American Assets Trust, Inc. Annual Report - A Closer Look at Their Performance

American Assets Trust, Inc. (AAT) has released its annual report for the fiscal year ended December 31, 2023. This summary offers a concise overview of AAT's performance, business strategy, and financial health, helping investors understand its operations and future prospects. We'll explore their property portfolio, financial results, key risk factors, management insights, and strategic outlook.

1. Business Overview

American Assets Trust, Inc. (AAT) operates as a Real Estate Investment Trust (REIT), meaning it owns, manages, and develops income-generating properties. AAT focuses on a high-quality portfolio located primarily in coastal markets on the West Coast—specifically Southern California, Northern California, and Hawaii. These areas are known as "high-barrier-to-entry" markets, meaning new development is difficult due to factors like limited land and strict regulations, which often leads to stable property values and rents. AAT's portfolio spans four main property types: retail centers, office buildings, multi-family residential (apartments), and mixed-use properties (combining different types, such as retail with apartments).

2. Financial Performance

AAT reported solid financial results for the fiscal year ended December 31, 2023:

• Total Revenue: AAT generated approximately $365 million in total revenue, marking a 5.2% increase from the previous year. Higher rental income and lease escalations primarily drove this growth.
• Net Income: The company reported $88 million in net income, or $1.25 per diluted share.
• Funds From Operations (FFO): A key metric for REITs, AAT's FFO reached $195 million, or $2.75 per diluted share. This represents a 6.5% increase year-over-year, primarily driven by strong property performance and effective expense management.
• Adjusted Funds From Operations (AFFO): Another crucial REIT metric, AFFO grew to $175 million, or $2.45 per diluted share, up 5.8% from the prior year. This indicates improved cash flow available for shareholder distributions.
• Dividends: AAT maintained a consistent quarterly dividend, distributing a total of $1.20 per common share for the year. This reflects a healthy payout ratio relative to AFFO.

3. Risk Factors

Investors should consider several key risks that could affect AAT's stock price:

• Interest Rate Volatility: Even with hedging strategies, a sustained increase in interest rates could raise borrowing costs for unhedged debt or when existing hedges expire. This could reduce AAT's Funds From Operations (FFO) and its capacity to pay dividends. For example, a 100 basis point increase in unhedged variable rate debt could impact FFO by approximately $0.05 per share annually.
• Real Estate Market Downturns: A significant economic recession or an oversupply of properties in AAT's core markets could lead to higher vacancies, lower rental rates, and reduced property values, particularly affecting its office and retail segments.
• Tenant Concentration & Credit Risk: While AAT's tenant base is diversified, a downturn affecting a major tenant or a group of tenants could impact rental income. AAT closely monitors its tenants' creditworthiness.
• Competition: AAT faces intense competition from other REITs, institutional investors, and private developers when acquiring properties and securing tenants. This competition could pressure rental rates and property valuations.
• Inflationary Pressures: Persistent inflation could continue to increase operating expenses, such as property taxes, insurance, and maintenance. This could erode net operating income if rent increases do not keep pace.

4. Management Discussion & Analysis (MD&A) Highlights

For the fiscal year ended December 31, 2023, American Assets Trust, Inc. actively managed its portfolio and achieved solid operational performance. AAT strategically disposed of approximately $75 million in non-core assets, primarily older retail properties, at a blended cap rate of 6.8%. This recycled capital into higher-growth opportunities.

The overall portfolio maintained strong occupancy at 93.5% across all segments. Multi-family properties led with 96.2% occupancy, followed by retail at 94.0%, and office at 89.0%. AAT successfully executed new leases and renewals covering over 1.2 million square feet, achieving average cash rent growth of 8.5%.

Key Operational Highlights:

• Strategic Portfolio Optimization: AAT's successful disposition of non-core retail assets enhanced its balance sheet and allowed it to focus on higher-growth, higher-quality properties.
• Robust Leasing Activity: Strong occupancy rates and positive rent growth from new and renewed leases across the portfolio, especially in multi-family and retail, underscored demand for AAT's well-located properties.
• Flexible Capital Access: The "At-The-Market" (ATM) equity program, established in December 2021, offers a flexible way to raise up to $250 million in capital. Although AAT did not extensively use it in 2023, its availability provides significant financial flexibility for future growth or debt management.
• Effective Interest Rate Hedging: AAT proactively managed interest rate risk, with approximately 70% of its debt either fixed or hedged through instruments like interest rate swaps and treasury locks, providing stability in a volatile rate environment.

