• In our view, the prudent response by Australian retail REITs to the COVID-19 pandemic will provide a buffer for them to weather further disruptions.
• We expect these REITs to continue to prioritize cash preservation and use available financial levers, such as expenditure curtailment, reduction in cash distributions, and other sources, to offset the impact of the pandemic.
• Further, a continued disciplined approach to liquidity management underpins rating stability.
• On July 8, 2021, S&P Global Ratings revised its rating outlook on three Australian retail REITs to stable from negative. We affirmed the ratings on all eight retail REITs. The outlook on one REIT remains negative. The outlook on the other four remains stable.

MELBOURNE (S&P Global Ratings) July 8, 2021--S&P Global Ratings today took the following rating actions on Australian retail REITs.

We revised the outlook on three REITs to stable from negative reflecting their ability to weather the COVID-19 pandemic and maintain a buffer to absorb further disruptions. The outlook on Australian Prime Property Fund Retail remains negative given the uncertain outlook for the REIT from unitholder redemption requests and recent asset sales. The stable outlooks on the other four REITs reflect their sizable rating buffers to withstand volatile market conditions.

We expect real GDP to grow 4.9% in Australia and 4.6% in New Zealand in 2021 (real GDP was -2.4% in Australia and -1.2% in New Zealand in 2020). The economic recovery will be supported by a robust jobs market and asset price inflation. These factors boosted consumer confidence and lifted Australia's private consumption in the first quarter of 2021 back to pre-COVID-19 levels.

Australia's implementation of the Code of Conduct for small and midsize enterprises in April 2020 resulted in landlords negotiating with tenants facing financial stress or hardship as a direct result of COVID-19. This put the financial onus on landlords and led to substantial credit charges that hit landlords' earnings and credit metrics in 2020. In addition, the provision of the JobKeeper supplement by the federal government ensured that small businesses remained viable. Thus, helped landlords maintain their tenant base and high occupancy rates. Both the Code of Conduct and JobKeeper wage support ended in March 2021. Nevertheless, we expect some of these credit charges to continue into 2021, albeit at lower levels than in 2020.

During this time, landlords received limited government tax relief. However, they pulled the financial levers in their control to create financial headroom. They reduced operating expenses to limit the earnings hit, and put most noncommitted investments, developments, and acquisition plans on hold. Additionally, the likes of Scentre Group issued a hybrid note and Vicinity Centres raised equity during the height of COVID-19 in Australia.

Chart 1

Our rated REITs have better asset quality and solid market positions relative to the wider market. Their shopping centers therefore benefitted from a faster recovery in tenancy cash collection and occupancy rates as Australia recovered from COVID-19.

We expect continued suppression of the virus with short, sharp lockdowns will be required until a higher proportion of the population is vaccinated. In response, landlords have offered to temporarily ease payment terms and extend leases for impacted tenants with shorter lease terms. In the longer-term, we expect landlords to ensure the integrity of a retail tenancy lease remains intact. This view is supported by leases that stipulate that rent is increased either by a fixed annual amount or linked to the consumer price index (CPI). Importantly these leases are not tied to a retailer's turnover. This supports our view that the rated retail REITs will maintain their strong competitive positions.

Changing consumer behavior toward retailing is yet to manifest into definitive trends. It is uncertain whether the elevated levels of e-commerce transactions during the pandemic will be sustained. However, we expect the secular industry changes toward online retailing to persist, albeit at a gradual pace. Demand for retail space will therefore be anemic in the next few years. In particular, lesser-quality retail space that does not have a strong catchment area or solely fulfil an essential retailing requirement may be negatively affected in a post-COVID-19 setting. Likewise, the success of omni-channel retailers and their physical store requirements is evolving. Retail centers in central business districts and, to a lesser extent, assets with exposure to public transport hubs will continue to be affected due to the growing work-from-home trend.

