DBRS Confirms Canadian Apartment Properties REIT at BBB (low), Stable Trend

DBRS has today confirmed the Issuer Rating of Canadian Apartment Properties REIT (CAP or the Trust) at BBB (low) with a Stable trend. The rating confirmation reflects increasing operating income driven by stabilizing multi-family residential fundamentals in the Trust’s markets over the course of the past year. Operating performance has also benefited from CAP’s focus on upgrading the quality of its multi-family residential portfolio by acquiring properties in high barrier to entry markets (Greater Toronto Area and Greater Vancouver Area) while disposing of non-core assets located in markets with lower rental rates (Quebec and southwestern Ontario). CAP maintained strong occupancy levels and achieved healthy rental rate growth across each of its asset segments and most of its markets in 2010. The Calgary and Edmonton markets were exceptions due to aggressive rental rate discounting. Higher cash flow and stable distributions also resulted in modestly improved financial flexibility. Increased capital investment (acquisitions and growth capital expenditures of $97 million for the 12-month period ended September 30, 2010) was mainly funded by debt and resulted in the debt to gross book value of assets ratio to increase to 63.5% from 63.0% a year earlier. That said, CAP’s EBITDA interest coverage improved, due to higher operating income and lower interest rates on refinanced debt. As such, CAP’s financial metrics remain acceptable for the current rating category.

Although CAP achieved modest improvement in its operating and financial, its rating remains below DBRS’s real estate industry rating of BBB due to the following limitations: (1) above-average concentration in the GTA; (2) exposure to substantial condominium development in core markets; (3) relatively low EBITDA interest coverage; and (4) debt structure is entirely comprised of secured debt, which ranks ahead of the Issuer Rating. The following factors continue to underpin CAP’s BBB (low) rating: (1) focus on the relatively more stable multi-residential segment; (2) attractive property locations in Toronto with several properties located along the Toronto Transit Commission (TTC) corridor; and (3) good presence in Canada’s largest residential rental markets, which generally have more stable economies.

Going forward, DBRS’s stable rating outlook reflects our expectation that CAP will continue to achieve reasonable same portfolio NOI growth in 2011 driven by higher average rental rates (on suite renewals and turnovers), recent building investments, and cost saving initiatives. While DBRS expects rental rates to improve, a siginificant amount of new condominium supply in the GTA market (49.9% of CAP’s portfolio) will likely moderate the pace of growth over the next several years. Over the medium term, CAP will likely continue to grow its portfolio by acquiring properties in underrepresented markets and new markets across Canada, which should provide greater stability to the Trust’s earnings profile over time.

In terms of financial profile, DBRS expects cash flow from operations and cash available for distribution to continue to improve along with comparable operating income. CAP’s building improvement budget is approximately $125 million for the period 2011-2014 ($60 million of which is expected in 2011, declining to $5 million by 2014), and management has also indicated they intend to continue growing through acquisitions. DBRS expects these investments to be financed with incremental debt while maintaining debt-to-gross book value below 65%, which is an appropriate level for the current rating category.

Coverage ratios should remain near current levels as any improvement in EBITDA and/or positive refinancing activity will likely be offset by additional debt. A negative rating movement would be contingent on the following: (1) unexpected weakness in the multi-family residential sector and; (2) leverage levels rising above 65% combined with a sustained decline in EBITDA interest coverage below 2.00 times. On the other hand, a rating improvement would result from a material reduction in secured debt levels, significant improvement in earnings demonstrated by a sustained increase in EBITDA interest coverage above 2.30 times and/or a meaningful improvement in geographic diversification.

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 rating is based on public information.