DBRS Confirms Dream Office at BBB (low), Stable Trend

DBRS has today confirmed the rating of Dream Office Real Estate Investment Trust’s (Dream Office or the Trust, formerly Dundee Real Estate Investment Trust) Senior Unsecured Debentures at BBB (low) with a Stable trend. The confirmation acknowledges Dream Office’s solid financial metrics, but considers the expectation of lower occupancy levels and an increase in property reinvestment as the Trust’s office markets become more competitive over the next few years.

The rating continues to be supported by Dream Office’s mid-size portfolio of office properties that are well-located in central business districts (CBD) and suburban markets, diverse creditworthy tenant base and conservative financial profile. The rating is constrained by Trust’s limited diversification by asset type, large proportion of suburban office properties, geographic concentration and high proportion of secured debt.

Dream Office displayed reasonable earnings growth in H1 2014 that was in line with DBRS expectations. The growth was primarily the result of earnings contributions from property acquisitions in 2013. Same portfolio NOI, however, grew at a more modest rate of 0.6% in H1 2014, mainly due to higher rental rates on leasing activity partially offset by higher vacancies in Eastern Canada and at the Trust’s suburban Toronto and Calgary properties. Dream Office maintained its conservative financial profile, with EBITDA interest modestly increasing to 2.83 times (x) in H1 2014 versus 2.78x a year earlier.

The stable rating outlook reflects DBRS’s expectation of modest earnings growth in 2014, driven primarily by property acquisitions made in the latter part of 2013. DBRS also expects nominal near-term same property net operating income (NOI) growth in the 0% to 1% range as tenant move-outs in Q3 2014, including WorleyParsons and National Energy Board, will partially offset higher rental rates on leasing activity in the near term. Going forward, DBRS believes the office leasing environment could become increasingly more challenging over the next few years as new office developments come on line in the Trust’s core Calgary and Toronto markets. In addition, Dream Office has pending tenant move-outs representing approximately 800,000 square feet (sq. ft.) from 2015 to 2018. As a result of the above factors, DBRS believes there is potential for lower occupancy and negative leasing spreads. With that said, Dream Office’s average in-place rental rates are below market rental rates by approximately 8% as at June 30, 2014, which provides moderate protection to unfavourable changes in market rental rates.

DBRS does not expect Dream Office to make any meaningful property acquisitions as a result of a competitive property market and its current cost of capital, which makes property acquisitions less accretive. Alternatively, Dream Office is expected to continue to sell non-core assets ($75 million to $100 million planned in 2014) and reinvest these proceeds into higher-quality assets. The Trust also plans to develop under-utilized land, such as current surface parking, into office, retail residential or mixed-use properties. As a result, DBRS expects Dream Office to maintain conservative financial metrics and solid coverage ratios in 2015.

In DBRS’s view, the achievement of a positive rating action by Dream Office would be less dependent on improvement in coverage and leverage metrics and would most likely result from a significant improvement in asset quality and diversification, and/or lowering the proportion of secured debt. On the other hand, weaker-than-expected operating and earnings performance and/or higher financial leverage that leads to EBITDA interest coverage falling below 2.20x on a sustained basis could result in a negative rating action.

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.

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