American Assets Trust Inc
NYSE:AAT
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American Assets Trust Inc
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Good day, ladies and gentlemen, and welcome to the Q2 2019 American Assets Trust, Inc. Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we'll conduct a question-and-answer session, and instructions will be given at that time. [Operator Instructions] As a reminder, this call is being recorded.
It is now my pleasure to introduce Senior Vice President, General Counsel, Adam Wyll.
Good morning. I'd like to thank everyone for joining us today for American Assets Trust 2019 Second Quarter Earnings Conference Call. Joining me on the call are Ernest Rady and Bob Barton. These and other members of our management team are available to take your questions at the conclusion of our prepared remarks. Our 2019 second quarter supplemental disclosure package provides a significant amount of valuable information with respect to the company's operating and financial performance. The document is currently available on Web site.
Certain matters discussed on this call may be deemed to be forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements include any annualized or projected information as well as statements referring to expected or anticipated events or results. Although we believe the expectations reflected in such forward-looking statements are based on reasonable assumptions, our future operations and our actual performance may differ materially from the information contained in our forward-looking statements, and we can give no assurance that these expectations will be attained.
Risks inherent in these assumptions include, but are not limited to, future economic conditions, including interest rates, real estate conditions and the risks and costs of construction. The earnings release and supplemental reporting package that we issued yesterday and our annual report filed on Form 10-K and our other financial disclosure documents provide a more in-depth discussion of risk factors that may affect our financial conditions and results of operations. Additionally, this call will contain non-GAAP financial information, including funds from operations, or FFO; earnings before interest, taxes, depreciation and amortization, or EBITDA; and net operating income, or NOI.
American Assets is providing this information as a supplement to information prepared in accordance with generally accepted accounting principles. Explanations of such non-GAAP items and reconciliations to net income are contained in the company's supplemental operating and financial data for the second quarter of 2019 furnished to the Securities and Exchange Commission, and this information is available on the company's Web site at www.americanassetstrust.com.
I'll now turn the call over to our Chairman, President and CEO, Ernest Rady, to begin our discussion of second quarter results. Ernest?
Thank you, Adam. That was very eloquent, and good morning everyone. Thank you for joining American Assets Trust second quarter 2019 earnings call. We continue to make good progress on all fronts as we continue to focus our efforts on earnings growth, combined with growth and asset value for our shareholders. We saw a lot of positive developments during the second quarter '19, and we remain very optimistic going forward.
First of all, I want to welcome all of our new stockholders, and we sincerely appreciate your confidence and support. The whole transaction turned out well for everyone. The existing stockholders got enhanced marketability and another investment property for growth. Our new stockholders got immediate appreciation. So far, we've had better-than-expected leasing success with our recent acquisition of La Jolla Commons as we were very fortunate to be able to source and sign a new 73,000 square-foot lease within two weeks of closing. Bob will talk more about the details of the acquisition and impact of the recent lease that was signed.
Secondly, at Oregon Square, we have completed the modern renovation of the 830 building and increased the square footage from 33,000 square feet to 55,000 square feet. The 830 building is now a 100% leased to WeWork at current market rates, slightly above our initial estimates. We are now pursuing to do a similar modern renovation on the adjacent 710 building at Oregon Square and prospective tenants of ours began indicating interest.
Also, during the second quarter, our sustainability achievements include Hassalo on Eighth in Portland being designated as the first in the world to receive neighborhood LEED green certification, the Landmark at One Market being designated as the first BREEAM USA certification in San Francisco. BREEAM is B-R-E-E-A-M. We filed our first comprehensive sustainability report with GRESB. We posted our net asset value internal estimate of $51.50 a share on our Web site, and Bob will discuss that in more detailed later. In our view, the office markets in both San Francisco and Bellevue, Washington remain strong.
The Safeway store at Waikele Center remains on track to open in the fourth quarter of '19. We continue to reinvest and improve our existing assets and remain optimistic about the future of this portfolio and our ability to narrow the price-to-net asset value gap. On behalf of all of us at American Assets Trust, we thank you for your confidence and allowing us to manage your company, and we look forward to your continued support.
