DBRS Confirms Calloway REIT at BBB, Stable Trend

DBRS has today confirmed the Senior Unsecured Debentures rating of Calloway Real Estate Investment Trust (Calloway or the Trust) at BBB, with a Stable trend. The rating confirmation takes into consideration moderate portfolio growth, stable operating metrics and an expectation for coverage ratio improvement.

Calloway has achieved moderate growth in operating income mainly due to cash flow contributions from completed development projects, earn-outs from SmartCentres and property acquisitions in 2010 and 2009. Same-property net operating income growth was more modest for the year (+1.7%) and benefited from positive re-leasing activity, contractual rent step-ups on existing leases and the lease-up of vacant space. Occupancy levels for Calloway’s portfolio improved slightly during the year and remain very strong at 99.1%. From a financial standpoint, Calloway used equity proceeds to fund modest debt reduction and investments in 2010, which resulted in the Trust’s debt-to-gross book value ratio declining to 54.9% from 57.9% a year earlier. That said, Calloway’s EBITDA interest coverage of 1.93 times (including capitalized interest) remains aggressive for the current rating category. This metric is affected by the fact that Calloway incurs interest costs prior to cash flow contributions from completed projects coming online, and higher cost on debt issued during the past 18 months.

Calloway’s BBB rating incorporates the following credit strengths: (1) Calloway has the second largest retail portfolio in Canada, comprised of 24.2 million square feet (sq. ft.) of new-format unenclosed retail properties, many of which are anchored by Wal-Mart Canada (Wal-Mart, accounting for 25.7% of gross rental revenue); (2) Calloway has a long lease profile, with an average lease term to maturity of 8.6 years (Wal-Mart at 11.8 years); (3) Consistently high occupancy rates (close to or greater than 99%); and (4) relatively new properties with 71.3% of the portfolio developed since 2002, which minimizes capital requirements over the medium term.

The rating also takes into consideration the following challenges: (1) a significant number of the Trust’s retail properties are located in smaller, secondary Canadian markets that rely heavily on Wal-Mart to attract customers and other tenants; (2) low interest coverage ratio; and (3) a high proportion of anchor tenants.

The stable outlook takes into consideration DBRS’s expectation for a recovery in EBITDA interest coverage (including capitalized interest) that is more in line with the BBB rating category. Calloway is expected to experience further growth in cash flow from acquisitions and completed development projects and earn-outs in 2010 and 2011. These developments and earn-outs in 2011 are expected to add approximately 459,524 sq. ft. of leasable space to the portfolio and approximately $9.3 million in cash flow. In addition, EBITDA interest coverage will likely benefit from a lower cost of capital over the near term, which could make potential acquisitions and completed developments and earn-outs more accretive compared with previous years. Modest near-term lease maturities (2.5% of gross leasable area (GLA) in 2011 and 4.2% of GLA in 2012) should also provide underlying stability to cash flow. Calloway has adequate liquidity, from a variety of capital sources, to fund capital commitments that will total $258.3 million by the end of 2011.

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.