NEW YORK--(BUSINESS WIRE)--Fitch Ratings has assigned a 'BBB+' credit rating to Essex Portfolio, L.P.'s $500 million senior unsecured notes that priced on March 10, 2015. A full list of Fitch's ratings for Essex Property Trust, Inc. (NYSE: ESS) and its operating partnership, Essex Portfolio, L.P. (collectively, Essex or the company) follows at the end of this release.
On March 10, 2015, Essex Portfolio, L.P. priced $500 million aggregate principal amount of 10-year senior unsecured notes at a stated interest rate of 3.5%. The notes mature on April 1, 2025 and were priced at 99.747% of par value, resulting in a yield to maturity of 3.53%. The operating partnership expects to use net proceeds to repay indebtedness under its lines of credit and for general corporate purposes.
KEY RATING DRIVERS
Fitch's ratings for Essex consider the company's strong multifamily portfolio position within key densely populated and supply constrained markets in Northern and Southern California and Seattle. These markets have favorable demographics that include vibrant and growing labor markets and above average household income levels, as well as high homeownership costs that drive demand for multifamily apartments. Moreover, Fitch views the company's management team as being among the strongest in the multifamily REIT sector based on its track record of superior asset management and capital allocation.
Elevated, but improving leverage for the rating (primarily due to its merger with BRE Properties, which closed on April 1, 2014), geographic portfolio concentration risk and development risk are factors that balance these credit positives.
The Stable Rating Outlook reflects Fitch's expectation that Essex will de-lever over the near-to intermediate term.
Fitch expects Essex's leverage to moderate to below 7.0x in the first-half of 2015 and sustain in the high 6.0x-range through 2016. Same store net operating income (SSNOI) growth, incremental NOI from development deliveries and opportunistic share issuances under the company's at-the market (ATM) equity program are the principal drivers that support Fitch's leverage projections.
The company's leverage increased towards the mid-7.0x range as a result of its merger with BRE properties - up from 6.8x standalone as of Sept. 30, 2013 - the last full quarter prior to the merger announcement. Sustaining leverage above 7.0x remains a key rating sensitivity that could warrant a downgrade and/or negative revision of ESS' Rating Outlook.
ESS' leverage was 7.1x at Dec. 31, 2014, which is moderately below the company's 7.3x and 7.4x leverage during 2013 and 2012, respectively. Fitch defines leverage as debt less readily available cash to recurring operating EBITDA including recurring distributions from joint ventures.
Strong Internal Growth
Fitch expects ESS' SSNOI to grow by 8% during 2015, led by strength in its Northern California portfolio. Strong market demographics and portfolio management should continue to drive the company's SSNOI growth and allow for material organic de-levering.
The company has exhibited strong operating performance as measured by SSNOI growth and occupancy rates on an absolute and relative basis during this recovery. SSNOI growth was 9.2% in 2014, up from 7.4% in 2013, marking the fourth straight year of growth above 5.5%. Essex has maintained same-store occupancy within a range of 96% - 97% during the past five years.
ESS has a manageable debt maturity schedule with only 9% of total debt (including pro rata share of JV debt) maturing during the next two years. Fitch estimates that ESS has a liquidity coverage ratio of 1.5x through Dec. 31, 2016. Fitch defines REIT liquidity coverage as sources of liquidity (unrestricted cash, availability under ESS' unsecured revolving credit facility, and expected retained cash flows from operating activities after dividends) divided by uses of liquidity (pro rata share of debt maturities, remaining development / redevelopment expenditures and expected recurring capital expenditures).
Fitch estimates that ESS' unencumbered asset coverage of unsecured debt (UA/UD) was 2.2x at Dec. 31, 2014. Fitch calculates UA using a direct capitalization approach of annualized 4Q'14 unencumbered NOI using a stressed 7.5% capitalization rate. ESS' UA/UD is adequate for the rating.
Strong Fixed Charge Coverage
Fitch expects ESS' fixed-charge coverage to sustain in the low 3.0x range through 2016. The company's FCC was 3.2x during 2014, which was in-line with 2013, but down from 3.6x in 2012. Fitch defines fixed-charge coverage as recurring operating EBITDA less recurring capital improvements divided by interest incurred and preferred distributions.
