American Assets Trust (AAT) Q3 2023: Retail Leasing Spreads Climb 8% as Office Attrition Wanes

October 25, 2023 | By EarningsIQ Research

Retail leasing spreads and office rent growth outperformed even as sector sentiment remains negative. Management raised full-year guidance, citing broad-based segment strength and operational discipline, but flagged macro uncertainty for 2024. Investors should track leasing velocity and tenant credit quality as AAT navigates a bifurcated property landscape.

Summary

• Retail Strength Surfaces: Leasing spreads and occupancy gains highlight retail as a stabilizing force.
• Office Portfolio Resilience: Attrition is moderating, with new leasing activity set to offset move-outs.
• Forward Guidance Raised: Management signaled confidence for 2023, but cautioned on macro visibility into 2024.

Business Overview

American Assets Trust (AAT) is a diversified real estate investment trust (REIT), owning and operating a portfolio across office, retail, multifamily, and hotel properties, primarily in West Coast markets and Hawaii. The company generates revenue through rental income, lease renewals, and ancillary property services, with major segments comprising office (largest by square footage), retail (27% of NOI, net operating income), multifamily, and a flagship hotel asset in Waikiki.

Performance Analysis

AAT delivered a quarter of outperformance relative to internal expectations, led by robust retail leasing spreads and resilient office fundamentals. Same-store cash NOI (net operating income, a core REIT profitability metric) rose 1.8% year-over-year, with retail up 6.3%, offsetting flat performance in office and multifamily. Retail renewal activity was a standout: Q3 deals saw cash leasing spreads up 8% and straight-line spreads up 19%, reflecting sustained tenant demand in well-located, supply-constrained markets.

Office segment performance was mixed, with occupancy dipping slightly but rent spreads on new and renewal leases remaining positive—notably, new office leases posted 10% cash rent increases. Multifamily rent growth decelerated but remained positive in San Diego, while Pacific Northwest assets lagged due to oversupply and economic stress. Hotel operations at Embassy Suites Waikiki led its competitive set, though international demand remains below pre-pandemic levels due to currency headwinds and airlift constraints.

• Retail Leasing Momentum: Retail leasing spreads and occupancy gains drove segment outperformance and contributed two cents per share to Q3 FFO.
• Office Rent Growth: Despite sector headwinds, same-store office properties saw rent increases on both new and renewal leases, with attrition trending lower.
• Liquidity and Balance Sheet: AAT ended Q3 with $490 million in liquidity, and no near-term debt maturities, supporting operational flexibility.

Overall, AAT’s diversified asset mix and disciplined expense management enabled the company to raise full-year FFO guidance, with incremental contributions from every major segment.

Executive Commentary

Strategic Positioning

1. Retail as a Defensive Anchor

Retail fundamentals remain robust, with occupancy just under 95% and dominant properties in supply-constrained, high-income markets. The company’s retail segment contributed the largest incremental upside to Q3 results, and management emphasized its role as a stabilizer amid sector volatility.

2. Office Portfolio Quality and Bifurcation

AAT’s office assets are positioned as modern, amenitized, and well-located, distinguishing them from commodity office properties. Management sees a “flight to quality” dynamic, with new leasing proposals and positive rent spreads suggesting resilience even as public sentiment on office remains negative. Attrition from right-sizing and remote work is waning, with net absorption expected to turn positive in 2024.

3. Multifamily: San Diego Strength, Pacific Northwest Drag

San Diego multifamily assets posted blended rent growth and rising occupancy, led by student housing demand. However, Portland area properties lagged due to market oversupply and economic stress, highlighting the importance of geographic and segment diversification within the portfolio.

4. Balance Sheet Flexibility and Debt Management

AAT’s conservative leverage and liquidity position provide multiple refinancing options for upcoming maturities, with $490 million in liquidity and a staggered maturity schedule. Management is proactively planning for higher interest expense in 2024, reflecting prudent risk management.

