NEW YORK--(BUSINESS WIRE)--
Fitch Ratings has downgraded the credit ratings of Liberty Property Trust (LRY) and its operating partnership, Liberty Property Limited Partnership (collectively Liberty, or the company) as follows:
Liberty Property Trust
--Issuer Default Rating (IDR) to 'BBB' from 'BBB+'.
Liberty Property Limited Partnership
--IDR to 'BBB' from 'BBB+';
--Unsecured revolving credit facility to 'BBB' from 'BBB+';
--Medium-term notes to 'BBB' from 'BBB+';
--Senior unsecured notes to 'BBB' from 'BBB+';
--Preferred operating units to 'BB+' from 'BBB-'.
Fitch revised the Rating Outlook to Stable from Negative.
KEY RATING DRIVERS
The downgrade is principally based on the increase in Liberty's leverage to the low 6.0x area from the mid-4.0x's in 2009, against the backdrop of increased development risk and a persistent shortfall in Liberty's dividend coverage from adjusted funds from operations (AFFO).
The Stable Outlook reflects Fitch's expectation for Liberty's leverage to remain in the low 6.0x range through 2015, which is appropriate for the 'BBB' rating.
Development Drives Leverage Higher
The expansion of Liberty's non-stabilized asset pool (primarily through development and, to a lesser extent, under-leased acquisitions) has increased the company's leverage to a level that is consistent with a 'BBB' IDR. Fitch expects leverage to sustain in the low 6.0x range through 2015.
Fitch estimates that Liberty's leverage would have been 6.1x pro forma for the company's recent acquisition of the Cabot Industrial Value Fund III Operating Partnership, L.P., compared with 6.0x, 4.9x and 4.7x as of Dec. 31, 2012, 2011 and 2010, respectively. Fitch defines leverage as net debt-to-recurring operating EBITDA, including Fitch's estimate of recurring cash distributions from joint ventures (JVs).
Fitch expects Liberty's leverage will increase in the near term, but remain in the low 6.0x range due to the previously announced $700 million sale of a portfolio of suburban office assets. The transaction will be dilutive to Liberty's earnings in 2014 until its development deliveries ramp up in the second half of the year, and due to the company using a portion of the proceeds to repay debt. The sale will close in two transactions. Liberty completed the first transaction, totaling $367.7 million on Dec. 24, 2013 and anticipates closing on the second in January 2014.
Increased Development Risk
Fitch expects Liberty to increase its development activities in 2014 and 2015 to a level where the estimated total cost of investments approaches the high single digits as a percent of undepreciated gross assets.
The company's development pipeline totaled 3.9% of gross assets at Sept. 30, 2013, down from 6.4% in sequential quarters due to the delivery of two large projects. Fitch expects Liberty to begin approximately $500 million of new developments over 2014 and 2015 with roughly two-thirds initiated on a speculative basis.
Liberty has earmarked a portion of the proceeds from the suburban office portfolio sales to repay maturing unsecured debt and help fund its 2014 development starts, effectively prefunding most of this year's development spending. Fitch views this positively as a risk mitigant, notwithstanding the near-term dilution to earnings that will hurt the company's leverage and coverage metrics until these developments stabilize.
Liberty's unfunded development commitments totaled 2.5% of undepreciated gross assets at Sept. 30, 2013. Fitch expects the company's funding obligation to increase to the mid-to-high single digits as a percentage of gross assets as its development platform grows during the next two years.
Fitch generally views Liberty's development franchise as a credit positive; however, Fitch is cautious about Liberty's plans to purchase land and/or begin developments in markets entered only recently via its acquisition of the Cabot portfolio.
The company has an established track record of development success that extends back to its founding. Liberty has developed over 64 million square feet through a combination of office, warehouse, hotel and mixed-use projects. The total includes 186 build-to-suit developments, which evidences the company's strong relationships with corporate clients. Liberty also has an expertise in LEED-certified development, with 61 projects completed or under construction.