The company maintains an active development pipeline with remaining costs to complete the pipeline of $420 million (pro rata for ESS' ownership percentage of joint ventures where the majority of the projects reside). However, ESS has begun to taper its development activities in light of the strong recovery in apartment fundamentals, which has lowered the risk adjusted returns from development, generally.
Remaining funding represents 3.2% of gross assets as of Dec. 31, 2014, compared with 7.3% at the end of 2013 and the company's 11.2% cycle peak in 2Q'12. Fitch expects this ratio to sustain in the 3% range over the next two years as the company finishes the build out of its current pipeline. Fitch views ESS' willingness to dial-back development risk in the face of strong multifamily operating fundamentals as evidence of the company's commitment to maintaining a conservative balance sheet.
The company is geographically concentrated in three primary markets: Southern California (44% of NOI), San Francisco Bay Area (38%), and the Seattle metropolitan area (18%). As such, the company is more heavily exposed to fluctuations in only a few markets. Fitch also notes the seismic risk present in California.
Fitch currently rates Essex as follows:
Essex Property Trust, Inc.
--Issuer Default Rating 'BBB+';
--Preferred Stock 'BBB-'.
Essex Portfolio L.P.
--Issuer Default Rating 'BBB+';
--Unsecured Line of Credit 'BBB+';
--Senior Unsecured Notes 'BBB+'.
--ESS reduces its leverage to below 7.0x, consistent with targeted financial policy prior to its merger with BRE Properties, Inc.;
--ESS continues to unencumber properties as its mortgages mature;
--Development starts are counter-cyclically reduced in the near-to-medium term;
--ESS capitalizes on BRE merger synergies related to asset and portfolio management, and corporate and financing expenses;
--The company's Northern California and Seattle markets continue to show above average employment growth, due to their outsized exposure to tech industry companies; and
--Moderate improvement in the company's Southern California markets, which have lagged during this economic recovery.
The Stable Outlook is driven by Fitch's expectations that positive multifamily fundamentals in ESS' markets combined with declining leverage and stable coverage will support credit metrics that are consistent with the rating.
Preferred Stock Notching
The two-notch differential between ESS' IDR and preferred stock rating is consistent with Fitch's criteria for corporate entities with a 'BBB+' IDR. 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 a negative revision of ESS' ratings and/or Outlook:
--Fitch's expectation of leverage sustaining above 7.0x (Leverage was 7.1x at Dec. 31, 2014);
--Fitch's expectation of fixed-charge coverage sustaining below 2.5x (Coverage was 3.2x at Dec. 31, 2014);
--Fitch's expectation of UA/UD sustaining below 2.0x (UA/UD was 2.2x on a pro forma basis as of Dec. 31, 2014).
Although Fitch does not anticipate any upwards rating momentum, the following factors could result in a positive revision to ESS' ratings and/or Outlook:
--Fitch's expectation of leverage sustaining below 6.0x;
--Fitch's expectation of fixed-charge coverage sustaining above 3.5x;
--UA/UD sustaining above 3.0x.
Additional information is available at 'www.fitchratings.com'.
Applicable Criteria and Related Research:
--'Essex Property Trust, Inc. Rating Navigator' (Feb. 26, 2015);
--'Treatment and Notching of Hybrids in Nonfinancial Corporate and REIT Credit Analysis' (Nov. 25, 2014);
--'Recovery Rating and Notching Criteria for Equity REITs' (Nov. 18, 2014);
--'Corporate Rating Methodology: Including Short-Term Ratings and Parent and Subsidiary Linkage' (May 28, 2014).
Applicable Criteria and Related Research:
Essex Property Trust, Inc. - Ratings Navigator
Treatment and Notching of Hybrids in Nonfinancial Corporate and REIT Credit Analysis - Effective Dec. 13, 2012 to Dec. 23, 2013
Recovery Rating and Notching Criteria for Equity REITs ￢ﾀﾓ Effective May 12, 2011 to May 3, 2012
Corporate Rating Methodology: Including Short-Term Ratings and Parent and Subsidiary Linkage