Any sizable rental arrears that may continue to be incurred due to the pandemic, and the likelihood of their collectability beyond this ongoing and sporadic business disruption remain key credit factors for REITs. In our stress case, most of our rated REITs have sufficient buffer in their credit metrics. This is illustrated in their leverage and cash flow adequacy metrics. Our stressed assumptions included the following:

• Standard rental increases in line with our forecast for CPI in Australia;
• A reduction in occupancy by about 5% from our base case in fiscals 2022 to 2024 (year ending June, with the exception of Scentre Group and AMP Capital Shopping Centre Fund which is December).
• An increase in holdover leases that raises the lease maturity profile by 5% in fiscal 2022; and
• Net rental reversions of about -15% in fiscal 2022, improving to -10% in 2023 and 2024.

Chart 2

All the Australian and New Zealand REITs we rate have either strong or adequate liquidity, with sufficient cash and undrawn bank lines to meet bank and bond debt maturing over the next 12 months. The rated REITs rely on continued support of their equity base and we acknowledge that institutional money has been seeking to rotate out of retail into other asset classes. Most wholesale REITs have a best endeavors clause to meet equity redemptions that arise from the infrequent liquidity windows. The quantum of equity redemptions can place stress on a REIT's credit quality, particularly if the redemption requires sizable asset divestments that could affect its long-term business prospects, operating diversity, and credit rating headroom.

REITS WITH REVISED OUTLOOKS

GPT Wholesale Shopping Centre Fund (GWSCF)

The stable outlook reflects our view that GWSCF's solid asset quality and sound operating strategies will continue to support the ratings. At the upper end of the REIT's target gearing range (ratio of net debt to total assets) of 10%-30%, we expect the ratio of funds from operations (FFO) to debt to be about 12%.

Downside scenario

Downward rating pressure could arise from erosion of the REIT's portfolio diversity or quality, a change in management's operating strategy, or a shift to more aggressive financial policies. This could include the FFO-to-debt ratio falling sustainably below 12% without a clear deleveraging path.

Upside scenario

Upward rating movement would depend on the REIT improving its portfolio asset quality and diversity while maintaining its financial policies. Portfolio diversity should materially improve if the REIT reduces the largest single-asset exposure to a third or less of its total portfolio value. Upward rating momentum could also arise from a commitment to financial policies consistent with the FFO-to-debt ratio sustaining above 15%.

QIC Shopping Centre Fund (QSCF)

The stable outlook reflects our view that QSCF's moderate financial policies would provide sufficient headroom to absorb some earnings volatility through the economic cycle. By maintaining high occupancy levels and continual investment into its town center strategy, we believe QSCF can sustain its portfolio quality and maintain a ratio of FFO to debt above 9%.

Downside scenario

Downward rating pressure could arise from significant debt-funded development, a change in management's operating strategy, or a shift to more aggressive financial policies. This could be indicated by the FFO-to-debt ratio falling below 9% on a sustained basis, without a clear deleveraging path.

We would also consider a downgrade if structural retail headwinds materially weaken the credit quality of QSCF's tenants, dampening the REIT's business prospects over the next two to three years.

Upside scenario

Upward movement in the rating is likely to depend on QSCF adopting more-conservative financial policies such that, at the top of its target gearing policy, the FFO-to-debt ratio is likely to be greater than 12%.

Scentre Group

The stable outlook on Scentre Group reflect our expectation that Scentre will continue to redevelop its shopping-center portfolio in a measured manner, so as to maintain its superior asset quality and operating stability. We expect management to actively use available financial levers to manage the balance sheet in response to any further fallouts from the pandemic.

The rating on Scentre can accommodate a gearing of 40% for short periods, given management's stated intention to operate within a gearing range of 30%-35%. However, we expect the FFO-to-debt ratio to remain greater than 9% and the ratio of debt to EBITDA to below 7.5x.

Downside scenario

The rating could come under pressure if Scentre's debt exceeds the upper end of its target gearing level for a prolonged period, such that the FFO-to-debt ratio remains less than 9% or the debt-to-EBITDA ratio stays above 7.5x.

