Fitch Ratings assigns a 'BBB-' credit rating to the $300 million aggregate principal amount of 4.375% senior unsecured notes due June 15, 2022 issued by Duke Realty Limited Partnership, a subsidiary of Duke Realty Corp. (NYSE: DRE). The notes were issued at 99.271% of principal value to yield 4.466% to maturity.
Net proceeds from the offering are expected to be used to repay outstanding debt with near-term maturities, including balances on the revolving credit facility, and for general corporate purposes.
Fitch currently rates DRE and its operating partnership as follows:
Duke Realty Corp.
--Issuer Default Rating (IDR) 'BBB-';
--Preferred stock 'BB'.
Duke Realty Limited Partnership
--Senior unsecured notes 'BBB-';
--Senior unsecured exchangeable notes 'BBB-';
--Unsecured revolving credit facility 'BBB-'.
The Rating Outlook is Stable.
Fitch anticipates 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 747 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 17.2% of annual base rents at March 31, 2012. Lease expirations are less than 13% of the total annual base rent in any given year, with just 4.9% expiring for the remainder of 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 continues to shift the composition of the portfolio.
The company's leverage, defined as net debt to recurring operating EBITDA, was approximately 7.0 times (x) at March 31, 2012, compared with 7.0x at Dec. 31, 2011 and 7.2x at Dec. 31, 2010. Fitch expects leverage to trend toward the mid 6.0x range, which is solid for the 'BBB-' rating.
The company has moderately increased its development pipeline recently. In-process development (including joint ventures) represented 4.3% of undepreciated book assets as of March 31, 2012, compared with 2.6%, 1.3% and 1.4% as of Dec. 31, 2011, Dec. 31, 2010 and Dec. 31, 2009, respectively. Remaining cost to be spent was 3.3% of total undepreciated assets as of March 31, 2012. Notably, the majority of the developments are build-to-suit projects and MOBs, thus minimizing lease-up risk, which Fitch views positively.
DRE has adequate liquidity and financial flexibility. As of March 31, 2012, the company had 429 unencumbered properties (excluding seven wholly owned properties under development) with a gross book value of $4.9 billion. Unencumbered asset coverage of unsecured debt based on applying an 8.5% cap rate to unencumbered annualized stabilized NOI was adequate for the 'BBB-' IDR at 2.0x as of March 31, 2012. The average cap rate for asset purchases and sales over the past two years has been approximately 8%.
Pro forma the notes issuance, 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 April 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. Fixed-charge coverage (defined as recurring operating EBITDA, less recurring capital expenditures and straight-line rent adjustments, divided by total interest incurred and preferred dividends) was 1.5x for the 12 months ended March 31, 2012, up slightly from 1.4x in 2011 and 1.4x in 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.
Suburban office fundamentals remain weak, as evidenced by an occupancy decline to 85.5% at March 31, 2012 from 86.2% at March 31, 2011 for DRE's stabilized office portfolio. In addition, net effective rental rates on new leases remain weak and were $12.89 per square foot (psf) in first-quarter 2012, compared to $12.05 psf in 2011, $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,' available on Fitch's Web site at www.fitchratings.com, 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 March 31, 2012, leverage was approximately 7.0x);
--Fixed-charge coverage sustaining above 2.0x (latest 12-month coverage was 1.5x as of March 31, 2012).
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%.
Additional information is available at 'www.fitchratings.com'. The issuer did not participate in the rating process or provide additional information beyond its available public disclosure. The ratings above were unsolicited and have been provided by Fitch as a service to investors.
Applicable Criteria and Related Research:
--'Recovery Rating and Notching Criteria for Equity REITs' (May 3, 2011).
--'Criteria for Rating U.S. Equity REITs and REOCs' (Feb. 27, 2012);
--'Treatment and Notching of Hybrids in Nonfinancial Corporate and REIT Credit Analysis' (Dec. 15, 2011);
--'Corporate Rating Methodology' (Aug. 12, 2011);
--'Parent and Subsidiary Rating Linkage' (Aug. 12, 2011).
Applicable Criteria and Related Research:
Recovery Ratings and Notching Criteria for Equity REITs
Criteria for Rating U.S. Equity REITs and REOCs
Treatment and Notching of Hybrids in Nonfinancial Corporate and REIT Credit Analysis
Corporate Rating Methodology
Parent and Subsidiary Rating Linkage