DBRS Confirms First Mortgage Bonds of Fifth Avenue LP & 1023803 Alberta Ltd. at “A,” Stable Trend

DBRS has today confirmed the rating on the First Mortgage Bonds (the Bonds) of Fifth Avenue LP & 1023803 Alberta Ltd. (collectively the Issuers), a 50-50 joint venture between a wholly owned subsidiary of Brookfield Canada Office Properties (Brookfield) and 1023803 Alberta Ltd. (managed by Alberta Investment Management Corp. (AIMCo) on behalf of certain Government of Alberta funds and endowments and certain Alberta public sector pension plans (AIMCo’s clients)) secured by Fifth Avenue Place (FAP or the Complex) at “A” with a Stable trend.

The rating confirmation follows the announcement that Imperial Oil Limited (the Company) (rated AA (high) with a Stable trend by DBRS), FAP’s largest tenant, accounting for 717,024 sq. ft. or 48.6% of the total leasable area, has given notice that it will be leaving the Complex by the end of the Company’s lease in April 2016.

DBRS notes that in its initial rating assignment of “A” to FAP on July 5, 2011, the rating took into consideration the expiry of the Imperial Oil space and the possibility of the Company leaving the Complex prior to its lease expiration in April 2016 (with no further extension options and a requirement to remove its leasehold improvements).

The rating confirmation is based on: (1) the attractive location and good quality of the property; (2) the substantial lead time to find new tenants (approximately 3.7 years remaining on Imperial Oil’s lease), and (3) the fact that Imperial Oil’s blended rental rate is approximately $10 to $15 below market rates, which provides protection against deteriorating market conditions. These factors, combined with favourable conditions in the Calgary office market characterized by low vacancies and limited new supply, are the basis of DBRS’s view that the property manager will be effective in its releasing efforts to maintain the credit risk profile of the Complex.

From a net cash flow and coverage ratio perspective, DBRS originally assumed two different scenarios in order to test the ability to service the bond during a period where there may be a short-term shortfall in cash flow. In the first scenario, DBRS considered that the property manager did not lease up any space for more than the cost of operating the premises (including realty taxes, operating costs and utilities), which any prudent sponsor is unlikely to do. In this first scenario, there would be sufficient cash flow to cover debt service.

In our second and more likely scenario, we considered that the property manager is able to lease up the space in advance of Imperial Oil vacating the property. In this scenario, there is high likelihood that the sponsor would be able to sign leases at a minimum of Imperial Oil’s current in-place rent which is well below market rent. This will result in a shortfall from property cash flow in 2016, as re-leasing costs are expected to be approximately $30 million. However, the Issuers will have adequate funding in the form of letter of credits and/or a backstop guarantee, totaling $36 million, to cover the anticipated leasing cost and shortfalls on debt service obligations of the Bonds.

DBRS will continue to monitor the releasing efforts and Calgary’s market conditions. If the office market conditions begin to soften and leasing initiatives become challenging over the next few years, DBRS will reconsider the rating and its outlook.

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

The applicable methodologies are Rating Real Estate Entities and CMBS Rating Methodology, which can be found on our website under Methodologies.