American Assets Trust, Inc.

Ladies and gentlemen, thank you for standing by. Welcome to the Q2 2020 American Asset Trust, Inc. Earnings Call. At this time, all participants are in a listen-only mode. After the speaker's presentation, there will be a question-and-answer session. To ask a question during the session, you need to press star 1 on your telephone. If you require any further assistance, please press star B0. I would now like to do Thursday's conference call. Mr. Atterwell, you may begin, sir.

Thank you. Good morning, everyone. Welcome to American Asset Trust, Inc.' 's second quarter 2020 earnings call. Yesterday afternoon, our earnings release and supplemental information were furnished to the SEC on Form 8K. Both are now available on the Investors section of our website, AmericanAssetsTrust.com. A telephonic replay and on-demand webcast will also be available for this call over the next week. During this call, we will discuss non-GAAP financial measures, which are reconciled to our GAAP financial results and our earnings release and supplemental information. We will also be making forward-looking statements based on our current expectations. These statements are subject to risks and uncertainties discussed in our SEC filings. You're cautioned not to place undue reliance on these forward-looking statements. Actual events could cause our results to differ materially from these forward-looking statements, which we undertake no duty to update. And with that, I'll turn the call over to Ernest Rady, our Chairman and CEO, to begin the discussion of our second quarter 2020 results. Ernest? Thank you, Adam. That was well done, as always.

These have been unprecedented times. that I've never seen before in my lifetime. When COVID-19 began, I honestly didn't know how bad it would be. We expected to be catastrophic, but we just didn't know how bad it would be. Now that the second quarter's behind us, I can tell you that it's not as catastrophic as our worst-case projections. It still has been no fun. Office has performed extremely well, has been the shining light in our portfolio with high credit tenants in strong markets and that we would like to continue to grow. Multifamily has also performed well, better than we expected. Occupancy has been slightly lower, but collections have been strong in the mid-90s, and we expect a meaningful uptick in occupancy in August 1st. as a local private university takes possession of approximately 130 units in our San Diego multifamily portfolio at good risk by a master lease that has recently been executed. Retail, as expected, has been very tough. Every deal feels like a street fight in retail. We try to balance what is best for the company and its shareholders, with how to maintain the long-term viability of these retail tenants that are so important to our shopping centers. We know that some are not going to make it. Of course, we're hopeful that most will make it. In fact, we're hopeful that all will make it. We have a committee comprised of myself, Chris Sullivan, and Adam Weil that review every tenant request. If a tenant asks for a deferral, we ask for something from the tenant in return as well. Each one is a negotiation, and we try to make sure that we're getting something fair in return for anything less than 100% on-time collection of our contractual rents. I truly believe that our management team is second to none and has done an excellent job strategically navigating through this pandemic. The American Trust is reflective of the quality people that we have working together as appreciative of the quality people that we have working in our company that are focused on creating value for our shareholder each and every day. Lastly, I want to mention that our board of directors has improved increasing the quarterly dividend 25% over the second quarter 2020 dividend of $0.20 to $0.25 for the third quarter based on higher rent collections in the second quarter than we had expected. combined with the significant embedded growth that we continue to expect in our office portfolio and the recent master lease sign in our multifamily portfolio. A year from now, once there is a vaccine, we expect to look back and we hope that this is nothing more than a bad memory. I believe that when we come out of this, we will be as good a company or even better when all this started. I'm now going to turn the call back over to Adam Weil, our EVP and Chief Operating Officer, who will give us a quick update on our operations during this pandemic, followed by Paul Barton, our EVP and Chief Financial Officer, and we will end with a quick update on the leasing success that Steve Senter, our Vice President of Office Properties, is seeing.

Adam, please. Thanks, Ernest. From an operations perspective, as coronavirus infections continue to increase in many of our markets, we remain hyper-focused on the safety and well-being of our personnel, tenants, and vendors, as 100% of our properties remain open and accessible by our tenants. We remain committed to ensuring full compliance with the ever-changing regulatory mandates from all levels of government, not to mention staying in front of and working against proposed regulations that we think would do damage to our industry and economy. like SB 939 in California, which did not pass, and the proposed repeal of Prop 13 for commercial properties in California, which we believe is essentially a targeted tax increase on business, which would ultimately be passed on to tenants and customers, most of whom can't absorb such increases and could lead to even more business failures. As Ernest mentioned, we continue to work with our tenants on rent deferments and other lease modifications to assist those tenants as best we can whose business have been significantly impacted by COVID-19. We've also renegotiated or bid out most of our vendor contracts to meaningfully reduce operating expenses, many of such reductions on a long-term basis, all the while maintaining our best-in-class properties. And we've leveraged the high unemployment rates in our markets to hire top-caliber associates to fill open positions at AAT. Finally, we appreciate more than ever the positive impact that ESG has including fostering a culture of diversity and inclusion, has on our business, our economy, and our society. Particularly in light of current events, our focus on human capital and physical and mental well-being, both within our company and in our communities, has never been stronger and represents the foundation that our culture was built on. For more insight on our ESG efforts, please take a look at our recently published 2019 Sustainability Report, which can be found on the Sustainability page of our website. With that, I'll turn the call over to Bob to discuss Q2 results and the impact from COVID-19. Bob?

