Morningstar DBRS Changes Trend to Negative from Stable and Confirms Artis Real Estate Investment Trust’s Ratings at BBB (low) and Pfd-3 (low)

DBRS Limited (Morningstar DBRS) changed the trend to Negative from Stable and confirmed the Issuer Rating and Senior Unsecured Debentures rating of Artis Real Estate Investment Trust (Artis or the REIT) at BBB (low) and its Preferred Trust Units rating at Pfd-3 (low).

KEY CREDIT RATING CONSIDERATIONS
The Negative trend reflects the sustained deterioration of EBITDA interest coverage beyond Morningstar DBRS’ prior year expectation of 2.7 times (x) or above because of the REIT’s high proportion of variable rate debt. Morningstar DBRS anticipates a modest improvement in the coverage in the medium term as the REIT continues to execute its Business Transformation Plan through monetizing assets and using the proceeds to repay further variable rate debt. However, Morningstar DBRS notes that, given the increased variable rate debt in an elevated interest rate environment and an already weakened coverage ratio, Artis has less cushion for the current leverage at the given rating level. Morningstar DBRS has also revised its assessment of the REIT’s portfolio size lower as the REIT continues to shrink in size following the asset dispositions carried out in the last 12 months ended (LTM) September 30, 2023. Morningstar DBRS believes that the weakening of the REIT’s financial risk metrics and declining market presence, coupled with its relatively smaller size for the current rating category, increase the possibility of a downgrade action in the near future.

CREDIT RATING DRIVERS
All else equal, Morningstar DBRS would consider downgrading Artis should it fail to achieve a Morningstar DBRS EBITDA interest coverage ratio of 1.83x or better on a sustained basis, or should the Morningstar DBRS total debt-to-EBITDA not improve to 8.6x or better on a sustained basis in the near term. Also, further negative rating actions could occur if the REIT’s debt maturity profile remains short on a sustained basis in the near term. Conversely, Morningstar DBRS would consider restoring a Stable trend should either of these metrics be comfortably achieved on a sustained basis, all else equal.

FINANCIAL OUTLOOK
Morningstar DBRS projects the Morningstar DBRS EBITDA interest coverage metrics to weaken and fluctuate in the 1.6x range by YE2023 and YE2024, primarily because of the REIT’s greater cost of debt as a result of its high variable debt exposure. The Morningstar DBRS debt-to-EBITDA is forecast to increase in the high 9x range at YE2023 because of the loss of EBITDA from recent asset sales carried out in 2023 before showing modest improvement to the high 8x range at YE2024. This improvement will be largely driven by the REIT’s asset monetization plans as demonstrated by the recent sale of its Calgary/Winnipeg Retail portfolio for aggregate proceeds of $222 million, which is expected to close in H1 2024. Morningstar DBRS understands the net disposition proceeds will be used to repay further debt. For comparative purposes, the REIT had Morningstar DBRS total debt-to-EBITDA and EBITDA interest coverage ratios of 9.2x and 1.84x, respectively, as of the LTM ended September 30, 2023.

CREDIT RATING RATIONALE
The rating confirmation is supported by (1) Artis' well-diversified, albeit reduced, stable and recurrent income-producing portfolio through economic cycles; (2) strong tenant and property diversification; and (3) lack of aggressive expansion and development activities. The rating is constrained by (1) Artis’ weak interest coverage amid a high interest rate environment and elevated leverage for the REIT’s portfolio size and EBITDA; (2) lack of scale in any markets that it operates; and (3) the smaller portfolio size on both EBITDA and square footage bases relative to the BBB (low) rating category.

ENVIRONMENTAL, SOCIAL, AND GOVERNANCE CONSIDERATIONS
There were no Environmental/Social/Governance factors that had a significant or relevant effect on the credit analysis.

A description of how Morningstar DBRS considers ESG factors within the Morningstar DBRS analytical framework can be found in the Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (January 23, 2024) at https://dbrs.morningstar.com/research/427030.

BUSINESS RISK ASSESSMENT (BRA) AND FINANCIAL RISK ASSESSMENT (FRA)
(A) Weighting of BRA Factors
In the analysis of Artis Real Estate Investment Trust, the BRA factors are considered in the order of importance contemplated in the methodology.

(B) Weighting of FRA Factors
In the analysis of Artis Real Estate Investment Trust, the FRA factors are considered in the order of importance contemplated in the methodology.

(C) Weighting of the BRA and the FRA
In the analysis of Artis Real Estate Investment Trust, the BRA carries greater weight than the FRA.

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

Morningstar DBRS applied the following principal methodology:
-- Global Methodology for Rating Entities in the Real Estate Industry (April 11, 2023), https://dbrs.morningstar.com/research/412477.

The following methodologies/criteria have also been applied:
-- DBRS Morningstar Global Criteria: Preferred Share and Hybrid Security Criteria for Corporate Issuers (October 19, 2023), https://dbrs.morningstar.com/research/422134/

--DBRS Morningstar Global Criteria: Common Adjustments for Calculating Financial Ratios (November 9, 2023), https://dbrs.morningstar.com/research/423052

-- DBRS Morningstar Global Criteria: Rating Corporate Holding Companies and Parent/Subsidiary Rating Relationships (September 27, 2023), https://dbrs.morningstar.com/research/421119

The credit rating methodologies used in the analysis of this transaction can be found at: https://dbrs.morningstar.com/about/methodologies.

A description of how Morningstar DBRS analyzes corporate finance transactions and how the methodologies are collectively applied can be found at: https://dbrs.morningstar.com/research/397223.

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 credit rating was initiated at the request of the rated entity.

The rated entity or its related entities did participate in the credit rating process for this credit rating action.

Morningstar DBRS had access to the accounts, management, and other relevant internal documents of the rated entity or its related entities in connection with this credit rating action.

This is a solicited credit rating.

The conditions that lead to the assignment of a Negative or Positive trend are generally resolved within a 12-month period. Morningstar DBRS trends and credit ratings are under regular surveillance.

Information regarding Morningstar DBRS credit ratings, including definitions, policies, and methodologies, is available on dbrs.morningstar.com or contact us at [email protected].

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