I'll now turn it over to Bob Barton, our Executive Vice President and CFO. Bob, please.
Good morning, and thank you, Ernest. Last night, we reported second quarter 2019 FFO of $0.51 per share and net income attributable to common stockholders of $0.18 per share for the second quarter. Second quarter results are primarily comprised of the following four highlights. First, on June 20, we acquired the La Jolla Commons office campus in San Diego comprised of two Class A+ office towers in University Town Center, also known as UTC, one of the most desirable submarkets in the city of San Diego, which we believe is on the forefront of significant and prolonged growth.
The acquisition also includes a fully entitled development parcel for an approximately 224,000 square-foot Class A office tower. La Jolla Commons I was built in 2008 and consists of approximately 303,000 square feet that was approximately 72% leased at the time of acquisition to a diversified credit tenant base. La Jolla Commons II was built in 2014 and is 100% leased to LPL Financial that as of today has a market cap of approximately $7 billion and a weighted average lease term remaining at La Jolla Commons of 9.9 years. As of the date of the acquisition, the combined project was approximately 88% leased in a submarket with approximately 97% occupancy.
Our underwriting assumed a lease-up of approximate -- to approximately 96% leased by the beginning of the third quarter of 2020. We saw the scarcity of large contiguous spaces in the UTC submarket and were able to sign a new lease with Alumina less than 2 weeks after our closing at rates that were approximately 10% higher than what we modeled in our underwriting. This also confirms that our in-place rents are approximately 10% or more below market. Note that as of today, Alumina has a market cap of approximately $44 billion.
With the signing of this Alumina lease less than 2 weeks after we closed the acquisition, La Jolla Commons combined lease percentage is now 96% leased, a year sooner than we expected. The net purchase price of approximately $514 million was paid with approximately $472 million of net proceeds received from the secondary offering, with the balance coming from our existing credit facility. The NOI yield that we modeled in our due diligence was approximately 5.4% on in-place NOI and 5.6% at year-end 2019 and a stabilized yield of 6% in 2020, factoring in a 7% vacancy factor.
With the signing of Alumina, our stabilized NOI yield for year-end 2019 is approximately 6.3%, and year-end 2020 is also expected to be approximately 6.3% due to the midyear start date in 2020 of this new lease. The average NOI yield of the property over the term of the next 10 years is to -- is estimated to be approximately 7%. Our unlevered IRR expectation on this transaction with the signing of the Alumina lease is expected to increase to approximately 8.25%. In structuring this acquisition, our focus was to protect and enhance our existing FFO earnings growth estimates that we have previously shared and continue to reduce our net debt to EBITDA to 5.5x or less, while factoring in the short-term NAV dilution for consistent long-term earnings growth that we believe will produce long-term NAV accretion.
Secondly, in connection with the acquisition of La Jolla Commons, we did a 1-day marketed follow-on equity market, the first since our IPO in January 2011, and we issued 10,925,000 shares of common stock at $44.75 per share. The shares issued were approximately a 17% expansion of our existing common stock shares outstanding. The offering was oversubscribed, and we believe the shares were well received and have traded well since the offering. Also, we believe the expansion of shares has significantly increased the average daily flow, which was also one of our objectives, combined with our focus on earnings growth and balance sheet debt metrics.
Third, yesterday, July 30, we entered into a no-purchase agreement for the private placement of $150 million unsecured 3.91% senior guaranteed notes with an 11-year maturity. A month earlier, we entered into a treasury rate lock to manage the risk of the interest rate volatility. Factoring in the treasury rate lock, the effective weighted average interest rate will be approximately 3.88% for the 11 years. Proceeds from the private placement offering will be used to repay the outstanding balance on our existing credit facility and leave approximately $60 million of cash on the balance sheet.
After the private placement offering, our pro forma net debt to EBITDA is estimated to be 5.5x at year-end 2019 and 4.8x at year-end 2020 and 4.6x at year-end 2020 based on our current operating model. Fourth, we posted our annual net asset value internal estimate on our Web site based on our forward NOI estimates in the first quarter. Our NAV process takes about 8 weeks to complete, and we incorporate input from respected brokers in our various markets as well as our own internal knowledge of our markets and recent transactions.
