day, ladies and gentlemen, and welcome to the Second Quarter 2018 American Assets Trust Earnings Conference Call. At this time, all participants are in a listen only mode. Later, we will conduct a question and answer session and instructions will be given at that time. As a reminder, this call is being recorded. I would now like to introduce your host for today's conference, Mr.
Adam Weil, Senior Vice President and General Counsel. Please go ahead, sir.
Good morning. I'd like to thank everyone for joining us today for American Assets Trust 2018 Q2 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 2018 Q2 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 our website. 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 19 95. 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 cost of constructions.
The earnings release and supplemental reporting package that we issued yesterday and our annual report filed on Form 10 ks 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 Q2 of 2018 furnished to the Securities and Exchange Commission, and this information is available on our website at www.americanassetestrust.com.
I'll now turn the call over to our Chairman, President and CEO, Ernest Rady, to begin our discussion of second quarter results. Chris? Thanks, Adam, and good job as always, and good morning, everyone. Thank you for joining American Assets Trust's Q2 2018 earnings call. We're halfway through 2018, and we are making very good progress.
We've had solid results in the Q2 as to our earnings, noting that certain of the outperformance is in large part due to the one time termination fees, which we do not anticipate to recur in subsequent quarters. Bob will share some of the re leasing success that we've had on the terminated space. We have published our NAV, net asset value estimate again this year at $50.10 a share and it is available on the Investor Relations portion of our website. Bob will also talk about more about this later. As you've heard me say before, we focus on both NAV and FFO growth.
Leasing has been good. In July, we signed the lease with Safeway at Waikele Center in Oahu. We are pleased to partner with Safeway as we reposition well at Waikele Center. Our retail portfolio was approximately 97% leased as of the end of Q2. Our office portfolio was approximately 94% leased as of the end of Q2.
San Francisco and Bellevue, Washington are our strongest office markets, followed by Portland and San Diego. We are very well positioned in these markets. The renovation of the former Kmart building at Waikele Center in Hawaii is underway. Demolition of the former Kmart building begins this August, and we are in active discussions with multiple national tenants to fill the new multi tenant building that will replace the former Kmart building. With respect to the renovation of 1 of the buildings at Oregon Square in the Lloyd District, we are currently in the permitting process and we have signed a contract with a general contractor to commence the work in the Q3 of the year.
The building is approximately 30,000 square feet and will include an open floor plate with creative office space with more natural light. We expect this project to be finished for the first half of twenty nineteen. We also continue to focus on maintaining a low leverage investment grade balance sheet. In addition, we believe that our high quality, diversified portfolio and high barrier coastal west cards markets will outperform. And I think our results today confirm that.
On behalf of all of us at American Assets Trust, we thank you for your confidence in allowing us to manage your company and we look forward to 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 Q2 2018 FFO of $0.58 per share and net income attributable to common stockholders of $0.07 per share for the Q2. Let's dive right into the outperformance for this quarter. Included in our 2nd quarter earnings approximately $3,700,000 of termination fees or approximately $0.057 of FFO per share. The majority of these termination fees came from 2 former tenants, 1 at the Lloyd District, which remained current on their rent through Q2 and we were able to reach a fair termination agreement in the Q2.
That space has already been re leased by an investment grade tenant at a higher market rate. The new lease has a 7 year term and is expected to commence towards the end of Q1 'nineteen. The second tenant was one of our initial tenants at Torrey Point in San Diego and a fair termination agreement was also reached with this tenant in the 2nd quarter. While the termination fees are a pleasant outcome for our earnings in the 2nd quarter, if we exclude the $0.057 of termination fees, our core FFO would have still been approximately a healthy $0.52 per share in the 2nd quarter. Moving on, the company's Board of Directors has declared a dividend on its common stock of $0.27 per share for the quarterly period ending September 30, 2018.
The dividend will be paid on September 27, 2018 to stockholders of record on September 13, 2018. Our retail portfolio ended the quarter at 96.7 percent leased, combined with the highest annualized base rents amongst our peers. On a year over year basis, our retail occupancy was down approximately 10 basis points from the Q2 of 2017, leaving approximately 106,000 square feet vacant in our 3,000,000 plus square foot retail portfolio. A significant portion of the retail vacancy is primarily attributed to the space that has been leased to the Sports Authority at Waikele Center in Hawaii, which consisted of approximately 50,000 square feet. As Ernest mentioned, we are pleased to finally report Safeway as a national grocer has signed a 20 year lease with multiple options to extend for the space formerly leased to Sports Authority.