5. Hotel Recovery Linked to International Demand

The Embassy Suites Waikiki continues to outperform local peers, but full recovery is contingent on the return of Japanese travelers. Upcoming increases in airlift and infrastructure improvements position the asset for upside as international demand normalizes.

Key Considerations

This quarter’s results underscore AAT’s disciplined execution and the value of asset class diversity, but also reveal the nuanced pressures facing each segment. Investors should focus on:

• Retail Outperformance as a Buffer: Sustained leasing momentum in retail provides a reliable earnings foundation amid office and multifamily volatility.
• Office Leasing Pipeline: New and renewal leasing activity is accelerating, supporting management’s view that attrition has peaked and net absorption will turn positive.
• Tenant Credit and Bad Debt Exposure: Management maintains conservative reserves, especially for select office and retail tenants (e.g., WeWork, Rite Aid, Petco), but has not seen material defaults year-to-date.
• Debt Maturity Flexibility: Multiple refinancing levers and strong cash position reduce near-term refinancing risk, though higher rates will impact 2024 interest expense.
• Hotel Upside Tied to International Travel: Embassy Suites’ performance will hinge on the pace of Japanese tourism recovery and currency trends.

Risks

Macro headwinds—including persistent inflation, rising interest rates, and global instability—cloud visibility for 2024, especially in the office and multifamily segments. Tenant credit risk remains a watchpoint, particularly for select office and retail tenants on management’s reserve list. Hotel performance could be volatile if international travel lags or U.S. consumer demand softens unexpectedly. Management’s guidance prudently excludes impacts from future acquisitions, dispositions, or unplanned capital events.

Forward Outlook

For Q4 2023, AAT expects:

• Incremental FFO contribution from multifamily due to Q3 leasing activity
• Seasonal decline in hotel performance, as Q3 is typically the strongest quarter

For full-year 2023, management raised FFO per share guidance to $2.36–$2.40 (midpoint $2.38), reflecting a 2.6% increase over prior guidance.

• Guidance assumes continued retail and office outperformance, stable credit, and no major capital events

Management highlighted that 2024 visibility is limited due to macroeconomic and geopolitical uncertainties, with interest expense expected to rise and segment-level performance subject to broader market conditions.

• 2024 guidance will be provided in February, with a focus on refinancing strategy and segment demand signals
• Key watchpoints include office absorption, retail retention, and hotel international demand recovery

Takeaways

AAT’s Q3 results demonstrate the importance of asset class diversity and operational discipline in a turbulent market. Retail outperformance and office rent growth offset headwinds in multifamily and hotel, while balance sheet strength provides strategic flexibility.

• Retail and Office Resilience: Segment-level outperformance in retail and stabilization in office underpin the earnings upgrade and support management’s confidence in the core portfolio.
• Credit and Refinancing Discipline: Conservative reserves and proactive debt management mitigate near-term risk, but higher rates will weigh on 2024 results.
• 2024 Inflection Points: Investors should monitor leasing velocity, tenant credit, and macro signals as AAT navigates a bifurcated real estate landscape.

Conclusion

American Assets Trust continues to differentiate itself through disciplined execution and a diversified portfolio, raising guidance on the back of retail and office strength. While macro uncertainty tempers the outlook, the company’s operational resilience and balance sheet flexibility position it to capture upside as market conditions evolve.

Industry Read-Through

AAT’s results reinforce a growing bifurcation in commercial real estate: well-located, high-quality assets with strong amenitization and tenant demand are outperforming commodity peers, particularly in office and retail. Retail’s resilience and the “flight to quality” in office leasing are themes likely to persist, with investors rewarding operational discipline and tenant credit vigilance. Multifamily deceleration and hotel recovery remain market-specific, spotlighting the need for geographic and asset class diversification. Broader REITs and property owners should heed the importance of balance sheet flexibility, as refinancing risk and interest expense will continue to shape sector performance into 2024.

AAT Real Estate REIT Diversification Retail Office Multifamily Leasing