DBRS Confirms CREIT at BBB, Stable Trend

DBRS has today confirmed the rating of Canadian Real Estate Investment Trust’s (CREIT or the Trust) Senior Unsecured Debentures at BBB with a Stable trend. The confirmation acknowledges steady growth in operating income and solid interest coverage ratios but continues to reflect the Trust’s size and scale as a limiting factor. CREIT’s BBB rating reflects the following credit strengths: (1) a well-diversified portfolio by asset type, geography and tenant; (2) a stable retail property portfolio; (3) a conservative balance sheet and strong coverage metrics; and (4) consistently high portfolio occupancy rates. The rating also considers the following challenges: (1) a smaller portfolio size compared to other DBRS-rated real estate entities in the BBB category; (2) high levels of secured debt as a percentage of total debt; (3) exposure to secondary and suburban markets; and (4) limited opportunity to grow through acquisition of quality assets with attractive valuations due to a competitive market.

For the year ended December 31, 2012, CREIT achieved strong growth in operating income, mainly as a result of full-year earnings contribution from completed acquisitions in late 2011 (a portfolio of 19 industrial properties and two unenclosed shopping centres in Mississauga, Ontario) and new acquisitions in 2012. The new acquisitions in 2012 include a 50% interest in Altius Centre and a 50% interest in Calgary Place, both good quality Class A office buildings located in the central business district (CBD) of Calgary, Alberta. To a lesser extent, the growth is also attributable to the transfer of development properties to income-producing property status (94,695 square feet (sq. ft.) during 2012) and higher rental rates achieved on leasing activities over expiring rents.

In terms of same-portfolio net operating income (NOI), CREIT displayed growth of 1% to $201 million for the year ended December 31, 2012. The same portfolio benefited primarily from higher rental rates on leasing activity and an increase in occupancy in western Canada, while same-portfolio NOI in Ontario was slightly lower due to soft industrial fundamentals. The Trust’s overall average occupancy rate was 94.7% as of December 31, 2012, a modest increase from 94.4% the prior year.

From a financial profile standpoint, CREIT primarily used free cash flow and debt proceeds to fund its acquisitions in 2012. As a result, gross debt-to-book value assets (on a cost reset value basis) increased to 46.4% at the year ended December 31, 2012, from 43.2% at the end of 2011 (37.9% at the year ended December 31, 2012, versus 35.7% at the end of 2011 on a fair value basis) and EBITDA interest coverage (including capitalized interest) decreased to 3.05 times for the year ended December 31, 2012, from 3.12 times at year-end 2011 despite growth in operating income and a modest decline in the Trust’s weighted-average interest rate. That said, CREIT’s coverage ratios remain among the strongest of DBRS-rated real estate entities.

The Stable rating outlook reflects DBRS’s expectation that CREIT will continue to deliver steady growth in net rental income and EBITDA in 2013 based on full-year cash flow contribution from completed property acquisitions and development projects in 2012. Year to date in 2013, CREIT has approximately 4.0 million sq. ft. (owned interest) of properties in its development program, primarily with strategic and experienced development partners, reducing some development risks. Most of the developments are retail space with large grocery anchors/shadow anchors and industrial properties with good locations, all complimentary to CREIT’s current portfolio profile. DBRS estimates these developments could add approximately $50 million of additional NOI over the next five to seven years. As at December 31, 2012, CREIT has 15.7% and 15.3% of the industrial and office portfolio expiring in 2013, respectively, which could provide opportunities to achieve higher rental rates at maturities. In addition, CREIT’s portfolio diversification and reasonable retail lease maturities should provide underlying stability to cash flow and minimize the effects of this exposure.

DBRS expects CREIT to maintain a conservative financial profile and strong coverage ratios in relation to its peers. In fact, DBRS could tolerate a moderate increase in leverage within the current rating category. In DBRS’s view, the achievement of a positive rating action by CREIT would be less dependent on improvement in coverage and leverage metrics and would be based on a significant increase in the size and scale of the Trust’s portfolio while maintaining or improving its asset quality and diversification and/or lowering the proportion of secured debt.

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

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