DBRS Limited (DBRS Morningstar) changed the trends on H&R Real Estate Investment Trust’s (H&R or the Trust) Issuer Rating and Senior Unsecured Debentures rating to Negative from Stable. DBRS Morningstar also confirmed the ratings at BBB (high). The Negative trends reflect H&R's weaker-than-expected financial risk metrics, particularly total debt-to-EBITDA of 10.1 times (x) at March 31, 2021, on a last 12 months basis; DBRS Morningstar's lowered expectation for material improvement in the Trust's total debt-to-EBITDA in the near-to-medium term; as well as H&R's modestly weaker business risk assessment. DBRS Morningstar has revised downward its assessment of H&R's portfolio size due to the Trust's materially reduced EBITDA ($715 million in the last 12 months), and prolonged road to recovery, which results in modestly lower tolerance for leverage for a given rating level.
DBRS Morningstar's worsened expectation is that the Trust will generally operate with total debt-to-EBITDA in the 9.5x to 10.0x range through YE2022 as H&R's multifamily and retail segments take longer than previously expected to recover from ongoing setbacks related to the Coronavirus Disease (COVID-19) pandemic (e.g., lower profit margins resulting from lower occupancy, percent rents, collections, etc.). While still elevated for the rating, this leverage level would represent modest improvement relative to the last 12 months, with such improvement supported by the economic rebound from the pandemic; recently completed and imminent development completions contributing meaningful cash flows; and the Trust continuing to manage debt lower. These expectations and the aforementioned results contrast with DBRS Morningstar's ratings confirmation press release on June 19, 2020, wherein DBRS Morningstar cited its expectations for total debt-to-EBITDA of 9.8x in 2020 and 9.2x by YE2021, all else equal, based on anticipation of recovery in H&R's operating environment in 2021. DBRS Morningstar acknowledges the decisive measures the Trust has taken to mitigate credit risk, including cutting unit distributions in half in May 2020; however, H&R's credit risk profile has deteriorated on a sustained basis and downside risks remain, notwithstanding DBRS Morningstar's view that the worst of the pandemic is in the rear view.
The rating confirmations consider (1) H&R’s continued robust access to liquidity ($1.2 billion proforma amendments to the Trust's unsecured credit facility), (2) DBRS Morningstar's expectation that H&R's quality retail and multifamily assets will bounce back from the pandemic and again provide stability to cash flows, as evidenced by improving trends in collections, bad debts, and multifamily leasing velocity, and (3) the expectation that sizable recent and imminent development completions such as River Landing in Miami will deliver solid results, thereby contributing to the Trust's underlying asset quality. The rating confirmations also consider DBRS Morningstar's expectation that H&R will continue to manage by various means, including capital recycling, an elevated level of secured debt maturities through the balance of the year ($1.1 billion).
The ratings continue to be supported by the Trust’s large and diversified real estate portfolio, well-laddered long-term leases and investment grade-rated tenants. The ratings continue to be constrained by leverage as noted above, as well as tenant concentration, as reflected by H&R's top 10 tenants representing 43.8% of annualized rental revenue at March 31, 2021, elevated exposure to generally more volatile energy tenants and markets (e.g., Calgary and Houston office properties), and H&R’s relatively limited market position as a diversified real estate operator lacking scale in any particular market or niche.
DBRS Morningstar will likely consider rating downgrades within the next 12 months if H&R's operating environment fails to improve sufficiently (e.g., multifamily and retail segments fail to recover as expected) causing DBRS Morningstar to consider further downward revisions to the Trust's business risk assessment or H&R's total debt-to-EBITDA trends higher than DBRS Morningstar's current expectations of 10.2x at YE2021 and 9.4x at YE2022. DBRS Morningstar would consider restoring the Stable trends should H&R's total debt-to-EBITDA sufficiently beat expectations such that DBRS Morningstar can comfortably expect total debt-to-EBITDA below 9.2x on a sustained basis, all else equal.
A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework can be found in the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings at https://www.dbrsmorningstar.com/research/373262.
All figures are in Canadian dollars unless otherwise noted.
The principal methodology is Rating Entities in the Real Estate Industry (April 23, 2021; https://www.dbrsmorningstar.com/research/377358/rating-entities-in-the-real-estate-industry), which can be found on dbrsmorningstar.com under Methodologies & Criteria. Other applicable methodologies include the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (February 3, 2021; https://www.dbrsmorningstar.com/research/373262).
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 trends and ratings are under regular surveillance.
For more information on this credit or on this industry, visit www.dbrsmorningstar.com or contact us at email@example.com.
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