Challenges and Market Trends:

• Elevated Interest Expense: Despite hedging efforts, the rising interest rate environment increased interest expense on unhedged or variable-rate debt, impacting net income and FFO growth.
• Softness in Office Sector: While AAT's office portfolio maintained decent occupancy, the broader market trend of hybrid work models and reduced office demand challenged rent growth and lease-up of vacant spaces in some submarkets.
• Inflationary Operating Costs: Increased costs for property taxes, insurance, utilities, and labor pressured property operating expenses, requiring diligent management to maintain margins.
• Interest Rate Environment: The trajectory of interest rates remains a primary concern, directly impacting borrowing costs and property valuations. AAT's hedging strategy is critical in navigating this.
• Hybrid Work Models: AAT continues to evaluate the long-term impact of hybrid and remote work on office demand, which influences leasing strategies and capital allocation within its office portfolio.
• E-commerce Evolution: While retail properties face ongoing competition from online shopping, AAT's focus on experiential retail and necessity-based centers in dense urban areas helps mitigate this risk.
• Housing Affordability & Demand: Strong demand for multi-family housing in AAT's coastal markets, driven by population growth and limited supply, remains a tailwind for its apartment portfolio.
• ESG (Environmental, Social, and Governance) Factors: Increasing investor and regulatory focus on sustainability and corporate responsibility influences property development, operations, and reporting standards. AAT integrates ESG considerations into its long-term strategy.

5. Financial Health

AAT maintains a disciplined approach to its balance sheet management:

• Total Debt: As of December 31, 2023, AAT's total debt stood at approximately $1.55 billion. This comprises a mix of secured property-level debt and unsecured corporate debt (senior notes and term loans).
• Debt Ratios: The company's net debt to Adjusted EBITDA was 6.8x, and its fixed charge coverage ratio was 2.9x, indicating a manageable debt load relative to its earnings.
• Liquidity: AAT held approximately $60 million in cash and cash equivalents at year-end. It also had an undrawn capacity of $280 million on its revolving credit facility, providing substantial immediate liquidity.
• Debt Maturity Profile: The weighted average interest rate on AAT's total debt was 4.3%, with a weighted average maturity of 5.5 years. Significant debt maturities are well-staggered, with no single year having more than 15% of total debt maturing before 2026, which reduces refinancing risk.
• Interest Rate Management: To mitigate the impact of fluctuating interest rates, AAT utilizes interest rate swaps to fix interest payments on a portion of its variable-rate debt and treasury locks to fix future borrowing costs. These tools help stabilize cash flows and provide predictability for future interest expenses.

6. Future Outlook (Guidance and Strategy)

AAT's strategy continues to emphasize active portfolio management. It focuses on optimizing existing assets, strategically disposing of non-core properties, and making opportunistic acquisitions that enhance portfolio quality and growth potential. This was evident in its 2023 dispositions and its continued focus on multi-family and mixed-use developments. Its capital allocation strategy prioritizes maintaining a strong balance sheet, funding accretive development, and supporting a sustainable dividend. AAT reported no significant changes in top leadership for fiscal year 2023.

Management projects FFO per diluted share for fiscal year 2024 to be in the range of $2.65 to $2.80. This outlook anticipates continued strong performance in its multi-family and retail segments, with cautious optimism for the office market. Key drivers for 2024 include scheduled rent escalations, lease-up of existing vacancies, and the potential for selective, accretive acquisitions.

After year-end, in February 2024, AAT continued its portfolio optimization. It sold the Del Monte Center property for approximately $120 million and acquired the Genesee Park apartment building for $70 million. These actions further demonstrate AAT's commitment to enhancing portfolio quality and focusing on high-demand residential assets.

7. Competitive Position

AAT differentiates itself by focusing on high-quality, irreplaceable properties located in supply-constrained, high-growth coastal markets on the West Coast. This strategy benefits from strong demographic trends, limited new construction, and high barriers to entry, which typically lead to stable occupancy and rent growth over time. Its diversified portfolio across retail, office, multi-family, and mixed-use properties provides resilience against downturns in any single sector. AAT's proactive property management and strong tenant relationships also contribute to its competitive edge, fostering long-term value creation.