NEW YORK--(BUSINESS WIRE)--Fitch Ratings has affirmed the credit ratings for Home Properties, Inc. and Home Properties, L.P. (NYSE: HME; together Home) as follows:
Home Properties, Inc.
--Issuer Default Rating (IDR) at 'BBB'.
Home Properties, L.P.
--IDR at 'BBB';
--Unsecured revolving credit facility at 'BBB';
--Senior unsecured notes at 'BBB';
--Senior unsecured term loan at 'BBB'.
The Rating Outlook has been revised to Positive from Stable.
KEY RATING DRIVERS & POSITIVE OUTLOOK
The ratings reflect Home's key credit strengths, namely its durable operating performance along with leverage and fixed charge coverage metrics that are expected to remain strong for the rating through the cycle. These positive elements are balanced by a capital structure that is still predominantly Fannie Mae and Freddie Mac-led (the GSEs) secured debt and untested access to the public unsecured bond markets. The Positive Outlook is predicated on Home continuing to unencumber its portfolio and demonstrating access to the public unsecured bond market over the next 12-to-24 months, which combined, would result in a more mature capitalization consistent with the higher rating.
STILL DEVELOPING CAPITAL MARKETS ACCESS
The largest ratings constraint is the sizable percentage of secured debt in HME's capital structure (though Fitch notes the company's progress over the past few years) and its untested access to the public unsecured bond market. At March 31, 2014, GSE debt comprised 26% of total enterprise value and 70% of all debt outstanding. Home's dependence upon secured debt and bank debt is a differentiating factor between Home and its higher-rated REIT peers. Demonstrated access to the public unsecured bond markets would materially improve the company's capital access, funding options and liquidity and is one driver of potential positive rating momentum. The revision of the Rating Outlook to Positive from Stable is driven in large part by Fitch's expectation that HME will demonstrate access to the public bond market and reduce secured debt to 50% of total debt over the next 12-to-24 months.
DURABLE OPERATING CASHFLOWS
HME's portfolio performance, measured by same-store net operating income (SSNOI) growth and occupancies, has been strong on an absolute and relative basis to both its public peers and markets. Since 2001, HME has averaged SSNOI growth of 3.9% that troughed at -1.1% in 2003 and was flat during the most recent recession. This compares favorably to the REIT peer group which averaged lower annual growth (1.9%), troughed at -6.2% in 2003 and declined -4.7% in 2009. Further, HME's cash flow durability has not come at the expense of upside potential as HME's highest annual growth rate (8.1%) has been within 100bps of its peers' average of 9%. Fitch notes that HME's same-store portfolio benefits from the company's rehabilitation strategy and expenditures. Due to the short turnaround and unit-by-unit nature of the program, assets are not removed from the same-store pool, thus some of the growth is attributable to the asset improvements.
Fitch expects national multifamily operating fundamentals will continue to moderate from recent highs as supply increases and rental affordability and rent-versus-buy dynamics shift in favor of home ownership. However, the effects of moderation will be more muted for Home as many of its tenants are renters by necessity and do not ultimately envision owning a home. Fitch's forecasts assume HME's SSNOI growth will moderate to 3% through 2016 from 4% and 8.1% in 2013 and 2012, respectively.
HME's operating performance runs counter to the notion that older, lower quality, lower rental-rate multifamily properties exhibit lower growth. The focus on tenants that rent by necessity and are often lifelong renters has resulted in lower tenant turnover (typically in the 30%-40% range as opposed to the 50%-60% range for other multifamily REITs), lower property performance volatility, and generally flat-to-positive net operating income (NOI) growth, all of which are credit positives.
STRONG CREDIT METRICS
HME's leverage and fixed charge coverage metrics have consistently improved since 2010, are appropriate for a 'BBB+' IDR, and can be maintained through-the-cycle in Fitch's view. Leverage was 5.9x for the trailing 12 months (TTM) ended March 31, 2014 and Fitch anticipates continued improvement to the mid-5.0x range through 2016, driven primarily by low single-digit SSNOI growth. This compares favorably to leverage of 7.2x and 8.2x for the years ended Dec. 31, 2012 and Dec. 31, 2011, respectively. Fitch defines leverage as net debt-to-TTM recurring operating EBITDA.
HME's fixed charge coverage has seen a similar improvement, rising to 3.1x for the TTM ended March 31, 2014, compared with 2.6x and 2.1x for the years ended Dec. 31, 2012 and Dec. 31, 2011, respectively. Fitch anticipates fixed charge coverage will improve to the mid-to-high 3.0x range through 2016. Fitch defines fixed charge coverage as recurring operating EBITDA less recurring capital expenditures divided by total interest incurred.
HME's ratings are also supported by its strong unencumbered asset coverage of unsecured debt and manageable dividend distributions. Fitch estimates unencumbered assets cover unsecured debt obligations by 3.9x assuming a stressed 8.5% capitalization rate. Fitch expects that unencumbered asset coverage would decline to 2.5x-3.0x through 2016 should HME refinance mortgage maturities with unsecured debt, which would remain appropriate for the ratings.
Additionally, Home has kept its AFFO dividend payout ratio (dividends divided by adjusted funds from operations) between 75% to 85%, allowing the company to retain some operating cashflow ($67 million in 2013 and $37 million for 1Q'14 annualized, which was impacted by the dividend increase and 1Q'14 weather-related increase in operating expenses).
HME's liquidity coverage ratio is appropriate for the ratings at 1.3x for the period April 1, 2014 through Dec. 31, 2015. Coverage improves materially to 3.0x assuming 80% of secured debt is refinanced; however, Fitch views this as less likely given HME's plans to continue unencumbering the portfolio. Driving the appropriate liquidity coverage is HME's generally well-staggered debt maturities as only 11.2% of debt matures through 2015 and 9.9% maturing per year on average. Debt maturities are somewhat concentrated in 2018 when $90 million of private placement notes and the $250 million term loan mature.
The following factors may result in positive momentum in HME's ratings and/or Outlook:
--Reduced reliance on secured debt and demonstrated access to the public unsecured bond markets;
--Fitch's expectation of net debt-to-recurring operating EBITDA sustaining below 6.5x (leverage was 5.9x for TTM ended March 31, 2014);
--Fitch's expectation of fixed-charge coverage sustaining above 3.0x (coverage was 3.1x for the TTM ended March 31, 2014).
The following factors may result in negative momentum in HME's ratings and/or Outlook:
--Fitch's expectation of leverage sustaining above 8.0x;
--Fitch's expectation of fixed-charge coverage sustaining below 2.0x;
--Fitch's expectation of a liquidity shortfall.
Additional information is available at 'www.fitchratings.com'.
Applicable Criteria and Related Research:
--'Corporate Rating Methodology: Including Short-Term Ratings and Parent and Subsidiary Linkage' May 28, 2014;
--'Rating U.S. Equity REITs and REOCs: Sector Credit Factors' Feb. 26, 2014;
--'Recovery Ratings and Notching Criteria for Equity REITs' Nov. 19, 2013.
Applicable Criteria and Related Research:
Recovery Ratings and Notching Criteria for Equity REITs
Criteria for Rating U.S. Equity REITs and REOCs
Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage