Morningstar DBRS Changes Trend to Negative from Stable and Confirms Issuer Rating on Armada Hoffler, Limited Partnership at BBB

DBRS, Inc. (Morningstar DBRS) changed the trend to Negative from Stable and confirmed the Issuer Rating on Armada Hoffler, Limited Partnership (the Company or the Issuer) at BBB. Morningstar DBRS notes that the rating is based on the credit risk profile of the consolidated entity, Armada Hoffler Properties, Inc., which includes the Company and its subsidiaries.

KEY CREDIT RATING CONSIDERATIONS
The Negative trend reflects the sustained deterioration of EBITDA interest coverage and debt-to-EBITDA ratios beyond Morningstar DBRS’ expectations. Morningstar DBRS recognizes a pathway toward improving the financial risk assessment (FRA) metrics in the medium term; however, the execution risk of future capital events presents challenges to achieving lower leverage. FRA factors were primarily affected by the acquisition of the Interlock, a Class A mixed-use asset in West Midtown Atlanta that was primarily debt financed.

Morningstar DBRS also factored into its analysis the Company’s 50% equity interest in Harbor Point Parcel 3, a joint venture for the purposes of developing and owning T. Rowe Price’s new global headquarters in Baltimore scheduled to stabilize in Q3 2024. The addition of the T. Rowe Price headquarters on a proportionate share to the portfolio adds a trophy asset with a long-term credit tenant lease. The weakened FRA factors were partially offset with improvements to business risk assessment (BRA) factors, i.e., asset quality, lease maturity and tenant quality, and portfolio size.

CREDIT RATING DRIVERS
All else equal, Morningstar DBRS would consider a negative rating action should the Company not achieve a Morningstar DBRS EBITDA interest coverage ratio of 2.66 times (x) or better on a sustained basis, or should the Morningstar DBRS total debt-to-EBITDA not improve to 8.6x or better on a sustained basis in the near term. Conversely, Morningstar DBRS would consider restoring a Stable trend should either of these metrics be comfortably achieved on a sustained basis, all else equal.

FINANCIAL OUTLOOK
Morningstar DBRS projects Morningstar DBRS EBITDA interest coverage metrics to weaken to the mid-2.00x by YE2023 and low-2.00x range by YE2024, primarily because of the greater cost of debt and higher debt levels. The Company has high variable debt exposure, which is largely offset by various floating-to-fixed rate swaps and interest rate caps. Morningstar DBRS debt-to-EBITDA is forecast to increase near 10.0x at YE2023 before modest improvement to mid-9.0x at YE2024, largely driven by EBITDA growth from development deliveries, the Interlock acquisition, and same-store net operating income growth. For comparative purposes, the Company had a Morningstar DBRS total debt-to-EBITDA and EBITDA interest coverage ratios of 9.3x and 2.79x, respectively, as of the last 12 months ended September 30, 2023.

CREDIT RATING RATIONALE
The rating confirmation is supported by (1) the Company's market position in the Mid-Atlantic region, (2) the asset quality of its multifamily and office portfolio, (3) the quality and diversification of its commercial tenant base, and (4) the longer-term weighted-average lease terms for its office and retail assets. The rating is constrained by (1) the exposure to general contracting income, which can cause cash flow volatility; (2) the geographic concentration of assets in the Virginia Beach, Virginia, and Baltimore markets; (3) elevated leverage metrics relative to the BBB rating category; and (4) the smaller portfolio size on EBITDA and square footage basis relative to the BBB rating category.

As of September 30, 2023, the Company had no rated senior unsecured debt outstanding; however, if the Issuer were to issue rated senior unsecured debt, Morningstar DBRS expects that the debt would be issued with terms and conditions consistent with market standards that would result in the rated senior unsecured debt ranking pari passu with all current and future unsecured credit facilities, which are satisfactory to Morningstar DBRS.

ENVIRONMENTAL, SOCIAL, AND GOVERNANCE CONSIDERATIONS
There were no Environmental/Social/Governance factors that had a significant or relevant effect on the credit analysis.

A description of how Morningstar DBRS considers ESG factors within the Morningstar DBRS analytical framework can be found in the Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (January 23, 2024) at https://dbrs.morningstar.com/research/427030.

BUSINESS RISK ASSESSMENT (BRA) AND FINANCIAL RISK ASSESSMENT (FRA)
(A) Weighting of BRA Factors
In the analysis of Armada Hoffler, Limited Partnership, the BRA factors are considered in the order of importance contemplated in the methodology.

(B) Weighting of FRA Factors
In the analysis of Armada Hoffler, Limited Partnership, the FRA factors are considered in the order of importance contemplated in the methodology.

(C) Weighting of the BRA and the FRA
In the analysis of Armada Hoffler, Limited Partnership, the BRA carries greater weight than the FRA.

Notes:
All figures are in U.S. dollars unless otherwise noted.

Morningstar DBRS applied the following principal methodology:
-- Global Methodology for Rating Entities in the Real Estate Industry (April 11, 2023), https://dbrs.morningstar.com/research/412477

The following methodologies have also been applied:
-- DBRS Morningstar Global Criteria: Common Adjustments for Calculating Financial Ratios (November 9, 2023), https://dbrs.morningstar.com/research/423052
-- DBRS Morningstar Global Criteria: Rating Corporate Holding Companies and Parent/Subsidiary Rating Relationships (September 27, 2023), https://dbrs.morningstar.com/research/421119

The credit rating methodologies used in the analysis of this transaction can be found at: https://dbrs.morningstar.com/about/methodologies.

A description of how Morningstar DBRS analyzes corporate finance transactions and how the methodologies are collectively applied can be found at: https://dbrs.morningstar.com/research/397223.

The credit rating was initiated at the request of the rated entity.

The rated entity or its related entities did participate in the credit rating process for this credit rating action.

Morningstar DBRS had access to the accounts, management, and other relevant internal documents of the rated entity or its related entities in connection with this credit rating action.

This is a solicited credit rating.

The conditions that lead to the assignment of a Negative or Positive trend are generally resolved within a 12-month period. Morningstar DBRS trends and credit ratings are under regular surveillance.

Information regarding Morningstar DBRS credit ratings, including definitions, policies, and methodologies, is available on dbrs.morningstar.com or contact us at info-DBRS@morningstar.com.

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