DBRS Confirms Fifth Avenue Place Bonds at “A,” Changes Trend to Negative

DBRS Limited (DBRS) has today confirmed the rating on the First Mortgage Bonds (the Bonds) of Fifth Avenue LP & 1023803 Alberta Ltd. secured by Fifth Avenue Place (FAP or the Complex) at “A,” and changed its trend to Negative from Stable. In DBRS’s previous report dated August 7, 2014, DBRS acknowledged the re-leasing risk associated with the Imperial Oil space but expected that the property manager would be able to re-lease a majority of the remaining space before 2016 at a minimum of Imperial Oil’s expiring in-place rental rate. DBRS also indicated that meeting this expectation would preserve the Bond’s “A” rating. However, since then, a contraction in oil prices has caused the office leasing environment in downtown Calgary to become more challenging and has resulted in weakening tenant demand and downward pressure on office market rental rates.

The Negative trend reflects DBRS’s concern that it will now take longer for the property manager to re-lease the pending vacant space to new tenants in this more challenging office environment and the economics of any new tenant leases will likely be less favourable to the Complex than those under Imperial Oil’s current leases. However, DBRS notes that Imperial Oil’s blended rental rate on the remaining vacant space is approximately 10%-15% below market which can help mitigate the potential downside risk associated with future re-leasing.

Nevertheless, a material improvement in debt service coverage ratio over the near to medium term will, in DBRS’s opinion, be difficult to achieve. As of March 31, 2015, the property manager has yet to secure new tenants for approximately 36.7% of the remaining vacant space (approximately 263,000 square feet, or 18.1% of total area for FAP). DBRS notes that downtown Calgary Class A office vacancy rates have risen to 10.0% as at Q1 2015 and net asking rents have decreased by approximately 17.6% from a year earlier. DBRS believes that FAP will likely continue to face leasing challenges due to the low oil price environment, increased levels of vacant space in the downtown Calgary office market and new supply from five new office buildings being completed over the next couple of years. As such, a deterioration in the debt service coverage ratio to below 1.65 times (x) due to higher vacancy rates and/or lower rental rates associated with Imperial Oil lease expiry would likely result in a downgrade to the A (low) rating category in the near term.

DBRS estimates that in the event that the property manager is unable to re-lease any of the remaining Imperial Oil space, the annual debt service coverage ratio would decrease to approximately 1.35x. While this level is acceptable for the A (low) rating category on a temporary basis, a prolonged debt service coverage ratio below 1.50x could cause DBRS to reconsider the A (low) rating. DBRS notes upon Imperial Oil’s lease expiry, the Trust Indenture requires a debt service reserve of up to $6 million and a Tenant Improvement and Leasing Commissions Reserve of up to $30 million to be funded by the Issuers on or prior to April 30, 2016. These reserves are required to cover any shortfalls in the debt service obligation of the Bonds, as well as to cover expenses associated with tenant improvements and leasing commissions for new tenants. Although unlikely, DBRS notes that a trend change from Negative to Stable could occur if the property manager were to re-lease a significant amount of the impending vacant space in the Complex such that debt service coverage returns to the 1.65x to 1.75x range.

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 methodology is Rating Entities in the Real Estate Industry, which can be found on our website under Methodologies.

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

DBRS will publish a full report shortly that will provide addi¬tional analytical detail on this rating action. If you are interested in receiving this report, contact us at info@dbrs.com.