DBRS Confirms Choice Properties at BBB, Restores Stable Trend with Announced Acquisition of CREIT

DBRS Limited (DBRS) confirmed the Issuer Rating and Senior Unsecured Debenture rating of Choice Properties Limited Partnership (CPLP) and the Senior Unsecured Debenture (guaranteed by CPLP) rating of Choice Properties Real Estate Investment Trust (the Trust; together with CPLP, CP REIT or Choice Properties) at BBB. All trends have been changed to Stable from Positive. These confirmations and change to the Stable trend reflect DBRS’s recent rating action on Loblaw Companies Limited (Loblaw; rated BBB with a Stable trend by DBRS; see the DBRS press release dated February 15, 2018) following the announcement by the Trust it plans to acquire all of the assets and assume all the liabilities of Canadian Real Estate Investment Trust (CREIT) for cash and shares of CP REIT (the Transaction).

The CPLP Issuer Rating takes into consideration DBRS’s view that the credit risk profiles and ratings of CPLP are aligned with that of Loblaw, as Loblaw effectively controls CP REIT through its majority ownership and is the dominant tenant (see the implicit support discussion below). The Senior Unsecured Debenture (guaranteed by CPLP) of the Trust is based on the guarantee provided by CPLP.

Following the $6.0 billion Transaction, on a pro forma basis Loblaw will hold a 62% direct effective interest in the Trust and Loblaw’s controlling shareholder, George Weston Limited (GWL, rated BBB with a Stable trend by DBRS), will own a 4% direct effective interest in the Trust. Prior to the Transaction, Loblaw held an 82% and GWL a 6% direct effective interest in the Trust. Notwithstanding the reduction in the effective ownership interest, the effective control of CP REIT by Loblaw remains unchanged.

Pro forma the Transaction, CP REIT will generate approximately $890 million in net operating income (NOI) from 69 million sq. ft. of gross leasable area (GLA), compared to $585 million of NOI and 44 million in sq. ft. of GLA prior to the Transaction. Pro forma the Transaction, CP REIT’s real estate portfolio of 752 properties will be somewhat more diversified by asset class (with the addition of CREIT’s office and industrial assets), improving tenant mix (although Loblaw will still represent 58% of rent, compared to 88% prior to the Transaction) and will be better geographically diversified. The Transaction is anticipated to close April–May 2018.

While Loblaw does not provide explicit support to CPLP, DBRS assesses the level of implicit support, and therefore the degree of ratings linkage, by Loblaw to CPLP as strong after giving effect to the Transaction based on the following considerations, which take into account essentiality, contractual obligations, reputation and integration: (1) CPLP is essential to the operation of Loblaw. CPLP is Loblaw’s dominant landlord, representing a substantial number of Loblaw’s corporate- and franchise-owned stores, rent and GLA, both currently and for the foreseeable future, with the weighted-average term to maturity of Loblaw-banner leases at ten years. (2) There are substantial contractual arrangements between CPLP and Loblaw, including the Strategic Alliance Agreement whereby (a) CPLP will have the right of first offer to purchase any property in Canada that Loblaw seeks to sell; (b) Loblaw will be generally required to present shopping centre property acquisitions in Canada to CPLP to allow for a right of first opportunity to acquire the property itself; (c) CPLP has the right to participate in future shopping centre developments involving Loblaw; and (d) CPLP will compensate Loblaw over time with intensification payments, as CPLP pursues development, intensification or redevelopment of excess land acquired from Loblaw. There are also long-term lease agreements, services and property management agreements between Loblaw and CPLP. (3) The reputational risk implications of CPLP to Loblaw are high, given its strong interconnections with CPLP. (4) Integration between Loblaw and CPLP is strong through strategies, operations and oversight. Given its ownership interest in the Trust, Loblaw has the right to nominate the trustees who serve on the Trust’s board.

Choice Properties’ credit risk profile could be assessed on a stand-alone basis if Loblaw’s ownership and/or control in the Trust were to diminish materially over time. The ratings of CPLP and the Trust could also move independently of Loblaw, without a meaningful reduction of ownership by Loblaw, should CPLP continue to materially grow and diversify its tenant base away from Loblaw over the longer term. Should this occur, Choice Properties’ stand-alone risk profile would be based on the DBRS methodology “Rating Entities in the Real Estate Industry,” which incorporates business and financial risk assessment factors.

Notes:
All figures are in Canadian dollars unless otherwise noted.

The principal methodologies are Rating Entities in the Real Estate Industry (April 2017) and DBRS Criteria: Guarantees and Other Forms of Support (February 2018), which can be found on dbrs.com under Methodologies.

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 under Related Documents or by contacting us at info@dbrs.com.

The rated entity or its related entities did participate in the rating process for this rating action. DBRS had access to the accounts and other relevant internal documents of the rated entity or its related entities in connection with this rating action.

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