Fitch Affirms Duke Realty Corp.'s IDR at 'BBB'; Outlook Stable

NEW YORK--(BUSINESS WIRE)--

Fitch Ratings has affirmed its 'BBB' Issuer Default Rating (IDR) for Duke Realty Corp. DRE and its operating partnership Duke Realty Limited Partnership (collectively Duke). A full list of Fitch's ratings for Duke is available at the end of this release.

The Rating Outlook is Stable.

KEY RATING DRIVERS

The ratings take into account Duke's large, high quality and diversified portfolio of predominantly industrial and medical office properties, as well as its strong access to various forms of capital, including a healthy level of internally generated retained cash flow after dividends. The company's leverage and fixed-charge coverage (FCC) metrics are consistent to moderately strong for the 'BBB' rating. Development risk and only adequate unencumbered asset coverage of unsecured debt (partly due to non-income producing development assets) balance these credit strengths.

Asset Sales Improve Credit Profile

Fitch expects the percentage of Duke's NOI derived from suburban office properties to decrease to below 10% by year-end 2015 through a combination of asset sales, industrial and medical office same-store NOI (SSNOI) growth and development stabilizations. DRE sold $161 million of dispositions during 1Q'15, including the entirety of its Cleveland office and its retail property portfolios.

In April, the company closed on the sale of a $1.1 billion suburban office portfolio to an affiliate of Starwood Capital that was announced in late January. The transaction divests all the company's wholly-owned, in-service, suburban office properties located in Nashville, Raleigh, South Florida, and St. Louis. After the closing of the Starwood office portfolio sale, Duke's NOI percentage from suburban office should approximate 12%. Also in April, DRE sold a 5.2 million square foot industrial portfolio primarily consisting of older assets located in the Midwest, generating proceeds of $270 million. These properties comprised the majority of Duke's 5.9 million square foot Midwest industrial portfolio.

Appropriate Leverage for Ratings

Fitch expects DRE's leverage to sustain in the low 6.0x range through 2017. The company's pro forma leverage was 6.2x at March 31, 2015 based on trailing 12-month (TTM) recurring operating EBITDA after adjusting for the company's April portfolio sales. This compares to 7.0x, 6.8x and 8.0x during 2014, 2013 and 2012, respectively. Fitch's low 6.0x leverage expectation for Duke is appropriate to moderately strong for a 'BBB' rated REIT focused primarily on high-quality bulk industrial properties. Fitch defines leverage as consolidated debt, net of readily available cash over recurring operating EBITDA, including cash distributions from unconsolidated joint ventures (JVs).

Adequate Fixed Charge Coverage

Fitch expects that FCC will improve to roughly 3.0x in 2017, driven by low-to-mid single digit same-store net operating income (SSNOI) growth, incremental NOI from development deliveries and lower recurring capex given a reduced suburban office footprint. Fixed charge coverage (FCC) was 2.2x for the TTM ending March 31, 2015, an increase from 2.1x, 1.9x and 1.6x during 2014, 2013 and 2012, respectively. Duke's preferred equity repurchases have also helped its FCC. Projected FCC is consistent with the 'BBB' IDR. Fitch defines FCC as recurring operating EBITDA, less recurring capital expenditures and straight-line rent adjustments, divided by total interest incurred and preferred dividends.

Pre-Leasing Balances Development Risk

Fitch expects DRE to start between $400 million to $500 million of new industrial and medical office developments per year through 2017. The company's ability to win new build-to-suit (BTS) developments could push starts closer to the high end of the range. Fitch's ratings for Duke anticipate a more conservative development posture for the company during this cycle that includes limiting the pipeline size to within a range of 5% to 7.5% of undepreciated assets (currently implies $500 million to $700 million), with the speculative component generally limited to less than half. Duke's development pipeline totalled $405.6 million including joint ventures (JVs) at 100%, representing 4.4% of undepreciated gross assets at March 31, 2015. The company's unfunded committed development expenditures (at DRE's share) represented 2.4% of gross assets. This is down from 2.8% and 3.9% at year-end 2014 and 2013, respectively, but up from its 0.7% cycle low in 2009. The pipeline's leased percentage has also decreased to 55% at March 31, 2015 versus 58% and 89% at the end of 2014 and 2013.

Improving Fundamentals

Fitch expects DRE's SSNOI to sustain in the low-to-mid single digits through 2017, driven by positive industrial and medical office leasing spreads and modest occupancy gains. Duke's SSNOI increased by 6.8% for the quarter ending March 31, 2015, led by 7.1% growth in its bulk distribution portfolio and solid 5.9% gains for its medical and suburban office assets. Duke's in-service portfolio occupancy was 96% at the end of the first quarter, up from 95.3% at Dec. 31, 2014 and 94.2% at Dec. 31, 2013. Spreads on renewal leases were positive 8.4% during the first quarter compared with 8.8% and 3.1% during 2014 and 2013, respectively.

