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 confirmation takes into consideration the expected recovery of EBITDA interest coverage to a level more comfortably within the parameters of the current rating category. The Trust achieved a reasonable rate of growth in its portfolio despite a competitive acquisition market, and also benefited from lower interest rates while keeping financial leverage fairly stable.

Calloway’s credit rating continues to reflect several key strengths. The Trust has: (1) the second-largest retail portfolio in Canada, comprising approximately 26.2 million square feet (sq. ft.) of new-format unenclosed retail properties; (2) a relatively long duration lease profile, with an average lease term to maturity of 7.8 years (10.2 years for Wal-Mart); (3) historical occupancy rates above 98%; and (4) relatively modest maintenance capital expenditure requirements, as most of the portfolio (72.5%) has been developed within the last 10 years.

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, relying heavily on Wal-Mart to attract customers and other tenants; (2) considerable geographic concentration in Ontario; and (3) the presence of a large anchor tenant weighs on revenue growth potential.

Calloway has achieved moderate growth in operating income, mainly as a result of cash flow contributions from completed development projects, earn-outs from SmartCentres and property acquisitions in 2011 and 2012. Same-property net operating income growth was modest for the year (+1%), benefiting from positive re-leasing activity and contractual rent step-ups on existing leases. Occupancy levels for Calloway’s portfolio remain very strong at 99.0%. From a financial standpoint, Calloway funded investments during the LTM ending September 30, 2012, with an even mix of debt and equity, resulting in debt-to-gross book value ratio (including convertible debentures) of 52.4%, virtually unchanged from the prior year. The Trust benefited from a declining interest rate environment, as its weighted-average interest rate decreased significantly from 5.86% in Q3 2011 to 5.46% in Q3 2012. As a result, Calloway’s EBITDA interest coverage recovered to 2.28 times (including capitalized interest), a level more comfortably within the parameters of the current rating category for the Trust.

DBRS’s stable outlook on Calloway takes into consideration the expectation for continued improvement in EBITDA interest coverage (including capitalized interest) within the current rating category. Calloway is expected to experience further growth in cash flow mainly from completed development projects, the opening of the Premium Outlet in Toronto and earn-outs in 2013. Developments and earn-outs in 2013-2014 are expected to add approximately 502,152 sq. ft. of leasable space to the portfolio and approximately $12.4 million in income. EBITDA interest coverage should also continue to benefit from a declining average cost of debt capital over the near term. In December 2012, the Trust announced the redemption of its 6.65% convertible debentures, a coupon rate that is significantly higher than recent capital raises.

In terms of new projects, Calloway also announced a 50% joint venture with SmartCentres to develop 6.0 million sq. ft. of commercial, residential and retail properties within the Vaughan Metropolitan Centre (VMC). This project is expected to be developed and financed over the course of the next 10 to 15 years, with progress dependent on the success of preleasing over the construction timeframe. DBRS believes Calloway will fund the development in a balanced manner, keeping Calloway’s key credit metrics within the current rating category for the near to medium term.

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

The related regulatory disclosures pursuant to the National Instrument 25-101 Designated Rating Organizations are hereby incorporated by reference and can be found by clicking on the link to the right under Related Research or by contacting us at info@dbrs.com.

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