There is significant landlord work needed to be completed before the Safeway lease commences. We believe the landlord work will be completed and the Safeway store open will open in the 3rd or Q4 of 2019. During the trailing 4th quarter, 70 retail leases were signed representing approximately 200,000 square feet or approximately 6% of our total retail portfolio. Of these leases signed, 59 leases consisting of approximately 179,000 square feet, were for spaces previously leased. On a comparable basis, the annual cash basis rent increased 6.3% over the prior leases.
Our office portfolio ended the quarter at approximately 93 0.8%, an increase of approximately 510 basis points on a year over year basis, primarily due to the reclassification of Oregon Square into construction progress as of January 1, 2018, combined with an increase in occupancy at 1 Beach Street in San Francisco and our Torrey Reserve Campus in San Diego, leaving a vacancy of approximately 6.2% or 159,000 square feet of our 2,600,000 square foot office portfolio. During the trailing 4 quarters, 76 new office leases were signed representing approximately 553,000 square feet or 22% of our total office portfolio. Of these leases signed during the year, 49 leases consisting of approximately 409,000 Square Feet were for spaces previously leased. On a comparable basis, the annual cash basis rent increased 12.4% over the prior leases. Let's talk about same store NOI for a moment.
Same store retail cash NOI increased in the 2nd quarter to 5.2%. The increase primarily relates to increased rents at our Loma Santa Fe Plaza and Alamo Quarry Market shopping centers combined with the incremental NOI from the acquisition of the Forever 21 building in Q3 2017 at our Del Monte Center on the Monterey Peninsula. We owned the land and acquired the building at Del Monte Center that we didn't own in Q3 'seventeen. The incremental NOI from the Forever 21 building is approximately 135 basis points. Absent the Forever 21 building, the same store NOI is still a healthy 3.9%.
Same store office NOI increased 13% in the 2nd quarter, primarily due to termination fees, as previously mentioned. Additionally, we saw healthy increases in the base rents at Torrey Reserve Campus in San Diego, the landmark at 1 Market Street in San Francisco and the Lloyd District Portfolio in Portland, Oregon. These increases were offset by abatements at City Center Bellevue on several existing tenants and the build out period of newly leased space in Q1 2018. CCV is approximately 97% leased today and we expect to see increases in base rents beginning in Q3 and Q4 of this year. Same store multifamily cash NOI consisting of Hassell and eighth in Portland and our San Diego multifamily properties with the exception of Pacific Ridge was relatively flat for the Q2, down approximately 1%.
Revenues increased approximately $348,000 primarily due to higher occupancy rates. The increase in revenues was offset by an increase and real estate taxes. Pacific Ridge, which was acquired on April 28, 2017, will be included in next quarter's same store calculation. Waikiki Beachwalk, our mixed use property consisting of the Embassy Suites Hotel and Waikiki Beach Walk Retail, combined same store cash NOI was relatively flat for the Q2, down approximately 1.5%. Broken down further, this represents the Embassy Suites Hotel down approximately 4% and Waikiki Beach Walk Retail up approximately 1 0.2%.
The decrease in cash NOI at the Embassy Suites Hotel represents a higher occupancy combined with a lower ADR year over year resulting from a softer Japanese wholesale market. At our Waikiki Beach Walk retail property, tenant sales remain high at $11.30 per square foot for the rolling 12 months as our tenants continue to benefit from the excellent location and good economy. Turning to our Q2 results, FFO increased approximately $0.07 to $0.58 per FFO share compared to the Q1. The 2nd quarter results include the following activity. 1st, and as previously discussed, termination fees increased FFO by approximately $0.057 per FFO share.
And second, we repaid the 6.09 percent mortgage on Loma Palisades Apartments with a principal balance of approximately 70 $3,000,000 on March 30, 2018, resulting in a reduction of interest expense and increasing FFO per share approximately 0.1 $0.06 in the 2nd quarter. Now as we look at our balance sheet and liquidity at the end of the second quarter, we had approximately $379,000,000 in liquidity, comprised of $51,000,000 of cash and cash equivalents and $328,000,000 of availability on our line of credit. Our leverage, which we measure in terms of net debt to EBITDA, was 6.1x. This quarter's net debt to EBITDA ratio benefited from the onetime termination fees received in the 2nd quarter. Our interest coverage and fixed charge coverage ratio ended the quarter at 4.0x.
