NEW YORK--(BUSINESS WIRE)--Fitch Ratings has upgraded the credit ratings of Highwoods Properties, Inc. (NYSE: HIW) and its operating partnership, Highwoods Realty Limited Partnership, (collectively Highwoods, or the company) as follows:
Highwoods Properties, Inc.
--Issuer Default Rating (IDR) to 'BBB' from 'BBB-';
--Preferred stock to 'BB+' from 'BB';
Highwoods Realty Limited Partnership
--IDR to 'BBB' from 'BBB-';
--Senior unsecured lines of credit to 'BBB' from 'BBB-';
--Senior unsecured term loans to 'BBB' from 'BBB-';
--Senior unsecured notes to 'BBB' from 'BBB-'.
The Rating Outlook is Stable.
KEY RATING DRIVERS
The upgrade reflects Highwoods' improved credit metrics to levels consistent with a 'BBB' rated office REIT. HIW's credit profile also benefits from a well-positioned real estate 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. Highwoods also has adequate financial flexibility and strong contingent liquidity provided by unencumbered assets, which cover unsecured debt by 2.2x assuming a stressed 9% cap rate.
These strengths are tempered by uneven operating fundamentals and a base case liquidity shortfall driven by elevated utilization under the line of credit and high adjusted funds from operations (AFFO) payout ratio.
APPROPRIATE CREDIT METRICS
Leverage improved to 5.7x at Dec. 31, 2013 from 6.0x at Dec. 31, 2012 and 6.7x at Dec. 31, 2011. Leverage is expected to increase to approximately 6.0x in 2014 as the company increases debt to fund its 86% pre-leased development pipeline, and stabilize around 6.0x over the longer term, appropriate for the ratings. Fitch defines leverage as net debt-to-recurring operating EBITDA.
Fixed charge coverage improved to 2.5x for the trailing 12 months (TTM) ended Dec. 31, 2013, driven in part by higher balances on the line of credit, compared to 2.3x in 2012 and 2.0x in 2011. Fitch expects that coverage will sustain in the mid-to-high 2.5x range over the next 12-24 months, driven by low-single digit same-store NOI (SSNOI) growth, incremental cash flow from development completions and value-add acquisitions, and continued access to debt capital at favorable rates. Fitch defines FCC as recurring operating EBITDA, less recurring capital expenditures and straight-line rent adjustments, divided by total interest incurred and preferred dividends.
IMPROVED ASSET QUALITY
HIW's portfolio is concentrated in secondary markets such as Raleigh, where the company is headquartered, Atlanta, Nashville and Tampa. However, the company targets premier submarkets that have historically outperformed the broader respective markets. SSNOI grew at a 0.8% average annual pace from 2006-2013, which is 100 basis points above a weighted average sample of HIW's markets during that time, per Portfolio and Property Research. The company has also improved asset quality within these submarkets - Class A properties now comprise 73% of the portfolio compared to 38% at year-end 2004.
FAVORABLE TENANT PROFILE
Highwoods has a diverse tenant base with no tenant aside from the Federal Government (6.4% of cash rent) contributing more than 1.8%. Additionally, 10 of the top 20 tenants are rated investment grade by Fitch and collectively contribute only 25.1% of cash revenue. The tenant base is also well-diversified by industry; no industry represents more than 12% of cash revenue aside from the professional, scientific and technical services industry - there is concentration here due to Highwoods' presence in Raleigh, Durham, and Chapel Hill, commonly known as the 'Research Triangle.' The general granularity of HIW's tenant base is a credit positive.
NEGATIVE CASH RENT SPREADS
The cash rent trend for HIW's office portfolio has been negative - rent spreads declined 7.3% in 2013 - as rent escalated leases expire and new leases commence. Despite these rolldowns, the weighted average rental rate across the portfolio increased 3% year-over-year given annual rent escalators and higher in-place rents on acquisitions. Contractual rent increases and longer tenors on new leases drove office GAAP leasing spreads of positive 5.2% during 2013.
PRE-LEASING MITIGATES DEVELOPMENT RISK
The cost to complete Highwoods' development pipeline grew to 3.7% of gross assets at Dec. 31, 2013, an increase from 0.8% and 1.2% over the prior two years, respectively, driven by the $110 million build-to-suit project for Met Life in Raleigh. High pre-lease rates (the pipeline is currently 86% pre-leased) mitigate the risk from growth in Highwoods' unfunded development commitments by reducing leasing risk inherent in the development business.
MINIMAL NEAR-TERM REFINANCING RISK
Only 6.1% of pro rata debt matures on average over the next three years and Highwoods does not face any unsecured debt maturities until 2017, which limits corporate refinancing risk. Fitch expects that the company will refinance $133 million of 2014 mortgage maturities with new unsecured debt. In the event that the unsecured market was inhospitable, adequate in-place debt yields averaging 15.7% through 2016 support new mortgage refinancing.
BASE CASE LIQUIDITY SHORTFALL
HIW's projected sources of liquidity cover uses of liquidity by only 0.8x for the 2014-2015 period, leading to a $100 million deficit. Fitch expects that the shortfall will be cured by asset sales and unsecured debt/equity issuance under the company's $250 million at-the-market equity program. Further, HIW's $3.2 billion unencumbered asset pool (based on a stressed 9% cap rate) can provide liquidity in a more challenged capital markets environment.
ELEVATED LINE OF CREDIT USAGE
The liquidity shortfall is driven in part by a $216 million balance on the $475 million line of credit (45% drawn) at Dec. 31, 2013 that matures in 2018, which is nearly double the 23% REIT average at the same period. Highwoods has also maintained higher utilization historically - the line was 35% drawn on average since 2006 compared to 30% for the broader REIT sector. Fitch does not expect the elevated balance to impact credit quality in the near term given an accommodating capital markets environment; however, the company's liquidity deficit would be materially amplified in a less hospitable debt financing market similar to late 2008-2009.
AFFO PAYOUT RATIO IMPROVING
Highwoods' AFFO payout ratio improved to 95.3% in 2013 from 98.6% in 2012 and 106.2% in 2011. Fitch expects the ratio to further improve in 2014 as development completions and value-add acquisitions contribute incremental cash flow. That being said, the high payout ratio limits Highwoods' ability to generate internal liquidity (less than $10 million in 2013). Sustaining 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:
--Fitch's expectation of leverage sustaining below 5.5x (leverage at Dec. 31, 2013 was 5.7x);
--Maintaining a fixed charge coverage ratio above 2.5x (fixed charge coverage was 2.5x for the TTM ended Dec. 31, 2013);
--Unencumbered asset coverage of unsecured debt assuming a stressed 9% cap rate above 2.5x (coverage is currently 2.2x).
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 2.0x;
--Fitch's expectation of leverage sustaining above 6.5x.
Additional information is available at 'www.fitchratings.com'.
Applicable Criteria and Related Research:
--'Rating U.S. Equity REITs and REOCs (Sector Credit Factors) (Feb. 26, 2014);
--'Treatment and Notching of Hybrids in Nonfinancial Corporate and REIT Credit Analysis' (Dec. 23, 2013);
--'Recovery Ratings and Notching Criteria for Equity REITs' (Nov. 19, 2013);
--'Corporate Rating Methodology' (Aug. 5, 2013);
--'Parent and Subsidiary Rating Linkage' (Aug. 5, 2013).
Applicable Criteria and Related Research:
Parent and Subsidiary Rating Linkage Fitch's Approach to Rating Entities within a Corporate Group Structure
Rating U.S. Equity REITs and REOCs (Sector Credit Factors)
Treatment and Notching of Hybrids in Non-Financial 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