Good morning and thank you, Ernest and Adam. Last night we reported second quarter 2020 FFO of $0.48 per share and net income attributable to common shareholders of $0.13 per share for the second quarter. Let's look at the results of the second quarter for each property segment. Our office property segment continues to perform well during these uncertain times. Office properties, excluding our One Beach Street property located on the north waterfront of San Francisco, which is under redevelopment, were at 96% occupancy at the end of the second quarter, an increase of approximately 3% from the prior year. More importantly, same-store cash NOI increased 16% in Q2 over the prior year, primarily from City Center Bellevue in Washington, Lloyd District Campus, Office Campus in Oregon, and Troy Reserve Campus here in San Diego. Our retail properties have not fared as well during the pandemic. Retail properties were at a 95% occupancy at the end of the second quarter, a decrease of approximately 2% from the prior year. However, retail collections have been difficult during the pandemic, as reflected in our negative same-store cash NOI. Additionally, due to COVID-19, we have taken a reserve for bad debts against the outstanding retail accounts receivable and straight-line rents receivable at the end of the second quarter of approximately 14% and 7%, respectively. From a dollar perspective, this translates into approximately $2 million and $1.4 million, respectively, for a total of $3.4 million dollar reserve related to our retail sector, which is approximately four and a half cents of FFO. We intend to continue evaluating and potentially revising these reserves each quarter as we monitor the ever-changing viability and solvency of each of our retail tenants. Our multifamily properties were at an 85% occupancy at the end of the second quarter, a decrease of approximately 8% from the prior year, as also reflected in our negative same-store cash NOI. But as Ernest mentioned, we expect this to increase back into the low to mid-90% occupancy once our master lease with a local private university commences on August 1st. Our mixed-use property, consisting of the Embassy Suites Hotel and the Waikiki Beachwalk Retail, is located on the island of Oahu. The state of Hawaii remains in self-quarantine through the end of August, which has significantly impacted the operating results in the second quarter of 2020. The Embassy Suites' average occupancy for the second quarter of 2020 was 17%. compared with the prior year's second quarter average occupancy of 92%. A good rule of thumb in our view is that a hotel without any leverage on it needs to have approximately a 50% to 60% occupancy to break even. Our team in Hawaii forecasted earlier this month a 46% to 50% occupancy by year-end 2020. To our pleasant surprise, we ended June... with a 29% occupancy, much higher than the average occupancy of 17% for the quarter. Additionally, in the last 15 days, we have been seeing occupancy ranging from 45% to 55% with our team in Hawaii expecting to end the month of July at a 62% occupancy. Right now, it is our understanding that only two hotels remain open in Waikiki, one of which is our Embassy Suites Hotel, which has been completely renovated and is like a brand new hotel. Let's talk about billings and collections. On a company-wide basis, we collected approximately 83% of the total second quarter billings, which primarily consists of base rent and cost reimbursements. We have also collected approximately 83% of July's billings as of the end of last week. We expect those percentages to increase as we continue to work hard on collection efforts. In Q2, our office rent collections were approximately 98%. Our retail rent collections, excluding Waikiki Beach retail, were approximately 62%. And by the way, so far in July, it's about 70%. And our multifamily collections were approximately 95%. Waikiki Beachwalk Retail had an approximately 30% collection rate in Q2. As Ernest noted earlier, the Board of Directors has decided to increase the quarterly dividend from $0.20 to $0.25 per share. The Board took into consideration the increase in collections over what was expected during Q2, combined with the embedded growth in cash flow from the office sector over the next several years, as well as the master lease in the multifamily sector. Using the same 83% collection rate applied to our initial targeted dividend of 30 cents per quarter gets you to approximately 25 cents per share per quarter. As we look at the liquidity on our balance sheet, at the end of the second quarter, we had approximately $396 million in liquidity comprised of $146 million of cash and cash equivalents and $250 million of availability on our line of credit. And only one of our properties is encumbered by a mortgage. Our leverage, which we measure in terms of net debt to EBITDA, was 6.4 times on a quarterly annualized basis, resulting from the lower EBITDA from the added reserves that we took in the retail sector during Q2. On a trailing 12-month basis, our EBITDA would be approximately 5.8 times. Our focus is to maintain our net debt to EBITDA at 5.5 times or below. Our interest coverage and fixed charge coverage ratio ended the quarter at 3.8 times on a quarterly annualized basis and at 4.1 times on a trailing 12-month basis. And finally, with respect to the $250 million of unsecured debt maturities that come due in 2021, we expect to extend the The $100 million term loan, up to three times with each extension for a one-year period subject to certain conditions, and the remaining $150 million Series A notes does not mature until October 31st, 2021, which we would expect to refinance at lower rates. Regarding our guidance, as we previously disclosed, we withdrew our 2020 guidance on April 3rd due to the uncertainty that the pandemic would have on our existing guidance, particularly in our hotel or retail sector. Unfortunately, the economy continues to change day by day, and the current outcome remains uncertain as to impact and duration, which is why we will continue to withdraw our 2020 guidance. I'll now turn the call over to Steve Center, our Vice President of Office Properties, for a brief update on our successes and opportunities in our office segment. Steve?