Lastly, we are revising our guidance for our full year 2018 FFO per share to a range of $2.05 to 2 $0.10 per share with a midpoint of $2.08 per share from original guidance of $2.01 to $2.09 per share with a midpoint of $2.05 The increase in our midpoint of $0.03 per share is primarily attributable to the receipt of termination fees in the 2nd quarter, net of the 3rd and 4th quarter revenue loss from such terminating tenants that were in our original guidance. As of the date of this earnings call, we estimate that 3rd quarter FFO share will be approximately $0.49 and 4th quarter FFO share will be approximately $0.50 per share, which will result in the midpoint of $2.08 per share in our new guidance. As always, our guidance excludes any impact from future acquisitions, dispositions, equity issuances or repurchases, future debt refinancings or repayments other than what we have already discussed. One last comment regarding the NAV that we published earlier in July, which we encourage you to read together with the disclaimers as to our methodology. Our NAV that we have published each year is an estimate at a point in time.
It takes approximately 8 weeks to complete our due diligence and discuss with local real estate brokers in each of our markets as to cap rates, unlevered IRRs, dollar per square foot or per unit values and recent comps. We combined that with independent brokers' opinion of values and our own knowledge of the marketplace and what we are seeing as well. We use the unlevered IRR to cross check 3rd party estimates. For our Waikele property, we have used discounted cash flow or DCF model that factors in a discounted present value of cash flows during the redevelopment period in order to be as accurate as possible. Our goal is to provide an estimated NAV that we believe any individual asset could be sold for, if not more in the private market.
Last year, we published a NAV of $50.75 per share. This year, we published a NAV of $50.10 per share. Our view is that AAT is a solid $50 per share value based on our NAV estimates. Unfortunately, the stock market currently has a different view as we have been trading at a discount to NAV. On the other hand, we continue to believe that it is a good long term value for shareholders.
We believe it is our job to close that gap between NAV NAV reflects 7 catalysts that we believe will create earnings growth over the next 8 quarters. We believe these catalysts combined with our high quality Coastal West Coast assets and focus on NAV and FFO growth will help to close that gap. We will continue our best to be as transparent as possible and share with you our analysis and interpretations of our quarterly numbers. We are well prepared with an even a stronger balance sheet than in prior years to capitalize and execute on the opportunities that we believe will present themselves over the coming quarters. Operator, I'll now turn the call over to you for questions.
Thank you. Our first question is from the line of Craig Schmidt of Bank of America. Your line is open.
Good morning, Craig. Hey, Craig. Good morning.
Are you finding increasing construction costs and labor shortages are having an impact on the development returns and timelines?
I'd say yes. Jerry, you want to answer that? Yes. Yes, sure. Construction costs are rising.
There are labor charges. It takes longer to get things done and it costs more. And I don't think that we're particularly suffering in that. I think the whole country is.
Understand. And maybe the planning and timing for the vacant Kmart space, when you think you might have it in shape that you could start actively leasing it?
We're just starting we've just signed the Safeway lease. We're just in the process of beginning demolition. We have to do that provide the new tenants access to the space that we're creating. And the timing of that is
Yes, correct. For our internal guidance, we are planning on the Q4 of 2020. Is that That's correct. That's for stabilized. Yes, for stabilized.
I think we have to go the interest in leasing and construction is underway. Absolutely.
Okay. Thank you.
Thank you, Craig.
Thank you. Our next question is from Rich Hill of Morgan Stanley. Your line is open.
Hey, guys. Good morning. I'm sorry if I missed this in the prepared remarks, but just want to be sure you are not providing updated guidance on same store NOI or did I miss that? I came on a little bit late.
Yes. Rich, we're not providing guidance on same store NOI, but we can take I mean, our original guidance on a total same store NOI that we issued in Q3 last year was 1.9 percent, which is broken down. Retail was 2.9%, office was flat, multifamily was about 4% and mixed use was about 2.9%. Based on what we see today, we think our best estimate for the that we will end 2018 in is we think that retail will be about the same, about 3%. Office, we think, will be about 3.8% versus flat.
And the primary reason on that is that our initial guidance included Oregon Square and we pulled Oregon Square out. We're also going to have some pickup in the 3rd Q4 from City Center Bellevue. Multifamily, I think, is going to remain the same around 3.8% to 4% and mixed use will be probably about where we said before. So I think that all in all, we will probably on a total same store NOI basis end up about 3%, 3.5%.
Got it. Versus the guide of the original guide of around 1.9%, which I think probably makes because if I'm doing my numbers correctly, you put up 5.9 in 1.8, which would mean, if I'm thinking about this correctly, if you're going to end up at 3.5, percent, some deceleration in 2H? Am I crunching those numbers right?
Yes, you're crunching those numbers right.
Got it. Okay. Thank you.
The issue is that there's just time required for all these new leases we signed to come on and that won't be till next year. But in the second half they won't be coming on. So pretty excellent.
