investa commercial property fund - analysis

Summary:

Investa Commercial Property Fund

Primary Credit Analyst:

Craig W Parker, Melbourne (61) 3-9631-2073; [email protected]

Secondary Contact:

Karan Rathod, Melbourne +613 9631 2011; [email protected]

Table Of Contents

Rationale

Outlook

Standard & Poor's Base-Case Scenario

Business Risk

Financial Risk

Liquidity

Other Credit Considerations

Ratings Score Snapshot

Related Criteria And Research

WWW.STANDARDANDPOORS.COM/RATINGSDIRECT FEBRUARY 29, 2016 1

1587710 | 302006718

Summary:

Investa Commercial Property Fund

Business Risk: STRONG

Vulnerable Excellent

Financial Risk: MODEST

Highly leveraged Minimal

aa- a-

Anchor Modifiers Group/Gov't

CORPORATE CREDIT RATING

A-/Stable/--

Rationale

Business Risk: Strong Financial Risk: Modest

• High-quality office portfolio

• Exposure to cyclical office property market and

variable tenant demand

• Moderately high tenant and geographic

concentration

• Short-dated debt-maturity profile

• Leverage currently below its target gearing range of

15%–30%


1587710 | 302006718

Outlook: Stable

The stable outlook reflects our view that Investa Commercial Property Fund's (ICPF) high-quality asset base,

experienced management team, and conservative operating strategy should mitigate the risks associated with the

fund's exposure to cyclical office property markets. In the short term, we believe the fund will successfully manage

the refurbishment of its portfolio while maintaining adequate liquidity. We expect the fund to maintain gearing

(debt-to-total assets) within its targeted range of 15%-25% over the medium term and at a maximum gearing level

of 30% for strategic opportunities. We also expect that the potential acquisition of Investa Office Management

(IOM) can be accommodated within our forecasts for its credit metrics.

Downside scenario

Downward rating movement could occur if ICPF were to undertake large debt-funded acquisitions, asset

enhancement projects or construction developments that increased its gearing beyond our expectations. If this

were to occur, coverage measures would weaken, with funds from operations (FFO)-to-debt remaining less than

12% or EBITDA interest coverage at less than 3x. Downward rating pressure could also arise if the fund were to

change its operating strategy toward acquiring lower-grade office properties or adopted a more speculative

approach to its development program, including lower tenant pre-commitment thresholds or increased exposure to

construction and execution risk. A further sustained deterioration of the fund's occupancy level may also place

downward pressure on the rating.

Upside scenario

In our opinion, there is limited upward pressure given our view of the inherently cyclical nature of the office

property market. Nevertheless, upward movement could occur if the fund materially diversified its asset base and

adopted more-conservative financial policies.

Standard & Poor's Base-Case Scenario

We expect ICPF's FFO and earnings to modestly grow over the next two-to-three years. Driving this would be steady

rental growth from the fund's established portfolio and realization of earnings attributed to the potential acquisition of

420 George St, Sydney and completed 567 Collins St, Melbourne. Leverage will temporarily increase as a result of the

potential acquisition of 420 George St; however, it would be within our expectations.


1587710 | 302006718

Summary: Investa Commercial Property Fund

Assumptions Key Metrics

• Distributions of 100% of operating income;

• Participation rate of about 55% for its distribution

reinvestment arrangement;

• Potential acquisition of 420 George St, Sydney for

A$295 million; and

• Completion of the development of 567 Collins St,

Melbourne in the year ended Dec. 31, 2015.

Year end June 30 2015A 2016F 2017F

EBITDA interest coverage 5.2x 3.5x-5.5x 3.5x-5.5x

Debt-to-EBITDA 2.0x 3.5x-4.5x 2.5x-3.5x

FFO-to-debt 42.7% 15%-25% 15%-25%

A--Actual. F--Forecast. FFO—Funds from operations.