Thank you, Bob. At the end of the second quarter, net of one beach, which is under redevelopment, our office portfolio stood at approximately 96% lease, with approximately 6% expiring through the end of 2021. We were fortunate to renew the IRS and Veterans Benefits Administration leases early in 2020 at first in Maine and Portland in a total of 131,000 feet at start rates nearly 20% above the rates at expiration. Given the quality of our assets and the strength of the markets in which they are located, With technology and life science as key market drivers, we continue to execute new and renewal leases at favorable rental rates, delivering continued NOI growth. With leases already signed, we have locked in approximately $29.6 million of NOI growth comprised of $6 million in 2020, $14 million in 2021, and $9.6 million in 2022 in our office segment. We anticipate significant additional NOI growth in 2022 through the redevelopment and leasing of 1 Beach Street in San Francisco and 710 Oregon Square in the Lloyd Submarket of Portland, along with the repositioning of two buildings at Torrey Reserve in the Delmar Heights Submarket of San Diego. In addition, we can grow our office portfolio by up to 768,000 round-the-world square feet, or 22%, on sites we already own by building Tower 3 at the Lloyd Commons, which is 213,000 feet, from blocks 90 and 103 at Oregon Square, totaling up to 555,000 square feet. Tower 3 at La Jolla Commons is into the city with San Diego for permits, and we continue evaluating market conditions, prospective tenant interest, and hopefully decreasing construction costs, leading to our upcoming, commencing construction. Next, schematic design is completed for blocks 90 and 103 at Oregon Square, with design development at 50% complete. We are scheduled for our first hearing with the Design Review Committee in Portland on August 20th. We currently have two active requests for proposals from prospective tenants for blocks 90 and 103, totaling 422,000 square feet. But again, we will be evaluating market conditions, tenant interest, and construction costs prior to commencing construction. We have a stable office portfolio with little near-term rollover, significant built-in NOI growth, and additional upside through repositioning and redevelopment redevelopment within our existing portfolio, plus substantial new development on sites we already own. Operator, I'll now turn the call over to you for questions.

Again, ladies and gentlemen, if you have a question or a comment, please press this log in the one key on your touchtone telephone. Our first question comes from Richard Hill with Morgan Stanley.

Hey, you got Ron Kandem on the line for Richard.

You can tell Richard we're glad to have you, Ron. So welcome.

That's right. Just a couple quick ones from me. The first is just going back to sort of the reserves taken on the uncollected rents in the retail portfolio. I guess the question is trying to get an understanding of how much conservatism is baked into that and how confident do you feel that, you know, there's not maybe more reserves coming down the line? as sort of the pandemic unfold. So trying to get a sense of the conservatism and the numbers that you guys took.

Yeah, Ron, thanks for the question. You know, we record those reserves in accordance with generally accepted accounting principles. And under that, there's a section called 842. And what it says is that we have to be – 75% confident that we're going to receive 95% of the cash flows. And in layman's terms, what we look at is, is a tenant going to survive or not survive? And so we have a group of about eight people, including Adam, who's involved with the leases, Chris Sullivan heads up our retail, our controller. It's a whole team effort. And what we do is we try to be We're not trying to be aggressive at all. What we're trying to do is be conservative. But in this pandemic, it changes daily. And what we do is we continue to evaluate that on a month-to-month basis. And as new developments happen, will the reserves increase over time? You know, as the pandemic continues to linger – there will probably be more fallouts, and as a result, we'll probably have to add to reserves. But at this point in time, I feel that those reserves that we've put on the books are adequately represented on a conservative basis.

