DBRS Confirms Petro-Canada Centre at A (low)

DBRS has today confirmed the rating of the First Mortgage Bonds of Petro-Canada Centre (PC Centre or the Project) at A (low) with a Stable trend.

PC Centre continues to experience strong financial performance driven by robust demand for office space in Calgary, however tenant-concentration risk is a constraining factor for the rating with Petro-Canada occupying 55.4% of PC Centre. PC Centre experienced 6.5% growth in net operating income (NOI) in 2007 and has maintained 100% occupancy at the end of the past two years. Interest-coverage ratios continued a steady upward trend in 2007 with coverage for the First Mortgage Bonds increasing to 3.9 times (from 3.5x), while debt-service coverage was strong at 2.6x (from 2.4x), a level that compares well with other properties rated by DBRS.

Average in place office net rents grew by 5.4% to just under $25 per square foot, still well below current market rents in the range of $35 to low $40s per square foot. The average increase in net effective rents on both renewal and new leases was 77% to $42 per square foot, as compared to average in-place office rents at the end of 2006. The overall increase in NOI is more modest given the relatively low level of leasing activity over the past two years. In 2007, leasing activity was about 135,000 square feet or just under 8% of leasable area including renewals and new leases.

Looking ahead, DBRS expects even stronger growth in NOI in 2008 of between 8% to 10% as significantly higher net rents on recent leasing activity in 2007 combined with rent steps from existing leases are expected to contribute over $3.5 million in incremental NOI.

PC Centre’s lease maturities in 2008 are 11% which includes Bell Canada/Bell West’s accelerated lease termination date of December 31, 2008 (from 2012) for 158,563 square feet (9.2% of total leasable area). DBRS does not foresee significant releasing risk in the context of the current office market especially given the in place net rent of $23 per square foot, which is well below market. Therefore, although the Bonds mature in December 2008, the re-leasing risk is expected to be manageable.

The owners are still considering options to refinance PC Centre and despite significantly weaker credit markets, DBRS expects that financing should be available given the overall strength of the property and the Calgary office market. However, the deterioration in credit markets does cause refinancing risk to be much greater than last year as the availability has declined.

The downtown Calgary office market continues to experience strong demand, although new space coming online in 2007 has relieved some of the pressure with current occupancy at 94.9% as compared 99.6% at end of Q1 2006. Despite the new supply, in 2007 the upward pressure on asking net rental rates continued in Calgary’s downtown core with asking rents up 12% to 14% to $35 to $40 on average per square foot. Current new projects underway in downtown Calgary are expected to add about 0.5 million square feet in 2008 and another 2.6 million square feet in 2009 (a total increase of 9% downtown and 13% within the core). The space is about 50% pre-leased overall and with no further growth this could result in occupancy falling to closer to the low 90% level. As well, there are additional projects in planning that could add another five million to six million square feet of office space in downtown Calgary. New supply represents a longer-term challenge that could negatively impact the market especially in 2011 and beyond depending on conditions at the time.

The rights of the First Mortgage Bonds are protected by a Subordination Agreement and Lock Box Agreement between the First and Second Mortgage Bondholders. First Mortgage Bondholders are well-secured, given a loan-to-value (LTV) estimated at under 30%, based on current market values. The total debt outstanding at maturity will be $240 million, including $174 million of First Mortgage Bonds and $66 million of Second Mortgage Bonds. As mentioned, although difficult credit markets have materially reduced the availability of financing for real estate, at this point DBRS expects financing to be available given the location of PC Centre within a strong Calgary office market.

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