Summit Lux Finance S.a r.l. — Moody’s affirms Summit’s Ba1 ratings and assigns a Ba1 rating to the planned backed senior unsecured notes by Summit Lux Finance S.a r.l., outlook remains stable

Rating Action: Moody’s affirms Summit’s Ba1 ratings and assigns a Ba1 rating to the planned backed senior unsecured notes by Summit Lux Finance S.a r.l., outlook remains stableGlobal Credit Research – 19 Jan 2022Frankfurt am Main, January 19, 2022 — Moody’s Investors Service (« Moody’s ») has today affirmed the Ba1 corporate family rating (CFR) of Summit Properties Limited (« Summit ») and its existing E300 million senior unsecured notes maturing in 2025. At the same time, Moody’s assigned a Ba1 rating to the planned new E300 million guaranteed senior unsecured notes to be issued by Summit Lux Finance S.a r.l., guaranteed by Summit. The outlook on Summit ratings remains stable and the outlook for Summit Lux Finance S.a r.l. is stable.RATINGS RATIONALESummit’s Ba1 corporate family rating (CFR) reflects the company’s solid cash flow generation, strong interest coverage and moderate leverage supported by its financial policy of maintaining a net LTV of around 40% as well as net debt to EBITDA at below 9.0x. At the same time the rating also incorporates the relatively smaller scale and greater portfolio concentration compared to higher rated European and US peers, with a GAV of ~E1.2bn as of January 2022, of which currently nearly half is constituted by German commercial properties located across major cities and secondary locations.After a major German portfolio disposal in June 2021 of close to E1 billion, Summit started diversifying its real estate operations into the US, by acquiring a mixed portfolio of affordable workforce housing apartment buildings in NYC, Class B/C malls and hotels. More specifically, as of December 2021 the residential segment comprised around 2,800 chiefly rent-stabilized and fully occupied residential units located throughout New York City (« NYC »), 14 income-generating retail properties spread across US, that according to the company, have large outparcels for sale or repurposing. Additionally, the company owns a majority stake in 2 NYC hotel properties, which we understand the company will dispose in the mid-term.The recent acquisition activity reflects Summit’s opportunistic portfolio management, a credit challenge, that could imply uncertainty around long-term business profile, targeted asset type or location and expose the company to execution risks specially in new estate segments or jurisdictions. However, we understand that Summit will remain focused on its current strong jurisdictions and very liquid real estate markets of Germany and the US, with a mid-term target of conforming a portfolio of ~E2.0bn with nearly equal weight in both countries and diversified across German commercial properties (between 40% and 50% share), residential units in NYC (40%) and US retail properties (between 10 and 20%).We expect the company’s operational performance in Germany to remain solid, characterized by a sustained like-for-like rental growth; and appreciate that the company’s new footprint in the NYC residential market will offer a defensive and very granular rental income stream, which is further supported by solid long-term demand fundamentals. There are some downside risks given limited growth potential, regulatory risk and vulnerability to tenants’ credit risk in the case of economic downturn, rising unemployment or from low-income households. Additionally, we remain cautious on the future performance of the acquired US retail properties, which remain under pressure from secular challenges and highly sensitive to COVID-19 developments. Summit properties is also now exposed to FX-risks stemming from its new operations in US, which could introduce some volatility in earnings and property values.The credit challenges stemming from the transition of the company’s business profile are balanced against management’s solid operational track record of creating value on investments and delivering sustained rental growth, while observing balanced financial policies, reflected in a strongly positioned Ba1 rating ahead of company’s expansion into the US.The Ba1 rating assigned to the planned guaranteed senior unsecured notes is in line with the long-term corporate family rating. Moody’s expects the new notes to rank pari passu with all other unsecured obligations of the issuer. They will benefit from debt incurrence covenants including a maximum LTV ratio of 60%, maximum secured loan to value ratio of 45%, a minimum unencumbered asset ratio of 1.25x and a minimum interest coverage ratio of 2x.Proceeds from the planned new notes will be used to repay around E150 million of existing indebtedness with the remainder earmarked to enhance its liquidity buffer for additional investments or other corporate purposes.STRUCTURAL CONSIDERATIONSThe existing and planned new guaranteed senior unsecured notes are structurally subordinated to currently USD 346 million secured loans in connection with the acquired NYC residential properties, with no covenants and around E33 million secured loans in connection with 3 German commercial properties, that have maintenance covenants, with generally significant headroom.We caution that in the case of the company’s predominant class of debt shifting sustainably towards secured debt as a consequence of future acquisitions over the next six to 18 months, we could notch down the rating of the existing and planned new senior notes, to reflect a weaker position of unsecured creditors post investments into secured assets. A minimum of at least 1.5x unencumbered property asset coverage ratio for unsecured creditors and weighted towards stable or liquid asset classes will be required for maintaining rating of the notes at the same level of the long-term corporate family rating.RATIONALE FOR STABLE OUTLOOKThe stable rating outlook reflects our expectation for the next 12-18 months that the company will continue to deliver positive operational results, supporting a stable cash flow generation at a strong level, while maintaining a balanced growth strategy in line with its financial policy of maintaining a LTV around 40% and net debt to EBITDA below 9x.FACTORS THAT COULD LEAD TO AN UPGRADE OR DOWNGRADE OF THE RATINGSThe below rating guidance is calibrated on the company’s current business profile, including a relevant footprint in Germany. Should the company’s