Business & Finance
Business and Finance
Business and Finance
Thu, March 24, 2011
Wed, March 23, 2011 Fitch Assigns Initial 'BBB' IDR to Essex Property Trust; Outlook Stable
NEW YORK--([ BUSINESS WIRE ])--Fitch Ratings has assigned initial credit ratings to Essex Property Trust, Inc. (NYSE: ESS) and its operating partnership, Essex Portfolio L.P. (collectively, Essex) as follows:
Essex Property Trust, Inc.
--Issuer Default Rating (IDR) 'BBB';
--Preferred stock 'BB+'.
Essex Portfolio L.P.
--Issuer Default Rating (IDR) 'BBB';
--$275 million unsecured revolving credit facility 'BBB';
--Senior unsecured notes (indicative rating) 'BBB'.
The Rating Outlook is Stable.
The ratings center on Fitch's expectation that ESS' near-to medium-term credit profile will be consistent with a rating of 'BBB'.
The ratings are supported by ESS' moderate leverage, consistent coverage of fixed charges, and strong unencumbered asset coverage of unsecured debt. Further supporting the ratings are the company's solid management team and long-term track record as astute operators and capital allocators in the multifamily sector.
ESS' ratings are further supported by its strategy of owning assets in supply constrained, high barrier to entry, West Coast markets. These markets tend to have high population density, proximity to solid job growth markets and high cost of for-sale single family housing, improving the demand drivers for multifamily housing.
For full year 2010, fixed charge coverage (defined as recurring operating EBITDA less Fitch's estimate of recurring capital improvements divided by interest incurred and preferred stock distributions) was 2.4 times (x), which is strong for the 'BBB' rating. Fixed charge coverage was 2.3x for the years ended Dec. 31, 2009 and 2008, respectively.
ESS' net debt to recurring operating EBITDA for the year ended Dec. 31, 2010 was 8.3x, up from 7.1x and 6.5x in 2009 and 2008, respectively. However, leverage is skewed higher by a substantial amount of recent acquisitions, which have yet to benefit EBITDA on a full year's basis. Fitch expects that upon a full year's contribution to EBITDA, leverage would be approximately 7.8x, which is appropriate for a 'BBB' rated multifamily REIT, given the degree of ESS' geographic concentration.
Further supporting the ratings is a high ratio of unencumbered assets to unsecured debt. Based on applying a 7.5% capitalization (cap) rate to annualized 2010 fourth quarter (4Q'10) unencumbered net operating income (NOI), ESS' unencumbered assets covered unsecured debt by 5.5x. However, the high coverage is driven by ESS' historical strategy of being primarily a secured borrower. ESS' only current unsecured debt is its revolving credit facility which had a balance of $176 million as of Dec. 31, 2010.
ESS has a manageable debt maturity schedule with just $157 million or 7% of total debt maturing from Jan. 1, 2011 through Dec. 31, 2012, excluding the unsecured revolving line of credit. Fitch calculates that ESS' sources of liquidity (unrestricted cash, availability under its unsecured revolving credit facility, expected retained cash flows from operating activities after dividend distributions) exceed uses of liquidity (pro rata share of debt maturities and expected recurring capital expenditures) by $92.4 million from Jan. 1, 2011 to Dec. 31, 2012, resulting in a liquidity coverage ratio of 1.4x, which is appropriate for the 'BBB' rating. The coverage ratio would rise to 3.7x, assuming 80% of secured debt is refinanced. Liquidity coverage adjusted for estimated remaining non-discretionary development costs of $54 million would be 1.1x assuming no refinancings and 2.2x assuming 80% of secured debt is refinanced.
The ratings are supported by a recent positive inflection in multifamily fundamentals in ESS' markets. ESS' same property net operating income (NOI) increased by 0.5% in 4Q'10 relative to 4Q'09, after six consecutive quarters of declining same property NOI. Fitch anticipates that fundamentals will continue to improve from current levels, due to moderate job growth, limited new supply and a high cost of for-sale single family housing in ESS' markets.
The ratings also point to the strength of ESS' long-tenured management team, including senior officers and property and leasing managers.
Offsetting these ratings strengths are the company's almost exclusive use of secured debt, geographically concentrated portfolio, active development pipeline and recent acquisitions of assets with large amounts of vacancy, and recent missteps in the utilization of forward-starting swap contracts.
