American Assets Trust (AAT) Q4 2023: Office Cash NOI Turns Negative, Guidance Cut by 5.8% Amid Leasing Delays

2024-02-08 | By EarningsIQ Research

AAT enters 2024 with its first-ever negative office same-store cash NOI guidance, reflecting protracted decision cycles and permitting delays in key markets. Management’s conservative posture pushes 317,000 square feet of speculative office leasing out to 2025, driving a 5.8% guidance cut. With retail and multifamily showing resilience but offset by rising costs and sector-specific risks, AAT’s long-term value will hinge on execution in leasing, cost containment, and a rebound in Hawaii tourism.

Summary

  • Office Drag Emerges: Same-store office cash NOI heads negative as leasing cycles extend and speculative leasing is deferred.
  • Retail and Multifamily Hold Ground: Retail leasing spreads remain robust, while multifamily faces occupancy gains but margin pressure.
  • 2024 Hinges on Execution: Guidance implies downside, with upside tied to leasing velocity, cost control, and tourism recovery.

Business Overview

American Assets Trust (AAT) is a diversified real estate investment trust (REIT) focused on owning, operating, acquiring, and developing high-quality office, retail, multifamily, and mixed-use properties in supply-constrained, high-barrier-to-entry markets, primarily on the West Coast and Hawaii. Revenue is generated through rental income from its portfolio, which is diversified across office (largest segment by NOI), retail (27% of 2023 NOI), multifamily, and hotel assets, with a strategy emphasizing irreplaceable locations and premium amenities.

Performance Analysis

2023 marked record highs for AAT in FFO per share, total revenue, and net operating income (NOI), despite macro headwinds and sector-specific volatility. The company achieved a 3% increase in FFO per share and 4% revenue growth year over year, with compounding FFO growth since IPO exceeding 7% annually. However, Q4 saw a sequential dip in FFO per share, mainly due to seasonal softness in the Waikiki Embassy Suites hotel, underscoring the portfolio’s exposure to tourism cycles.

Segment performance diverged. Retail posted robust leasing spreads (7% cash, 13% straight-line in Q4), with portfolio occupancy near 95% and minimal 2024 expirations. Multifamily delivered positive same-store NOI growth (5.5% for 2023), but faced decelerating rent growth and margin compression from rising expenses and new supply, especially in San Diego and Portland. Office fundamentals weakened, with same-store cash NOI guidance turning negative for the first time, driven by delayed tenant decision-making and a conservative approach to speculative leasing.

  • Office Leasing Cycle Elongation: Management deferred 317,000 square feet of speculative office lease-up to 2025, citing permitting and construction lags, removing 5 cents per share from 2024 FFO guidance.
  • Retail Strength and Watchlist: Leasing spreads remained strong, but management reserved for potential tenant credit events (Rite Aid, Petco, Angelica Theaters) despite current rent payments.
  • Multifamily Margin Squeeze: Occupancy gains required rent concessions, and expenses (insurance, labor, repairs) are rising faster than revenue, especially as new supply hits West Coast markets.

Liquidity remains solid at $483 million, but leverage (net debt/EBITDA at 6.5x) is above target, with improvement contingent on leasing up La Jolla Commons 3 and refinancing $100 million in July 2024 at favorable rates.

Executive Commentary

"We believe that long-term focus, guided by high-quality, irreplaceable, and diverse portfolio properties, as well as the strength of our balance sheet, our top-notch management team, our very nimble and efficient operating platform, and our ability to quickly and prudently adapt to meet the evolving demands, will allow us to remain well-positioned to continue growing our earnings on an accretive basis and could contribute to our outperformance over the long term."

Ernest Rady, Chairman and CEO

"This is the first time that we have had negative same-store office cash NOI guidance, and in our view, it is due to this unique point in time in which existing and prospective office tenants are taking a longer period of time to make decisions on leasing office space...we took a somewhat conservative approach, and we will continue to update our numbers each quarter as we prefer to under-promise based on the uncertainty and longer decision-making we see."

Bob, Chief Financial Officer

Strategic Positioning

1. Office Portfolio: Flight to Quality, but Timing Risk

AAT’s office assets are concentrated in high-barrier, coastal markets, with a strategy to differentiate via amenities and premium locations. However, leasing velocity has slowed, with tenants requiring longer to commit and permitting/construction cycles extending up to a year. Management’s decision to push speculative leasing out of 2024 guidance reflects a cautious, credibility-first stance, but also signals near-term NOI drag. The “flight to quality” thesis is intact for trophy assets, yet execution risk is elevated until market decision cycles normalize.

2. Retail: Dominance in Trade Areas, Watching Tenant Credit

Retail properties are nearly fully leased and command strong renewal spreads, benefiting from supply constraints and favorable demographics. AAT’s assets are “dominant in their trade areas,” and management expects continued rent growth. However, tenant bankruptcies (WeWork, Rite Aid) and reserves for at-risk tenants indicate persistent credit risk, even as current rent payments remain intact. Conservative reserves (over 1% of revenue) reflect prudent risk management but also temper upside.

