Fitch Ratings has assigned a Long-Term Issuer Default Rating (IDR) to Independence Realty Trust, Inc. (IRT) of 'BBB'.

The Rating Outlook is Stable. Fitch has also assigned an IDR of 'BBB' to the company's subsidiary, Independence Realty Operating Partnership, LP and its senior unsecured debt, which includes the company's credit facility and two unsecured term loans.

The rating reflects IRT's solid balance sheet, stable property performance and anticipated execution of its portfolio optimization plan and deleveraging strategy. This is offset to some extent by the company's historical predominantly secured financing approach and less developed capital access.

Key Rating Drivers

Portfolio Optimization Leading to Deleveraging: In 4Q23, IRT announced its Portfolio Optimization and Deleveraging Strategy, which targets sales of 10 properties located in seven states in order to reduce or exit these markets, while also deleveraging its balance sheet. IRT completed four of these dispositions in 4Q23 for a total gross sales price of approximately $201 million. Two more of these assets were sold in February 2024, with the remaining sales expected to be closed in 1Q24. In sum, these property sales are expected to raise approximately $525 million of capital, which is expected to be used to pay down debt.

Fitch calculates REIT leverage (net debt to recurring operating EBITDA for 2023 of 6.7x, which includes the beginning of the Optimization program 4Q23 sales, which is modestly down from 7.1x REIT leverage for 2022. Fitch expects further delevering to occur into the forecast period as the company completes its disposition program, pays down debt with the proceeds and continues to generate positive organic growth with an expectation of REIT leverage sustaining below the 6x level by the end of the forecast period.

Moderating Operations: Fitch expects IRT's organic growth to largely moderate beginning in 2024 within the context of the possibility of a slowing economic environment, supply headwinds, and elevated year-over-year comps. As such, IRT exhibited strong organic growth in the last few years with SSNOI growth of +5.7% in 2023, +13.7% in 2022 and +11.4% in 2021. The U.S. Sunbelt region has experienced accelerated growth in recent years, driven by shifting lifestyle preferences and by affordability trends driving sustainable pricing power.

The market has attracted an influx of investor interest and flow of funds that is contributing to current Sunbelt oversupply in many markets. IRT is positioned relatively well to withstand this concern given the diversification of its portfolio, affordable price point offerings and renovation program.

Expected Transition to Unsecured Strategy: IRT has historically predominantly funded its business with secured financing, consisting of property level mortgage debt and secured credit facilities. As of Dec. 31, 2023, 67% of the company's debt is secured, considerably above most multifamily peers. However, 65 of the company's 110 multifamily properties are unencumbered, providing some degree of financial flexibility and contingent liquidity. The company has minimal debt coming due over the next couple years but Fitch expects the company will seek to replace maturing secured financing (mortgages) with unsecured financing through the forecast horizon.

This will result in a more meaningful transition towards unsecured financing as Independence has higher levels of debt maturities by 2026. Thus far, the company has made a modest transformation as unencumbered NOI as a percentage of total NOI increased from 49% to 53% from YE 2019 to YE 2023. Fitch views the transition to unsecured financing favorably as it gives the company incremental financial flexibility.

Sustained Margins: IRT has exhibited margin improvements over the last few years to sustain through the forecast period due to capital spend initiatives and cost saving measures, increased rents and the Steadfast acquisition. IRT's focus on its value-add renovations program improves the quality, durability and appeal of its portfolio, while increasing its cash flow and overall value creation despite the relatively muted acquisition front, stemming from the wider bid/ask spread environment and lack of a significant development pipeline.

Portfolio Diversification: IRT's assets are concentrated in the Sunbelt region, which has limited supply constraints and barriers to entry given the relative availability of land combined with lenient zoning regulations. These factors have historically led to cycles of overbuilding in the region, negatively impacting supply/demand fundamentals. However, the portfolio does possess a good level of diversification with a presence in 25 markets and an incremental modest focus in the more stable Midwest region. The portfolio can mostly be characterized as Class B assets, although, the company is in a perpetual state of upgrading its assets, on the margin, through its renovation program.

Low Development Exposure: Fitch expects development going forward to be a minimal component of IRT's growth strategy. As of Dec. 31, 2023, IRT's total projected cost of development was approximately $223 million with an estimated $66 million remaining to be funded. In addition, the company has four development projects housed within joint ventures, where it has the option to buy or sell the projects at completion, further minimizing development exposure. The company's unfunded costs as a percentage of gross assets was low at 1.0% as of 4Q23 and poses minimal liquidity risk.

Solid Unencumbered Coverage: The company has a high ratio of net unencumbered assets to unsecured debt (UA/UD) at 3.2x at YE 2023 (4Q23 unencumbered NOI annualized divided by a stressed capitalization rate of 8.5%), which is above average among REITs. However, this ratio appears strongly high partially due to IRT's historical approach of maintaining a predominantly secured balance sheet and possessing a moderately sized unencumbered pool. Fitch anticipates that as the company raises additional unsecured debt and unencumbers additional assets, this ratio would decline to the 2.5x-3.0x range, which remains suitable for the 'BBB' rating category.

