NEW YORK--(BUSINESS WIRE)--Fitch Ratings has affirmed the ratings for Liberty Property Trust (NYSE: LPT) and its operating subsidiary Liberty Property Limited Partnership, including the Long-Term Issuer Default Rating (IDR) at 'BBB'. A full list of rating actions follows at the end of this release.
KEY RATING DRIVERS
The ratings reflect Liberty's appropriate leverage and fixed-charge coverage (FCC) for a 'BBB' rated REIT with the company's asset profile. Moderate liquidity pressure, partly due to Liberty's growing but manageable development pipeline, and a persistent high AFFO payout ratio balance the positive rating elements.
Appropriate Leverage & Coverage
Fitch expects Liberty's leverage to sustain between 5.5x - 6.0x through 2018, although leverage could migrate outside of that range by 2016-end, depending on the timing of asset sales. Asset sales proceeds should offset the expansion of Liberty's development pipeline and non-stabilized asset pool (primarily through development and, to a lesser extent, under-leased acquisitions) and keep the company's leverage within a range consistent with a 'BBB' IDR.
The company's leverage was 5.7x as of March 31, 2016 compared to 5.7x and 5.8x for the years ended 2015 and 2014, respectively. Fitch defines leverage as debt, net of Fitch-estimated readily available cash over recurring operating EBITDA, including recurring cash distributions from joint ventures (JVs). The inclusion of 50% of preferred units as debt, consistent with Fitch's hybrids criteria, has an immaterial impact on the company's leverage metrics.
Fitch expects Liberty's fixed-charge coverage (FCC) to sustain in the mid-to-high 2x range, which is appropriate for the rating. The company's FCC was 2.8x for the TTM ended March 31, 2016 in comparison to 2.8x, 2.6x and 2.5x for the years ended 2015, 2014 and 2013, respectively. Fitch calculates FCC 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.
Increasing Development Pipeline
Liberty has expanded the scope of its development activities, in tandem with the recent U.S. economic cycle. Liberty had 6.3 million square feet of wholly-owned development under construction as of March 31, 2016, representing a total estimated investment of $603.8 million (7.9% of gross assets). The projects were 48.7% pre-leased and had remaining funding requirements of $215 million (2.8% of gross assets). Liberty's development exposure as measured by cost-to-complete to gross assets has grown from a 0.9% cycle low in 2012 and is towards the high end of its mid-2% trend range since 2013. Fitch expects LPT to have a low single-digit development exposure, and expects development yields in the high single digits.
Fitch views Liberty's increased development exposure as a modest net positive given the market's current position in the commercial real estate cycle and supply/demand fundamentals in Liberty's markets. While growth in e-commerce demand (primarily big-box) is outpacing GDP growth, it represents an incremental and underserved form of demand that should be sustainable for the foreseeable future. Fitch expects Liberty to begin approximately $500 to $700 million of new developments during 2016 with roughly two-thirds initiated on a speculative basis. Asset sales (predominantly from within the company's remaining suburban office portfolio) will likely represent the company's principal source of development funding.
Repositioning Should Improve Portfolio
Liberty's repositioning strategy will improve its portfolio by establishing a national industrial footprint, combined with sharpening its focus on office properties in a few key, core metro markets. Since a repositioning announcement in 2013, the company has grown its industrial platform, via development and portfolio acquisitions. The company has focused its operations in 24 US and UK markets and has also sold 18.8 million square feet of suburban office and high finish flex product, exiting 10 markets at over $2 billion of dispositions.
Fitch views this repositioning strategy as positive, presuming it is fully executed. The strategy will enhance asset value and drive improved long-term cash flow growth and stability, as it should reduce the amount of recurring capex incurred for suburban office properties.
Moderate Liquidity Pressure
Fitch's stressed liquidity analysis shows Liberty's uses of cash exceeding its internally generated sources of cash for the period April 1, 2016 to Dec. 31, 2017. Unsecured bond maturities and elevated development funding commitments are the principal uses of Liberty's cash during the next two years. Fitch estimates the company's liquidity coverage improves to 0.7x from 0.6x if the company refinances 80% of maturing mortgage debt. Fitch expects the company will fund its development pipeline and some debt maturities with asset sales, which would mitigate the liquidity shortfall but introduces execution risk should the timing of asset sales not be sufficient to fund development.
Conservative Leasing Profile
Liberty's lease maturity schedule is reasonably well balanced through 2021. On average, leases representing 11.2% of the company's wholly-owned base rent (ABR) expire per year through 2021 with a maximum of 14.4% of base rents expiring in 2017. Fitch expects Liberty's average occupancy to increase by 1% to 2% during 2016 to 2018, due to strength in its industrial portfolio, offset by modest occupancy losses in its office portfolio.
