Morningstar DBRS Confirms Credit Rating on Mortgage Loan Made to Albert & Lyon Equities Inc., Albert & Lyon Properties LP, and Canderel CSQ Ottawa LP - Constitution Square

DBRS Limited (Morningstar DBRS) confirmed the credit rating on the following mortgage loan made to Albert & Lyon Equities Inc., Albert & Lyon Properties LP, and Canderel CSQ Ottawa LP - Constitution Square by a major Canadian financial institution:

-- Mortgage Loan at A (low) (of)

The trend is Stable.

All credit ratings have been removed from Under Review with Negative Implications where they had been placed on April 15, 2024, as part of Morningstar DBRS' review of transactions secured by office properties within its North American Commercial Mortgage Backed Securities Single-Asset/Single-Borrower (NA CMBS SASB) portfolio. The review was prompted by Morningstar DBRS' view that a shift in the use and demand for office space has been observed in the last few years. Amid the increase in remote work and hybrid schedules, tenant demand in urban markets, such as those most frequently represented in the NA CMBS SASB space, has been the most resilient for those higher-quality buildings that offer extensive amenity packages and are located close to transportation hubs with other nearby draws for commuters and city dwellers alike. These trends are expected to be sustained in the long term and their ripple effects of increased tenant improvement costs, capital improvement expectations, and decreased demand for some markets and neighborhoods will continue to influence investment activity for the office sector as a whole. For more information regarding the approach and analysis conducted, please refer to the press release titled "Morningstar DBRS Takes Rating Actions on North American Single-Asset/Single-Borrower Transactions Backed by Office Properties," published on April 15, 2024.

At the conclusion of the April 2024 review, several transactions, including the subject transaction, remained Under Review with Negative Implications. This generally reflected the existence of evolving factors for those credits for which Morningstar DBRS identified a need for more information to be gathered to inform the analysis. With this review of the subject transaction, Morningstar DBRS has resolved the Under Review with Negative Implications status. The full details of the credit rating actions and ratings rationale are outlined below.

The credit rating confirmation reflects Morningstar DBRS' expectations that the loan's leverage point remains in line with issuance expectations. This is supported by the loan's continued amortization, recent leasing momentum, strong tenant roster which includes credit tenants, high property quality and central location. As part of this review, Morningstar DBRS derived an updated value of $247.4 million, which is slightly lower than the Morningstar DBRS value of $256.6 million previously derived.

The mortgage loan is secured by Constitution Square, a Class A LEED Platinum complex encompassing 1.1 million square feet (sf) of office and street level retail, located in Ottawa's central business district (CBD). The complex consists of three towers all of which are connected at grade level by a two-storey contiguous lobby and retail atrium. It offers convenient access to Parliament Hill and the new O-train LRT line via Lyon Station. The first mortgage loan has a 20-year loan term, of which the first five years are interest-only payments with amortization thereafter over a 30-year period. The interest-only period ended with the September 2022 payment date and the loan is now making both principal and interest payments. As of the June 2024 remittance, the loan balance has been paid down 3.0% to $233.0 million from $240.3 million at issuance.

Morningstar DBRS has reviewed recent leasing information and is comfortable that the property's Class A status, recent capital improvements and location support the positive leasing momentum at the property. Submarket vacancy for Class A office space was 11.2% as of Q1 2024, according to CBRE, and several buildings in the Ottawa CBD have recently been taken offline as potential residential conversions, which puts the property in a better position to retain tenants. The loan is not scheduled to mature until September 2037, which gives it substantial runway for re-stabilization.

Morningstar DBRS had previously concluded a value of $256.6 million for the subject property based on the Morningstar DBRS net cash flow of $17.3 million and a capitalization (cap) rate of 6.75%. With this review, Morningstar DBRS increased the cap rate to 7.0%, resulting in an updated Morningstar DBRS value of $247.4 million. The implied loan to value (LTV) ratio increased slightly to 94.2% from 93.0% based on the prior Morningstar DBRS value. Additionally, Morningstar DBRS applied positive qualitative adjustments to the LTV Sizing Benchmarks totaling 6.75%, compared to the total positive adjustment of 10.5% previously. Morningstar DBRS' adjustments continue to reflect the expectations for cash flow stability and market fundamentals given credit tenancy and desirable location near Parliament Hill. However, the decline in occupancy and generally challenged office landscape pose challenges, thereby supporting the downward adjustment to these figures.

Morningstar DBRS' credit ratings on the applicable classes address the credit risk associated with the identified financial obligations in accordance with the relevant transaction documents. Where applicable, a description of these financial obligations can be found in the transactions' respective press releases at issuance.

Morningstar DBRS' long-term credit ratings provide opinions on risk of default. Morningstar DBRS considers risk of default to be the risk that an issuer will fail to satisfy the financial obligations in accordance with the terms under which a long-term obligation has been issued. The Morningstar DBRS short-term debt rating scale provides an opinion on the risk that an issuer will not meet its short-term financial obligations in a timely manner.

ENVIRONMENTAL, SOCIAL, AND GOVERNANCE CONSIDERATIONS   
There were no Environmental/Social/Governance factor(s) 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; https://dbrs.morningstar.com/research/427030)

All credit ratings are subject to surveillance, which could result in credit ratings being upgraded, downgraded, placed under review, confirmed, or discontinued by Morningstar DBRS.

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

The principal methodology is North American CMBS Surveillance Methodology (March 1, 2024; https://dbrs.morningstar.com/research/428798)

Other methodologies referenced in this transaction are listed at the end of this press release.

The Morningstar DBRS rating assigned is higher than the results implied by the LTV sizing benchmarks by more than three notches. Morningstar DBRS typically expects there to be a substantial likelihood that a reasonable investor or other user of the credit ratings would consider a three-notch or more variance from the credit rating stresses implied by the LTV sizing benchmark to be a significant factor in evaluating the credit ratings. The variance is warranted given the loan's continued amortization, recent leasing momentum, strong tenant roster which consists of credit tenants, high property quality and borrower commitment given total capital expenditure of approximately $21 million since 2008, and central location near Parliament Hill.

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.

Please see the related appendix for additional information regarding the sensitivity of assumptions used in the credit rating process.

DBRS Limited
DBRS Tower, 181 University Avenue, Suite 700
Toronto, ON M5H 3M7 Canada
Tel. +1 416 593-5577

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

North American Single-Asset/Single-Borrower Ratings Methodology (March 1, 2024; https://dbrs.morningstar.com/research/428799)

Morningstar DBRS North American Commercial Real Estate Property Analysis Criteria (June 28, 2024; https://dbrs.morningstar.com/research/435293)

North American Commercial Mortgage Servicer Rankings (August 23, 2023; https://dbrs.morningstar.com/research/419592)

Legal Criteria for Canadian Structured Finance (June 20, 2023; https://dbrs.morningstar.com/research/416101)

A description of how DBRS Morningstar analyses structured finance transactions and how the methodologies are collectively applied can be found at: https://dbrs.morningstar.com/research/410863. (July 17, 2023)

For more information on this credit or on this industry, visit dbrs.morningstar.com or contact us at [email protected].