portfolio mix materially change in the light of future acquisition activity, guidance will need to be revisited.FACTORS THAT COULD LEAD TO AN UPGRADEThe ratings could be upgraded if Summit is able to strengthen its business profile with a solid track record of good operating results in its expansion markets combined with strong credit metrics. Specifically:- Track record of a predictable and long-term oriented business strategy combined with positive operational results, such as increasing occupancy, net operating income and values- Increase in scale to levels commensurate with investment-grade peers and with focus on stable asset classes in its current jurisdictions- Track record of operating at Moody’s-adjusted debt/gross assets at well below 40% and net debt to EBITDA at well below 7x, while maintaining an FCC ratio well above 4.0x- Track record of accessing public capital markets, resulting in a strong liquidity, combined with a long-dated and well-staggered debt maturity profile as well as robust unencumbered assets ratio of well above 50% and weighted towards stable and liquid asset classes providing a good coverage to unsecured creditorsAll factors need to be met for an upgrade.FACTORS THAT COULD LEAD TO A DOWNGRADE- More opportunistic business strategy that elevates execution and financial risks- Deterioration in the operating performance, including dropping occupancy rate, declining net operating income, valuation impairments, or if property market fundamentals weaken sharply- Moody’s-adjusted debt/gross assets above 50% or net debt to EBITDA rises above 9x- FCC declining below 3x- The company’s liquidity profile deteriorates- The quality of the unencumbered asset pool deteriorates materially or if unencumbered property asset coverage ratio for unsecured creditors falls below 1.5x and is weighted towards relatively less stable or liquid asset classesAny of the above can cause a downgrade.LIQUIDITYSummit will maintain an adequate liquidity with a cash balance of around E450 million pro-forma for the refinancing and acquisitions signed in H2 2021; after funding the remaining of the acquisition pipeline and paying out a E80 million dividend during 2022 we expect the company to have around E200 million in available cash over the next 12 to 18 months.Available liquidity together with Moody’s funds from operations of between E85 million and E90 million per year will adequately cover all cash needs of Summit, over the next 12 to 18 months.The company’s solid liquidity is further supported by no debt maturities before 2025 and a growing track record accessing the public debt markets.Company’s unencumbered asset ratio will remain between 50% and 55% over the next 12 to 18 months, mainly because of secured loans on the acquired NYC residential properties that have a maturity of around 7 years, and which we understand the company can repay after the end of the interest-only period within 3 years.The German real estate portfolio is largely unencumbered, and we understand that the US retail assets will have no debt attached to them, after a repayment of a bridge facility from the bond proceeds and will be thus fully unencumbered. We assess the latter as a less-attractive asset class which weakens the overall quality of Summit’s unencumbered asset pool.ESG CONSIDERATIONSSummit Properties Limited is a private company, 99.1% stake owned by Summit Real Estate Holdings (controlled by the Managing Director of Summit, Zohar Levy). He established Summit in 2006 and was key in the development of the company, with 25 years of professional real estate experience and more than 15 years in Germany’s real estate market. His main asset is its 45% stake in Summit Real Estate Holdings, listed on the Tel Aviv Stock Exchange with a market capitalization of E1.7bn.As a private company, Summit has limited access to public equity and in terms of corporate governance, the company’s ownership structure could raise concerns around less checks and balances than we typically see in publicly traded and widely held companies. The recent acquisition activity reflects Summit’s opportunistic portfolio management, which is a credit challenge, as discussed above. However, the stability of the management team as well its long track record is expected to support sustained adequate business practices in line with company’s financial policy of maintaining a net LTV of around 40% as well as net debt to EBITDA at below 9x.Summit is also exposed to social risks arising from shortage of affordable workforce housing in NYC, which elevates the stringency of housing policies and limits rental growth. At its retail properties, Summit is exposed to the secular shift from e-commerce and changes in consumer spending preferences, exacerbated by the pandemic. The operational-intensive nature of both asset classes exposes Summit to counterparty risk, as the company’s performance in the US retail and residential segments will be also largely connected to the performance of the respective property managers. To align interest, the property managers have a minority stake in the current investments, ranging between 5% to 15%.The NYC’s 2025 and 2030 environmental targets will prompt residential landlords such as Summit to perform substantial investments in order to improve energy efficiency and comply with future requirements; and the company’s commercial real estate properties in Germany could see potential rising environmental regulation and greater investment requirements driven by the goal to decarbonise the economy.PRINCIPAL METHODOLOGYThe principal methodology used in these ratings was REITs and Other Commercial Real Estate Firms Methodology published in July 2021 and available at https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_1272320. Alternatively, please see the Rating Methodologies page on www.moodys.com for a copy of this methodology.COMPANY PROFILESummit Properties Limited (Summit) is a private company with a E1.2 billion real estate portfolio pro-forma for new acquisitions signed until 1 November 2021. Company is diversified across German commercial real estate properties (49% of company’s portfolio) next to US residential and retail assets (together accounting for 51%).REGULATORY DISCLOSURESFor further specification of Moody’s key rating assumptions and sensitivity analysis, see the sections Methodology Assumptions and Sensitivity to Assumptions in the disclosure form. 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