Modest Internal Growth
Fitch anticipates only moderate same-store NOI growth during the next two years, despite strengthening industrial fundamentals. Fitch expects Liberty's same-store NOI to grow by 2% in 2014 and 3.5% in 2015, on a GAAP basis, as modest occupancy gains are partially offset by negative office leasing spreads. The company experienced 0.9% GAAP same-store NOI growth for the nine months ended Sept. 30, 2013 relative to the same period in 2012.
Dividend Coverage Shortfall
Fitch expects Liberty's common dividends to exceed 100% of its AFFO again in 2014. Dilution from the company's $700 million suburban office portfolio sales is the principal driver of the shortfall, notwithstanding the improvement in Liberty's portfolio property mix in favor of less capital intensive industrial assets.
Liberty's AFFO payout ratio was 98.1% for the nine months ended Sept. 30, 2013 and 102.5% and 96.6% for the years ended Dec. 31, 2012 and 2011, respectively. Fitch expects the company's payout ratio to exceed 100% for the full year ended 2013, primarily due to acquisition costs associated with the Cabot portfolio.
Cabot Strengthens Industrial Platform
Fitch views Liberty's acquisition of Cabot and subsequent sale of $700 million of suburban office and flex industrial assets as a credit positive.
The transaction is consistent with Liberty's strategy of increasing its ownership of industrial properties. The addition of Cabot's 177 properties, comprising 23 million industrial square feet, combined with the $700 million of suburban office dispositions, will increase Liberty's industrial property exposure (including flex space) to 81% of wholly-owned square feet from 73% at Sept. 30, 2013.
The company's exposure to suburban and metro office properties will drop to 19% of wholly-owned square feet from 27%.
The purchase also diversified Liberty's portfolio into 10 new markets, with Atlanta, Dallas/Ft. Worth and Cincinnati representing the three largest based on square feet. In total, 64 assets, comprising 9.6 million square feet, are located in markets new to Liberty. Fitch views this positively given greater geographic cash flow diversity for its portfolio in strategically important U.S. logistics markets.
The transaction will also deepen Liberty's ownership in 14 existing markets, with the United Kingdom, South Florida and the Baltimore/Washington, D.C. corridor representing the three largest increases based on square feet acquired relative to existing portfolio square feet in each respective market.
Coverage metrics are appropriate for the rating category. Fitch estimates that Liberty's coverage would have been 2.4x pro forma for the acquisition of the Cabot portfolio based on an annualized run rate of combined 3Q'13 results. This compares with 2.4x, 2.5x and 2.2x for the years ended Dec. 31, 2012, 2011 and 2010, respectively.
Fitch calculates fixed-charge coverage as recurring operating EBITDA, including the agency's estimate of recurring cash JV distributions, less recurring capital expenditures and straight-line rents, divided by total interest incurred and preferred operating unit distributions.
Adequate UA/UD Coverage
Fitch estimates Liberty's unencumbered asset coverage of unsecured debt (UA/UD) at 2.0x as of Sept. 30, 2013 pro forma for the acquisition of the Cabot portfolio. This level of coverage is adequate for the 'BBB' rating. The $700 million suburban office portfolio sale could weaken the company's UA/UD coverage to the high 1.0x's in the near term.
The magnitude of the decline will depend on the use of proceeds, which Fitch expects will include a mix of development funding and, potentially, the repayment of $200 million of unsecured notes that mature in August 2014. However, incremental NOI from development deliveries in 2014 and 2015 should bring the ratio back above 2.0x.
Fitch calculates UA/UD under a direct capitalization approach of unencumbered NOI that assumes a stressed 8.5% cap rate.
Conservative Leasing Profile
Liberty's portfolio lease maturity schedule is reasonably well balanced through 2018. On average, 12.6% of the company's average base rent (ABR) expires per year through 2018 with a max 13.4% of ABR expiring in 2016. These metrics exclude Cabot in the absence of disclosure; however, Fitch does not expect a meaningful change in Liberty's lease expiration profile, given the granularity of the Cabot portfolio.