Among other data points, we focus on cap rates, supply/demand constraints in particular markets, weighed average cost of capital, dollar per square foot or dollar per unit, unlevered IRRs and certain ceilings that are perceived in each market. We look at the valuation of each asset based on metrics that we would look at when making an acquisition. Our conclusion was that our 2019 NAV internal estimate is $51.50 per share, which is approximately a 3% increase over our 2118 -- over our 2018 estimate. The Google lease that was signed at Landmark at One Market in San Francisco was a big contributor.
NAV estimates are just that, an estimate at a point in time. It is not a perfect science, but we try to be as accurate as possible. And if we're going to air, we try to air on the side of being conservative. The average NAV estimate of sell-side research analysts is approximately $47.88 per share, ranging from a low of $43.74 to a high of $51.86. The reason that we post our internal NAV is to help both investors and research analysts understand how management views our diversified portfolio of high-quality office, multifamily and retail in coastal West Coast markets and to allow investors and research analysts to use the data that we post to perform their own independent NAV analysis on our portfolio.
If we were simply one asset class that is easy to understand, we would probably not go through the effort to post our NAV. Let's talk about retail. Our retail portfolio ended the quarter at 97.5% leased, combined with the highest annualized base rents among our peers. On a comparative year-over-year basis, our retail occupancy increased approximately 88 basis points over the second quarter of 2018, leaving approximately 78,000 square feet vacant in our 3-million-plus square foot retail portfolio. During the trailing 4 quarters, 67 retail leases were signed, representing approximately 401,000 square feet, or 13% of our total retail portfolio. Of these leases signed, 52 leases consisting of approximately 216,000 square feet were for spaces previously leased.
On a comparable basis, the annual cash basis rent increased 7% over the prior leases. Our office portfolio ended the quarter at approximately 93.7% leased. On a comparative basis, when you exclude La Jolla Commons from 2019 and factor in 2018 the vacancies at Torrey Point in San Diego and Oregon Square in Portland, our office occupancy experienced an increase of approximately 503 basis points on a year-over-year basis, primarily due to an increase in occupancy at Torrey Point, Oregon Square and City Center Bellevue. Office vacancy at the end of 2Q '19 is 6.3% or 216 square feet -- 216,000 square feet of our 3.4 million square foot office portfolio. It's also important to note that we believe our in-place rents for the office portfolio are approximately 19% below market. During the trailing 4 quarters, 63 new office leases were signed, representing approximately 695,000 square feet or 20% of our total office portfolio.
Of these leases signed during the year, 42 leases, consisting of approximately 518,000 square feet, were for spaces previously leased. On a comparable basis, the annual cash basis rent increased 45.3% over the prior leases. Let's talk about same-store NOI for a moment. Same-store retail cash NOI decreased in the second quarter by 3.3%, which translates into less than $0.01 of FFO. The decrease primarily relates to decreased rents at Carmel Mountain Plaza after we terminated the ground lease with the ground lessee, who owned the former Sears building in exchange for a non-cash termination fee equal to the net present value of the former Sears building of approximately $4.5 million.
Within approximately two weeks after closing that transaction in Q1 2019, we signed a new lease with At Home for the entire 108,000 square feet, which upon opening earlier this month, reactivated the easterly end of the shopping center. We began straight-line rent in Q2 2019, and cash rents begin in August 2019. Same-store office cash NOI decreased 10% in the second quarter, primarily due to the termination fee of approximately $2.4 million received in 2Q '18 from a tenant at our Lloyd Center building. The tenant was replaced within approximately 4 weeks with Genentech, at higher rents reflecting the current market. Genentech took possession with the straight-line earnings beginning in Q2 '19 and cash rents beginning at the end of Q4 '19.
If we exclude the 2Q '18 termination fee from our calculation, same-store cash NOI related to our office segment increased 2.1%, primarily due to the rental abatements burning off on new or renewed tenants at City Center Bellevue. Same-store multifamily cash NOI increased 4.4% primarily due to increased cash NOI achieved at our Loma Palisades apartments in San Diego and Hassalo at Eighth apartments in Portland. The increase in Loma Palisades was primarily due to increased base rents of approximately 6% coupled with a reduction in rental expenses of approximately 3%.