Fitch expects Liberty's rents to grow by 1% to 4%, on average, during 2016 on a GAAP basis, with mid-to-low single-digit-negative suburban office lease spreads partially offsetting positive mid-single-digit industrial rent spreads and low-single-digit flex property spreads.
Modest Internal Growth
Fitch anticipates only moderate same-store NOI growth during the next two years, despite strengthening industrial fundamentals. Fitch expects Liberty's GAAP same-store NOI to be flat to up 3% in 2016, and to remain in the mid-3% range for 2017 and 2018, as the company disposes of most of its office portfolio. Liberty's SSNOI change was 2.1% for the quarter ended March 31, 2016 and 2.4%, -1%, 1.3% and -0.8% for the years ended Dec. 31, 2015, 2014, 2013 and 2012, respectively.
Slightly Low UA/UD Coverage
Fitch estimates Liberty's unencumbered asset coverage of unsecured debt (UA/UD) at 1.9x as of March 31, 2016. This level of coverage is slightly low for the 'BBB' rating, where most Fitch-rated REITs have coverage exceeding 2.0x. Fitch calculates UA/UD under a direct capitalization approach of unencumbered net operating income (NOI) that assumes a stressed 8.5% cap rate.
Weak Dividend Coverage
Liberty's AFFO payout ratio was 95.6% for the TTM ended March 31, 2016 and 94% and 98.5% for the years ended Dec. 31, 2015 and 2014, respectively. The company continues to reduce its exposure to commodity suburban office properties in favor of less capital intensive industrial assets and metro/CBD office (i.e. Philadelphia and Washington, D.C.). Although the REIT model is not reliant on internally generated cash flow as a source of funds, Fitch generally views persistently high AFFO payout ratios as a weakness in corporate governance that is evidence of a focus on shareholders over bondholders.
Cycle-Tested Management; Some Shareholder-Friendly Actions
The ratings also reflect the strength of Liberty's management team, including senior officers and property and leasing managers. The company has upgraded its portfolio historically by selling lower-growth assets, such as secondary-market suburban office and flex properties. Liberty has used the proceeds to acquire and develop industrial distribution assets, which have exhibited stronger demand characteristics and are less capital intensive. These positives are offset in part by shareholder-friendly activities, such as a persistently high AFFO payout ratio and recently engaging in share buybacks, both to the detriment of unsecured bondholders.
Preferred Stock Notching
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 Stable Outlook reflects Fitch's expectation that Liberty's credit metrics will remain consistent for the 'BBB' rating over the rating horizon.
Fitch's key assumptions within our rating case for the issuer include:
--SSNOI growth of 2% during 2016, 2017 and 2018;
--Land acquisitions of $50 million per year during through 2018;
--Development spending of $550 million in 2016 and $450 million in 2017 and 2018;
--Development deliveries of $400 million per year through 2018 at yields of 7%;
--Dispositions of $1 billion during 2016 and $300 million in 2017 and $200 million in 2018 at an average cap rate of 8.3%;
--No unsecured bond issuance during 2016 and $400 million in 2017 and $300 million in 2018;
--No equity issuance.
The following factors may result in positive momentum in the rating and/or Outlook:
--Fitch's expectation of leverage sustaining below 5.5x (leverage was 5.7x as of March 31, 2016);
--Fitch's expectation of FCC sustaining above 3.0 (FCC was 2.8x for the TTM ended March 31, 2016);
--UA/UD sustaining above 2.3x (UA/UD was 1.9x as of March 31, 2016).
The following factors may result in negative momentum in the rating and/or Outlook:
--Fitch's expectation of leverage sustaining above 7x for several quarters;
--Fitch's expectation of FCC sustaining below 2.3x for several quarters;
--Fitch's expectation of an AFFO dividend payout ratio sustaining above 100%.
FULL LIST OF RATING ACTIONS
Fitch has affirmed the following ratings:
Liberty Property Trust
--IDR at 'BBB'.
Liberty Property Limited Partnership
--IDR at 'BBB';
--Unsecured revolving credit facility at 'BBB';
--Medium-term notes at 'BBB';
--Senior unsecured notes at 'BBB';
--Preferred operating units at 'BB+'.
The Rating Outlook is Stable.
Summary of Financial Statement Adjustments - Financial statement adjustments that depart materially from those contained in the published financial statements of the relevant rated entity or obligor are disclosed below:
--Historical and projected recurring operating EBITDA is adjusted to add back non-cash stock based compensation and include operating income from discontinued operations;
--Fitch has adjusted the historical and projected net debt by assuming the issuer requires $25 million of cash for working capital purposes that is otherwise unavailable to repay debt;
--Fitch has included 50% of the company's preferred operating units as debt.
Additional information is available on www.fitchratings.com.
Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage (pub. 17 Aug 2015)
Treatment and Notching of Hybrids in Non-Financial Corporate and REIT Credit Analysis (pub. 29 Feb 2016)
Dodd-Frank Rating Information Disclosure Form