American Assets Trust, Inc. (NYSE:AAT) Q3 2023 Earnings Call Transcript

American Assets Trust, Inc. (NYSE:AAT) Q3 2023 Earnings Call Transcript October 25, 2023

Operator: Good day and welcome to the American Assets Trust Third Quarter 2023 Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions]. Please note, today’s event is being recorded. I would now like to turn the conference over to Adam Wyll, President and Chief Operating Officer. Please go ahead.

Adam Wyll: Thank you. Good morning, everyone. Welcome to American Assets Trust third quarter 2023 earnings call. Yesterday afternoon, our earnings release and supplemental information were furnished to the SEC on Form 8-K. Both are now available on the Investors section of our website americanassetstrust.com. And with that quick intro, I’ll turn the call over to Ernest Rady, our Chairman and CEO to begin the discussion of our third quarter 2023 results. Ernest?

Ernest Rady: Thanks, Adam, and good morning, everyone. During these times when the economic and business landscapes are so unpredictable, it has become imperative for us to focus on what we can control, including how we can adapt to meeting the evolving market demands in such a turbulent economy. Along these lines, we have a history of overcoming challenges with resilience, and we are confident that our high-quality operating platform and real estate portfolio will remain steadfast in spite of market adversely. As we face persistent inflation, higher for longer federal funds rates, much tighter credit conditions, and truly unfortunate geopolitical instability in war. We are certainly not naive to the fact that the office sector, in particular, seems to be painted with a broad negative brush.

It may take time for the office sector to see a meaningful bifurcation of performance, and value between the more modernized and amenities office projects like ours versus that of commodity office. But we are confident that we’ll be on the right side of that equation. And not to mention, as we see replacement costs for high of the property like ours soaring and likely to continue to climb over the years to come, I think that today’s real estate prices for premier properties will be a bargain in the future. Meanwhile, in Q3, 2023, we were once again encouraged by our operating fundamentals, which were stronger than our projections against the negative backdrop for commercial real estate. Nevertheless, we remain optimistic that our earnings trajectory for the rest of the years as we have once again increased our full-year guidance based on our better-than-expected performance so far in 2023.

Candidly, the outlook beyond this year, at least in the short term is less certain with the prevailing economic and global challenges. But as always, I promise you, we’ll work hard, do our very best, and look forward to presenting our ’24 guidance next February. Adam, Bob, and Steve will go into more detail on our various asset segments, financial results, and guidance. But first, I want to mention that the Board of Directors has approved and maintained a quarterly dividend of $0.33 per share for the fourth quarter, which we believe is supported by our financial results and is an expression of the board’s confidence in our expected performance. The dividend will be paid under December 21st to shareholders of record on December 7th. Again, on behalf of all of us at American Assets Trust, we thank you for your confidence and continued support in allowing us to manage your company.

I’m now going to turn the call back to Adam.

Adam Wyll: Thanks, Ernest. At American Assets Trust, we focus our strategy and decision-making on what we believe will create long-term financial outperformance. Specifically, our portfolio of high-quality properties and our asset class diversity, which provides more stability and protection from risks associated with changes and economic conditions of a particular market or industry. Our property locations and demographics favoring cities with temporary climates, higher household incomes, and education levels near world-renowned universities and transit centers, our fortress balance sheet, and debt profile with a well-staggered debt maturity schedule. Our integration of property technologies to provide operational cost savings and efficiencies, our economically prudent ESG initiatives in our integrity and transparency in our communications and business dealings with our stakeholders.

We certainly believe that these factors together with simply improving our properties is critical to remaining best-in-class among our peers and being fiercely competitive in the marketplace, which will enable our continued long-term success notwithstanding the inevitable cycles of the real estate industry including the one we are currently mired in. In fact, as of the end of Q3, we had our highest-ever average monthly base rent per square foot for both of our office portfolio and retail portfolio and also highest average monthly rent per unit for our multifamily portfolio since our IPO. Pretty proud of that. Briefly on the office utilization front, a recent study by Resume Builder showed that 90% of companies plan to implement return turn to office policies within the next 12 months to 14 months with a meaningful amount of those companies also stating that they would threaten to terminate employees that don’t comply.

