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

DBRS Limited (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 reflects Dream Office’s solid financial metrics but considers the expectation for weakening office fundamentals over the next few years. New office supply in Dream Office’s core markets and the effect of a low oil price environment on office tenant demand in the Trust’s Alberta markets (Alberta accounts for 27% of net operating income (NOI)) are expected to put pressure on occupancy levels and rental rates. In the near term, DBRS believes Dream Office’s current below-market in-place rental rates should provide moderate protection to unfavourable changes in market rental rates. DBRS notes, however, that a prolonged downturn in the energy sector and excess new supply could result in a negative rating action. This action would be based on weaker-than-expected operating and earnings performance and/or higher financial leverage that leads to EBITDA interest coverage falling below 2.20 times on a sustained basis.

The Stable rating trend reflects nominal near-term same-property NOI growth in the 0% to 1% range, as tenant move-outs 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 1.2 million square feet from 2017 to 2020. 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 7.8% as at December 31, 2014 (YE2014) (10% in downtown Toronto and 15% in downtown Calgary), which provides moderate protection to unfavourable changes in market rental rates in the near term. DBRS notes the Trust’s recent announcement to reorganize its external management agreement. The Trust has acquired a subsidiary of Dream Asset Management Corporation (Dream), a party to the asset management agreement with the Trust, resulting in the elimination of its asset management fees with Dream. In consideration for the sale, Dream will receive exchangeable limited partnership units, which are exchangeable for 4.85 million Trust units (4.3% of outstanding Trust units post acquisition). Dream and the Trust have entered into a new agreement in which Dream will continue to provide strategic oversight of the Trust and the services of its Chief Executive Officer on a cost recovery basis. DBRS estimates that this reorganization will be cash flow positive. 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 ($300 million planned in 2015) and reinvest these proceeds into existing assets, such as intensification projects. As a result, DBRS expects Dream Office to maintain conservative financial metrics and solid coverage ratios commensurate with the existing rating category.

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.