DBRS Confirms Brookfield Office Properties at BBB and Pfd-3, Trends Stable

DBRS Limited (DBRS) has confirmed the rating of Brookfield Office Properties Inc.’s (Brookfield or the Company) Senior Unsecured Notes at BBB and its Cumulative Redeemable Preferred Shares, Class AAA at Pfd-3, both with Stable trends. The confirmation acknowledges DBRS’s previous expectation that Brookfield’s coverage ratios would remain at aggressive levels for the current rating category during the re-leasing transition period (2015–2016) at BPNY. The confirmation reflects DBRS’s expectation for a gradual improvement in coverage ratios in 2016, driven by income contributions from leases at BPNY, and that Brookfield will use asset disposition proceeds to reduce debt. If Brookfield fails to achieve this improvement in its financial metrics through debt reduction and/or earnings growth within a year, a negative rating action could occur. The current ratings are based on Brookfield’s large, premier office portfolio, its presence in relatively stronger office markets and long-term leases to high quality tenants; however, the ratings also consider the Company’s low coverage ratios, concentration in New York and Toronto markets and high proportion of secured debt.

The stable rating outlook incorporates DBRS’s expectation of moderate earnings growth in 2016 because of signed leases at BPNY and rent increases on lease rollovers, particularly in Brookfield’s downtown and midtown New York markets. DBRS expects BPNY leases signed over the past couple of years to contribute approximately $60 million in incremental rental income in 2016. In addition, Brookfield’s earnings should benefit from rental income growth, as market rental rates are higher than average in-place rental rates by approximately 62% for midtown New York, 45% for downtown New York and 22% for the overall portfolio. DBRS believes these positive factors will be partially offset by modestly lower earnings for Brookfield’s Canadian properties, particularly in Calgary, resulting in an estimated 5.0% to 6.0% EBITDA growth for the year.

The rating outlook also reflects the expectation that Brookfield’s cash flow from operations will continue to remain insufficient to fund maintenance capital expenditures, leasing costs and common and preferred dividends. As such, Brookfield is expected to generate negative free cash flow in the near to medium term. DBRS expects the Company to fund its free cash flow deficit, development expenditures and debt reduction with proceeds from property dispositions. DBRS believes lower debt levels and earnings growth should help Brookfield’s EBITDA interest coverage (including capitalized interest) gradually improve to 1.70 times (x) within the next year. Over the longer term, DBRS expects
EBITDA interest coverage (including capitalized interest) to increase to 2.00x, a level which is acceptable for the current rating category.

RATING DRIVERS
If Brookfield achieves weaker operating income and/or increased leverage such that the Company fails to meet DBRS’s expectations of EBITDA interest coverage (including capitalized interest) increasing to 1.70x within a year, a negative rating action could occur. Although highly unlikely, a positive rating action would require Brookfield to demonstrate meaningful improvement in operating income and significant deleveraging of its balance sheet.

Notes:
All figures are in U.S. 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 (May 2015) and Preferred Share and Hybrid Criteria for Corporate Issuers (January 2016), which can be found on our website under Methodologies.

The full report providing additional analytical detail is available by clicking on the link under Related Research at the right of the screen or by contacting us at info@dbrs.com.

For more information on this credit or on this industry, visit www.dbrs.com or contact us at info@dbrs.com.