At Hassalo at Eighth, total revenues were up slightly, while our rental expenses decreased approximately 18%, primarily due to efficiencies realized with our NORM recycled water program as well as reductions in payroll, facilities, services, and insurance expenses. As previously announced, Waikiki Beach Walk, our mixed-use property consisting of Embassy Suites hotel and Waikiki Beach Walk Retail was moved out of same-store designation beginning in Q1 '19 as the mixed-use property undergoes a significant renovation, which began at the beginning of the year, including stalling work on all outdoor balconies and exterior painting on both towers.
As the renovation work is ongoing for the second quarter of 2019, our mixed-use properties reported a combined slight decrease in cash NOI of less than 0.5 percent. And looking at the results separately, the Embassy Suites hotel cash NOI decreased 6%, primarily due to a reduction in revenue resulting from a reduction in occupancy percentage and RevPAR and an increase in real estate taxes. At Waikiki Beach Walk Retail, cash NOI increased 6%, primarily due to increases in base rent and parking income, partially offset by an increase in real estate taxes.
Tenant sales remained high at $1,061 per square foot for the rolling 12 months, as our tenants continued to benefit from the excellent location and good economy. Turning to our second quarter results, FFO decreased approximately $0.05 to $0.51 per -- FFO per share compared to the first quarter. The second quarter results include the following activity. First, the significant leases commenced at Lloyd Center Tower and City Center Bellevue. Although the leases have commenced, cash rent won't commence until later in the fourth quarter. Accordingly, the net amount of straight-line revenues recognized have increased during the second quarter, resulting in an increase of $0.026 per FFO share compared to the first quarter.
Second, the increase in NOI related to the acquisition of La Jolla Commons on June 20 resulted in an increase of $0.014 per FFO share compared to the first quarter. Third, as previously mentioned, we received a onetime non-cash termination fee of approximately $4.5 million in Q1 2019 on account of termination of the Sears ground lease, which provided approximately $0.068 of FFO per share in Q1 but no corresponding amount in Q2. Finally, the equity offering, which closed on June 14, increased our outstanding common shares by 10,950,000 shares. The increased weighted average outstanding common shares in 2Q '19 had a dilutive impact of approximately $0.022 per FFO share compared to the first quarter.
Now, as we look at our balance sheet and liquidity at the end of the second quarter, we had approximately $300 million in liquidity, comprised of $45 million of cash and cash equivalents and $255 million of availability on our line of credit. Our leverage, which we measure in terms of net debt to EBITDA, was 6.7x, as expected, at the end of the second quarter, although our continued focus is to get our net debt to EBITDA back down to 5.5x or below.
As I have previously discussed, based on our current model, our pro forma net debt to EBITDA is estimated to be approximately 5.5x at year-end 2019, 4.8x at year-end '20 and 4.6x at year-end 2021. Lastly, we are reaffirming our 2019 FFO guidance range of $2.18 to $2.26 per FFO share with a midpoint of $2.22 per FFO share. When I compare our 3Q '19 consensus of $0.569 FFO per share on my Bloomberg screen to our internal model, we are lower by approximately $0.01 of FFO share. We believe this difference is primarily related to the recently completed follow-on equity transaction and the dilution based on the weighted average shares outstanding that were issued.
As always, our guidance and these prepared remarks exclude any impact from future acquisitions, dispositions, equity issuances or repurchases, future debt re-financings or repayments other than what we have already discussed. We will continue our best to be as transparent as possible and share with you our analysis and interpretations of our quarterly numbers.
Operator, I'll now turn the call back over to you for questions.
Thank you. [Operator Instructions] And our first question comes from the line of Rich Hill with Morgan Stanley. Your line is now open.
