DBRS Confirms H&R REIT Real Estate Investment Trust at BBB, Stable Trend

DBRS has today confirmed the rating of H&R Real Estate Investment Trust’s (H&R or the Trust) Senior Unsecured Debentures at BBB with a Stable trend. The rating confirmation takes into consideration modest portfolio growth, stable operating metrics and an expectation for coverage ratios to recover following the completion of The Bow in 2012.

H&R’s portfolio growth in 2010 was focused on single tenant retail properties throughout the United States, with a concentration in Texas. These assets are generally new, occupied by high quality tenants, and under long-term leases. In Q1 2011, the Trust entered into an agreement to acquire Atrium on Bay, a multi-tenanted, mixed-use property located in downtown Toronto for $345 million. Notwithstanding the growth in the portfolio, H&R’s operating income declined in 2010 due to property dispositions that occurred over the past couple of years and a weakening U.S. dollar. Same portfolio NOI growth, however, was relatively flat as improving results from the Canadian portfolio offset negative results in the U.S. portfolio. At the same time, occupancy levels for H&R’s portfolio remain very strong at 98.9%.

H&R’s coverage ratios were expected to decline to levels outside of the current rating’s parameters during the construction phase of The Bow, as capitalized interest ramps up with the development. DBRS estimates that EBITDA interest coverage ratio, including capitalized interest, could reach a low point of 1.50x to 1.60x in 2011. Although this level of coverage is aggressive for the current rating category, DBRS accepts it on a temporary basis because The Bow is fully pre-leased to EnCana Corporation (EnCana; rated A (low) by DBRS) under a 25-year triple-net lease.

H&R’s BBB rating is also supported by the following strengths: (1) long term lease profile with an average term of 10.2 years; (2) large diversified portfolio with high quality tenants; and (3) very strong portfolio occupancy levels. The rating also takes into consideration the following challenges: (1) low coverage ratio for the rating category; (2) limited internal growth opportunities; and (3) portfolio concentration in Alberta and Ontario.

The stable rating outlook takes into consideration DBRS’s expectation that operating income will increase in 2011 mainly due to full year cash flow contributions from recent property acquisitions and contractual rent step-ups on existing leases. In addition, The Bow is expected to generate stable cash flows starting in 2011-2012, with rental rates increasing by 0.75% for office space and 1.5% for parking annually. DBRS expects cash flow contributions of approximately $94.3 million from EnCana during the first year of tenancy. As a result, DBRS expects coverage ratios to improve toward a more acceptable level of 2.0x when The Bow is completed and EnCana takes full occupancy in 2012. DBRS also believes H&R has adequate liquidity (construction and operating facilities and free cash flow) to fund the remaining construction costs of The Bow, upcoming near-term debt maturities and its revised distribution policy. The Trust also has good access to the capital markets highlighted by its recent senior unsecured debenture issue. Over the medium term, management may consider selling a partial interest in The Bow or obtaining long-term financing on the Project. DBRS notes that proceeds from a partial sale could be used to repay the construction facility, which would result in The Bow being free and clear of any debt.

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.