Rating Action

Johannesburg, 29 October 2019 – GCR Ratings (“GCR”) has affirmed the national scale long and short term Issuer ratings assigned to Fortress REIT Limited (“Fortress” or “the REIT”) of AA-_(ZA) and A1+_(ZA); with a Stable Outlook.

Rated Entity / Issue	Rating class	Rating scale	Rating	Outlook / Watch
Fortress REIT Limited	Issuer Long Term	National	AA-_(ZA)	Stable Outlook
Fortress REIT Limited	Issuer Short Term	National	A1+_(ZA)	Stable Outlook

On May 22, 2019, GCR announced that it had released a new rating framework and sectoral criteria. As a result, the ratings were placed “Under Criteria Observation”. Subsequently, GCR has finalised the Fortress rating review under the new Criteria for Rating Real Estate Investment Trusts and Other Commercial Property Companies. As a result, the ratings have been removed from ‘Under Criteria Observation’ and the ratings reviewed in line with the new methodology.

Rating Rationale

The ratings continue to be underpinned by diversification in the fund, with sound cash flows expected to continue to derive from the REIT’s hybrid strategy. In this regard, the ZAR hedge in the form of dividends from the pan-European exposure via NEPI Rockcastle should continue to counterbalance pressure on Fortress’ property portfolio arising from a challenging letting environment amidst weak domestic macroeconomic fundamentals.

Fortress’ strong portfolio quality assessment is supported by its scale, together with tenant, geographic and asset diversification. Its sector preference to logistics and rural retail properties has also translated to relatively strong earnings resilience. Its development risk is higher than that of peers, which together with the BEE-scheme related exposures has translated to higher consolidated debt levels in recent years than observed historically. While Fortress continues to recycle capital from legacy industrial and office properties, the amount realised in FY19 declined from approximately R1.6bn achieved in the each of the previous three years, with management targeting at least R1bn p.a. over the rating horizon. These risks are counterbalanced by the moderately low, and declining development exposure as a proportion of the overall portfolio, as well as demonstrated flexibility in project rollout.

Vacancies remain high overall, due to the distortion arising from non-core assets. Tenant quality is sound, but the declining weighted average lease expiry reflects uncertainty in the domestic operating environment. Although reasonable, escalations are also under pressure, while low or moderately negative reversions are expected to persist. Overall, property margins will continue to reflect the adverse impact of tenants’ efforts to manage down rising all-in occupancy costs as rates and utilities continue to reprice, but this is counterbalanced by cash flows expected from Fortress’ exposure to well-positioned international assets, which should see it to sustain the combined operating margin above 100%.

While Fortress intends to manage the LTV ratio between 30%-35%, the range increases to 35%-40% when stressed for general market risk. Debt to operating income will continue to trend at the higher end of the 4.5x-5.0x range, partly due to drag from developments. The base interest coverage is expected to range between 3.0x-3.5x, although note is taken of the distortion from the capitalised costs related to ongoing developments. GCR considers the renewed access to debt capital markets demonstrated by recent note issues (c.R1.1bn) as improving the assessment of the REIT’s access to capital, while the ongoing release of listed securities would further enhance financial flexibility.

Ongoing disposals and reasonable headroom maintained on undrawn bank facilities (FY19: R3.5bn) provide a base coverage of 12 months’ uses of liquidity of at least 1.0x. Non-core listed securities and reasonable covenant headroom also enhance the overall liquidity assessment. This is somewhat counteracted by a high ongoing refinancing requirement and some lumpiness in the intermediate term, which currently reduces the weighted average debt maturity profile to less than three years.

Outlook Statement

The stable outlook reflects the view that that Fortress’ diversified earnings base will continue to sustain sound debt serviceability through the ongoing logistics development cycle, despite headwinds from a challenging domestic operating environment.

Rating Triggers

An upgrade could arise from further improvements to the funding profile, achieved by a longer weighted average debt maturity profile, continued release of scrip, and rigorous management of the development cycle that supports more conservative leverage levels. Conversely, negative rating action could be taken if there is persistent pressure on portfolio performance due to sustained weakening in the fundamentals of the property portfolio. Negative rating action would also be taken if debt service and/or leverage metrics weaken below the range for the ratings, despite headroom on existing covenants.

Analytical Contacts

Primary analyst	Patricia Zvarayi	Deputy Sector head: Corporate Ratings
Johannesburg, ZA	Patricia@GCRratings.com	+27 11 784 1771

Committee chair	Eyal Shevel	Sector head: Corporate Ratings
Johannesburg, ZA	Shevel@GCRratings.com	+27 11 784 1771

Related Criteria and Research

Criteria for the GCR Ratings Framework, May 2019

Criteria for Rating Real Investment Trusts and Other Commercial Property Companies, May 2019

GCR’s Country Risk Score report, published June 2019

GCR’s SA Sector Risk Score report, published October 2019

GCR’s Industry Research on the SA Commercial Property Market, July 2019

Ratings history

Fortress REIT Limited

Rating class	Review	Rating scale	Rating	Outlook/Watch	Date
Issuer Long term	Initial	National	A-_(ZA)	Stable Outlook	Apr 2012
Issuer Short Term	Initial	National	A1-_(ZA)	Stable Outlook	Apr 2012
Issuer Long term	Last	National	AA-_(ZA)	Stable Outlook	Apr 2019
Issuer Short Term	Last	National	A1+_(ZA)	Stable Outlook	Apr 2019