ESS has a primarily secured debt profile; the only unsecured debt currently in the company's capital structure is ESS' unsecured revolving line of credit with $275 million total capacity, and a balance as of Dec. 31, 2010 of $176 million. That said, the unsecured line has characteristics similar to secured indebtedness, given that the company is required to maintain a pool of unencumbered assets as a borrowing base, with a value >1.67x the total line balance outstanding plus all other outstanding unsecured debt, based on a 6.75% cap rate. The borrowing base requirement is not common in other REIT unsecured credit facilities; it serves as a stronger form of a covenant and restricts management's ability to freely access its unencumbered pool.
The company is geographically concentrated in three primary markets, Southern California (48.9% of NOI), Northern California (San Francisco Bay Area) (32.1%) and the Seattle metro area (16.4%). As such, the company is exposed to fluctuations in these West Coast markets, which have lagged the broader multifamily fundamental recovery. Fitch rates California GO Bonds at 'A-'; Outlook Stable. While ESS has outperformed a market-weighted PPR index over the long term, Fitch notes the seismic risks of the state.
The company maintains an active development pipeline representing 4.6% of total assets as of Dec. 31, 2010. This ratio was as large as 20.5% of total assets in 1Q'08. That said, Fitch acknowledges the de-risking of the company's strategy and balance sheet by the reduction of its development exposure. The company has also recently acquired assets that require substantial lease-up, which places near-term pressure on leverage. The completion and lease-up of these assets generates uncertainty regarding timing of lease-up and returns on invested capital.
In order to minimize interest rate risk related to the long-term funding of the company's development pipeline and upcoming debt maturities, during 2006 and 2007 ESS entered into $355 million of forward starting swap contracts to lock in interest rates. However, due to the development pipeline being scaled back and interest rates trending lower in the past few years, the swaps proved to be ill-timed and were settled for a cash payment of $81.3 million during 2010. That charge increased the effective interest rate on subsequent mortgage financing to 6.8%, and will be reflected as non-cash amortization of financing costs to interest expense over the 10-year life of the mortgages. Therefore, there will be an approximate $8 million per year non-cash amortization charge reflected in interest expense for the next 10 years. Recent mortgage financings have been as low as sub 5%.
The two notch differential between ESS' IDR and its preferred stock credit rating is consistent with Fitch's criteria for corporate entities with a 'BBB' IDR. Based on Fitch's criteria report ('Equity Credit for Hybrids & Other Capital Securities'), ESS' preferred stock is 75% equity-like and 25% debt-like since it is perpetual and has no covenants but has a cumulative deferral option in a going concern. Net debt plus 25% of preferred stock to recurring EBITDA was 8.4x as of Dec. 31, 2010, compared to 7.2x as of Dec. 31, 2009.
The following factors may have a positive impact on the ratings and/or Outlook:
--Net debt to recurring operating EBITDA sustaining below 7.0x (as of Dec. 31, 2010 leverage was 8.3x);
--Fixed charge coverage sustaining above 3.0x (as of Dec. 31, 2010, coverage was 2.4x);
--Consistent access to the unsecured bond market;
--Increased size and geographic diversity of portfolio.
The following factors may have a negative impact on the ratings and/or Outlook:
--Leverage sustaining above 8.0x;
--Coverage sustaining below 2.0x;
--If operating fundamentals relapse similar to the environment of 2009, rather than improve as currently expected;
--A liquidity shortfall.
Essex Property Trust is a multifamily REIT that acquires, develops, redevelops, and manages apartment communities in supply-constrained markets. The company went public in 1994 and currently has ownership interests in 147 apartment communities, and has an additional two properties in various stages of development.
Additional information is available at [ www.fitchratings.com ].
Applicable Criteria and Related Research:
--Criteria for Rating U.S. Equity REITs and REOCs, March 15, 2011;
--Corporate Rating Methodology, Aug. 16, 2010;
--Equity Credit for Hybrids & Other Capital Securities - Amended, Dec. 29, 2009;
--Rating Hybrid Securities, Dec. 29, 2009
--Recovery Rating and Notching Criteria for REITs, Dec. 23, 2009.
Applicable Criteria and Related Research:
Criteria for Rating U.S. Equity REITs and REOCs
[ http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=610687 ]
Corporate Rating Methodology
[ http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=546646 ]
Equity Credit for Hybrids & Other Capital Securities - Amended
[ http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=493112 ]
Rating Hybrid Securities
[ http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=493086 ]
Recovery Rating and Notching Criteria for REITs
[ http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=492828 ]
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