Rating Action Overview

• Australia-based GPT Wholesale Office Fund (GWOF) has financial headroom to proceed with its committed developments and refurbishment initiatives while remaining within our expectations for the current rating level.
• On Nov. 10, 2023, S&P Global Ratings affirmed its 'A-' long-term and 'A-2' short-term issuer credit ratings on GWOF and its related debt issues.
• The stable outlook reflects our view of GWOF's adoption of a 60% distribution payout ratio, down from about 90% previously. This greater cash retention will bolster credit metrics and counter risks from escalating interest costs, competitive leasing conditions, and declining office valuations over the next 12-24 months.

Rating Action Rationale

GWOF's modest financial policies, including the recent change to a 60% distribution payout ratio, will support the 'A-' rating. The reduction in the distribution payout ratio will allow for a greater proportion of capital expenditure (capex) to be funded from internal cash flow. Absent this change, the fund's gearing (ratio of net debt to total tangible assets) would have been higher, resulting in weaker credit metrics.

We estimate GWOF's ratio of funds from operations (FFO) to debt will narrow to 13%-13.5% for fiscal 2024 (ending June 30, 2024), from 16.1% in fiscal 2023. The development of 51 Flinders Lane in Melbourne will require ongoing funding during its construction phase; and this will weaken the fund's credit metrics from solid levels previously. We believe GWOF will remain committed to maintaining the 'A-' rating. Beyond the scheduled completion of 51 Flinders Lane in the second half of 2025, we expect the fund to support credit metrics through potential unit holder redemptions and further development opportunities.

GWOF is well-placed to weather challenging office conditions.  Australian wholesale office trusts face a number of challenges over the next few years. Tenants are seeking to consolidate their office requirements amid the adoption of hybrid working practices.

We believe GWOF's asset quality and competitive office space offerings position it well to meet tenant requirements. The fund's portfolio comprises 17 prime grade (61% premium, 36% A-grade, and 3% developing) assets. The ownership of quality assets allows it to offer tenants high-quality amenities, locations in core central business districts, and strong sustainability credentials.

The prospect of interest rates remaining "higher for longer" is negative for the commercial real estate sector because escalating interest costs are weakening credit metrics. GWOF increased its interest rate hedge ratio to above 80% as of Sept. 30, 2023, and we project the fund will operate at the upper end of its policy ranges. This will offset the impact of any subsequent interest rate increases over the next 12-18 months.

That said, there will also be prolonged hits to valuations, with office discount rate spreads likely to expand to long-term averages. However, GWOF has headroom against the upper end of its 10%-30% gearing target range (gearing was 22.6% as of Sept. 30, 2023), and it will benefit from its dividend policy change. Furthermore, the fund's 91.9% occupancy rate and 4.9 years weighted-average lease expiry will provide some protection against increased competition in leasing.

With only the 51 Flinders Lane development committed, GWOF is well-placed due to its moderate development pipeline, considering the likelihood of continued weakness in office demand.  While the capex for 51 Flinders Lane will erode most of the existing buffer in the fund's credit metrics, the project is relatively de-risked with a fixed-price contract. Construction has progressed up to structural foundations. Outside of this, we anticipate the fund will spend only on existing building refurbishment, along with limited spending on design works for its existing development sites, with no further construction spend.

Our base case forecasts capex of A$320 million in fiscal 2024 and A$210 million in fiscal 2025, inclusive of the expenditure on 51 Flinders Lane. The development will offer smaller floor plates, targeted at sub-1,500-square-meter tenancies. In our view, this will expose GWOF to increased credit risk from smaller tenants and the potential for higher lease turnover relative to other assets in the fund's portfolio. This asset will represent 5.5% of GWOF's total assets at completion. We continue to view the fund's liquidity as strong with no debt maturities over the 24 months ending June 30, 2025.

Outlook

The stable rating outlook reflects GWOF's high-quality and diversified asset base, experienced management team, and moderate financial policies. We expect GWOF to conduct any development or refurbishment activity in a measured manner, and to continue to manage its liquidity and funding profile conservatively over the next 12-24 months. This includes maintaining net gearing within the fund's target range of 10%-30%.