Adequate Financial Flexibility

The company's liquidity profile is also adequate with total sources of liquidity covering total uses by 1.3x for the April 1, 2015 - Dec. 31, 2016 period. Including the cost to complete its development pipeline reduces Duke's coverage to an adequate 1.0x. Fitch defines liquidity coverage as sources of liquidity divided by uses of liquidity. Sources of liquidity include unrestricted cash, availability under the unsecured revolving credit facility, and projected retained cash flow from operating activities after dividends. Uses of liquidity include pro rata debt maturities, expected recurring capital expenditures, and remaining development costs.

DRE's liquidity profile is also supported by 1.9x pro forma unencumbered asset coverage of unsecured debt assuming a stressed 8.25% cap rate, which is only adequate for the 'BBB' rating. Duke's UA/UD is hurt by the capital allocated to non-income producing development assets.

Duke has a well-balanced debt maturity schedule. The company's next unsecured maturity is not until March 1, 2016 when its $150 million 5.500% senior unsecured notes mature.

Conservative Dividend Payout

Fitch expects DRE's dividend payout ratio to improve modestly over the next 12-24 months through SSNOI growth and incremental NOI from development completions and a smaller portfolio contribution from more capital intensive suburban office properties. Duke's AFFO payout ratio was 71% in 2014 compared to 76% in 2013 and 83% in 2012. The company retains roughly $90 million of internally generated cash flow annually that can be used to service financial obligations and fund external growth.

Stable Outlook

The Stable Rating Outlook is based on Fitch's expectation that leverage will stabilize in the low 6.0x range and coverage will improve to roughly 3.0x, and that the company will maintain adequate financial flexibility over the near to medium term.

KEY RATING ASSUMPTIONS

--SSNOI growth of 4% in 2015 and 3% in 2016 and 2017;

--Acquisitions and CIP completions of roughly $100 million and $400 million, respectively in each year during the forecast period;

--Land acquisitions of roughly $50 million per year during the next three years, roughly offset by non-core land sales;

--Development spending of roughly $450 million per year through 2017;

--Dispositions totaling $1.65 billion during 2015 (implies an incremental $150 million between May 1 and Dec. 31, 2015) and no dispositions during 2016 and 2017;

--No equity issuance during the forecast period;

--Unsecured bond issuances of $500 million and $750 million during 2016 and 2017 at rates of 4.5% and 4.75%, respectively, with a portion of the proceeds used to unencumbers assets as consolidated mortgages mature.

RATING SENSITIVITIES

Duke's asset quality and balance sheet improvements have led to positive momentum in its credit profile, but Fitch's Outlook for the company remains Stable. Further de-leveraging could result in the company exceeding several positive rating sensitivities we have identified. However, Fitch plans to observe the level at which DRE's metrics stabilize (and the company's tolerance for operating outside of these metrics) before considering a positive rating action given our rating case expectation for Duke's leverage to sustain in the low 6.0x range through 2017. Duke has not publicly committed to maintain financial policies consistent with a higher rating level.

The following factors may collectively or individually result in upward rating momentum:

--Fitch's expectation of leverage sustaining below 6.0x (pro forma leverage was 6.2x for the TTM ended March 31, 2015);

--Fitch's expectation of FCC above 3.0x (TTM coverage was 2.2x).

The following factors may have a negative impact on the ratings:

--Fitch's expectation of leverage sustaining above 7.0x;

--Fitch's expectation of FCC sustaining below 2.0x

FULL LIST OF RATING ACTIONS

Fitch has affirmed the ratings for Duke Realty Corp. and Duke Realty Limited Partnership as follows:

Duke Realty Corporation

--IDR at 'BBB'.

Duke Realty Limited Partnership

--IDR at 'BBB';

--Senior unsecured line of credit at 'BBB';

--Senior unsecured term loan at 'BBB';

--Senior unsecured notes at 'BBB'.

Fitch has withdrawn its 'BB+' preferred stock rating for Duke Realty Corporation as the company no longer has any preferred stock outstanding as it was taken private.

Additional information is available on www.fitchratings.com

Applicable Criteria

Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage (pub. 28 May 2014)

https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=749393

Recovery Ratings and Notching Criteria for Equity REITs (pub. 18 Nov 2014)

https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=813628

Treatment and Notching of Hybrids in Non-Financial Corporate and REIT Credit Analysis (pub. 25 Nov 2014)

https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=821568

Additional Disclosures

Solicitation Status

https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=985598

Endorsement Policy

https://www.fitchratings.com/jsp/creditdesk/PolicyRegulation.faces?context=2&detail=31

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