Business Risk: Strong

ICPF has a sizable portfolio of high-quality office assets valued at A$3.2 billion at Dec. 31, 2015. Their assets are

diversified across Australia, with a significant exposure (47.6%) to Sydney's central business district (CBD). Offsetting

this concentration is our view that Sydney's office market is the strongest performing in the country with a deep tenant

base. Also performing well is the Melbourne CBD market, which comprises 26.6% of ICPF's total portfolio. We expect

the exposure to the Sydney market to increase with the potential acquisition of 420 George St building, which is

consistent with the fund's strategy of enhancing its asset quality. In addition, the proportion of high-quality assets

increased following the practical completion of a new office tower at 567 Collins St Melbourne. We also note the fund's

exposure to Perth through its holding in the QV1 building. This office market is more volatile than Sydney or

Melbourne given its exposure to the Australian mining sector, which is currently bearing the brunt of a cyclical

downturn. However, we note that the QV1 asset has a long weighted-average lease expiry (WALE), which will help to

offset income volatility for the maturing leases at this building.

Portfolio occupancy (by income) has noticeably increased to 94.3% at Dec. 31, 2015 (90.8% at Jan. 31, 2015), due to

the success of the fund manager in leasing more space at 120 Collins St, Melbourne, which experienced vacancy levels

of up to 27% in 2014. In addition ICPF has improved its WALE to 5.1 years at Dec. 31, 2015 (4.6 years at Jan. 31,

2015). The counterparty exposure is sound with long-term lease contracts to solid tenants, coupled with a high

proportion of fixed rent reviews that underpin ICPF's cash flow. However, while some tenant and geographic

concentration weighs down ICPF's credit quality, we believe that this does not detract from the solid business.

ICPF's operating strategy is to manage offices located in Australian CBDs. This means that it will eventually sell down

its ownership of Kings Row in 2016, which is not in a CBD location. We also expect the fund to undertake modest

levels of refurbishment and development of its high-quality asset base, which is integral to attracting and retaining a

wide array of tenants. ICPF is currently externally managed by Investa Office Management (IOM), benefiting from

IOM's property management expertise and market research. We note that ICPF has proposed to internalize

management of the fund by purchasing the management rights to IOM from the current owner, Morgan Stanley.


1587710 | 302006718


Financial Risk: Modest

ICPF's financial risk profile continues to reflect its moderate financial policies that include a target gearing range of

15%-25% (debt to total assets) with a maximum of 30% for strategic opportunities. Gearing was a very conservative

10.8% at Dec. 31, 2015, from 17.6% at Jan. 31, 2015. The decrease was partly attributable to a A$580 million equity

raising in fiscal 2015. This low gearing is temporary, as we expect it to increase following the potential acquisition of

420 George St, Sydney. However, we expect it will remain within the fund's financial policy targets.

Reducing capitalization rates and increased asset values are driving the buoyant office markets in Australia, which has

also been supported by strong investor demand for high-quality assets. As a consequence, we are mindful that absolute

measures of ICPF's gearing range needs to benchmarked against leverage measures. We expect that at the manager's

peak gearing, the ratio of FFO to debt will remain greater than 12%.

The fund continues to use its distribution reinvestment arrangement (DRA) to retain funds, which generated a

participation rate of 64.8% in fiscal 2016, and 66% in the December 2015 quarter. We consider that continued investor

take-up under the fund's DRA and the fund's preparedness to raise new equity when required will maintain ICPF's

sound balance-sheet position.

ICPF has a short weighted-average debt maturity of around two years. Its debt funding consists of A$200 million of

committed bank facilities (undrawn at June 30, 2015), which matures toward the end of calendar 2016; a A$250 million

medium-term note (MTN) issue due in June 2016 and A$30 million due in June 2022. The secured MTN creditors

benefit from overcollateralization by more than 2x, which based on our recovery analysis, warrants the secured debt to

be given one-notch benefit to 'A'. We are mindful of the upcoming maturity of the A$25 million MTN issue as well as

the fund's undrawn bank facility. We expect that ICPF will manage this refinancing risk well before the scheduled

maturities.