Our strategy has always been to try and under-promise and over-deliver, and there's no pressure to have those reserves less than they ought to be. And so, as Bob says, the committee has looked at it carefully, and that's our best bet under these present circumstances, Ron, and thank you for asking.

Got it. Just a couple more quick ones. Just on the dividend, you know, I think you decided to raise it in 3Q by 5 cents. You know, I think you cited just better rent collections. I'm just trying to get a little more color what went into that decision because it feels like You know, maybe the board, you know, thinks that the worst is behind them, and you feel like you sort of have a handle on the pandemic and the fallout to be able to sort of do that. So what went into that decision? What gave you confidence to boost it? And how should we think about that going forward?

You know, as I said earlier, Ron, going into this pandemic, frankly, I was close to panicked because I'd never seen circumstances like this And I thought that we're in for a catastrophic situation. The situation has not been as bad as our worst case thoughts led us to. And so when we presented to the board a quarter of a go to cut from 30 cents to 20 cents, we took into account our view of the unknowns that we were facing. But as we've come face to face with those unknowns, While they've been very upsetting and very difficult, they haven't been as catastrophic as we expected. So we suggested to the board that they look at this with a more balanced approach and rather the catastrophic approach that we had suggested at the last quarter. And so we hated to cut a dividend, if you want to know the truth. We would love to have maintained the dividend at the same level we have since we went public and increase it as we have over the 11 or 12 years since we've been public. That is just not in the cards given the circumstances that we're presently facing. We'll just have to see how it unfolds. The board will make a decision quarter by quarter, but I would think that based on the projections we have now, and the feel we have in the marketplace that the 25 cents should be able to be continued. And, you know, with any good luck, hopefully we'll get back to where we'd like to be, which is the same dividend as in prior years and even a small increase, if at all possible, feasible.

Great. And then my last one, if I may, you know, I think one of the questions we're getting the most on the desk is just about sort of work from home and the implications, right? And, you know, when I think about, you know, your portfolio and, you know, just a great amount of demand and attendance, I think the numbers have sort of shown that. The question is really, you know, what's the possibility of sort of the office market turning into a have-or-have-not, right, when you think about some of maybe the older stock out there compared to sort of your sort of class-based stocks? Is there – what's the possibility of maybe those assets being disproportionately impacted from work from home? And, you know, what are you hearing from tenants on the work from home front? What's their thinking these days? Thank you.

Well, I think when this started, everybody said, well, who needs office? But I tell you, as somebody who is involved in business on a day-to-day basis, we miss work. people coming into the office, and all the good results that flow from that, the idea flow, the training. And so I know the theory is you don't need office. The practice is office is a valuable way to operate a business, and I'm looking forward to people coming back. How this is all going to come about, I don't know, but I have confidence that the office portfolio we have in the high-quality, high-growth markets where there's innovation and job creation, we will have a market for our office and hopefully even a growing market. That's my best guess. I don't know what the answer is, but you probably hear from lots of people. If it was New York City, I would be more frightened. If it was Chicago, I'd be more frightened. Our coastal, west coast markets are very vibrant, and I think we have a good future with the portfolio that we have.

Great. Very helpful. Thank you. Appreciate it.

Thank you, Ron.

Our next question comes from Todd Thomas with KeyBank Capital Markets.

Hi. Thanks. Good morning. Just the first question, I guess, following up on that, just wondering if you had any updates specifically from Google regarding their planned move-in and occupancy at Landmark, just given their latest announcement about not bringing back employees until at least the summer of 21.

Jerry Pamieri is going to answer that. He's in constant contact with them and will update you. Yeah, and thanks for the question, Todd.

Yeah, good morning, Todd. So at our landmark project in San Francisco in March, we basically stopped construction at that point. And at that point, we had two of the seven floors completed already. They have remobilized this week, and they are proceeding with the work. During the break, I'll call it, there was a lot of discussion about what they would do with this case, whether they would reprogram, whether they would change their layout or their floor plan, and the decision has been made to proceed with the plans as originally contemplated. So they're moving expecting to complete somewhere around the first quarter of 21.

Okay. And then, you know, Ernest, I appreciate your perspective sort of longer term, but curious, you know, in the interim here, you know, as you're moving forward with, you know, a number of, you know, leasing initiatives in the office segment, you know, are you seeing any changes in demand across your markets, you know, any changes in conversations with with tenants about how they're thinking about, you know, office space rents, you know, or their decision and sort of willingness to sign leases today?