Downside scenario

We could lower our rating if GWOF's ratio of FFO to debt falls below 12% sustainably. This could occur because of large debt-funded acquisitions or developments that increase its gearing toward the top end of the gearing target. A material escalation in interest costs beyond our base-case assumptions could also weaken credit metrics.

Downward rating pressure could also arise if GWOF shifts its operating strategy toward the acquisition of lower-grade office properties; or if the fund adopts a more speculative approach to its large-scale developments, such as lower tenant precommitment thresholds or increased exposure to construction and execution risks.

Upside scenario

Upward pressure on the rating on GWOF is limited, given our view of the inherently cyclical nature of the office property market. Nevertheless, upward movement could occur if the fund materially diversifies its asset base and adopts more conservative financial policies.

Company Description

Established in 2006, GWOF is an externally managed, unlisted Australian REIT. The fund's portfolio consists of 17 office properties and four development sites on the east coast of Australia, with a gross asset value of about A$9.43 billion as of Sept. 30, 2023. The fund comprises two stapled funds: GPT Wholesale Office Fund No. 1 and GPT Wholesale Office Fund No. 2.

Our Base-Case Scenario

Assumptions

• GWOF's revenue to increase about 3.8% in fiscal 2024 and 3.2% in fiscal 2025. Tenant incentives to remain high over the next two years at 30%-40% of gross new rents.
• Portfolio occupancy to be 90%-91%, reflecting our subdued outlook on major Capital City net absorption.
• We anticipate refurbishment and redevelopment will be required. This will ensure that GWOF's assets are upgraded to meet tenant requirements for sustainable office space. Consequently, revenues and EBITDA should improve as these upgrades are completed.
• Capex to be about A$320 million in fiscal 2024 and A$210 million in fiscal 2025. This includes our cost forecasts for developing 51 Flinders Lane.
• Distribution payout ratio of 60% of FFO as per management guidance.
• No divestments over the next two years.
• No upcoming debt maturities in the next 12 months.
• The distribution reinvestment plan remains active. We assume the current 6.5% take-up rate will persist.

Key metrics

Liquidity

We expect GWOF to maintain strong liquidity. The short-term rating on the fund is 'A-2'. GWOF's ratio of liquidity sources to its uses will likely be above 1.5x for the 12 months ending June 30, 2024, and remain more than 1.0x over the subsequent 12 months.

We believe GWOF will balance the timing of sizable potential acquisition and development activity against its sources of liquidity. Our view of its sound relationship with banks, generally prudent financial risk management, and access to wider debt capital markets also support our liquidity assessment.

Our assessment of the company's liquidity considers the following sources and uses over the 12 months ending June 30, 2024:

Principal liquidity sources:

• Minimal cash and liquid investments.
• Cash FFO of A$270 million-A$280 million.
• Undrawn bank lines of A$1,050 million as of June 30, 2023; and
• Active distribution reinvestment plan.

Principal liquidity uses:

• Capex between A$310 million and A$330 million.
• Distribution payout ratio of 60% of FFO; and
• No upcoming debt maturities.

Ratings Score Snapshot

Related Criteria

• General Criteria: Environmental, Social, And Governance Principles In Credit Ratings, Oct. 10, 2021
• General Criteria: Group Rating Methodology, July 1, 2019
• Criteria | Corporates | General: Corporate Methodology: Ratios And Adjustments, April 1, 2019
• Criteria | Corporates | Industrials: Key Credit Factors For The Real Estate Industry, Feb. 26, 2018
• General Criteria: Methodology For Linking Long-Term And Short-Term Ratings, April 7, 2017
• Criteria | Corporates | General: Methodology And Assumptions: Liquidity Descriptors For Global Corporate Issuers, Dec. 16, 2014
• Criteria | Corporates | General: Corporate Methodology, Nov. 19, 2013
• General Criteria: Methodology: Industry Risk, Nov. 19, 2013
• General Criteria: Country Risk Assessment Methodology And Assumptions, Nov. 19, 2013
• General Criteria: Methodology: Management And Governance Credit Factors For Corporate Entities, Nov. 13, 2012
• General Criteria: Principles Of Credit Ratings, Feb. 16, 2011

Ratings List