ICPF's acquisition of Investa Office Management (IOM)

ICPF recently announced its intention to acquire IOM, which is currently owned by Morgan Stanley Real Estate

Investing (MSREI). Under this proposed structure, ICPF will own the management rights to its own portfolio, as well as

Investa Office Fund (IOF). Should the transaction successfully proceed, we do not expect any adverse impact on the

rating on ICPF. In addition to a reduction in management fees (that are currently paid to IOM), the fund will continue

to prudently grow the asset base consistent with its financial policies.

We have not factored this transaction into our base-case projections.

Liquidity: Adequate

We consider ICPF to have adequate liquidity. We expect its sources-to-uses to be greater than 1.2x in the next 12

months. We consider the distribution reinvestment arrangement, successful refinance of maturing debt, and potential

for moderate asset sales will support ICPF's liquidity position.


1587710 | 302006718


Principal Liquidity Sources Principal Liquidity Uses

• FFO of about A$150 million; and

• Undrawn facilities of A$200 million.

• Capital expenditure requirement of about A$100

million over the next year.

• Distributions of about A$50 million (net of DRA);

and

• Successful acquisition of 420 George St, Sydney.

Other Credit Considerations

As the fund has the ability to increase its gearing to the maximum level of 30%, we have applied a negative financial

policy modifier that lowers the anchor by two notches. At higher gearing levels, the financial risk profile would

deteriorate to an intermediate level. However, it is unlikely that a change in gearing within the fund's financial policy

range would prompt a rating action: the lower anchor score would be offset by removing the two-notch financial policy

modifier.

When the fund is operating at its peak gearing level, we would also apply a positive comparable rating analysis

modifier, which provides one-notch uplift. We expect that at the top of its target gearing range, the fund will exhibit

credit metrics that are consistent with the top half of the intermediate financial risk descriptor. These stronger credit

metrics are supportive of the one-notch uplift and consistent with other real estate peers.

Ratings Score Snapshot

Corporate Credit Rating

A-/Stable/--

Business risk: Strong

• Country risk: Very low

• Industry risk: Low

• Competitive position: Strong

Financial risk: Modest

• Cash flow/Leverage: Modest

Anchor: a

Modifiers

• Diversification/Portfolio effect: Neutral (no impact)

• Capital structure: Neutral (no impact)

• Financial policy: Negative (-2 notches)

• Liquidity: Adequate (no impact)


1587710 | 302006718


• Management and governance: Satisfactory (no impact)

• Comparable rating analysis: Positive (+1 notch)

Related Criteria And Research

Related Criteria

• Methodology And Assumptions: Liquidity Descriptors For Global Corporate Issuers, Dec. 16, 2014

• General Criteria: Group Rating Methodology, Nov. 19, 2013

• General Criteria: Country Risk Assessment Methodology And Assumptions, Nov. 19, 2013

• Key Credit Factors For The Real Estate Industry, Nov. 19, 2013

• Corporate Methodology: Ratios And Adjustments, Nov. 19, 2013

• General Criteria: Methodology: Industry Risk, Nov. 19, 2013

• Corporate Methodology, Nov. 19, 2013

• Management And Governance Credit Factors For Corporate Entities And Insurers, Nov. 13, 2012

• 2008 Corporate Criteria: Rating Each Issue, April 15, 2008

Standard & Poor's (Australia) Pty. Ltd. holds Australian financial services licence number 337565 under the Corporations Act 2001. Standard &

Poor's credit ratings and related research are not intended for and must not be distributed to any person in Australia other than a wholesale

client (as defined in Chapter 7 of the Corporations Act).

