DBRS Confirms Brookfield Canada Office Properties at BBB, Stable Trend

DBRS has confirmed the Issuer Rating of Brookfield Canada Office Properties Real Estate Investment Trust (BCOP or the Trust) at BBB, with a Stable trend. BCOP’s BBB rating incorporates the following credit strengths: (1) BCOP has a premier Class-A to AAA office portfolio located in the downtown markets of Toronto, Calgary, Ottawa and Vancouver, featuring a number of flagship office properties, such as Bay Adelaide Centre West Tower (BAC), First Canadian Place, Bay Wellington Tower, Exchange Tower and Bankers Hall; (2) the portfolio has strong occupancy levels, which are above market comparables in each of its markets, with exception to Toronto; (3) BCOP’s reasonable debt levels and coverage ratios; and (4) BCOP has strong ownership and an experienced external management team. Conversely, the rating incorporates the risks associated with: (1) BCOP’s portfolio’s heavy concentration in the downtown markets of Toronto and Calgary; (2) significant property concentration with the Trust’s top five properties, accounting for about 55.7% of total square feet in the portfolio; (3) above-average tenant concentration (this concern, however, is somewhat mitigated by the high creditworthiness of the Trust’s top 15 tenants).

BCOP has achieved good growth in operating income, mainly due to incremental income from the acquisition of a 25% interest in the Canadian Office Fund (see DBRS press release, dated December 5, 2011) and the continued lease-up of the Trust’s BAC in Toronto. BCOP also achieved same-property net operating income growth of 7.8% in 2011 over the comparable period in 2010, mainly due to leasing activity at BAC and higher average rental rates on lease renewals during the year.

DBRS notes that office leasing conditions in BCOP’s core markets, particularly Calgary and Toronto, are healthy and have experienced lower vacancy rates and increasing market rents over the last 18 months. With the exception of the Toronto market, BCOP’s portfolio continues to achieve occupancy levels above market levels, highlighting the overall quality of the Trust’s portfolio and tenant base. Although portfolio occupancy levels declined during the year, mainly due to higher vacancy rates in the acquired Canadian office fund properties, portfolio occupancy levels remain strong at 96.2% as at Q4 2011.

From a financial standpoint, BCOP used debt proceeds to fund the acquisition of the 25% interest in the Canadian office fund and its negative free cash flow position. As a result, BCOP’s debt-to-capital ratio increased to 43.1% for the year ended December 31, 2011, from 40.4% for the comparable period 2010. BCOP’s EBITDA interest coverage, however, improved to 2.22 times, benefiting from higher cash flow levels.

The stable outlook takes into consideration DBRS’s expectation for good cash flow growth in 2012, mainly due to incremental cash flow from the 25% interest in the Canadian Office Fund and the continued lease-up of BAC. In addition, a minimal amount of lease maturities in 2012 will provide good support to cash flow stability and limit the Trust’s exposure to re-leasing risks and any softening in market rents. In the near term, DBRS expects BCOP to over-distribute; however, we expect the payout ratio to gradually decline to the 90% to 95% range as leasing activity begins to stabilize. With no current development and/or redevelopment projects and a limited amount of high quality office properties being brought to market, BCOP’s capital spending is expected to remain below the levels of the past couple of years. DBRS expects BCOP will continue to fund its negative free cash flow position and capital spending with debt from property refinancing activity. Going forward, DBRS expects BCOP to operate with an EBITDA interest coverage in the 2.00 times to 2.20 times, which is reflected in the current rating. Overall, DBRS expects BCOP’s financial profile to remain stable in 2012, with support higher cash flow levels, reasonable liquidity and good access to the capital markets to fund manageable capital commitments (mainly maturing mortgages).

Notes:

The applicable methodology is Rating Real Estate Entities, which can be found on our website under Methodologies.