Hey, good morning guys. Bob, as always, thank you for the color and a lot of detail. I want to come back to La Jolla Commons, obviously, you're ramping it up, it's going to be stabilized faster than anticipated, don't think that really starts until 2020, but I'm thinking about sort of the ramp that you provided earlier this year to 2021 and given that it's going to be stabilized maybe a year before you anticipated, could you maybe help us quantify or maybe help us think about how incremental that a year additional stabilization will be to the bridge you previously provided?
Well, Rich, thanks for the question. We'll be issuing guidance on our Q3 '19 call, but from where we sit today and looking at our corporate operating model, the numbers that were in our bridge seem to be conservative.
Okay, helpful. And just to reiterate, or to clarify, did I hear you correctly that in 2020 you expect around 7% NOI from La Jolla Commons?
That was on a average. The NOI yield over the average term over the next decade will be 7%. So it's going to ramp up from 6.3%, increasing approximately 50 -- 25 to 50 basis points a year till exceeds 8%. And if you look at the average of that NOI yield over that term, it will be approximately 7%.
Okay. Thank you. That's it for me.
Thank you, Rich.
Thanks, Rich.
Thank you. [Operator Instructions] Our next question comes from the line of Craig Schmidt with Bank of America. Your line is now open.
Yes, thank you. Good morning. I was wondering the mix is starting to favor office. As you look forward to 2020 and beyond, what do you think the balance and the mix of your different components of -- the different mixed uses in office multifamily, retail could be going forward?
As I've said -- this is Ernest, Craig, as I've said on our investor presentation, our job is not to be a retail or office or an apartment REIT. Our job is to create wealth for stockholders. And as we go forward, we think we have significant opportunities within our portfolio, and we continue to look at opportunities outside of our portfolio, but in the same 3 asset classes and coastal West Coast focus. So I'd like to tell you exactly what it's going to be, but we're going to be, hopefully, where the bucks are, and we're going to enhance our shareholder value.
Craig, it's Bob. Let me just add to Ernest's comment on that. It's that I love the way he describes that we are -- we're really a wealth builder. But having said that, we understand that there is a cloud over retail, and so there is no current intention on acquiring more retail. And we think the growth in our NOI will really come from office and multifamily going forward.
Okay. Thank you.
Thank you.
Thank you. And our next question comes from the line of Mitch Germain with JMP Securities. Your line is now.
Thanks for taking my question. To that point, would you consider maybe selling one of your retail assets, maybe throwing a cap rate out there and using some of that as a means to delever?
Sure. If we saw a better opportunity to enhance shareholder wealth, that's what we get up every morning for and look forward to those opportunities. If we had an opportunity to sell a retail asset that made sense and acquire either another retail asset or another asset in the 2 types of properties we own, we'd look at it. Over the years, this portfolio got built by doing $2 billion worth of trades, and we're not out of the trade business yet.
Great. And just on the acquisition that you guys completed this quarter. Maybe just talk about the process? Was it a fully marketed transaction? What sort of capital could you possibly have been bidding against? Maybe just maybe describe how the process played out?
I don't know that I can really do that because we weren't involved until we had the opportunity presented to us, in effect, a take it or leave basis. We acted very quickly, and I think that you'd have to talk to the brokers and find out exactly what their process was. I didn't comment on it because I wasn't involved. All we were involved is when it was presented to us, we said we love it, we'd like to do it, we moved on it and we closed it.
Mitch, let me just add to that, that when we heard about it, it was not on the market and it was off market. And we moved quickly once we had a handshake.
Off market, sort of a euphemism. I don't know what that was.
Agreed. And then last question on the deleveraging. Obviously, a portion of that is the equity raise though a portion of that obviously is some of the income coming online from the leasing, right? Is that the way that we should think about how the deleveraging plays out over the course of the next 18 months?
Yes, yes, that deleveraging, nothing additional is needed. That's all organically going forward.
Thank you.
Thank you. And I'm showing no further questions at this time. So with that, I'll turn the call back over to Chairman and CEO, Ernest Rady, for closing remarks.
Thanks, again, for all our new shareholders joining us. We're extremely delighted about our position now. We think that our future over the next number of years is going to be a pleasant surprise for all of us, and we look forward to sharing that with you as it evolves. Thank you, again, for joining us.