DBRS Confirms Allied Properties REIT Stability Rating at STA-4 (middle)

DBRS has today confirmed the Stability Rating of Allied Properties Real Estate Investment Trust (Allied or the Trust) at STA-4 (middle). The rating confirmation takes into consideration modest portfolio growth in new markets over the past year, the conservative financial profile of the Trust, and the concentration of lease rollovers during the 2011 to 2013 period.

Allied’s portfolio growth was based on acquisitions consisting of four Class I office properties, two of which are located in new markets (Calgary and Vancouver). These acquired properties are well occupied, with comparable tenants, and they also modestly improve the Trust’s geographic diversification. Allied’s 2010 operating income increased significantly as contributions from property acquisitions more than offset a 6% decline in same-portfolio net operating income, which was affected by higher vacancies in the Trust’s Toronto properties. However, overall portfolio occupancy at 95% remains high and within the Trust’s historical range. Despite the increase in cash flow, Allied’s payout ratio has temporarily exceeded 100% due to above-average leasing costs and higher overall cash distributions during the year. Allied’s negative free cash flow and property acquisitions in 2010 were funded primarily with equity proceeds. As a result, Allied’s financial leverage remains conservative and at a good level for the current rating category.

Despite conservative debt levels, Allied’s STA-4 (middle) rating is constrained by the following limitations: (1) a relatively small portfolio containing approximately six million square feet (sq. ft.); (2) single-market exposure – downtown Toronto accounts for 51.3% of gross leasable area (GLA); (3) high degree of lease maturities and concentration by asset-type (office space accounts for 88.3% of GLA); and (4) lower credit quality tenants. Allied’s rating is underpinned by (1) well-maintained and located Class I office properties in large Canadian cities; (2) high portfolio occupancy levels; and (3) conservative financial leverage.

Going forward, DBRS expects that Allied will continue to achieve reasonable operating income growth due to full-year cash flow contributions from recent acquisitions and, to a lesser extent, from near-term leasing activity. In addition, Allied’s management has indicated that it plans to make acquisitions in the $100 million to $150 million range during 2011. Although Toronto office market fundamentals have shown improvement over the last several quarters, new Class A office supply still under construction and recently completed office properties will likely put pressure on market occupancy and rental rates, which could expose Allied to re-leasing risk on a significant portion of its leases that mature over the 2011-2013 period. DBRS expects that Allied will fund its property acquisitions and development projects with available debt capacity. The aforementioned risks should remain manageable given the Trust’s conservative financial profile. DBRS also expects that Allied will continue to operate with a debt-to-gross book value assets ratio in the 50% to 55% range.

A negative rating action could result from: (1) weaker operating and earnings performance; (2) a sustained increase in financial leverage (debt-to-gross book value assets ratio above 55% and EBITDA interest coverage below 2.30 times); and/or (3) increasing portfolio concentration. On the other hand, a rating improvement would likely be the result of: (1) a material increase in portfolio size; (2) improved geographic diversification; (3) a significant improvement in earnings; and/or (4) moderation of financial leverage that results in a sustained increase in EBITDA interest coverage above 3.00 times.

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

The applicable methodologies are Rating Real Estate and Rating Income Funds, which can be found on our website under Methodologies.