DBRS Upgrades H&R Real Estate Investment Trust to BBB (high), Stable Trend

DBRS has today upgraded the Senior Unsecured Debentures rating of H&R Real Estate Investment Trust (H&R or the Trust) to BBB (high) from BBB, with a Stable trend.

The rating upgrade is based on the successful integration of the Primaris Retail Real Estate Investment Trust (Primaris REIT) portfolio, the stabilization of the Bow Tower in Calgary, and recent high-quality property investments, which have resulted in significant operating income and portfolio growth, lower debt levels and an increase in its coverage ratios to levels above previous DBRS expectations. The upgrade also reflects DBRS’s expectation that the Trust will continue to build its sizable unencumbered asset base while reducing secured debt levels over the next few years, thereby enhancing financial flexibility and providing additional support to unsecured bondholders.

In DBRS’s view, H&R’s key business and financial risk metrics are more in line with the BBB (high) rating. Since DBRS’s rating assignment in 2004, H&R has grown its portfolio from 26.3 million square feet (MMSF) to 54.8 MMSF, with operating income reaching approximately $828 million for the last 12 months (LTM) ended June 30, 2014, representing a 257% increase during that period. Portfolio growth has been driven by a series of high-quality acquisitions (such as Primaris REIT and one-third interest in Scotia Plaza) and a $294 million investment in ECHO Realty LP and the stabilization of the Bow Tower. More recently, H&R has reduced leverage by using proceeds from non-core asset dispositions and a higher proportion of equity than debt to fund its investments. Debt levels have declined to 48% on a debt-to-total-assets basis as at June 30, 2014, and EBITDA interest coverage increased to 2.49 times (x) for the LTM ended June 30, 2014, from 1.79x in 2012.

DBRS expects operating income to grow in the mid-single-digits range in the near term; however, DBRS expects the pace and magnitude of acquisitions to decline, given the competitive pricing in the current property market. Alternatively, the Trust will likely focus on property development (Long Island City and Airport Road projects) and potential shopping centre expansion opportunities as well as selling non-core properties while integrating its recent acquisitions. H&R’s size and scale, portfolio diversification and long-term lease profile (averaging ten years to maturity), should also provide underlying stability to cash flow going forward.

DBRS expects that debt levels will remain fairly steady which, when combined with the expected growth in operating income and interest expense savings on debt refinancing, should result in an improvement in H&R’s EBITDA coverage (including capitalized interest) toward the 2.60x to 2.80x range. Although current secured debt levels remain high (77.8% of total debt) for the current rating category, DBRS expects H&R to gradually reduce its use of secured borrowings and become a more frequent issuer of unsecured debentures. In addition, DBRS expects H&R to continue to build its sizable unencumbered asset pool (currently $1.26 billion compared with $1.27 billion of Senior Unsecured Debentures outstanding as at June 30, 2014). The Trust currently has 25 properties valued at approximately $1.6 billion, which are encumbered with mortgages totalling $380.2 million (representing an average loan-to-value ratio of 23.3%). DBRS expects H&R to repay these mortgages over the next few years with unsecured borrowings, which should enhance financial flexibility and provide additional support to bondholders.

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.

This rating is endorsed by DBRS Ratings Limited for use in the European Union.

The applicable methodology is Rating Entities in the Real Estate Industry (October 2013), which can be found on our website under Methodologies.