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 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 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 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.