OBAS Optibase Ltd

Optibase Ltd.

 

Monitoring Report | May 2021

 

This credit rating report is a translation of a report that was written in Hebrew for a debt issued in Israel. The

binding version is the one in the origin language.

Contacts:

 

Hay Riany, CPA

Team Leader – Primary Rating Analyst

Hay.riany@midroog.co.il

 

Shiran Fima, CPA

Analyst – Secondary Rating Analyst
Shiranfh@midroog.co.il

 

Ran Goldstein, VP

Head of Real Estate Finance

Rang@midroog.co.il

Optibase Ltd.

 

 

Midroog affirms the Baa1.il rating with stable outlook for bonds (Series A) issued by Optibase Ltd. (hereinafter: "the Company").

 

Outstanding bonds rated by Midroog:

 

Summary of rating rationale

 

 

 

 

 

 

2                        5/25/2021	Optibase Ltd. - Monitoring

•

The Company has sufficient liquid balances for bond service. As of December 31, 2020, the Company's (consolidated) liquid balances amounted to USD 29 million. The balance of Company bonds (Series A) as of said date amounted to only USD 3.1 million, expected to be fully redeemed in December 2021.

 

Midroog's basecase scenario includes, inter alia, repayment of bank loans and bonds in conformity with the Company's repayment schedule, CapEx investments in properties, payment to tenant LEM, in accordance with a settlement agreement as reported by the Company on October 20, 2020, as well as potential investment in new properties, in accordance with Midroog's scenario. The basecase scenario also includes current receipts and payments from Company properties.

 

As part of the basecase scenario, Midroog has prepared various sensitivity scenarios including, inter alia, potential erosion of valuation of Company properties, potential erosion of USD/NIS exchange rate, as well as various sensitivity scenarios regarding timing and the Company's revenues and expenses.

 

Accordingly, the Company's ratio of net debt to net CAP over the short to medium term should range between 60%-64% which is a strong ratio for the rating; the Company's FFO total sum over the medium to long term should range between USD 9-11 million only, which is negative for the rating; but the coverage ratio of net debt to FFO should be fast for the rating, ranging between 22-24 years.

 

Midroog's adjustments applied to the financial ratios (hereinafter: "Midroog adjustments") include, inter alia, adjustment of valuation of Company properties in lieu of their presentation at depreciated cost on the Company's financial statements, which are compiled in conformity with US GAAP, by excluding accumulated depreciation and/or including the fair value and adding the Company's share of debt and results of equity-accounted investees.

 

Rating outlook

 

The Stable rating outlook reflects our assessment that the Company will maintain a stable cash flow from its properties, as well as sufficient liquid balances for bond service.

 

Factors That Could Lead to a Rating Upgrade:

 

•	Significant growth in operations and improved property diversification

•	Significant increase in FFO sum

•	Significant improvement in financial flexibility, with emphasis on scope of un-pledged assets

 

Factors That Could Lead to a Rating Downgrade:

 

•	Significant decrease to Company's liquidity

•	Significant erosion of leverage ratios and/or coverage ratios of the Company beyond Midroog's forecasts

Optibase Ltd. – Key data, USD in millions

Detailed rating considerations

 

Company operations in the rental property market in the USA and in Switzerland support the stability of the Company's operating environment

 

The Company has rental properties located in the USA and Switzerland, which is supportive of a stable operating environment.

 

The USA is rated Aaa with a Stable outlook by Moody's investors service and has a strong, stable economy. Unemployment in the USA increased significantly in the first half of 2020, due to the Corona Virus, after being at historical lows in recent years, and has peaked at double-digit levels. However, since the second half of last year, the unemployment rate has recovered and as of April 2021, the unemployment rate in the USA was at 6.1%, and is expected to decrease further, down to 4.3% in 2023¹.

 

In the US office space market, occupancy rates in the first quarter of 2021 decreased to 84% (from 87.7% in the corresponding period last year), with a decrease in Philadelphia (86.9%) as well as Chicago (82.4%), where the Company does business, inter alia². Let it be noted that while occupancy rates in Philadelphia and in Chicago have been relatively volatile over the years, these areas have seen a consistent upward trend in rent fees.

 

Switzerland, which is also rated Aaa with a Stable outlook by Moody's investors service, has a strong, stable economy. The unemployment rate in Switzerland is very low, and only increased slightly in 2020 (remaining below 4%). As of April 2021, the unemployment rate was only 3.3%, and is expected to decrease to 2.8% in 2023³.

 

The office market in Geneva, Switzerland – where the Company's material property (CTN) is located – has seen constantly growing supply in recent years, which somewhat impacted occupancy rates and rent. This being said, occupancy rates remained high compared to other markets, at 94% in 2020⁴.

 

The Company has total assets appropriate for the rating, but the weak operational diversification and short contract duration negatively affect its business profile

 

In conformity with Midroog's basecase scenario, the Company's total assets (after Midroog adjustments) should continue to be appropriate for the rating.

 

However, the Company has but a small number of properties, and in 2020 the top property accounted for 45% of the Company's NOI. In Midroog's scenario, if the Company will acquire more properties in the short to medium term, after completing the sale of the property portfolio in Germany in 2020, the acquisition may contribute to the Company's property diversification.

