DBRS Confirms the Senior Unsecured Debenture Rating of H&R Real Estate Investment Trust at BBB (high), Stable Trend

DBRS Limited (DBRS) confirmed the rating of H&R Real Estate Investment Trust’s (H&R or the Trust) Senior Unsecured Debentures at BBB (high) with a Stable trend. The rating confirmation and Stable outlook take into consideration H&R’s continued improving asset quality, improving diversification particularly by way of its growing multifamily segment (both of which are offset with higher leverage) and DBRS’s expectation that the deterioration in H&R’s leverage metrics in recent years (debt-to-EBITDA of 8.9 times (x) for the last 12 months (LTM) ended March 31, 2018, versus 8.5x as at F2015) will stabilize near current levels while gradually declining in the medium term to levels more commensurate with the rating category.

Factors driving the deterioration in H&R’s leverage levels in recent years are: (1) an active debt-financed development pipeline with delayed earnings accretion; (2) capital recycling and portfolio upgrading via disposing of non-core assets with higher yields and acquiring higher quality assets at lower yields (with the former occurring prior to the latter) and (3) funding of share repurchases under its current Normal-Course Issuer Bid. All of the above contributes to a scenario where EBITDA is lower ($808.2 for the LTM ended March 31, 2018 versus $843.4 as at F2015) and debt is relatively unchanged ($7,177.7 as at March 31, 2018, versus $7,127.5 as at YE2015), resulting in H&R’s higher leverage metrics. However, DBRS is of the view that higher leverage is offset with improving asset quality and diversification by way of H&R’s growing multifamily platform. Some recent examples of H&R’s capital recycling program include the closed (as at June 8, 2018) sale of all of its U.S. retail assets (excluding 16 gas stations/convenience stores and one grocery-anchored retail property) for USD 620.4 million at a 2018 pro forma cap rate of 7.3% and the recent sale (April 2018) of its 50% interest in F1RST Tower (a 350,000 square foot office) in Calgary, Alberta. DBRS understands proceeds are to be used to fund further multifamily acquisitions and to reduce debt.

In light of ongoing portfolio activity, the credit risk profile of H&R continues to be supported by its large, high-quality mix of commercial real estate with exposure to all four primary property classes and its roster of high-quality tenants with long-term leases. Nevertheless, the credit risk profile is constrained by H&R’s high leverage levels, ongoing disruption in retail impacting H&R’s Primaris segment, concentrated tenant profile (42.5% rental revenues derived from top ten tenants as at March 31, 2018) and disproportionate exposure to Alberta (19.7% leasable area as at March 31, 2018).

DBRS would consider a negative rating action should one or more of the following factors occur on a sustained basis: (1) debt-to-EBITDA increases above 9.3x or (2) the operating environment deteriorates leading to higher vacancy and material declines in EBITDA and operating cash flows. A positive rating action is unlikely for the foreseeable future.

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

The principal methodology is Rating Entities in the Real Estate Industry (April 2018), which can be found on dbrs.com under Methodologies.

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 info@dbrs.com.

The rated entity or its related entities did participate in the rating process for this rating action. DBRS had access to the accounts and other relevant internal documents of the rated entity or its related entities in connection with this rating action.

DBRS will publish a full report shortly that will provide additional analytical detail on this rating action. If you are interested in receiving this report, contact us at info@dbrs.com.