This scenario could arise due to a sustained reduction of earnings because of a combination of lower portfolio occupancy, rental abatements, negative rental reversions, or e-commerce beginning to have a demonstrable impact on earnings. Larger capital expenditure than our expectations, material debt-funded acquisitions, substantial share buybacks, or a significant change to the group's operating strategy and distribution policy could also lead to such deterioration.

Upside scenario

We could raise the rating if Scentre adopts a more conservative financial policy, such that FFO-to-debt increases to more than 12% and the debt-to-EBITDA ratio reduces to below 6x at peak gearing.

REITS WITH UNCHANGED OUTLOOKS

AMP Capital Shopping Centre Fund (ASCF)

The stable rating outlook on ASCF reflects our view that the REIT's solid asset quality and sound operating strategies will continue to support the ratings. At the upper-end of the REIT's target gearing range of 15%-25%, we expect the ratio of FFO to debt to be about 15%. Accordingly, we anticipate that ASCF will manage its cash flow adequacy measures well above these levels during periods of reduced development activity.

Downside scenario

The main downside risk to the ratings would be significant debt-funded acquisitions or aggressive development activities that push the FFO-to-debt ratio below 15%, without a plan to return the level of borrowings to the target gearing range in a timely manner.

We may also consider a downgrade if the REIT undertakes asset divestments that noticeably reduces the scale or diversity of the portfolio.

Upside scenario

We are not likely to raise the ratings in the foreseeable future. However, we could raise the rating if ASCF adopts a more conservative financial policy such as a lower target gearing range. We would expect the REIT to maintain its FFO-to-debt ratio at more than 20% to support a higher rating.

Australian Prime Property Fund Retail (APPFR)

The negative outlook on APPFR reflects our view that weak operating conditions could impede the REIT's ability to maintain its S&P Global Ratings-adjusted FFO-to-debt ratio above 17% in fiscal 2022 and beyond. We expect APPFR's earnings to remain under pressure over the next 12 months due to business disruptions and related impacts stemming from the pandemic.

APPFR's asset sales to satisfy unitholder redemptions will affect its portfolio scale and diversity. The corresponding reduction in portfolio earnings and the lack of debt reduction will likely result in continuing elevated leverage.

We expect the REIT to bolster its liquidity, extend its debt maturity profile, and prudently manage capital spending. We also anticipate that the REIT will deploy levers--such as restricting distributions, managing asset sales, or raising new equity--to protect its credit metrics.

Downside scenario

Downward rating pressure could emerge if APPFR's FFO-to-debt (after S&P Global Ratings' adjustments) is likely to remain below 17% in fiscal 2022. This could arise due to a sustained reduction in earnings because of a combination of lower tenant occupancy, rental abatements persisting, or sizable negative rental reversions.

Downward rating pressure could also arise from a significant erosion of the REIT's portfolio diversity or quality (beyond our base-case expectations), a change in operating strategy toward higher-risk investments, or a shift toward more aggressive financial policies.

Upside scenario

We may revise the outlook to stable if we expect APPFR's adjusted FFO-to-debt ratio to remain sustainably above 17% and there is no material change to the REIT's operating strategy. The rating could also be placed on a stable footing if the REIT satisfies the remaining equity redemption requests predominantly by cash inflows from new equity raisings, or from unitholders revoking their original redemption request.

A return to rating stability is also likely be predicated on the REIT operating within its articulated financial policies, in particular, adhering to a 10%-25% look-through gearing range.

BWP Trust

The stable outlook incorporates the counterparty risk associated with BWP's main tenant, Bunnings (wholly-owned by Wesfarmers Ltd.), and the associated long-term leases. Key to rating stability for BWP are our expectations that:

• The Bunnings tenancies will represent more than 80% of the trust's portfolio income;
• The trust's weighted-average lease expiry (WALE) will not be materially below five years; and
• BWP will continue to be of strategic importance to Wesfarmers, and that Wesfarmers will maintain at least 20% ownership in BWP.