Low AFFO Payout Ratio: The company maintains financial flexibility through high retention of cash compared to REIT peers as Fitch calculates AFFO payout ratios of 55.2% in 2023 and 47.0% in 2022. Fitch anticipates the company will maintain minimal dividend increases prospectively, and choose instead to retain incremental cash flow to put towards its value-add renovation program.

Derivation Summary

IRT's 'BBB' rating reflects the company's portfolio of predominantly Class B Sunbelt and Midwest multifamily properties with solid credit metrics. Fitch rates the company below its nearest peers, Mid-America Apartment Communities (MAA; A-/Stable) and Camden Property Trust (CPT; A-/Stable) due to higher leverage and weaker demonstrated capital markets access. Historically, IRT has maintained primarily a secured funding strategy with the only unsecured debt up to this point coming in the form of an unsecured credit facility and bank term loans. However, the company envisions transitioning to more of an unsecured funding strategy prospectively.

IRT is smaller than its apartment peers as apartment unit count about half the size of CPT and less than a third of the size of MAA, so has less asset diversification. In addition, IRT has slightly lower average rental rates than MAA and considerably lower average rental rates than CPT. These lower price point offerings can be advantageous during an economic downturn when tenants are more price sensitive, and IRT's portfolio has historically been relatively stable. Moreover, IRT has mitigated risk to a degree with minimal development exposure compared to MAA and CPT, which have considerably larger development pipelines.

Fitch rates the IDRs of the parent REIT and subsidiary operating partnership, Independence Realty Operating Partnership, LP. on a consolidated basis, using a weak parent/strong subsidiary approach and open access and control factors, based on the entities operating as a single enterprise with strong legal and operational ties. Fitch assesses the quality of the overall linkage as high, which results in an equalization of IDRs across the corporate structure.

Key Assumptions

--+2-3% SSNOI growth in 2024-2026;

No acquisitions in the forecast period, $325 million of dispositions in 2024, increasing thereafter, reaching $800 million by 2026; annual dispositions of $300 million through 2026;

Development spend of $55 million in 2024, none thereafter through the forecast period;

Annual dividend growth of roughly 8%-10% through the forecast period;

Unsecured debt issuance of $125 million in 2025 and $375 million in 2026.

RATING SENSITIVITIES

Factors that could, individually or collectively, lead to positive rating action/upgrade

Fitch's expectation of leverage (net debt to recurring operating EBITDA) sustaining below 5.5x;

The company's demonstration of improved capital access, as potentially including unsecured note issuance and more consistent access to unsecured debt capital through higher frequency of issuance on par with 'BBB+' rated REIT issuers;

Fitch's expectation of REIT fixed-charge coverage (recurring operating EBITDA adjusted for maintenance capex relative to interest and preferred dividends) sustaining above 4.0x over the rating horizon.

Factors that could, individually or collectively, lead to negative rating action/downgrade

Fitch's expectation of leverage (net debt to recurring operating EBITDA) sustaining above 6.5x;

Fitch's expectation of REIT fixed-charge coverage (recurring operating EBITDA adjusted for maintenance capex relative to interest and preferred dividends) sustaining below 3.0x over the rating horizon;

Sustained negative operating fundamentals;

Unencumbered assets to unsecured debt (UA/UD) sustaining below 2.0x.

Liquidity and Debt Structure

Solid Liquidity Coverage: As of Dec. 31, 2023, the IRT had $23 million of readily available cash and $266 million available under its $500 million unsecured revolving credit facility. Fitch estimates IRT's liquidity coverage through fiscal YE 2025 at roughly 1.7x. Maturities are reasonably well laddered, with less than 10% of debt maturing through the end of 2025. Nonetheless, the company has approximately 40% of total debt maturing in 2028.

Fitch defines liquidity coverage as sources of liquidity divided by uses of liquidity. Sources include unrestricted cash, availability under unsecured revolving credit facilities, and retained cash flow from operating activities after dividends. Uses include pro rata debt maturities, expected recurring capex, and forecast (re)development costs.

Issuer Profile

Independence Realty Trust, Inc. (NYSE: IRT) is a real estate investment trust that went public in 2013 that owns and operates multifamily communities, primarily across Sunbelt and Midwest U.S. markets.

Date of Relevant Committee

29 February 2024

REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING

The principal sources of information used in the analysis are described in the Applicable Criteria.

ESG Considerations

The highest level of ESG credit relevance is a score of '3', unless otherwise disclosed in this section. A score of '3' means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity. Fitch's ESG Relevance Scores are not inputs in the rating process; they are an observation on the relevance and materiality of ESG factors in the rating decision. For more information on Fitch's ESG Relevance Scores, visit https://www.fitchratings.com/topics/esg/products#esg-relevance-scores.

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