DBRS Morningstar Downgrades H&R Real Estate Investment Trust to BBB, Changes Trends to Stable from Negative

DBRS Limited (DBRS Morningstar) downgraded H&R Real Estate Investment Trust’s (H&R or the Trust) Issuer Rating and Senior Unsecured Debentures rating to BBB from BBB (high) and changed the trends to Stable from Negative. The downgrades are largely due to sustained deterioration in H&R's Financial Risk Assessment (FRA) relative to DBRS Morningstar's last rating action on January 4, 2022, as well as downward pressure in the Trust's Business Risk Assessment (BRA). These rating actions consider DBRS Morningstar's anticipation that H&R will continue to execute its strategic plan to dispose of its grocery-anchored retail portfolio and several office properties as well as rezone several of its Canadian office properties into multifamily and industrial properties.

DBRS Morningstar has lowered its assessment of H&R's lease maturity profile and tenant quality as H&R's relative exposure to the multifamily segment (with short-term leases) continues to increase. DBRS Morningstar believes H&R's BRA could face continued downward pressure as it executes its strategic plan, particularly lease maturity profile, tenant quality, and market position as it reallocates capital to the highly fragmented U.S. multifamily sector. As a result, H&R has lower tolerance for leverage for a given rating.

In DBRS Morningstar's view, the sustained deterioration in H&R's FRA is largely due to the annualized impacts of recent dispositions, as H&R continues to recycle capital by selling income-producing properties and allocating sales proceeds to repaying debt and funding its development pipeline, as well as buying back units contrary to DBRS Morningstar's prior expectations. Indeed, DBRS Morningstar anticipates H&R's total debt-to-EBITDA ratio will fluctuate in the mid-9.0x range in the near to medium term from 8.6 times (x) for the last 12 months ended June 30, 2022. H&R’s leverage improved on a LTM-basis largely resulting from dispositions, including the Bow in Calgary; repayment of debt; and a recovery in H&R's operating environment boosting EBITDA.

With these rating actions, DBRS Morningstar believes H&R is well positioned within the current rating; however, leverage continues to be a constraining factor allowing limited financial flexibility, notwithstanding H&R's gradual progress toward an unsecured debt stack. Furthermore, downside risks are elevated in light of the weakening macroeconomic outlook.

The ratings continue to be supported by H&R's (1) high-quality real estate portfolio with strong positioning in key markets, notwithstanding recent dispositions; (2) highly creditworthy commercial tenants with long-term leases; and (3) solid asset type and geographical diversification with a broadly diversified portfolio across real estate subsectors and several markets in Canada and the U.S.

The ratings continue to be constrained by (1) the Trust's aforementioned elevated leverage; (2) the Trust's relatively smaller portfolio size; (3) tenant concentration, as reflected by H&R's top 10 tenants representing 39.6% of annualized rental revenue at June 30, 2022; and (4) execution risk related to H&R's strategic plan such that DBRS Morningstar would expect a greater buffer to threshold leverage levels for a given rating in light of capital recycling and development initiatives as well as potential further downward revisions in H&R's BRA.

DBRS Morningstar would consider taking further negative rating actions if H&R's total debt-to-EBITDA ratio deteriorates above 10.8x on a sustained basis. Given the challenges noted above, a positive rating action would require a material change in H&R's financial policy (e.g., significantly lower leverage, unencumbered balance sheet, etc.).

ENVIRONMENTAL, SOCIAL, AND GOVERNANCE CONSIDERATIONS
There were no environmental, social, and governance factors that had a significant or relevant effect on the credit analysis.

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/396929/dbrs-morningstar-criteria-approach-to-environmental-social-and-governance-risk-factors-in-credit-ratings (May 17, 2022).

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

The principal methodology is Rating Entities in the Real Estate Industry (April 20, 2022; https://www.dbrsmorningstar.com/research/395563), which can be found on dbrsmorningstar.com under Methodologies & Criteria.

A description of how DBRS Morningstar analyzes corporate finance transactions and how the methodologies are collectively applied can be found at: https://www.dbrsmorningstar.com/research/397223/interplay-of-global-corporate-finance-rating-methodologies-when-analyzing-corporate-finance-transactions.

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 [email protected].

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.

The conditions that lead to the assignment of a Negative or Positive trend are generally 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 protected].

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