Got it. And Ernest, you're leading me to my next question. Favorite property, 1 Market. Any updates there that you can share?
I think it's fair to say that we have a building that is called landmark and is a landmark. It's a trophy property. And it's fair to say that we have a lot of interest in leasing. I don't think we don't have anything we can announce just yet, but we're looking forward to the outcome. Steve, you want to add anything to that?
I think
it's the best building in San Francisco. The interest level is reflecting that, and I think the interest will
reflect yes, that's about all we can say until there's something concrete, but that's a great question.
Okay. Well, we continue to eagerly await that. Thank you. Thanks, guys.
Thank you. Thank you.
Thank you. Our next question is from Michael Carroll of RBC Capital Markets. Your line is open.
Hi, Mike. Yes. Good morning, Mike. Hey, morning.
I just had a quick follow-up on the Landmark question. I guess, Bob or Ernest, have you guys had discussions with Salesforce yet regarding, what it would take to terminate that lease? And what's the biggest hurdle right now, I guess, given the activity in San Francisco is very strong, is the hurdle right now sales force?
I don't know that we can comment. I think those discussions have been on a confidential basis. And until we have something concrete, I'd be reluctant to say anything. Adam, Steve, do you want to add anything to that? Got it.
There's lots of discussion, lots of activity, and I'd hate to say anything that becomes a promise and then we can't.
But we're very optimistic that the outcome will be favorable for our AAT space. On the Landmark building, while we can't get granular on it at the current time, as you realize, in place is significantly below market. And then the other point is that not only is it a terrific location and great building in the current interest of millennial creative office space. It is also, I believe, the last contiguous 100000 square feet of contiguous space that's available in San Francisco. Is that fair, Steve?
Well, it's clearly one of few and the total space is 254. And so, yes, there are just a handful of those spaces
left. Lots going on.
And what's your desire? Is your desire to break up that space to lease it to multiple tenants? Or do you want to find 1 large tenant to take that whole block down?
Rich, we'd like to find the biggest tenant who will pay us the most rent or the largest number of tenants who will pay us the most rent who have good quality. I think that's the conclusion you should arrive at should be governed by greed, which we are long on. So we'll do the best we can.
Okay, great. And then my final question is, can you talk and describe the leasing activity you're seeing at Torrey Point and Torrey Plaza? Do you
still expect that you can get
some leases signed by the end of the year?
Steve would answer that, but I think we will.
Yes, We have one lease with a very high credit tenant that's being finalized right now for another 13,500 feet. And we have another 10,000 foot tour happening today. So the interest level, especially post tsunami, has been very strong. And we're seeing people willing to
pay the premium for that setting. And so we're encouraged by that. And like I said, we've got one ready to go and numerous other suitors that we're quoting. So we're feeling good about it. I think you wanted to characterize it.
You say slow but steady and slow but steady wins the race, and I think we're going to be fine. It's just taken a little longer than we wished. And of course, the office rental markets in San Diego is not San Francisco or Bellevue, but it's certainly not that it's needed.
Okay, great. If you sign those leases by the end of the year, how soon can those commence? I mean, what's the build out time for those spaces?
The current lease, the rent commences on the lease we have in place September 1. The contemplated commencement data of the lease out for Signature is June 1, 2019.
Great. Thank you.
Thank you.
Thank you. Our next question is from Haendel St. Juste of Mizuho. Your line is open.
Hey, good morning.
Good morning Haendel.
Ernest, last quarter you mentioned you were open, at least open the conversation perhaps of a potential asset sale to help delever. I'm curious what your mindset here is today. Is there an update? Have you engaged a broker, had any discussions? Or perhaps has your thinking of that changed given the bit of the rebound in your stock over the last
6 years? No, Haendel, what governs us is an acquisition, which would be more beneficial to our stockholders than something we own. We haven't really found anything yet, and we really only have one property, which I would not characterize as a long term keeper. The things that we have are so difficult to find and replace. So we keep looking, but we don't have anything that's impending at the moment.
Okay. And so assuming that you don't sell any assets here, Bob, where do we expect the debt EBITDA by end of next year? Is $5,500,000 still a viable target absent a disposition?
Yes. It is. You have to take a look at what's going on. If we complete those 7 catalysts that we have referred to over the next 8 quarters, we think that that will increase EBITDA by approximately 10%, which should take a which should have a significant impact on the net debt to EBITDA.