I'll tell you, unless somebody's dead, dumb, and deaf, they're thinking about the circumstances that they're operating under now. But Steve's center is in constant contact with the agents and the prospective tenants, and you're probably best able to handle that, Steve.

Yeah, you know, we're seeing... tenants proceed with their plans. One example is Smartsheet just recently signing a deal to accelerate taking two additional floors at City Center Bellevue by 14 months. As Jerry pointed out, Google, they're proceeding with their plans. It's not a matter of if they're moving back in. It's a matter of when. And what I liked about the message from Jerry is that they're going with the design that they previously come up with pre-COVID. So it indicates to me that that's a belief that we're going to return to some semblance of normal and get back to business. And so we've got two deals we're in discussions with in Portland for 2023 deliveries, and those are businesses looking through the noise and looking into the future, and they've got to grow, and they need a home for all those employees. So far, so good, especially with our technology and life science companies.

Okay. And then shifting over to the multifamily segment, you know, the occupancy decline there was a little bit greater than we expected, but it seems like occupancy is going to get a boost with the master lease at Pacific Ridge. What's the term of that master lease? And, you know, is the master lease representative of market rents? And then when that kicks in on August 1st, where would you expect multifamily occupancy to be?

Now, the master lease is for two projects, Lomas Palisades and Pacific Ridge. And Abigail, why don't you take that? Abigail and Adam did a great job in negotiating this transaction.

Sure. Good morning. So that master lease agreement will span between Lomas Palisades and Pacific Ridge and consist of about 130 units at a little bit – above market rate because it's an all-inclusive rental rate package for the university. That will be for a 10-month term starting August 1st and then go through May 31st of 2021. Excuse me. And we anticipate that come August when all of the move-ins take place, not only in addition to the master lease but with other renters as well will probably be back to the low to mid-90s, as Bob mentioned earlier.

But one thing that you have to consider is that the governments now are extending the terms that tenants have to pay the rent. With this lease, it's collectible, and that's a huge difference. So in addition to the rates being acceptable and perhaps of the payment is assured, and that's a big deal in this crazy market.

Okay. All right, great.

Thank you.

Thank you, Todd. Thanks for your interest.

Our next question comes from Craig Schmidt with Bank of America.

Morning, Craig.

Good morning to you.

I was just wondering what you're seeing regarding the California efforts to roll back reopenings on the retail real estate, whether in terms of impacted traffic or possible impact on rent collection?

Chris, do you want to handle that? Yeah, I mean, this thing changes day by day. So maybe you can have an overview that you can share.

The largest impact that came back, as you remember, right after Memorial Day, that restaurants were allowed to start reopening in size. That only lasted for a couple of weeks or so, depending on what county you were in. And then when they shut down restaurants to operate inside dining, that really threw a wrench in the system. So as you drive around your own towns and where you are, you can see the restaurateurs had to try sidewalk dining or patios if they had. their main chefs and some staff on. So that really threw a monkey wrench into it. This is most of the shopping center guys have. You might have 10 to 15% food service in your properties. The other piece that that really hurt was all the salons, the nail salons, quite a bit of the service providers that were no longer able to have folks come inside and get a haircut or have the nails done. So it's this constant little chipping away that has certainly had an effect on retail. So that's the biggest piece I've seen, besides all the other problems with no tourism and the rest of it that the whole country and world is facing.

Thanks, Chris. And thank you, Craig. Any more questions, Craig?

I guess I know that in terms of university housing for the students, they're changing the densities that they're allowing. Is that having any impact, positive or negative, on you in terms of your multifamily leasing?

Yes, I think that was the genesis for the lease that we signed with the local university. They were de-dentifying, if that's a word, their dorms, and they needed more space. And fortunately, that lease expires just at the heavy rental season, so we'll have a better opportunity to fill those leases up. Hopefully, when the market is more normal, there is a vaccine, the world is returned to normal, and our properties will have the opportunity to fill them up again. But in the meantime, it's a great stopgap measure. Collectible.

Okay, thank you.

Thank you.

And I'm not showing any further questions at this time. I'd like to turn the call back over to Chairman Ernest Reddy for concluding remarks.

Again, to sum it all up, this is a very difficult time. American Assets Trust has great properties, a great team, and liquidity. It's certain that we will see the other side of this pandemic, and we will come out of this at least as good as we were coming into this and hopefully better with all the opportunities that are available to us. So thank you all for your interest, and we hope to talk to you 90 days from now.

Well, ladies and gentlemen, that concludes today's presentation. You may now disconnect and have a wonderful day.