This, of course, comes as more and more CEOs contend that employee collaboration, engagement, mentorship, and productivity are clearly suffering without in office presence. No surprise there. As labor forces soften and recessionary concerns ease, we believe many more large companies will begin to solidify future space plans. From what we can see based on tenant card swipes, access control records, and property manager estimates, we have seen an uptick in office utilization on average of a few percentage points at our properties since we last reported at the end of Q2 with Bellevue showing the most meaningful improvement. On the retail front, where we stand just under 95% leased and comprises 27% of our portfolio NOI, we continue to see an improved leasing environment post-COVID as retail fundamentals have remained strong for the most part despite sustained headwinds.

We had a significant retail renewal activity in Q3. Our comparable retail leasing spreads have maintained their favorable trajectory over the past year plus with an 8% increase on a cash basis and 19% increase on a straight-line basis for Q3 deals, an 8% increase on cash basis, and 15% increase on straight-line basis for the trailing four quarters. No doubt, this is a testament to our best-in-class and well-managed retail properties that are absolutely dominant in their trade areas, which reside in supply constrained and densely populated markets with favorable demographics. With respect to our multifamily communities, we continue to see positive, albeit decelerating rent growth as we posted better than expected results in Q3. In our view, the deceleration of rent growth is due in part to an increased amount of applicants not meeting our income and credit requirements, not to mention general economic stress on individuals and families.

Nevertheless, in San Diego, we saw leases on vacant units rent at an average rate of approximately 3% over prior rents, while rates on renewed units increased at an average of 11% over prior rents for a blended average of approximately a 6% increase. Additionally, in San Diego, net effective rents for our multifamily leases are now 9% higher year-over-year compared to the third quarter of 2022. Meanwhile, as expected, our occupancy in Pacific Ridge Apartments rebounded from just below 70% as of the end of Q2 to approximately 90% as of the end of Q3 with the move in of USD students this fall. This has ticked up a few more percentage points since the end of Q3 with additional occupancy or units in October. In Q3 in Portland, at our Hassalo on Eighth, we saw a blended increase of approximately 4% due move-ins and renewals with concessions being offered on longer-term leases.

Though net effective rents for our multifamily leases at Hassalo or approximately 3% higher year-over-year compared to the third quarter of 2022, the multifamily market in the Pacific Northwest has remained sluggish as our occupancy has softened. With that, I’ll turn the call over to Bob to discuss financial results and updated guidance in more detail.

Robert Barton : Thanks, Adam, and good morning, everyone. Last night, we reported third quarter 2023 FFO per share of $0.59 and third quarter ’23 net income attributable to common stockholders per share of $0.20. All in all, the third quarter was better than our expectations. Third quarter ’23 FFO was flat compared to the second quarter of 2023. Same-store cash NOI ended at 1.8% growth year-over-year for the third quarter. Our same-store office portfolio was flat in Q3 largely due to non-recurring rent deferral payments made in the comparable period. Excluding those payments received in Q3 of 2022, Q3 ’23 office same-store would have been 2.1% and total same-store cash NOI would have been 3%. On an individual office basis, we saw strong same-store growth in Q3 at Torrey Reserve of approximately 11%, Torrey Point of approximately 5%, Landmark at approximately 2.5%, and La Jolla Commons at approximately 7%.

Our same-store retail portfolio grew at 6.3% in Q3, primarily due to the commencement of new leases. Our same-store multifamily portfolio was flat in Q3, primarily due to higher vacancies at our Hassalo on Eighth of Portland. And our mixed-use portfolio grew at 2.1% in Q3, because of higher revenue at our Embassy Suites, Waikiki Beach Walk. Speaking of Embassy Suites Waikiki Beach Walk, our hotel continues to lead its competitive set in occupancy, ADR, and RevPAR year-to-date through September ’23. It is worth noting that demand this past summer of 2023 ended sooner than expected as occupancy dropped in the 3rd week of August. This typically does not occur until after Labor Day weekend and was likely the result of the Maui buyers, Japanese yen, and with the strengthening of the U.S. dollar, that makes it more attractive to travel internationally with Europe and the Caribbean as competing destinations.

Our partners in Oahu now believe that our Japanese guests are slated to return more meaningfully late summer of 2024. The Japanese yen, which is now approximately JYP149 to the U.S. dollar remains a major factor affecting the affordability of travel from Japan to Waikiki. Pre-COVID it was approximately 1.05 to 1.08 to the U.S. dollar. While the U.S. fed policy remains firm to keep inflation in check, pressure on the Japanese yen continues. However, on the positive side, demand from Japan was strong with further growth held back by the lack of air seats for the current period. The infrastructure is in place with Honolulu’s nearly complete airport renovation that handle more and much larger planes from Japan, like ANA’s Dreamliner. Delta Air Lines also recently announced that it will begin daily round-trip service between Tokyo, Hanada, and Honolulu this month.