---

1	Source: Trading economics

2	Source: CBRE

3	Source: Trading economics

4	Source: JLL

 

Chart 1: Property diversification based on Company share of NOI, as of December 31, 2020

 

 

Moreover, the business profile is negatively impacted by relatively short lease durations, which as of December 31, 2020 are on average shorter than 3 years, and by exposure to a material tenant accounting for 10% of Company revenues (excluding a 4% holding in commercial properties in Texas). Due to a settlement agreement signed by the Company and the tenant, following a legal proceeding, this tenant is expected to depart from the property by 2023. Let it be noted that departure of this material tenant, without prior preparation for occupancy of the areas to be vacated, may negatively impact both the Company's business profile and financial profile.

 

The Company's financial profile is supported by leverage and coverage ratios that are favorable for the rating, despite the relatively low FFO sum

 

As of December 31, 2020, the ratio of net debt to net CAP for the Company (after adjustments by Midroog) was 54%.  According to Midroog's basecase scenario, this ratio should be somewhat eroded due, inter alia, to investment in new properties, and due to potential erosion in valuations of Company properties because of the continued Corona Virus crisis, and therefore in the short to medium term should range between 60%-64% which is favorable for the rating.

 

Conversely, the Company has low FFO sum   for the rating, amounting to only USD 12.6 million in 2020. In conformity with Midroog's basecase scenario, this ration should range between USD 9-11 million over the medium term and which is low for the rating. However, the coverage ratio of net debt to FFO should range between 22-24 years and which is favorable for the rating.

 

In absence of un-encumbered properties, the Company's financial flexibility is limited, primarily due to properties with LTV ration that in Midroog's scenario would allow, if needed, for re-financing to generate excess cash flow. As of December 31, 2020, the Company's ratio of secured debt to investment property was 57%, and Midroog believes it may be slightly eroded due, inter alia, to re-financing of the property in Philadelphia and to potential erosion in valuation of Company properties because of the continued Corona Virus crisis and should range between 57%-60% over the short to medium term, which is appropriate for the rating.

 

As of December 31, 2020, the Company had liquid balances and credit facilities amounting in total to USD 36 million (consolidated), where the balance of Company bonds (Series A) amounted to only USD 3.1 million. This balance should be fully redeemed in December 2021. Midroog believes that the Company's liquid balances, and credit facilities should continue to be satisfactory for debt service of the bonds.

 

Let it be noted that Midroog included in this ratio representative annual liquid balances and credit facilities for debt service of un-secured debt principal which includes, inter alia, amortization with respect to debt secured by properties in Miami, as these do not generate current cash flow to cover debt service.

 

Chart 2: Repayment schedule of bonds (Series A) as of December 31, 2020, USD in millions

 

 

Other rating considerations

 

The Company's actual rating of Baa1.il is one notch lower than the rating based on the rating scorecard of A3.il, due to small scale of operations and weak property diversification of the Company, along with small holding stakes in some properties, which negatively impacts the Company's business profile and financial flexibility beyond what is reflected by the rating scorecard. Moreover, the Company's exposure to a material tenant, expected to depart in the next two years, may negatively impact the Company's business profile and financial profile, as noted above.

 

The scope of Company operations, and in particular the weak property diversification in some properties, negatively impact its business profile. FFO sum that is low for the rating, which may be more sensitive to fluctuations in properties and to volatility in certain rent agreement of the Company.

Moreover, small holding stakes in some properties negatively impact its credit repayment capacity. Thus, as of December 31, 2020, the Company's weighted average holding stake was 41% (excluding a 4% holding stake in commercial properties in Texas). Let it be noted that this rate was impacted, inter alia, after completing the sale of a property portfolio in Germany, which was 100% owned by the Company. The small holding stakes in properties negatively impact the Company's access to liquidity from these properties due, inter alia, to inability to decide on actions such as realization, re-financing and/or dividend distributions.

 

Company profile

 

Advanced Systems (1990) Ltd. In 1993, the Company was renamed Optibase Ltd. The Company was previously engaged in digital video technologies, and since 2009 has been engaged in the fixed income real estate business. Currently, the Company is engaged in purchase, holding and management of rental properties of various types in Switzerland and the USA. The Company is a public company with shares listed on NASDAQ. As of the rating report date, the controlling shareholder of the Company is the Capri Family Foundation.

 

Rating history

 

 

 

Related reports

 

Optibase Ltd. – Related Reports
Rating of Rental Property Companies – Methodology Report, May 2020
Adjustments to financial statements and presentation of key financial benchmarks for corporate ratings – Methodology Report, May 2020
Effect of Corona Virus outbreak on real estate market – Special Report – Sector Note, November 2020

Table of affinities and holdings

 

Midroog's rating scales and definitions

 

These reports are available on the Midroog website at www.midroog.co.il

 

 

Information from the issuer

 

In its ratings, Midroog relies, inter alia, on information received from competent organs of the issuer.

 

Note: Midroog appends numeric modifiers 1, 2, and 3 to each rating category from Aa.il to Caa.il. The modifier '1' indicates that the obligation ranks in the higher end of its rating category, which is denoted by letters. The modifier '2' indicates that it ranks in the middle of its rating category and the modifier '3' indicates that the obligation ranks in the lower end of that category, denoted by letters.

 

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