3. Multifamily: Growth Potential vs. Cost Pressures

Multifamily assets in San Diego and Portland face a classic squeeze: new supply and seasonal softness pressured rents, while operating expenses (insurance, labor, repairs) are rising faster than revenues. Occupancy gains required rent concessions, but long-term fundamentals remain positive due to high ownership costs and favorable demographics. Margin recovery will depend on absorption of new supply and cost discipline.

4. Capital Allocation and Balance Sheet Discipline

Management is prioritizing balance sheet strength, with liquidity at $483 million and a target to reduce net debt/EBITDA to 5.5x (from 6.5x currently). Near-term refinancing of $100 million in notes (modeled at 7.5% interest) introduces interest expense risk, but optionality exists to use the revolving line at lower rates if market conditions improve. Capex for 2024 is estimated at $59 million, with a continued focus on property enhancements and amenitization to support rent growth and tenant retention.

5. Hotel and Tourism: Recovery Hinges on Asian Demand

Embassy Suites Waikiki delivered record NOI in 2023, but full recovery is hampered by weak Japanese tourism (now at only 20% of pre-COVID levels). Domestic travel is partially filling the gap, but revenue per available room (RevPAR) remains below potential. A rebound in Asian tourism remains a key upside lever, but timing is uncertain and dependent on currency and macro trends in Japan.

Key Considerations

2024 is a transition year for AAT, with management guiding conservatively and emphasizing execution over optimism. The following factors will shape results:

  • Office Leasing Execution: The pace and timing of speculative and rollover leasing, especially at La Jolla Commons 3, will determine office NOI inflection and leverage reduction.
  • Retail Tenant Stability: Watchlist tenants (Rite Aid, Petco, Angelica) could surprise to the downside if bankruptcies or restructurings accelerate, despite current rent payments.
  • Multifamily Cost Management: Margin pressure from rising expenses must be offset by disciplined rent strategies and absorption of new supply.
  • Interest Expense Volatility: Refinancing outcomes and rate movements will impact FFO, with guidance assuming a conservative 7.5% for July refinancing.
  • Tourism Upside Optionality: Embassy Suites’ performance could materially improve if Asian (especially Japanese) tourism rebounds in 2024 or beyond.

Risks

Key risks for AAT include continued sluggishness in office demand, especially if hybrid work and decision delays persist longer than anticipated. Tenant credit deterioration in retail, unexpected cost inflation in multifamily, and interest rate volatility could all pressure earnings and liquidity. Tourism recovery in Hawaii remains an external swing factor, and leverage remains above target until major office assets are leased up.

Forward Outlook

For Q1 2024, AAT expects:

  • FFO per share reflecting the loss of speculative office revenue and higher interest expense
  • Continued strong retail spreads and stable multifamily occupancy, but with decelerating rent growth

For full-year 2024, management guided:

  • FFO per share range of $2.19 to $2.33, down 5.8% at the midpoint from 2023

Upside to guidance depends on:

  • Faster-than-modeled office lease-up (especially speculative space)
  • Interest expense coming in below modeled rates
  • Lower-than-expected bad debt and reserve utilization
  • Stronger multifamily rent growth and expense control
  • Recovery in Japanese tourism to Hawaii

Takeaways

AAT’s 2024 narrative is defined by conservative guidance, operational discipline, and a focus on risk management amid sectoral divergence.

  • Office Headwinds Drive Guidance Cut: Negative same-store office NOI and deferred speculative leasing are the primary drag, with timing and market confidence critical for future improvement.
  • Retail and Multifamily Remain Resilient, but Not Immune: Robust retail spreads and high occupancy offset by tenant risk and multifamily margin compression signal a mixed but stable outlook.
  • Execution and Market Timing Are Central: Results will hinge on leasing velocity, cost containment, and exogenous demand recovery, especially in Hawaii tourism and interest rates.

Conclusion

AAT’s 2023 financial records mask a more cautious 2024 outlook, as management prioritizes credibility and risk management over aggressive projections. Office sector headwinds and cost inflation are real, but the portfolio’s quality and balance sheet optionality provide a foundation for eventual upside—if execution aligns with market recovery.

Industry Read-Through

AAT’s results and guidance reflect persistent bifurcation in commercial real estate, where trophy office and dominant retail outperform commodity assets, but sector headwinds and tenant risk remain elevated. Office REITs face elongated leasing cycles and must manage expectations, with permitting and construction delays now a structural feature. Retail landlords with high-barrier assets retain pricing power, but must watch tenant credit closely. Multifamily operators in supply-heavy markets are entering a margin squeeze phase, with expense inflation outpacing rent growth. Hospitality assets tied to international tourism remain leveraged to macro and currency swings, with upside optionality but little control over timing. Investors should apply these lessons broadly across REITs with similar asset and geographic exposures.

AAT Real Estate REIT Office Retail Multifamily Leasing Guidance