American Assets Trust, Inc. — Q1 2018 Form 10-Q
Reporting period: Three months ended March 31, 2018. American Assets Trust is a REIT whose operations are conducted through American Assets Trust, L.P. At quarter-end, it owned 73.2% of the partnership. The portfolio comprised 26 operating properties across retail, office, multifamily and mixed-use, plus land at four properties classified as held for development and/or construction in progress.
Financial performance and position
| Metric | Q1 2018 | Q1 2017 | Change |
|---|---|---|---|
| Total revenue | $80.7 million | $73.8 million | Up 9% |
| Property operating income (NOI) | $51.8 million | $46.4 million | Up 12% |
| NOI margin | 64.1% | 62.9% | Up 1.2 percentage points |
| Operating income | $12.9 million | $23.3 million | Down 45% |
| Net income (loss) | $(0.7) million | $10.3 million | Declined $11.0 million |
| Net income (loss) attributable to common stockholders | $(0.5) million | $7.4 million | Declined $7.8 million |
| Diluted EPS | $(0.01) | $0.16 | — |
| FFO attributable to common stock and units | $32.5 million | $28.2 million | Up 15% |
| Diluted FFO per share/unit | $0.51 | $0.44 | Up 16% |
Rental income increased 9% to $76.2 million; other property income rose 21% to $4.5 million. Same-store NOI increased 4% to $45.0 million. Segment NOI rose 7% in retail, 3% in office, 59% in multifamily and 15% in mixed-use; multifamily’s increase primarily reflected the 2017 Pacific Ridge Apartments acquisition.
Depreciation and amortization increased 85% to $33.3 million, principally due to Waikele Center’s Kmart-space redevelopment. This increase more than offset higher property income in GAAP operating income and net results. Interest expense rose 4% to $13.8 million. Rental and other property expenses were $29.0 million, up 6%.
Operating cash flow was $44.0 million, compared with $47.6 million in Q1 2017. Investing cash outflow was $11.4 million; financing cash outflow was $59.3 million, versus $110.7 million of financing inflow a year earlier. Cash, cash equivalents and restricted cash totaled $65.2 million at quarter-end, including $55.3 million unrestricted cash. The prior-year cash balance was higher partly because of debt and derivative-settlement financing activity.
At March 31, 2018, balance-sheet debt, net of issuance costs, was approximately $1.284 billion: $205.5 million secured notes, $1.045 billion unsecured notes and $33.0 million drawn on the unsecured line. Gross principal debt was approximately $1.291 billion. Total assets were $2.214 billion and total liabilities were $1.384 billion. The company itself holds no debt; debt is held by the Operating Partnership. The Operating Partnership reported compliance with its debt covenants.
The $450 million unsecured credit facility includes a $350 million revolver and $100 million Term Loan A. At quarter-end, $35 million was drawn on the revolver; the facility also has an accordion feature subject to conditions. Secured debt fell by $74.1 million, including repayment in full of the $73.7 million Loma Palisades mortgage on March 30, 2018. The $0.27 quarterly dividend was declared and paid; Q1 2017’s dividend was $0.26 per share/unit.
Material changes and operating trends
- Revenue growth reflected acquisitions, same-store gains and improved mixed-use property performance. Gateway Marketplace contributed to retail growth; Pacific Ridge Apartments drove much of the multifamily increase.
- Same-store retail and office occupancy at quarter-end was 96.6% and 94.6%, respectively; multifamily occupancy was 92.7%. Mixed-use retail occupancy was 96.9%. Office occupancy improved from 89.3% a year earlier.
- Q1 comparable retail leases showed an average cash rent decrease of 4.2% overall; new comparable retail leases decreased 21.8% on a cash basis, while renewals increased 1.7%. Comparable office leases increased 11.6% on a cash basis, including 21.9% growth for new leases and 3.0% for renewals. Management cautioned that signed leases may not commence promptly or produce all contractual rent.
- Retail same-store NOI increased 2.9%; retail redevelopment same-store NOI increased 2.8%. Waikele Center was classified as redevelopment same-store due to construction activity.
- Real estate taxes increased 13% to $8.5 million, primarily reflecting office assessments and the Pacific Ridge acquisition. General and administrative expense increased 10% to $5.6 million, primarily due to employee-related costs.
Outlook, risks and unusual items
- No formal numerical earnings or FFO guidance was provided. Management expected leasing volume through the remainder of 2018 to be in line with historical averages and anticipated overall positive rental-income increases, while emphasizing that results are uncertain. Management described itself as cautiously optimistic about leasing and tenant trends.
- Growth strategy includes same-store leasing, development and redevelopment, and selective acquisitions. Future Lloyd District development phases depend on market conditions and expected risk-adjusted returns. The company may defer projects, limit acquisitions, reduce spending or reassess dividends if markets deteriorate.
- Management stated that available operating cash flow and credit-facility borrowings were expected to support near-term needs and dividend funding. Capital requirements depend on acquisitions and property improvements; long-term funding may require debt or equity issuance. The ATM program had up to $176.2 million of remaining capacity, but the company had no obligation to sell shares.
- Interest-rate exposure remains relevant: the filing reported $285 million of variable-rate debt and $1.006 billion of fixed-rate debt, including debt effectively fixed with swaps. A 1 percentage-point rate increase was estimated to reduce the fair value of fixed-rate instruments by $23.6 million; a 1-point decrease was estimated to increase it by $47.3 million. These are fair-value sensitivities, not estimates of earnings impact.
- Risks include tenant defaults, lease nonrenewals, weaker property markets, interest-rate and financing risks, development execution, retail and office-sector exposure, geographic concentration in Southern California, and REIT qualification requirements. Retail and office tenants represented 32.4% and 33.2% of quarterly revenue, respectively.
- The company reported no material legal proceedings and no material changes to previously disclosed risk factors. Del Monte Center groundwater remediation continues; the seller-funded escrow was considered sufficient, but additional costs could fall to the company if funds prove inadequate. A hotel franchise termination payment could be as high as $7.5 million under specified circumstances.
- The company adopted the new revenue-recognition standard on January 1, 2018 with no retained-earnings adjustment. It planned to adopt the new lease standard on January 1, 2019 and was still evaluating its impact; lessee contractual payments under lease agreements totaled approximately $37.5 million.
Important facts for investors to verify
- Whether the substantial increase in depreciation from the Waikele redevelopment is temporary or persists, and how redevelopment affects future occupancy, NOI and cash requirements.
- Debt maturity and refinancing plans, particularly the January 2019 Term Loan A maturity and the April 2019 One Beach Street mortgage maturity, along with variable-rate exposure and covenant headroom.
- Whether leasing spreads, especially negative cash spreads on new comparable retail leases, translate into sustained rental-income growth after tenant improvements and incentives.
- How much of reported revenue and NOI growth is acquisition-driven versus same-store, and whether recent occupancy improvements continue.
- Capital needs for development, redevelopment, tenant improvements and leasing commissions, and the potential use of revolving borrowings or ATM equity issuance.
- Progress and remaining funding for Del Monte Center remediation, and any developments affecting the hotel franchise or management agreements.