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

DBRS Limited (DBRS) has today confirmed Dream Office Real Estate Investment Trust’s (Dream Office or the Trust) Senior Unsecured Debentures rating at BBB (low) with a Stable trend. The confirmation reflects Dream Office’s near-term enhanced financial flexibility to fund redemption of the unsecured Series A and Series C debentures as well as DBRS’s expectation that its assumptions in the next paragraph will hold valid until redemption of both series of outstanding debentures is completed in June 2018 and January 2020, respectively. The confirmation follows Dream Office’s announcement to sell $1.7 billion of properties (expected to fully close by year end), launch a $440 million substantial issuer bid and reduce annual distributions by 30%. DBRS is maintaining the current rating category as the Trust’s enhanced immediate liquidity (defined as cash on hand and available and undrawn secured credit lines) and current lease profile largely offset the Trust’s deteriorated financial and business risk metrics over the remaining term of the outstanding debentures, provided that the assumptions discussed herein continue to hold. A deteriorated debt-to-EBITDA ratio worse than 8.2 times (x) and reduced immediate liquidity below that which is required to redeem the remaining outstanding debentures would result in a downgrade of Dream Office’s rating to non-investment grade status.

Assuming the successful completion of the announced transaction, DBRS expects that the Trust’s EBITDA will not fall below $180 million and that its debt-to-EBITDA ratio will not increase above 8.2x. DBRS also expects that, assuming a further anticipated sale of the remaining $500 million in assets to leave Dream Office with its targeted $2.4 billion core portfolio, the Trust’s EBITDA will not fall below $150 million and that its debt-to-EBITDA ratio will not increase above 8.2x. Furthermore, DBRS anticipates that sufficient immediate liquidity will be maintained to repay outstanding debentures at maturity and that no additional unsecured debentures will be issued.

Following the completion of the $1.7 billion sale of properties, $440 million substantial issuer bid and repayment of the outstanding balance on the credit line, DBRS expects that Dream Office will be left with approximately $850 million in liquidity (comprising $300 million in cash, investment in Dream Industrial REIT (TSX: DIR.UN), unencumbered assets and $350 million in available and unused credit lines) to redeem unsecured debentures as they come due and to execute on value-add initiatives for the Trust, including development and redevelopment activities. DBRS’s current rating is based on the assumption that maturing leases will continue to be renewed as they come due until the outstanding debentures are fully redeemed, after which the Trust may consider non-renewal of expiring leases to prepare selected properties for re-development and development. In its February 22, 2016, confirmation of the Trust’s rating at BBB (low), Stable trend, DBRS indicated that a debt-to-EBITDA ratio lower than 8.5x was required to maintain the investment-grade rating; however, the more restricted threshold of 8.2x reflects both subsequent changes in the business risk factors comprising DBRS’s rating (as discussed below) and DBRS’s pro forma net free cash flow estimates, which indicate that any further deterioration in EBITDA levels will result in increasingly negative free cash flow levels (after debt amortization payments and assuming distributions from DIR.UN are reinvested in their dividend reinvestment plan). DBRS estimates that, with such pro forma EBITDA levels as well as the distribution cut and fully executed NCIB, net free cash flow will be flat to negative, depending on maintenance capex and leasing cost expenditure assumptions.

The transaction significantly reduces the Trust’s portfolio size and diversification below that which DBRS’s primary business risk factors require in considering the current rating. The pro forma income-producing gross leasable area (GLA) decreases to 8.6 million square feet (sf) from 15.4 million sf as at Q1 2017. In addition, the Trust’s pro forma EBITDA will decrease to approximately $180 million from $336 million (annualized Q1 2017), which is lower than the current rating category threshold.

DBRS’s assessment indicates that the overall quality of the pro forma portfolio remains largely unchanged within its current business risk category while the overall diversification of the pro forma portfolio is reduced to levels below that which DBRS requires.

While the Trust expects to dispose of $1.7 billion in assets, only $740 million of this relates to non-core assets earmarked as dispositions to improve the overall portfolio quality. The remaining dispositions comprise the Trust’s lone trophy asset, Scotia Plaza, and assets originally earmarked as core to improving the portfolio quality, negating the positive impact of non-core dispositions on an overall portfolio basis.

From a geographic diversification perspective, as measured on a GLA basis, DBRS expects that the $2.9 billion portfolio results in increased exposure to downtown Toronto, a modest increase in exposure to Calgary (comprising higher downtown Calgary exposure and lower suburban Calgary exposure) and a decline in exposure to Suburban Toronto. While the transaction increases the exposure to core office markets, it does lower the portfolio’s overall geographic diversification to levels below that which is required by DBRS’s primary business risk factors in considering the current rating thresholds. From a geographic diversification perspective, as measured on an IFRS valuation basis, the $1.7 billion transaction increases the Trust’s portfolio concentration in the downtown Toronto office market to 62% from 53% of the portfolio (based on IFRS values at Q1 2017), magnifying Dream Office’s exposure to future potential downturns in Toronto downtown office market rents, occupancy and cap rates (key factors that drive the IFRS valuations).

DBRS’s assessment indicates that the lease maturity profile and tenant quality profile will remain unchanged within the current business risk category. DBRS anticipates that overall portfolio lease rollover risk will remain largely unchanged (on a GLA basis) over the next two to three years (remaining term of the outstanding debentures) while the downtown Toronto and Alberta lease rollover profiles have deteriorated slightly.

DBRS is confirming the current rating category as the Trust’s enhanced immediate liquidity and current lease profile largely offset the deteriorated financial and business risk metrics over the remaining term of the outstanding debentures, provided that the aforementioned assumptions continue to hold. A deterioration in the debt-to-EBITDA ratio worse than 8.2x and reduced immediate liquidity below that which is required to redeem the remaining outstanding debentures would result in a downgrade of Dream Office’s rating to non-investment grade status.

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.

This rating is no longer endorsed by DBRS Ratings Limited for use in the European Union.

The principal methodologies are Rating Entities in the Real Estate Industry (April 2017) and DBRS Criteria: Guarantees and Other Forms of Support (February 2017), which can be found on dbrs.com under Methodologies.

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