Business And Financial Risk Matrix

Business Risk Profile

Financial Risk Profile

Minimal Modest Intermediate Significant Aggressive Highly leveraged

Excellent aaa/aa+ aa a+/a a- bbb bbb-/bb+

Strong aa/aa- a+/a a-/bbb+ bbb bb+ bb

Satisfactory a/a- bbb+ bbb/bbb- bbb-/bb+ bb b+

Fair bbb/bbb- bbb- bb+ bb bb- b

Weak bb+ bb+ bb bb- b+ b/b-

Vulnerable bb- bb- bb-/b+ b+ b b-


1587710 | 302006718


S&P may receive compensation for its ratings and certain analyses, normally from issuers or underwriters of securities or from obligors. S&P

reserves the right to disseminate its opinions and analyses. S&P's public ratings and analyses are made available on its Web sites,

www.standardandpoors.com (free of charge), and www.ratingsdirect.com and www.globalcreditportal.com (subscription) and www.spcapitaliq.com

(subscription) and may be distributed through other means, including via S&P publications and third-party redistributors. Additional information

about our ratings fees is available at www.standardandpoors.com/usratingsfees.

S&P keeps certain activities of its business units separate from each other in order to preserve the independence and objectivity of their respective

activities. As a result, certain business units of S&P may have information that is not available to other S&P business units. S&P has established

policies and procedures to maintain the confidentiality of certain nonpublic information received in connection with each analytical process.

To the extent that regulatory authorities allow a rating agency to acknowledge in one jurisdiction a rating issued in another jurisdiction for certain

regulatory purposes, S&P reserves the right to assign, withdraw, or suspend such acknowledgement at any time and in its sole discretion. S&P

Parties disclaim any duty whatsoever arising out of the assignment, withdrawal, or suspension of an acknowledgment as well as any liability for any

damage alleged to have been suffered on account thereof.

Credit-related and other analyses, including ratings, and statements in the Content are statements of opinion as of the date they are expressed and

not statements of fact. S&P's opinions, analyses, and rating acknowledgment decisions (described below) are not recommendations to purchase,

hold, or sell any securities or to make any investment decisions, and do not address the suitability of any security. S&P assumes no obligation to

update the Content following publication in any form or format. The Content should not be relied on and is not a substitute for the skill, judgment

and experience of the user, its management, employees, advisors and/or clients when making investment and other business decisions. S&P does

not act as a fiduciary or an investment advisor except where registered as such. While S&P has obtained information from sources it believes to be

reliable, S&P does not perform an audit and undertakes no duty of due diligence or independent verification of any information it receives.

No content (including ratings, credit-related analyses and data, valuations, model, software or other application or output therefrom) or any part

thereof (Content) may be modified, reverse engineered, reproduced or distributed in any form by any means, or stored in a database or retrieval

system, without the prior written permission of Standard & Poor's Financial Services LLC or its affiliates (collectively, S&P). The Content shall not be

used for any unlawful or unauthorized purposes. S&P and any third-party providers, as well as their directors, officers, shareholders, employees or

agents (collectively S&P Parties) do not guarantee the accuracy, completeness, timeliness or availability of the Content. S&P Parties are not

responsible for any errors or omissions (negligent or otherwise), regardless of the cause, for the results obtained from the use of the Content, or for

the security or maintenance of any data input by the user. The Content is provided on an "as is" basis. S&P PARTIES DISCLAIM ANY AND ALL

EXPRESS OR IMPLIED WARRANTIES, INCLUDING, BUT NOT LIMITED TO, ANY WARRANTIES OF MERCHANTABILITY OR FITNESS FOR

A PARTICULAR PURPOSE OR USE, FREEDOM FROM BUGS, SOFTWARE ERRORS OR DEFECTS, THAT THE CONTENT'S FUNCTIONING

WILL BE UNINTERRUPTED, OR THAT THE CONTENT WILL OPERATE WITH ANY SOFTWARE OR HARDWARE CONFIGURATION. In no

event shall S&P Parties be liable to any party for any direct, indirect, incidental, exemplary, compensatory, punitive, special or consequential

damages, costs, expenses, legal fees, or losses (including, without limitation, lost income or lost profits and opportunity costs or losses caused by

negligence) in connection with any use of the Content even if advised of the possibility of such damages.

Copyright © 2016 Standard & Poor's Financial Services LLC, a part of McGraw Hill Financial. All rights reserved.


1587710 | 302006718

investa commercial property fund - analysis

Documents