DBRS Confirms Calloway REIT at BBB, Trend Stable

DBRS Limited (DBRS) has today confirmed the Senior Unsecured Debentures of Calloway Real Estate Investment Trust (Calloway or the Trust) at BBB with a Stable trend. The confirmation follows Calloway’s announced plans to acquire substantially all SmartCentres assets from companies associated with Mitchell Goldhar and several other vendors for a purchase price of approximately $1.16 billion (the Transaction).

In DBRS’s view, the Transaction’s near-term impact on Calloway’s credit risk profile is neutral. This view is based on a moderate increase in portfolio size and scale, enhanced asset quality as well as an improved growth profile and enhanced internal management capabilities through the acquired SmartCentres planning, development, construction management and leasing management platform (SC Platform). These credit positives are offset by an increase in total debt, including a higher proportion of secured debt and floating-rate debt as well as an increase in on-balance sheet development activity.

SmartCentres, a company wholly owned by Mr. Goldhar, is a leading developer and leasing manager of open format retail centres across Canada. The company has developed over 200 shopping centres, of which approximately 125 have been developed though its strategic joint venture relationship with Wal-Mart Canada (Wal-Mart). Prior to the Transaction, Calloway had acquired interests in more than 100 properties for more than $3.0 billion from SmartCentres and the Wal-Mart joint venture.

The Transaction includes interests in a portfolio of 24 properties located primarily in Ontario and Québec, including 22 shopping centres and two development properties. Twenty of the shopping centres are anchored or shadow-anchored by open-format Wal-Mart Supercentre-anchored shopping centres. The portfolio is 99.7% leased and comprises 3.6 million square feet (sf) of completed gross leasable area (GLA) and has development potential of 1.9 million sf of GLA (1.6 million sf through on-balance sheet development and 0.3 million sf through earn-outs). The total cost of the real estate portfolio is approximately $1.1 billion. The purchase price implies a capitalization rate of approximately 5.9% for the income-producing portion of the acquired real estate.

The Transaction also includes the acquisition of the SmartCentres development and leasing management platform, which comprises SmartCentres senior management and a professional team of development experts in the areas of acquisitions, planning, leasing, legal, engineering, architecture and finance. DBRS notes that following the closing of the Transaction, Calloway intends to rebrand its name to SmartREIT, reflecting its new capabilities and the considerable brand recognition of SmartCentres and its trademark Penguins icon.

DBRS expects Calloway to fund the Transaction with $644 million of assumed debt at a weighted-average interest rate of 2.6%, the issuance of $160 million in Class B LP units, $200 million in public equity priced at $28.70/unit and the balance with cash on hand and by drawing on existing credit facilities. DBRS notes that following the closing of the Transaction, Mr. Goldhar will indirectly hold a 23% economic interest in Calloway compared with his current economic interest of 21%.

DBRS notes that over the medium to long term, the Transaction provides Calloway with a source for future growth opportunities, including the development of properties for Wal-Mart in existing and potentially new markets. Should Calloway materially increase the size and scale of its portfolio and enhance diversification while maintaining financial metrics commensurate at least with the current rating category or conversely deleveraging and/or increasing EBITDA, which results in an improvement in EBITDA interest coverage (including capitalized interest) to above 3.00 times on a sustained basis, there could be a positive rating action.

Business Risk Profile
The Transaction is expected to increase Calloway’s GLA by 13.1%, or 3.6 million sf initially, with 1.9 million sf in developments and earn-outs expected to be completed by 2020. The acquired properties are almost fully leased at 99.7% and will extend Calloway’s average remaining lease term to maturity to 7.5 years from 6.8 years as at YE2014. DBRS estimates pro forma EBITDA to increase within the parameters of the current rating category by 13.6% to approximately $450 million from $396 million in 2014.

The Transaction also increases the Trust’s exposure to secondary markets, with its geographic concentration in Ontario (representing 58.1% of GLA post Transaction) and tenant concentration with Wal-Mart (representing 26.9% of gross rental revenues pro forma), which will continue to be limiting rating factors.

DBRS notes that the SC Platform should further enhance Calloway’s prospects for development as a source of growth. While DBRS believes the risks associated with a development-driven growth strategy are material (i.e., changes in supply-demand dynamics and funding availability), DBRS takes comfort in SC Platform’s proven track record in development and leasing and its relationship with Wal-Mart as a development partner, which mitigate these risks.

Financial Risk Profile
The Transaction is expected to have a modestly negative impact on Calloway’s financial profile. This view is based on a moderate increase in Calloway’s total debt, including an increase in the proportion of floating-rate debt and secured debt. DBRS forecasts debt-to-capital to increase to 47.1% from 43.4% as at December 31, 2014.

In addition, pro forma adjusted debt/EBITDA is expected to increase 8.4 times from 7.6 times in 2014, while EBITDA coverage (including capitalized interest) is expected to remain steady at 2.70 times (including capitalized interest expense). Despite a slight deterioration, Calloway’s key financial metrics will remain in the parameters of the current rating category with the exception of adjusted debt-to-EBITDA.

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 methodologies are Rating Entities in the Real Estate Industry, DBRS Criteria: Guarantees and Other Forms of Explicit Support and Preferred Share and Hybrid Criteria for Corporate Issuers, which can be found on our website under Methodologies.

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