DBRS Confirms Primaris Retail REIT Income Fund at STA-3 (low)

DBRS has today confirmed the STA-3 (low) rating of Primaris Retail Real Estate Investment Trust (Primaris or the Trust). The rating confirmation reflects the fact that Primaris continues to increase the size and scale of its predominately enclosed shopping centre portfolio by acquiring approximately 1.8 million of leaseable square feet (sq. ft., an increase of 19% from Q4 2008) over the last year.

These investments mainly include the acquisition of Sunridge Mall, a 809,000 sq. ft. enclosed shopping centre located in Calgary, Alberta, a 50% interest in the Woodgrove Centre, a 719,000 sq. ft. (Primaris’ share 359,500 sq. ft.) enclosed shopping centre located in Nanaimo, British Columbia and more recently the acquisition of Cataraqui Town Centre, a two-level 595,000 sq. ft. enclosed regional shopping centre located in Kingston, Ontario. DBRS notes that each property is well occupied (occupancy rates for these properties range from 96% to 100%) by national recognized tenants and are anchored by large department stores (the Bay and Sears) and or discount retailers, such as Wal-Mart and Zellers. In addition, these properties are well maintained having undergone renovations over the last five years and are either a dominant asset in a secondary market or the dominant shopping centre within their respective markets. Overall, DBRS views these investments as positive to Primaris’ business risk profile, further enhancing geographic, property diversification and modestly extending the Trust’s leasing profile, which should add to stability of cash flow going forward.

The rating confirmation also takes into consideration Primaris’ portfolio occupancy levels, which have held up relatively well despite a challenging economic environment over the last couple of years. As at Q2 2010, the Trust’s portfolio had an occupancy rate of 96.6%. The Trust also continues to experience positive leasing activity. During Q2 2010, Primaris achieved a respectable 5.9% increase in average rental rates over expiring rates on lease renewals (lease renewals represented 79.9% of the 312,512 sq. ft. of leased space during the quarter). However, DBRS expects rental rate growth to likely remain under modest pressure until overall portfolio sales performance improves. In terms of debt maturities, Primaris has a modest amount of debt set to mature over the next couple of years, mainly consisting of a mortgage on Dufferin Mall in 2011 and Eglinton Square in 2012. DBRS believes these mortgages offer significant up-financing opportunities at more favourable interest rates.

DBRS notes, however, that these positives attributes have been balanced by higher financial risk over the past several years. To fund portfolio growth, Primaris’ debt levels have increased to 53.7% or 61.2% including convertible debentures on a pro forma basis and placed corresponding pressure on credit metrics, particularly EBITDA interest coverage, which DBRS estimates at 2.20 times on pro forma basis. DBRS believes that this level is at the lower end of the range, which DBRS considers suitable for the Trust’s business risk profile. Going forward, DBRS expects Primaris to begin to restore EBITDA interest coverage to more appropriate levels in the 2.30 times to 2.40 times range.

The current rating is also constrained by the following factors: (1) Although Primaris has achieved significant growth over the past several years, the Trust’s portfolio size and cash flow levels remain small compared to its investment grade peers who operate portfolios with at least 20 million sq. ft.; (2) While tenant disruptions have been very manageable to date, the Trust’s focus on enclosed shopping malls exposes it to tenants that concentrate on discretionary goods/services and to the performance of large anchor tenants, including The Bay and Zellers (collectively, The Hudson’s Bay Company (HBC)) and Sears Canada. As at Q2 2010, HBC and Sears Canada represented approximately 28.8% of total leasable sq. ft. Given this significant concentration, DBRS notes that the loss of an anchor tenant could have a negative impact on the overall performance of the anchored property, including existing ancillary tenants. DBRS does note, however, that Primaris has been able to accommodate changes in anchor tenants from store closures in recent years, which has generally produced higher overall net rental income.

Overall, DBRS expects Primaris’ stability profile to remain stable with support from good operating metrics, a low interest rate environment and slowly recovering consumer spending levels. However, if the Trust’s stability metrics deteriorate from current levels (i.e., below the EBITDA interest coverage range of 2.20 times (including capitalized interest)) caused by weaker-than-expected operating performance, inadequate financial flexibility or material tenant disruptions, the rating would be pressured.

Note:
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.