November 27, 2017 / 7:16 AM / 2 years ago

Fitch Assigns First-Time 'BB+(EXP)' IDR to Emirates REIT with a Stable Outlook

(The following statement was released by the rating agency) LONDON, November 27 (Fitch) Fitch Ratings has assigned a Long-Term Issuer Default Rating of 'BB+ (EXP)' with a Stable outlook to UAE-based Emirates REIT. The expected ratings reflect Fitch's expectation that the company will successfully issue the sukuk and refinance all existing secured credit facilities. Fitch will assign final ratings once the company completes the refinancing and repays all secured debt. If the sukuk is not issued, or is issued under materially different terms than we have assumed, Fitch would need to re-examine the rating. The Stable Outlook reflects expectations of the Index Tower achieving higher tenancy levels, boosting overall occupancy rates and EBITDA margins, as well as of management's ability to prudently expand the portfolio beyond EUR1.5 billion (USD1.76 billion), reducing asset concentration. KEY RATING DRIVERS High-Quality, Relatively Small Portfolio: Emirates REIT owns 10 properties in Dubai with a leasable area of 2.2 million square feet (sqf) and a value of USD845 million as of September 2017. Fitch views the portfolio as relatively low risk with high-quality properties located in prime locations, although Emirates REIT is exposed to its largest asset, the Index Tower office, which accounts for 37% of the portfolio's value. Its properties are a combination of commercial and the education assets, striking a good balance between rental income growth and stability. The average lease maturity for commercial assets is relatively short at one to three years, depending on the unit type. This is mitigated by the education assets, which have long lease maturities of more than 25 years. Low, but Increasing Occupancy: The total occupancy of the portfolio stood at 84% as of September 2017, which is low compared to other rated REITs. Excluding the Index Tower, however, the occupancy is a solid 97%, benefiting from the full occupancy of the schools portfolio. As key infrastructure projects improve road and pedestrian access, as well as retail offerings, occupancy of the Index Tower should increase rapidly. The rate of tenant uptake is difficult to predict given the current soft office market in Dubai. High Tenant Concentration: Emirates REIT has 355 tenants in total, but the top two - GEMS and Jebel Ali School - contribute almost 23% of total portfolio income. Nevertheless, given both tenants are in the education sector with lease expiration beyond 2040, we view tenant concentration as less risky than usual. In addition, excluding the education sector, the largest office tenant, a long-term client, generates less than 5% of revenue. The large tenants are typically multinational companies with relatively low credit risk. Prudent management and business strategy: Emirates REIT's management is experienced and follows a cautious acquisition strategy focused on income-producing assets. Before executing an acquisition, the company vets potential assets through an extensive due diligence process, which includes approval from the Investment Board. The most recent acquisition for Emirates REIT was the European Business Center in August 2017 for USD37 million. As of September 2017, the property had a 94% occupancy rate with a market value of USD40 million. Dividend policy: The company has to pay a minimum annual dividend of 80% of net cash flow, as specified by regulations. An Independent Oversight Board approval is required to distribute any revaluation surplus credited to income and from property disposal gains. Improving Capital Structure: The proposed senior unsecured Sukuk issuance will be used to repay all existing credit facilities. The facility will improve the liquidity profile, which is currently weak, will remove all variable interest-rate risk amid a rising interest-rate environment, and the entire portfolio will become unsecured. Finally, financial flexibility will improve by extending the maturity schedule. Fitch forecasts Loan-to-Value (LTV) to remain around 40%, which is comfortable. REITS in Dubai cannot exceed 50% LTV owing to a regulatory cap. Beneficial Government support: The government's 38% ownership and position on the board is a supportive factor for the overall business model. Through this governmental representation, the company has been able to acquire two exclusive Emiri decrees that allow real-estate ownership in non-free zone areas. In addition, the company gains good insight on the business and economic outlook of the Dubai real-estate market. DERIVATION SUMMARY Emirates REIT's high-quality portfolio is smaller, and more geographically concentrated, than most rated peers. Emirates REIT has the lowest occupancy and EBITDA margins among peers, owing to the Index Tower, which is only 26% occupied. Emirates REIT compares with companies such as Grainger PLC (BB/Stable) which has a much more diverse residential portfolio based in the UK, with strong rent potential, offset by high leverage and a much weaker LTV. KEY ASSUMPTIONS Fitch's key assumptions within our rating case for the issuer include: - low single-digit rental growth, driven by a bottoming out of the commercial office market and built-in annual price increases in education contracts; - somewhat slower-than-expected occupancy rates in Index Tower and a delay in launching the retail arm in Index Tower; - value-add capex and acquisitions similar to historical levels and maintenance capex of approximately 3% of revenue per year; - replacement or value-add capex as part of the revaluation gains on the property portfolio; - issuance of the proposed sukuk. RATING SENSITIVITIES Future Developments That May, Individually or Collectively, Lead to Positive Rating Action - Total occupancy rates consistently above 90% - Reduced concentration with the top 10 assets comprising less than 50% of net rental income or value - Top 10 tenants accounting for less than 30% of annual base rent revenue - Rent-yielding property assets of at least EUR1.5 billion (USD1.76 billion) - Net debt/EBITDA consistently below 9.0x Future Developments That May, Individually or Collectively, Lead to Negative Rating Action - Occupancy rates materially falling below current levels - LTV consistently approaching or exceeding 50% - No reduction of net debt/EBITDA from current levels LIQUIDITY Improving Debt Maturity and liquidity: Emirates REIT's current liquidity score is weak. The upcoming Sukuk issuance, however, will replace all existing credit facilities and finance ongoing capital expenditure, significantly increasing liquidity. The proposed Sukuk will not only improve liquidity, but also remove variable interest-rate risk at a time or rising interest rates. The financing will also eliminate all secured debt. Unsecured assets can provide additional liquidity to REITs as unsecured assets can be sold if needed in times of stress. FULL LIST OF RATING ACTIONS Emirates REIT -- Issuer Default Rating (IDR): 'BB+(EXP)' with Stable Outlook. Contact: Principal Analyst Shrouk Diab Associate Director +971 4 424 12 50 Supervisory Analyst Bram Cartmell Senior Director +44 20 3530 1874 Fitch Ratings Ltd 30 North Colonnade London E14 5GH Committee Chairperson Paul Lund Senior Director +44 20 3530 1244 Date of Relevant Rating Committee: 16 November 2017 Summary of Financial Statement Adjustments - - Lease equivalent debt was calculated at USD10 million using an average multiple of 8x Additional information is available on For regulatory purposes in various jurisdictions, the supervisory analyst named above is deemed to be the primary analyst for this issuer; the principal analyst is deemed to be the secondary. 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