Downside scenario

We could lower the rating if Bunnings' operating performance materially weakens and if BWP's WALE falls materially below five years. Downward pressure may also occur if BWP pursues more-aggressive investment strategies or financial policies, such that its FFO-to-debt ratio remains less than 15%.

Upside scenario

Upward rating action is unlikely over the next two years. However, we could raise the rating if BWP adopts more-conservative financial policies. An adjusted debt-to-EBITDA ratio sustaining at less than 2.5x and adjusted FFO-to-debt ratio greater than 20% at peak gearing level will indicate a more conservative financial policy.

QIC Property Fund (QPF)

The stable outlook reflects our view that QPF's conservative financial policies and low gearing positions it well to absorb earnings volatility through the economic cycle. We believe QPF can sustain its portfolio quality and maintain its FFO-to-debt ratio above 12% by maintaining high occupancy levels and continual investments in its town center strategy.

Downside scenario

Downward rating pressure could arise from significant debt-funded development, a change in management's operating strategy, or a shift to more aggressive financial policies. We would also consider a downgrade if structural retail headwinds materially weaken tenant credit quality and occupancy levels, dampening QPF's business prospects over the next two to three years.

Upside scenario

Upward rating movement will depend on the REIT committing to sustaining its adjusted FFO-to-debt ratio above 15% at the top of its gearing policy.

Vicinity Centres

The stable outlook on Vicinity reflects our expectation that the quality and diversity of the REIT's portfolio will reduce earnings volatility through the economic cycle. In addition, we expect Vicinity to continue recycling assets and seeking capital partners to achieve its investment objectives, while limiting pressure on its balance sheet. Over the longer term, we expect the REIT's asset quality to improve as the group executes its repositioning strategy.

Our stable outlook also reflects our expectation that Vicinity will maintain its FFO-to-debt ratio above 12% and gearing (net debt to net tangible assets ratio) below 35%.

Downside scenario

Downward pressure could arise if Vicinity's operating performance persistently weakens or if the REIT adopts a more-aggressive growth strategy. In addition, we would consider a downgrade if Vicinity's ratio of FFO to debt falls below 12%.

We would also consider a downgrade if structural retail headwinds materially weaken the credit quality of Vicinity's tenants, dampening the REIT's business prospects over the next two to three years.

Upside scenario

We are not likely to raise the ratings in the foreseeable future. Upward movement in the rating is likely to depend on Vicinity adopting more-conservative financial policies such that at the top of its target gearing policy, the FFO-to-debt ratio is likely to be greater than 15%.

Related Criteria

• General Criteria: Group Rating Methodology, July 1, 2019
• General Criteria: Hybrid Capital: Methodology And Assumptions, July 1, 2019
• Criteria | Corporates | General: Corporate Methodology: Ratios And Adjustments, April 1, 2019
• Criteria | Corporates | General: Reflecting Subordination Risk In Corporate Issue Ratings, March 28, 2018
• Criteria | Corporates | Industrials: Key Credit Factors For The Real Estate Industry, Feb. 26, 2018
• General Criteria: Methodology For Linking Long-Term And Short-Term Ratings, April 7, 2017
• Criteria | Corporates | General: Methodology And Assumptions: Liquidity Descriptors For Global Corporate Issuers, Dec. 16, 2014
• Criteria | Corporates | General: Corporate Methodology, Nov. 19, 2013
• General Criteria: Methodology: Industry Risk, Nov. 19, 2013
• General Criteria: Country Risk Assessment Methodology And Assumptions, Nov. 19, 2013
• General Criteria: Methodology: Management And Governance Credit Factors For Corporate Entities, Nov. 13, 2012
• General Criteria: Principles Of Credit Ratings, Feb. 16, 2011

Related Research

• Asia-Pacific's Recovery Regains Its Footing, June 24, 2021
• Property In Transition: Remote Working Not Lights Out For Asia-Pacific Office Players, April 08, 2021
• Australian And New Zealand Retail REITs: Pandemic Leaves Lasting Pain, Jan. 11, 2021

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