April 5 – Fitch Ratings has affirmed the following credit ratings for Duke
Realty Corp. (NYSE: DRE) and its operating partnership, Duke Realty
Limited Partnership, (collectively, DRE or the company):
Duke Realty Corp.
–Issuer Default Rating (IDR) at ‘BBB-‘;
–Preferred stock at ‘BB’.
Duke Realty Limited Partnership
–IDR at ‘BBB-‘;
–Senior unsecured notes at ‘BBB-‘;
–Senior unsecured exchangeable notes at ‘BBB-‘;
–Unsecured revolving credit facility at ‘BBB-‘.
The Rating Outlook is Stable.
The affirmations reflect Fitch’s view that the company’s credit profile will
remain consistent with a ‘BBB-‘ rating in the near-to-medium term. Leverage is
appropriate for the rating category. The rating also takes into account the
company’s large pool of diversified industrial, office, and medical office
building (MOB) properties, solid unencumbered asset coverage of unsecured debt,
and adequate liquidity position. The ratings are balanced by a fixed-charge
coverage ratio that is low for the rating category and continued challenging
suburban office fundamentals, even as DRE continues to shift its portfolio away
from suburban office to a higher percentage of industrial properties and MOBs.
The company has a diversified portfolio of 748 bulk distribution, suburban
office, MOB, and retail properties located across 18 markets, which Fitch views
favorably from a property segment and geographical diversification standpoint.
The company’s portfolio also benefits from a highly diversified tenant base and
well-staggered lease expiration schedule, limiting tenant credit risk and lease
rollover risk. DRE’s largest 20 tenants represented just 17.4% of annual base
rents at Dec. 31, 2011. Lease expirations are less than 12% of the total annual
base rent in any given year, with just 7.4% expiring in 2012, indicating
long-term recurring cash flow across the portfolio.
DRE continues to execute on its strategic plan, which entails increasing the
exposure to industrial and MOB assets while reducing the exposure to suburban
office. Fitch has a negative outlook on suburban office fundamentals, and a
stable outlook on industrial and healthcare fundamentals, and as such, views the
company’s repositioning strategy favorably. However, there is potential for
near-term EBITDA dilution from asset purchases and sales as the company shifts
the composition of the portfolio.
The company’s leverage, defined as net debt to recurring operating EBITDA, was
approximately 7.0 times (x) at Dec. 31, 2011 (after adjusting for the timing of
the asset sale to Blackstone in December 2011), compared with 7.2x at Dec. 31,
2010 and 6.7x at Dec. 31, 2009. Fitch expects leverage to trend toward the mid
6.0x range, which is solid for the ‘BBB-‘ rating. In a stress case not
anticipated by Fitch in which same store net operating income (NOI) declines
7.5% in 2012 and 9.0% in 2013, leverage would be 9.6x in 2013, which would be
more consistent with a lower rating.
The company has moderately increased its wholly owned development pipeline
recently. However, development represented just 2.6% of undepreciated book
assets as of Dec. 31, 2011, compared with 1.3% and 1.4% as of Dec. 31, 2010 and
Dec. 31, 2009, respectively. Remaining cost to be spent was just 2.1% of total
undepreciated assets as of Dec. 31, 2011. The company’s new development starts
will focus on build-to-suit projects and MOBs, thus minimizing lease-up risk,
which Fitch views positively.
DRE has adequate liquidity and financial flexibility. As of Dec. 31, 2011, the
company had 432 unencumbered properties with a gross book value of $4.8 billion.
Unencumbered asset coverage of unsecured debt based on applying an 8.5% cap rate
to unencumbered NOI was adequate for the ‘BBB-‘ IDR at 1.9x as of Dec. 31, 2011.
The average cap rate for asset purchases and sales over the past two years has
been approximately 8.0%.
Sources of liquidity (unrestricted cash, availability under the unsecured
revolving credit facility, and projected retained cash flow from operating
activities after dividends) divided by uses of liquidity (pro rata debt
maturities, expected recurring capital expenditures, and remaining
nondiscretionary development costs) was 1.0x for the Jan. 1, 2012 – Dec. 31,
2013 period, or 1.3x, assuming DRE is able to refinance mortgage debt at 80% of
the maturing amount during this period.
DRE’s fixed-charge coverage ratio is low for the rating. Coverage (defined as
recurring operating EBITDA, less recurring capital expenditures and
straight-line rent adjustments, divided by total interest incurred and preferred
dividends) was 1.4x in 2011, unchanged from 2010. Coverage has remained in the
1.4x to 1.6x range since 2008, and Fitch anticipates that fixed-charge coverage
will improve moderately through 2014 to 1.8x, driven by moderate NOI growth and
reduced preferred dividends due to recent preferred redemptions. In addition,
the company has $178 million of 8.375% series O preferreds that become
redeemable in 2013, which DRE may redeem to further improve coverage.
In a stress case not anticipated by Fitch, in which same store NOI declines 7.5%
in 2012 and 9.0% in 2013, coverage would be 1.0x in 2013, which would be more
consistent with a lower rating.
Suburban office fundamentals remain weak, as evidenced by an occupancy decline
to 85.4% at Dec. 31, 2011 from 86.4% at Dec. 31, 2010 for DRE’s stabilized
office portfolio. In addition, net effective rental rates on new leases continue
to decline and were $12.05 per square foot (psf) in 2011, down from $12.56 psf
in 2010 and $13.03 in 2009. Fitch anticipates that DRE’s suburban office
portfolio will continue to face headwinds in the near term, driven by continued
weak rental rate growth and high leasing costs.
The Stable Rating Outlook is based on Fitch’s expectation that leverage will
stabilize in the 7.0x range in the near term and then trend lower to the mid
6.0x range in 2014, that coverage will improve moderately to 1.7x in 2013 and
1.8x in 2014, and that the company will maintain adequate liquidity.
The two-notch differential between DRE’s IDR and preferred stock rating is
consistent with Fitch’s criteria for corporate entities with a ‘BBB-‘ IDR. Based
on ‘Treatment and Notching of Hybrids in Nonfinancial Corporate and REIT Credit
Analysis,’ dated Dec. 15, 2011 and available on Fitch’s Web site at
, 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 have a positive impact on the ratings and/or Rating
Outlook:
–Net debt to recurring operating EBITDA sustaining below 6.0x (as of Dec. 31,
2011, leverage was approximately 7.0x after adjusting for the timing of the
Blackstone transaction);
–Fixed-charge coverage sustaining above 2.0x (latest 12-month coverage was 1.4x
as of Dec. 31, 2011).
The following factors may have a negative impact on the ratings and/or Rating
Outlook:
–Fixed-charge coverage sustaining below 1.3x;
–Net debt to recurring operating EBITDA sustaining above 8.0x;
–AFFO (adjusted funds from operations) payout ratio sustaining above 100%.