ANA Airlines will also operate all 14 weekly round-trip flights on the Narita Honolulu route beginning this December. This will bring the number of seats offered on the Honolulu route to a record high, including those before COVID. It’s just a matter of time before we see the full return of our guests from Japan. In the meantime, the U.S. market has filled a large part of the Japanese void in travel to Waikiki as shown in the following geographic revenue allocation. In 2019, approximately 40% of our revenue came from the U.S. and 40% from Japan. In 2023, approximately 73% of our revenue has come from the U.S. and just 9% from Japan. So that puts it more in perspective. Turning to liquidity. At the end of the third quarter, we had liquidity of approximately $490 million surprise of approximately $90 million in cash and cash equivalents, and $400 million of full availability on our revolving line of credit.

Additionally, as of the end of the third quarter, our leverage, which we measure in terms of net debt to EBITDA was 6.6 times. Our objective continues to be to achieve and maintain a net debt to EBITDA of 5.5 times or below. Our interest coverage and fixed charge coverage ratio ended the quarter at 3.5 times. We are well capitalized with no near-term maturities. We do have a $100 million unsecured debt maturity in July of 2024. We have several options for refinancing that debt maturity, including without limitation, another private placement using our untapped line of credit on a short-term basis or a new term loan, ultimately with an eye of potentially approaching the public debt markets again in 2025. We believe that we have several options and a good debt maturity ladder to work with along with a great banking syndicate.

Overall, I believe we are in pretty good shape. Let’s take a moment and talk about 2023 guidance. We are increasing our 2023 FFO per share guidance range to $2.36 to $2.40 per FFO share with a midpoint of $2.38 per FFO share, a 2.6% increase from our previously stated guidance issued on our Q2 ’23 earnings call that had a range of $2.28 to $2.36 with a midpoint of $2.32. Let’s walk through the following items that make up this increase in our ’23 FFO guidance that was not previously included in our original 2023 guidance. First, our retail properties contributed approximately $0.02 per FFO share of outperformance in Q3, primarily as a result of lower operating expenses and collecting certain rents that we had previously reserved. Second, our office properties contributed approximately $0.01 per FFO share of outperformance in Q3.

Third, our multifamily properties contributed approximately $0.01 per FFO share of outperformance in Q3. And fourth, our Waikiki Beach Walk Embassy Suites contributed approximately $0.005 of FFO share. And fifth, lower G&A expenses were slightly lower. Six, we expect our multifamily properties to contribute an incremental $0.01 per FFO share in Q4 due to leasing that occurred in Q3. These adjustments, when added together or approximately $0.06 per FFO share, represent the increase in the 2023 midpoint over our previous 2023 guidance midpoint. While we believe the 2023 updated guidance is our best estimate as of earnings call, we do believe that it is also possible that we could perform to the high end of this increased guidance range. As always, our guidance, our NOI bridge in these prepared remarks exclude any impact from future acquisitions, dispositions, equity issuances or repurchases, future debt refinancings or repayments other than what we’ve already discussed.

We will continue to do our best to be as transparent as possible and share with you our analysis and interpretations of our quarterly numbers. I also want to briefly note that any non-GAAP financial measures that we’ve discussed like NOI or reconciled to our GAAP financial results in our earnings release and supplemental information. I’ll now turn the call over to Steve Center, our Senior Vice President of Office Properties, for a brief update on our Office segment. Steve?

Steve Center: Thanks, Bob. At the end of the third quarter, our office portfolio was 86.8% leased with our same-store portfolio dropping 50 basis points to 89.7% leased, primarily due to a few known move-outs. In the third quarter, we executed 10 leases totaling approximately 87,000 rentable square feet, including two comparable new leases for approximately 27,000 rentable square feet with rent increases of 10% on a cash basis and 13% on a straight-line basis. Five comparable renewal leases totaling approximately 36,000 rentable square feet with rent increases of 5% on a cash basis and 14% on a straight-line basis. And three non-comparable leases totaling approximately 24,000 rentable feet, one of which was an approximately 14,000 rentable square foot medical tenant at Solana Crossing, yielding a $13 per rentable square foot annual triple net premium over a comparable office rent.

