DBRS Downgrades Cominar REIT to BB (high), Stable Trend

DBRS Limited (DBRS) has today downgraded the Senior Unsecured Debentures rating of Cominar Real Estate Investment Trust’s (Cominar or the Trust) to BB (high) from BBB (low). The trend is restored to Stable. The downgrade reflects Cominar’s elevated debt metrics with no visibility on the possibility of improvement (despite visibility in improving EBITDA growth trends) without a concurrent equity raise and/or further distribution cut. It is DBRS’s view that a distribution cut of at least 66.67% would have been required to meet the previously indicated debt metrics within a 12- to 18-month period and that the net impact of the 22.4% announced distribution cut is largely a wash to offset the announced dividend reinvestment plan (DRIP) suspension. DBRS also notes that an equity raise (and especially at current valuations), while maintaining the current distribution rate, would increase DBRS’s negative free cash flow expectations. DBRS expects that a lowering of EBITDA growth expectations, revisions to development pipeline expectations (adverse impacts on EBITDA and/or increase in scale) and rapidly increasing interest rates would result in a more rapid deterioration of the Trust’s debt metrics than expected.

On August 12, 2016, DBRS confirmed the rating of Cominar’s Senior Unsecured Debentures at BBB (low) and changed the trend to Negative from Stable. The Negative trend change reflected Cominar’s slower-than-expected progress toward reducing debt and bringing leverage metrics back to levels achieved prior to the $1.527 billion acquisition of a property portfolio from Ivanhoé Cambridge (the Acquisition) by the end of 2015 or early 2016. DBRS further stated that a rating downgrade would likely occur if there were a lack of improvement in the Trust’s debt metrics over the next 12 months. During the year, Cominar did issue $200 million in new equity (that closed in September 2016), reinstated the DRIP in September 2016 and completed the sale of non-core income properties for FY2016 total net proceeds of $115.6 million and a further $93 million in Q1 2017. The net impact of these actions was not sufficient to restore leverage metrics back to levels achieved prior to the Acquisition, because of the loss of the EBITDA contribution of the dispositions, fundamental weakness in the income-producing portfolio that further weighed down on EBITDA and net proceeds that were primarily put toward investments in income-producing properties, properties under development and land held for future development, unit buybacks and financing of negative free cash flow (before factoring in the DRIP and top up financing to meet debt amortization payments) as opposed to primarily paying down debt. In particular, DBRS notes material deterioration in Cominar’s debt-to-EBITDA ratio (a primary financial risk factor assessed in DBRS’s methodology for rating entities in the real estate industry) to 10.9 times (x) for the six months ended June 30, 2017, versus 10.2x over the same period (with the expectation that debt-to-EBITDA would settle at around 10.1x for the full-year ended 2017 (versus 9.7x for FY2016) once the total annualized impact of the dispositions are fully reflected in the numbers and factoring in Cominar management guidance and DBRS expectations for the year).

It is DBRS’s expectation that Cominar’s current financial structure in conjunction with DBRS’s EBITDA growth and development pipeline expectations will result in a flat debt-to-EBITDA metric around 10.0x through 2018, as expected improvement in EBITDA would be offset by increasing debt to fund non-income-producing developments and investments. Cominar had historically operated at a debt-to-EBITDA metric in the low 9.0x range preceding the Acquisition. In addition, over the same period, the trend within the publicly traded real estate industry (and many of Cominar’s investment-grade peers) has been to lower target operating leverage levels to mitigate risk in a generationally low interest rate and cap rate environment.

While DBRS recognizes that the debt metrics would improve on completion of the properties under development (as the incremental EBITDA comes online), DBRS typically does not include this consideration as part of its analysis unless presented with clear visibility (e.g., substantial pre-leasing completed etc.). This treatment is consistent across all DBRS-rated real estate entities where a visible ongoing development pipeline is present (the continuous replenishment of the pipeline results in a permanent part of capital tied up in non-income-producing developments). Development carries a significantly higher risk profile than income-producing properties in that there is no certainty in timing of completion, costs, lease-up of non-committed space and/or rents achievable on non-committed space. Further, there is no certainty that the equity or debt markets will be open on completion of a development program (future cost of capital and consequent project economics are unpredictable).

DBRS acknowledges that the Acquisition (many assets of which DBRS visited during its recent property tours in Montréal and Québec City) enhanced the Trust’s size and scale, portfolio quality, asset type mix and tenant diversification. These positive attributes, however, are more than offset by the increase in leverage levels and deterioration in risk profile described above.

With an expected debt-to-EBITDA metric of 10.1 times (x) for the year ended 2017, Cominar is on the high end of its peer group by a significant margin. DBRS notes that members of the peer group that sit at the high end of the 9.0x range own a portfolio of properties that trade at lower cap rates/higher valuations. DBRS notes that such properties should trade at a higher debt-to-EBITDA ratio by virtue of the lower EBITDA generated per dollar spent on acquiring such properties. In addition, Cominar’s debt-to-capital metrics are substantially higher than members of the peer group that sit at the high end of the 9.0x range, and the Trust’s interest coverage ratio is significantly lower, demonstrating Cominar’s relatively high exposure to an increasing interest rate and higher cap rate environment. Cominar has one of the lowest unencumbered asset ratios relative to its investment-grade peers and insufficient unencumbered assets to support outstanding unsecured debt and additional expected funding needs through FY2018 based on DBRS’s expectations and Cominar’s current financial structure.

The rating would be upgraded to BBB (low) if the Trust were to strengthen its financial profile with a distribution cut of sufficient scale to provide adequate cash flow retention to fund the equity component of properties under development and pay down debt and/or if the Trust issues sufficient equity to restore leverage metrics back to levels achieved prior to the Acquisition in October 2014.

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

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 to the right under Related Research or by contacting us at info@dbrs.com.

This rating is no longer endorsed by DBRS Ratings Limited for use in the European Union.

The principal methodology is Rating Entities in the Real Estate Industry (April 2017), which can be found on dbrs.com under Methodologies.

For more information on this credit or on this industry, visit www.dbrs.com or contact us at info@dbrs.com.