DBRS Limited (DBRS Morningstar) confirmed H&R Real Estate Investment Trust’s (H&R or the Trust) Issuer Rating and Senior Unsecured Debentures rating at BBB (high) with Stable trends. The confirmations and Stable trends take into consideration H&R’s elevated leverage levels driven in large part by the impact of the Coronavirus Disease (COVID-19) pandemic, government response thereto, and consequent economic slowdown. DBRS Morningstar views leverage as elevated as measured by total debt-to-EBITDA of 9.7x on a last-12-months (LTM) basis at March 31, 2020, and anticipates total debt-to-EBITDA may increase further in the near term as a result of the challenging operating environment; however, DBRS Morningstar expects, by year-end (YE) 2021, total debt-to-EBITDA to fall below 9.3x as deferred rents are collected, developments come online, and debt is reduced with excess free cash and proceeds from dispositions.
The Stable trends reflect H&R’s progress toward improving access to liquidity subsequent to Q1 2020, whereby H&R (1) entered into a new $500.0 million unsecured line of credit with a term of one year, (2) closed on a new $100.0 million mortgage maturing in 2029 with proceeds used to repay lines of credit, and (3) issued $400.0 million of 4.071% Series Q Senior Unsecured Debentures due June 16, 2025, with net proceeds intended to repay outstanding indebtedness and for general trust purposes. Pro forma these transactions, DBRS Morningstar estimates H&R’s access to liquidity of $1,141.3 million. The Stable trends also reflect H&R’s implementation of decisive measures to preserve cash to mitigate liquidity risk during the coronavirus pandemic, including cutting unit distributions by 50% effective May 2020 and curtailing development capex. DBRS Morningstar anticipates the distribution cut will save H&R approximately $200.0 million per year that can be redeployed, including to complete H&R’s existing developments such as the Trust’s notable River Landing mixed-use development in Miami, Florida. DBRS Morningstar expects capital recycling activities to continue with the recently announced agreement to sell a U.S. office property in California for US$165 million, subject to customary closing conditions.
The ratings continue to be supported by the Trust’s high-quality real estate, large and diversified portfolio, and the quality of its top tenants with long-term leases, notwithstanding near-term coronavirus-related challenges, which are affecting H&R's ability to collect on rent billings, particularly from its enclosed malls within its retail segment. Indeed, 35% of base rent and property operating costs for enclosed malls (enclosed malls representing 20% share of total rent) were collected for the month of May 2020 as of June 9, 2020. At this time, DBRS Morningstar has not changed its view on the overall business risk assessment of H&R as incremental improvement in diversification and quality through H&R’s growing multifamily segment somewhat mitigates the deterioration in the enclosed mall retail and oil & gas-related office segments. Notably, DBRS Morningstar downgraded Ovintiv Inc, H&R’s largest tenant, to BBB (low), Negative on June 8, 2020.
Tenant concentration, as reflected by H&R's top 10 tenants representing 42.0% of annualized rental revenue at March 31, 2020, and exposure to generally more volatile energy markets (e.g., Calgary and Houston office) remain constraining factors on the ratings. Other notable factors include H&R’s relatively limited market position as a diversified real estate operator lacking scale in any particular market or niche, and, most significantly, its high leverage, which may limit financial flexibility at the current rating.
DBRS Morningstar would consider a negative rating action should one or more of the following factors occur on a sustained basis: (1) deterioration of total debt-to-EBITDA above DBRS Morningstar’s expectations of 9.8x in 2020 and 9.2x by YE2021, all else equal; (2) further deterioration in the retail operating environment or credit quality of H&R’s key tenants, such that DBRS Morningstar revises downward its business risk assessment of H&R. Should DBRS Morningstar revise downward its business risk assessment of H&R, the current rating would tolerate commensurately less leverage. Given the above-noted constraints such as elevated leverage, a positive rating action is unlikely for the foreseeable future.
A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework and its methodologies can be found at: https://www.dbrsmorningstar.com/research/357792.
All figures are in Canadian dollars unless otherwise noted.
The principal methodologies are Rating Entities in the Real Estate Industry (June 4, 2020), and DBRS Morningstar Criteria: Rating Corporate Holding Companies and Parent/Subsidiary Rating Relationships (November 25, 2019), which can be found on dbrsmorningstar.com under Methodologies & Criteria.
For more information regarding rating methodologies and Coronavirus Disease (COVID-19), please see the following DBRS Morningstar press release: https://www.dbrsmorningstar.com/research/357883.
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 firstname.lastname@example.org.
The rated entity or its related entities did participate in the rating process for this rating action. DBRS Morningstar had access to the accounts and other relevant internal documents of the rated entity or its related entities in connection with this rating action.
Generally, the conditions that lead to the assignment of a Negative or Positive trend are resolved within a 12-month period. DBRS Morningstar’s outlooks and ratings are under regular surveillance.
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