In addition, no tenant represented more than 4% of annual base rent, and the top 10 tenants comprise only 17% of base rent as of Dec. 31, 2012.
Liquidity coverage, calculated as liquidity sources divided by uses, is 1.1x for the period Oct. 1, 2013 to Dec. 31, 2015. Sources of liquidity include unrestricted cash, availability under the company's unsecured credit facility, $700 million of net proceeds from the suburban office portfolio sale, and projected retained cash flows from operating activities after dividends and distributions. Uses of liquidity include the company's purchase of the Cabot Portfolio (closed on Oct. 8, 2013), debt maturities and projected recurring capital expenditures and development costs.
Liberty's debt maturities are reasonably well balanced. Including the company's share of JV debt, maturities average 8% through 2021 with a maximum of 17.8% maturing in 2016. The elevated amount of maturities in 2016 is partly due to $180 million of mortgage debt maturing. The maximum amount of unsecured debt maturing in a single year was 12.9% in 2020 as of Sept. 30, 2013, which Fitch views as manageable.
The company should have adequate capital access to refinance upcoming unsecured debt maturities given its demonstrated ability to access various forms of capital, including the company's $834 million equity raise in August 2013 and its $450 million unsecured notes offering in late September 2013.
The ratings also point to the strength of Liberty's management team, including senior officers and property and leasing managers. The company has successfully disposed of lower-growth assets such as secondary-market suburban office and flex properties and has acquired or is in the process of developing industrial distribution assets, which have exhibited stronger demand characteristics.
Preferred Stock Rating
The two-notch differential between Liberty's IDR and preferred stock rating is consistent with Fitch's criteria for corporate entities with an IDR of 'BBB'. Based on Fitch research on 'Treatment and Notching of Hybrids in Nonfinancial Corporate and REIT Credit Analysis', these preferred securities are deeply subordinated and have loss absorption elements that would likely result in poor recoveries in the event of a corporate default.
The following factors may result in positive momentum in Liberty's rating and/or Outlook:
--Fitch's expectation of leverage sustaining below 5.5x (leverage was 6.1x as of Sept. 30, 2013 on an annualized basis pro forma for the Cabot transaction);
--Fitch's expectation of fixed-charge coverage sustaining above 2.5x (pro forma coverage was 2.4x on an annualized basis for the quarter ended Sept. 30, 2013);
--UA/UD sustaining above 2.3x (UA/UD was 2.0x on a pro forma basis as of Sept. 30, 2013).
The following factors may result in negative momentum in Liberty's rating and/or Outlook:
--Fitch's expectation of leverage sustaining above 7.0x for several quarters;
--Fitch's expectation of fixed-charge coverage sustaining below 2.3x for several quarters;
--Fitch's expectation of an AFFO dividend payout ratio sustaining above 100%.
Additional information is available at 'www.fitchratings.com'.
Applicable Criteria and Related Research:
--'Treatment and Notching of Hybrids in Nonfinancial Corporate and REIT Credit Analysis' (Dec. 23, 2013);
--'Recovery Ratings and Notching Criteria for REITs' (Nov. 19, 2013);
--'Corporate Rating Methodology' (Aug. 5, 2013);
--'Criteria for Rating U.S. Equity REITs and REOCs' (Feb. 26, 2013);
--'Parent and Subsidiary Rating Linkage' (Aug. 5, 2013).
Applicable Criteria and Related Research:
Parent and Subsidiary Rating Linkage
Corporate Rating Methodology: Including Short-Term Ratings and Parent and Subsidiary Linkage
Criteria for Rating U.S. Equity REITs and REOCs
Recovery Ratings and Notching Criteria for Equity REITs
Treatment and Notching of Hybrids in Nonfinancial Corporate and REIT Credit Analysis ￢ﾀﾓ Effective Dec. 15, 2011 to Dec. 13, 2012
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