Risk Score Summary

Risk score	16.25

Operating environment	14.75
Country risk score	7.75
Sector risk score	7.00

Business profile	2.00
Portfolio quality	2.00
Management and governance	0.00

Financial profile	-0.50
Leverage and Capital Structure	-0.50
Liquidity	0.00

Comparative profile	0.00
Group Support	0.00
Peer analysis	0.00

Glossary

Capital Markets	The part of a financial system concerned with raising capital by dealing in shares, bonds, and other long-term debt securities.
Credit Rating	See GCR Rating Scales, Symbols and Definitions.
Country Risk	The range of risks emerging from the political, legal, economic and social conditions of a country that have adverse consequences affecting investors and creditors with exposure to the country, and may also include negative effects on financial institutions and borrowers in the country.
Covenant	A provision that is indicative of performance. Covenants are either positive or negative. Positive covenants are activities that the borrower commits to, typically in its normal course of business. Negative covenants are certain limits and restrictions on the borrowers’ activities.
Debt	An obligation to repay a sum of money. More specifically, it is funds passed from a creditor to a debtor in exchange for interest and a commitment to repay the principal in full on a specified date or over a specified period.
Diversification	Spreading risk by constructing a portfolio that contains different exposures whose returns are relatively uncorrelated. The term also refers to companies which move into markets or products that bear little relation to ones they already operate in.
Dividend	The portion of a company’s after-tax earnings that is distributed to shareholders.
Financial Flexibility	The company’s ability to access additional sources of capital funding.
Hedge	A form of risk management aimed at mitigating financial loss or other adverse circumstances. May include taking an offsetting position in addition to an existing position. The correlation between the existing and offsetting position is negative.
Hybrid	A form of security that has characteristics of various types of transaction or product.
Interest Cover	Interest cover is a measure of a company’s interest payments relative to its profits. It is calculated by dividing a company’s operating profit by its interest payments for a given period.
Issuer Ratings	See GCR Rating Scales, Symbols and Definitions.
Issuer	The party indebted or the person making repayments for its borrowings.
Lease	Conveyance of land, buildings, equipment or other assets from one person (lessor) to another (lessee) for a specific period of time for monetary or other consideration, usually in the form of rent.
Leverage	With regard to corporate analysis, leverage (or gearing) refers to the extent to which a company is funded by debt.
Liquidity	The speed at which assets can be converted to cash. It can also refer to the ability of a company to service its debt obligations due to the presence of liquid assets such as cash and its equivalents. Market liquidity refers to the ease with which a security can be bought or sold quickly and in large volumes without substantially affecting the market price.
Margin	A term whose meaning depends on the context. In the widest sense, it means the difference between two values.
Market Risk	Volatility in the value of a security/asset due to movements in share prices, interest rates, currencies, commodities or wider economic factors.
Portfolio	A collection of investments held by an individual investor or institutional investor. They may include listed securities, bonds, futures, options, real estate investments or any item that the holder believes will retain its value.
Proceeds	Funds from issuance of debt securities or sale of assets.
Rating Horizon	The rating outlook period
Rating Outlook	See GCR Rating Scales, Symbols and Definitions.
Refinancing	The issue of new debt to replace maturing debt. New debt may be provided by existing or new lenders, with a new set of terms in place.
Release	An agreement between the creditor and debtor, in terms of which the creditor release the debtor from its obligations.
Risk	The chance of future uncertainty (i.e. deviation from expected earnings or an expected outcome) that will have an impact on objectives.
Securities	Various instruments used in the capital market to raise funds.
Short Term	Current; ordinarily less than one year.
Trust	A third party that acts in the best interest of another party, according to the trust deed, usually the investors. Owner of a securitisation vehicle that acts in the best interest of the Noteholders.

Salient Points of Accorded Ratings

GCR affirms that a.) no part of the ratings process was influenced by any other business activities of the credit rating agency; b.) the ratings were based solely on the merits of the rated entity, security or financial instrument being rated; c.) such ratings were an independent evaluation of the risks and merits of the rated entity, security or financial instrument; and d.) the validity of the ratings is for a maximum of 12 months, or earlier as indicated by the applicable credit rating document.

The credit ratings have been disclosed to Fortress REIT Limited. The ratings above were solicited by, or on behalf of, the rated entity, and therefore, GCR has been compensated for the provision of the ratings.

Fortress REIT Limited participated in the rating process via face-to-face management meetings, teleconferences and other written correspondence. Furthermore, the quality of information received was considered adequate and has been independently verified where possible. The information received from Fortress REIT Limited and other reliable third parties to accord the credit ratings included:

the 2019 preliminary audited summarised consolidated financial statements;
prior four years of audited annual financial statements;
presentations and SENS announcements;
a breakdown of debt facilities available and maturities per counterparty at 30 June 2019 and post year-end.