DBRS Downgrades Fifth Avenue Place Bonds to A (low), Changes Trend to Stable

DBRS Limited (DBRS) has today downgraded the rating on the First Mortgage Bonds (the Bonds) of Fifth Avenue LP & ARI 5AP Investments LP (the Issuers) secured by Fifth Avenue Place (FAP or the Property) to A (low) from “A” and changed its trend to Stable from Negative. The rating action follows Imperial Oil Limited’s (IOL) lease expiry at FAP and reflects DBRS’s expectation that during the Property’s re-leasing transition period the debt service coverage ratio (DSCR) will reach a temporary low of 1.08 times for the last 12 months ended (LTM) April 30, 2017, before gradually increasing to the 1.60 times range for LTM April 30, 2018. This stabilized DSCR is more consistent with the A (low) rating category.

At the time the trend was changed to Negative on June 26, 2015, DBRS stated that a decline in DSCR to below 1.65 times due to higher vacancy rates/or lower rental rates associated with the IOL lease expiry would likely result in a downgrade to the A (low) rating category in the near term. When IOL’s 717,000 square feet (sf) of leases expired on April 30, 2016, approximately 262,000 sf of space remained uncommitted (accounting for 17.2% of FAP’s total area). Assuming the uncommitted portion of the former IOL space is not re-leased, DBRS expects net operating income to decline to a low of $25.8 million for LTM April 30, 2017, from $42.2 million for the year ended 2015, resulting in a DSCR of 1.08 times for LTM April 30, 2017, and to improve thereafter following the commencement of certain committed leases in May 2017.

The Stable trend incorporates DBRS’s expectation that DSCR will gradually increase to the 1.60 times range for LTM April 30, 2018, assuming the uncommitted portion of the former IOL space remains vacant and no other leases are signed. DBRS notes the economics of the committed leases are more favourable than those under the former IOL leases. In addition, the total billing area has also increased by approximately 44,000 sf with the inclusion of additional common areas. As a result, net operating income is expected to increase to $38.7 million for LTM April 30, 2018.

The Stable trend also considers DBRS’s view that leasing prospects for the remaining uncommitted portion of the former IOL space could modestly improve over next few years. The property manager has recently seen an increase in interest from tenants seeking to take advantage of lower rental rates for high-quality office space available in downtown Calgary. Notwithstanding a material amount of new Class AA and Class A office supply expected to come on line over the next few years and significant current vacancies, DBRS believes FAP could attract new tenants, due to its location in downtown Calgary, should a resurgence in office leasing activity occur. DBRS notes upon IOL’s lease expiry on April 30, 2016, the Trustee has removed its debt service reserve of $6 million as the pro forma DSCR was above the 1.00 times threshold. In addition, the Trustee has reduced the tenant improvement and leasing commissions reserve from $30 million to approximately $11 million due to IOL space that has been released. DBRS believes this amount is more than adequate to fund expenses associated with the lease up of the uncommitted portion of the former IOL space.

DBRS believes further negative rating action could occur if the DSCR were to fall below 1.50 times on a sustained basis caused by an increase in vacancies from tenant departures and/or the unsuccessful leasing of future lease expires.

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 (October 2015), which can be found on our website under Methodologies.

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