We are encouraged by significant new leasing proposal and tour activity across our portfolio, including eight deals currently on lease documentation totaling approximately 55,000 rentable square feet, which would result in approximately 52,000 rentable square feet of net absorption once signed. Nine additional deals and proposals totaling 134,000 rentable square feet, which would result in approximately 93,000 rentable square feet of net absorption assuming those deals closed. Of these numbers at our new development La Jolla Commons III, we are currently in lease documentation for 14,000 rentable square feet and in proposals for an additional 61,000 rentable square feet with expected rents generally consistent with our development underwriting.

No news to report on One Beach at this time. We continue to believe that strategic investments in our portfolio will position us to continue to capture more than our fair share of net absorption at premium rents despite current market headwinds. And while we are not immune to potential additional attrition due to current conditions, the attrition is waning and is expected to be more than offset by the new leasing activity just discussed. We have approximately 7% of the portfolio rolling in 2024 with the median suite size of approximately 3,600 rentable square feet, and at which approximately 30% of rentable square feet rolling is already in various stages of negotiation. We believe that the flight to quality for new tenants and the stickiness of quality for our existing customers with leases expiring will continue to drive solid performance from our office portfolio.

I’ll now turn the call back over to the operator for Q&A.

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Q&A Session

Operator: Before we get to the Q&A, I just want to give you a brief reminder that statements made on this call include forward-looking statements based on current locations, which statements are subject to risks and uncertainties discussed in the company’s filings with the SEC. You are cautioned not to place undue reliance on these forward-looking statements as actual events could cause the company results for different materially from those forward-looking statements. And now we’ll begin the question-and-answer session. [Operator Instructions]. Today’s first question comes from Haendel St. Juste with Mizuho. Please go ahead.

Ravi Vaidya: Hi, good morning. This is Ravi Vaidya on the line for Haendel. Hope you guys are doing well. Can we just dig into like what are the various bad debt or tenant credit kind of risks that are there within your various different segments within the portfolio?

Adam Wyll: Probably the only significant one is an office. And Steve, why don’t you handle that?

Steve Center: Ravi, are you looking for the reserves that we kind of placing on certain tenants in our portfolio?

Ravi Vaidya: Yes, like watch lists, reserves, things along that line.

Steve Center: Yes. So, I mean, we’re keeping an eye on folks like At Home on the retail side, At Co, UFC Gym, Rite Aid. On the office side of course. We work on the office side, we’re keeping our eye on. We work and there’s a few biotech tenants that we have in our portfolio that we’re just making sure stay well capitalized. As you know, we’ve been fairly conservative and having these reserves on those tenants and for the most part this year, we haven’t needed most of those. But we’d rather under-promise and over-deliver on this.

Ravi Vaidya: That’s helpful. Can you please quantify what that is on an ABR basis of these expenditures?

Steve Center: I don’t know that that’s possible, because there’s so many variables, but net, net people are still paying rents.

Robert Barton: Ravi, Bob here. We can look at it from a different perspective. We started out with $0.06 of reserves and we’ve used probably 60% of those through the year, whether it was a bad debt expense or whether an adjustment or rent abatement or reduction in the rent one way or the other. Some of them have been used or applied in our financial statements. Right now, from a reserve standpoint from the office, we have about 0.5% of office remaining and we have about 0.5% of retail remaining.

Steve Center: That’s for Q4.

Robert Barton: Yes, as we go into Q4.

Ravi Vaidya: Got it. That’s helpful. And just wanted to touch on the Embassy Suites in Hawaii. It’s nearly 90% occupied with a strong rate. But going forward, what do you have factored in terms of the recession or pull back of the spectrum has been from American tourists. And what’s your forecast for that looking forward?

Robert Barton: For just the hotel Waikiki Beach Walk or?

Ravi Vaidya: Yes, primarily the hotel.

Robert Barton: So, going into Q4, the hotel had seasonality. And so, in Q4 historically, we’ve been Q3 has been our strongest and we’re generally down about $0.02, $0.025 in Q3.

Steve Center: It’s very difficult to predict what the tourist is going to do, but that is a great property and a great location and we’ll do as well as anybody in the same set we are in. It’s a reservation are no longer made a long time out. They’re made short-term. So far so good.

Operator: And our next question today comes from Todd Thomas of KeyBanc. Please go ahead.