NEW YORK--(BUSINESS WIRE)--
Fitch Ratings has affirmed the following credit ratings of Highwoods Properties, Inc. (HIW) and its operating partnership, Highwoods Realty Limited Partnership, (collectively Highwoods, or the company):
Highwoods Properties, Inc.
--Issuer Default Rating (IDR) at 'BBB-';
--Preferred stock at 'BB'.
Highwoods Realty Limited Partnership
--IDR at 'BBB-';
--Senior unsecured lines of credit at 'BBB-';
--Senior unsecured term loans at 'BBB-';
--Senior unsecured notes at 'BBB-'.
The Rating Outlook is Stable.
KEY RATING DRIVERS
The ratings reflect Highwoods' well-positioned portfolio in the company's core markets, which is supported by a granular, strong credit quality tenant base with manageable lease expirations over the next several years. The company also has good financial flexibility highlighted by strong fixed charge coverage and improved access to capital. These strengths are tempered by uneven operating fundamentals evidenced by negative cash rent roll on expiring leases and elevated capital expenditures, high adjusted funds from operations (AFFO) payout ratio, and modest unencumbered asset coverage of unsecured debt for the rating.
IMPROVED ASSET QUALITY
HIW's portfolio is concentrated in Southeast markets including Raleigh, where the company is headquartered, as well as Atlanta, Nashville and Tampa. Highwoods also maintains a small industrial footprint in Atlanta (that management has indicated it will sell during 2013) and Piedmont Triad, and retail presence in Kansas City. These subsectors comprise a modest portion of the overall enterprise at 4.1% and 6.7% of cash revenue, respectively. Highwoods has continued to improve asset quality across the portfolio - Class A properties now comprise 72% compared to 38% at year-end 2004. Relatedly, in-place rents have increased more than 30% during this span. Fitch views the company's continued portfolio transition into higher quality properties favorably given better long-term growth prospects and greater likelihood of contingent liquidity that can be sourced from these assets.
STRONG FIXED CHARGE COVERAGE/ADEQUATE LEVERAGE
Fixed charge coverage was 2.3x for the trailing 12 months (TTM) ended June 30, 2013, flat from the year ended Dec. 31, 2012 but up from 2.0x for the year ended Dec. 31, 2011. Fitch expects that coverage will improve modestly and stabilize at 2.4x over the next 12-24 months, which is consistent with a 'BBB' rating.
Leverage at June 30, 2013 was 6.1x and has generally remained in the 6.0x-6.5x range during the last several years. Fitch expects that leverage will approach 6.5x at year-end 2013 as the company increases debt to fund acquisitions and its development pipeline; however, leverage will likely decline to the low 6.0x range over the longer term as development projects and new acquisitions continue to stabilize.
FAVORABLE TENANT PROFILE
Highwoods has a diverse tenant base with no tenant aside from the Federal Government (6.8% of cash rent) contributing more than 2.5%. Additionally, 11 of the top 20 tenants are investment grade and together contribute only 27.5% of cash revenue.
SUSTAINED NEGATIVE RENT ROLLS
The cash rent trend for HIW's office portfolio has been negative, as expiring rents with fully-realized rent escalators continue to see negative mark to market in the current leasing environment. Despite these rolldowns, the weighted average rental rate across the portfolio increased nearly 8% year-over-year given contractual rent escalators and higher in-place rents on acquisitions. Fitch expects that contractual rent escalators together with improving occupancy will largely offset continued rent rolldowns over the next 12-24 months.
INCREASING DEVELOPMENT PIPELINE
Highwoods' development pipeline has seen modest growth since the downturn. The 1.6% cost to complete the pipeline as a percent of gross assets is modest; however, the pipeline will grow to approximately 3% following the announced Met Life development in Raleigh. The increasing cost to complete the pipeline is mitigated by the high pre-lease rates that management targets (the current 93% rate will be further supported by the 100% leased Met Life project), which removes leasing risk inherent in the development business.
UA/UD SHOULD SEE NEAR-TERM IMPROVEMENT
HIW's unencumbered asset coverage of unsecured debt was 1.7x at the second quarter of 2013 (2Q'13), based on capitalizing unencumbered net operating income (NOI) at a stressed 9% cap rate. This level of coverage is adequate for the 'BBB-' rating. Coverage weakened from 1.9x in 2012 due to the sale of non-core unencumbered assets as well as the timing impact of recently acquired properties. Pro forma coverage for recent transactions is 1.8x and Fitch expects that coverage will grow toward 2.0x over the next 12-24 months as the company continues to unencumber assets and add newly acquired properties to the unencumbered pool.
HIGH AFFO PAYOUT RATIO
Highwoods' year-to-date adjusted funds from operations (AFFO) payout ratio of 99% is a credit concern. The company maintained the common dividend level through the downturn while also electing to pay the common dividend entirely in cash, rather than utilize a more conservative combination of cash and stock. This high payout limits Highwoods' ability to generate internal liquidity. An AFFO payout ratio in excess of 100% is inconsistent with an investment-grade rating.
The following factors may have a positive impact on Highwoods' ratings and/or Outlook:
--Unencumbered asset coverage of unsecured debt sustaining above 2.0x (pro forma coverage is 1.8x);
--Fitch's expectation of leverage sustaining below 6.0x (leverage at June 30, 2013 was 6.1x);
--Maintaining a fixed charge coverage ratio above 2.3x (fixed charge coverage was 2.3x for the TTM ended June 30, 2013).
The following factors may have a negative impact on the company's ratings and/or Outlook:
--Fitch's expectation of fixed-charge coverage sustaining below 1.8x;
--Fitch's expectation of leverage sustaining above 8.0x;
--Maintaining an AFFO payout ratio above 100%.
Additional information is available at 'www.fitchratings.com'.
Applicable Criteria and Related Research:
--'Corporate Rating Methodology' (Aug. 5, 2013);
--'Parent and Subsidiary Rating Linkage' (Aug. 5, 2013);
--'Criteria for Rating U.S. Equity REITs and REOCs' (Feb. 26, 2013);
--'Treatment and Notching of Hybrids in Nonfinancial Corporates and REIT Credit Analysis' (Dec. 13, 2012);
--'Recovery Ratings and Notching Criteria for Equity REITs' (Nov. 12, 2012).
Applicable Criteria and Related Research:
Criteria for Rating U.S. Equity REITs and REOCs
Treatment and Notching of Hybrids in Nonfinancial Corporate and REIT Credit Analysis
Recovery Ratings and Notching Criteria for Equity REITs
Corporate Rating Methodology: Including Short-Term Ratings and Parent and Subsidiary Linkage
Parent and Subsidiary Rating Linkage
- Security Upgrades & Downgrades
- Fitch Ratings
- Highwoods Properties
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Fitch Ratings, Inc.
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