April 3, 2017 / 2:20 PM / 3 years ago

Fitch Rates Essex Portfolio, L.P.'s Senior Unsecured Notes 'BBB+'; Outlook Stable

(The following statement was released by the rating agency) NEW YORK, April 03 (Fitch) Fitch Ratings has assigned a 'BBB+' rating to the senior unsecured notes due 2027 being issued by Essex Portfolio, L.P. A full list of Fitch's ratings for Essex Portfolio, L.P. and Essex Property Trust (NYSE:ESS) follows at the end of this release. KEY RATING DRIVERS Fitch's ratings for Essex consider the company's strong multifamily portfolio position within key densely populated and supply-constrained markets in Northern and Southern California and Seattle. These markets have favorable demographics (i.e. above-average job growth and household income levels) and high home-ownership costs that drive demand for apartments. Fitch views the company's management team as amongst the strongest in the multifamily REIT sector based on its track record of superior asset management and capital allocation. Geographic portfolio concentration and development are factors that balance these credit strengths. The Stable Outlook is driven by Fitch's expectation that the material improvement in credit metrics is largely complete. Moreover, as the issuer is operating at the low end of its financial policies, it has a cushion to buffer against deteriorating operating fundamentals should the cycle turn. ACHIEVED LOWER LEVERAGE TARGETS Fitch projects ESS's leverage will sustain around 6x assuming a decelerating but still accommodative operating environment and consistent development expenditures. This compares to leverage of 5.7x and 5.9x for 2016 and 2015, respectively and the issuer's stated 6x - 7x target. Leverage could trend lower as in 2016 depending upon how the issuer sizes development and redevelopment expenditures relative to equity issuances and asset sales. Fitch defines leverage as debt less readily available cash plus 50% preferred stock to recurring operating EBITDA, including recurring distributions from joint venture (JV) operations. Fitch expects ESS's fixed-charge coverage (FCC) will improve to the mid-to-high 3x range through 2018. Fitch defines FCC as recurring operating EBITDA including recurring JV distributions from operations less recurring capital improvements divided by cash interest incurred and preferred distributions. OPERATING FUNDAMENTALS SLOWING DUE TO NEW SUPPLY Fitch expects multifamily REITs will report another year of mid-single-digit growth in same-store net operating income (SSNOI). Essex SSNOI growth is projected to decelerate in 2017 from above-average growth in 2016. Essex has maintained same-store occupancy within a range of 96% - 97% during the past five years. GEOGRAPHIC CONCENTRATION & UNCERTAINTY SURROUNDING TECH The company is geographically concentrated in three primary markets: Southern California (44% of NOI), San Francisco Bay Area (39%), and the Seattle metropolitan area (17%). These markets generally, and ESS specifically, have benefited from strong demand driven by tech and related employers in recent years and by supply increasing at a slower relative pace. However, there is increasing uncertainty as to where we are in the tech cycle, venture capital fund flows, and the potential for tech valuations to decline and weigh on the market's psyche and capacity to absorb new supply. Strong market wage growth and zoning-related barriers to supply have been credit positives for ESS and should support growth over the long term. However, the long-term sustainability is unclear given the high employment and living costs fostered by supply constraints. At some point these elements could also lead to structural changes in the market. The compounding effects of above-average wage growth could pressure the marginal value of employees and incentivize employers to relocate to lower-cost markets. Alternatively, high costs of living could provide the will among voters for elected officials to soften zoning barriers to supply. Fitch views these to be long-term risks that are unlikely to occur during the one-to-two-year rating outlook horizon. DEVELOPMENT EXPOSURE IS NOTABLE BUT DOWN FROM 2015 The company maintains an active development pipeline with remaining costs to complete the pipeline of $528 million pro rata for ESS's ownership percentage of JVs. Remaining funding represents 3.6% of gross assets as of Dec. 31, 2016, compared with 4.5% at the end of 2015 and the company's 7.5% cycle peak in second-quarter 2012 (2Q12). Fitch views unfunded development costs approaching 10% would start becoming a credit concern. Fitch will assess ESS's willingness to dial-back development risk in the face of strong multifamily operating fundamentals as evidence of the company's commitment to maintaining a conservative balance sheet. ADEQUATE LIQUIDITY ESS has a manageable debt maturity schedule and will largely address 2017 maturities with this issuance. ESS's primary sources of liquidity are its readily available cash, its $1 billion credit facility maturing in December 2020 and its $25 million working capital line of credit maturing in January 2018. Fitch estimates that ESS's unencumbered asset coverage of unsecured debt (UA/UD) was 2.4x at Dec. 31, 2016, providing sufficient contingent liquidity to unsecured bondholders. Fitch calculates UA using a direct capitalization approach of 2016 estimated unencumbered NOI using a stressed 7.5% capitalization rate. ESS's UA/UD is adequate for the rating. KEY ASSUMPTIONS Fitch's key assumptions within the rating case for ESS include: --A deceleration in operating fundamentals with SSNOI growth declining to 4% in 2018; --Operating margins and capital intensity remain flat; --ESS maintains its current pace of development expenditures and is a modest net acquirer; --ESS does not issue equity and refinances its secured and unsecured debt maturities with like amounts in both markets. RATING SENSITIVITIES The following factors may result in a positive revision of ESS's ratings and/or Outlook: --Fitch's expectation of leverage sustaining below 6.0x and a public commitment by ESS to do so; --Fitch's expectation of fixed-charge coverage sustaining above 3.5x; --Should ESS's portfolio exhibit similar durability in operating cash flows relative to peers; --Should Fitch determine ESS has above-average access to capital consistent with 'A' category peers. The following factors may result in a negative revision of ESS's ratings and/or Outlook: --Fitch's expectation of leverage sustaining above 7x; --Fitch's expectation of FCC sustaining below 2.5x; --Fitch's expectation of UA/UD sustaining below 2x. FULL LIST OF RATING ACTIONS Fitch currently rates ESS and Essex Portfolio, L.P. as follows: Essex Property Trust, Inc. --Issuer Default Rating (IDR) 'BBB+'. Essex Portfolio, L.P. --IDR 'BBB+'; --Unsecured line of credit 'BBB+'; --Senior unsecured term loan 'BBB+'; --Senior unsecured notes 'BBB+'. Contact: Primary Analyst Ronald Nirenberg Director +1-212-612-7747 Fitch Ratings, Inc. 33 Whitehall St New York, NY 10004 Secondary Analyst Stephen Boyd, CFA Senior Director +1-212-908-9153 Committee Chairperson Steven Marks Managing Director +1 212 908-9161 Media Relations: Sandro Scenga, New York, Tel: +1 212-908-0278, Email: sandro.scenga@fitchratings.com. Date of Relevant Rating Committee: April 14, 2016. Summary of Financial Statement Adjustments - --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 included an estimate of recurring cash distributions from joint venture operations in recurring operating EBITDA. Fitch estimated the amount to be $53 million in 2015. --Fitch has adjusted the historical and projected net debt by assuming the issuer requires $5 million of cash for working capital purposes which is otherwise unavailable to repay debt. 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