Of course, I always think about the net debt to EBITDA being a quality factor too, and we have the highest quality assets and that makes them less cyclical. So I know from a public perspective, they'd like to have us at the level that is consistent with the rest of the industry. But from a practical point of view, our high quality assets, in my mind, at least allow us to have a slightly higher ratio and still be very, very sound and secure. But even yes, I absolutely agree with being sound and secure in Ernest's comments. But Ernest, the Board and management are all in agreement that we want to get that net debt to EBITDA down.
And we don't like
it in the mid-6s. We want it down to 5.5 percent or less.
And of course, the discussion is that the quality of the assets will eventually bring us to that without doing anything that would be short term beneficial, but long term a negative by selling.
Got it. Got it. Okay. A couple of quick follow ups or clarifications. Bob, first, I guess on lease termination fees, you mentioned you already lined up a replacement office tenant in Portland at a higher rate, but I didn't catch the update on the replacement tenant in Torrey.
Is there already someone lined up? And if so, how would the rate compare to the prior rate?
Are you talking about the replacement tenant in Torrey or Torrey Point? Torrey Point. Yes. Torrey Point. Well, hey, Steve, why don't you talk about that?
This is tied to the lease termination fees. So the tenants you referred to as being responsible for the lease term fees, just was curious on where you were replacing
the tenant in San Diego?
At Torrey Point? Yes.
So tsunami was roughly 30,000 feet. This replacement tenant, if you will, is 13,525 with other prospects in the same time frame that would fully replace tsunami. And the weighted average rents are going to be roughly the same as what we have.
I think I characterized San Diego earlier as slow but steady and we think that will win the race. But in San Diego, we didn't have an absolute replacement. On the other hand, we got a termination fee, which eases the pain as we strive to release that building up.
So Haendel, so the tenant that left and paid the termination fee, so let me back up a minute. Currently, we have a lease signed with 1 tenant for about 13,000 square feet. 16,000 square feet, which is about 17% of the building. And then Steve is in discussions. We are down the road with 1 tenant that we hope will finalize that lease and bring them in.
That will bring us up to about 32 percent. And then I think what's even more important though is that with those two tenants, it really validates the location and the beauty of that particular building.
Okay. Thanks for that. And then lastly, you mentioned that Safeway would be moving into space in Waikele in the back half of next year. Is that when the rent will commence as well or is that more early 2020? Thanks.
Yes. We expect on Safeway, we expect probably in the Q4 of 2019, it will be late 3rd, beginning of 4th when the FFO starts. The cash will be shortly after that.
About 90
days after that. Yes, about 90 days after that.
Okay. So it sounds like early 2020. Okay. Thanks.
Yes. Thank you. Thanks, Haendel.
Thank you. Our next question is from Mitch Germain of JMP Securities. Your line is open.
Thank you. How are you? Good morning, Mitch. Fantastic. Oregon Square, just I believe there are still tenants in there and you're still receiving income, but maybe where does that stand?
And then your thoughts about going and doing the work ahead of securing some sort of lease?
Okay. There's 4 Square City Blocks. One of them, we have the entitlement to build 600 plus units. Rents have been flat in Portland and construction costs have escalated. So we've got that on hold.
The building that we're going to rehab has no tenants in it And we've had some interest in it, but we don't have any kind lease with for it now. But I think that once it's and we've just started to market it. And I think once it's ready, it's going to be an attractive opportunity for somebody or some people to occupy.
Got you. And then
And then and one more square block is we're getting shovel ready in case we do find an anchor tenant for an office building. So that we are actively working that entire 4 blocks.
Mitch, the tenants in those buildings on those four blocks, we have purposely de leased or did not renew the leases in those buildings. And that we started that about 2 years ago and it's been empty for about a year now.
Got you. Does the type of product, that creative office product, is there a lot of similar space in Portland? Or are you really trying to create something that is lacking?
I think in the Lloyd District, there is substantial interest in office of that type. And of course, there is no shortage of office space anywhere perhaps other than the other 2 we mentioned. But we think that in that location, that product will be attractive to tenants. Steve, do you want to think? Great.
Okay.
Last one for me. Bob, with that same store guidance of 3%, give or take, for the year, was that including the term fee? Or is that excluding the term fee?
That would be including the term fee.
Got you.
Thank you.
Thank you, Mitch.
Thank you.
Thank you. And that does conclude our Q and A session for today. I'd like to turn the call back over to Mr. Ernest Rady for any further remarks.
Thank you guys for your interest. We continue to work to enhance the value of our properties and our stock, And we hope at some point we get the recognition that we deserve. In the meantime, we'll continue to do the best we can for you. Thank you.
Ladies and gentlemen, thank you for participating in today's conference. This does conclude today's program and you may all disconnect. Everyone have a great day.