American Assets Trust

Moat: 2.5/5

Understandability: 2/5

Balance Sheet Health: 4/5

AAT is a self-managed and self-administered REIT focused on acquiring, developing, and operating retail, office, mixed-use, and multifamily properties in high-barrier-to-entry markets in Southern California, Northern California, Washington, Oregon, Texas, and Hawaii.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

AAT operates in a highly competitive real estate industry, where local knowledge and execution are paramount, making it a business that is difficult for outsiders to quickly understand and dominate.

Business Overview:

American Assets Trust (AAT) operates in a diverse portfolio across multiple property types. Here’s a breakdown:

Geographic Diversification: AAT’s properties are concentrated in California, Oregon, Washington, Texas, and Hawaii which are all high barrier to entry markets for real estate.
Office: A significant portion of AAT’s portfolio consists of office properties, mainly located in key metropolitan areas such as San Diego, Honolulu, and Bellevue. While a large asset, revenues have remained stable, with slight volatility and modest growth. The office portfolio comprises high quality, well-located offices, mainly leased to large creditworthy tenants.
Retail: AAT’s retail portfolio mainly consists of retail centers, including grocery-anchored centers with many of the top retailers such as Target, Barnes and Noble, and Ulta Beauty. The REIT also owns outlet shopping centers and a mixed use center (La Jolla Commons). The growth in retail is more varied than the office segment, with increased volatility compared with its peers.
Multifamily: A smaller but growing segment of AAT’s portfolio, consisting of a smaller number of higher quality communities in San Francisco, San Diego, and Washington. This segment has shown consistent growth and resilience during market fluctuations.
Mixed Use: An important part of their portfolio is comprised of mixed-use assets, that create their own market value and opportunity.
Development and Entitlements: AAT owns some land for future development.

Industry Trends:

Evolving Demand: The real estate industry is constantly adapting to changing needs. There is an apparent shift towards mixed-use properties that combine elements of residential, retail, and commercial spaces, as well as demand for high quality retail.
Work From Home Impact: The demand for offices has been impacted by the prevalence of work from home. The rise in interest rates has impacted the commercial market and has led to increased concerns from the market.
Evolving preferences in retail: The consumer’s preference for purchasing certain products on-line vs in-store and the increased amount of grocery delivery and curbside pick-up has impacted the sector.
Interest Rate Sensitivity: REITs are particularly sensitive to fluctuations in interest rates. These will affect their ability to raise funds and may increase borrowing costs.
Economic Cycles: The market value of real estate, particularly income-producing real estate, is tied to overall economic performance, making it cyclical.
Inflation: High inflation has a positive impact in real property but negatively impacts margins and is a concern.

Competitive Landscape:

The real estate industry is highly competitive. AAT competes with other REITs, private real estate developers, and investors. Competitive advantages are centered on property location, tenant relationships, quality of assets and management expertise.

What Makes AAT Different:

Geographic Focus: AAT concentrates its portfolio in high barrier to entry markets. They have an advantage due to local knowledge.
High Quality Assets: AAT aims to own highly desirable, top-rated properties with long lasting tenants.
Proven Management: The management team has many years of experience and claims to have an expertise in the market, creating long-term strategic partnerships with major tenants.
Strong Balance Sheet and Conservative Approach: AAT’s balance sheet has a high rating and low leverage, enabling them to get through market downturns better than other companies. They are also cautious and conservative when it comes to investment.

Financials Analysis:

Let’s dive into AAT’s financial performance, focusing on the key metrics and recent trends using its most recent financials:

Revenue: AAT’s revenue streams are diversified across segments, but property revenue is the main driver. Overall revenues increased in the first nine months of 2023 with good occupancy and higher rates in all segments.
Net Operating Income (NOI): NOI increased by roughly 3% and 16% for stabilized and total properties respectively in the nine months ended September 30th, 2023 compared to the same period in 2022. This is mainly due to higher occupancy rates, along with improved leasing rates in the Retail sector.
Funds from Operations (FFO): The company’s core FFO was reported to be $1.30 per diluted share in the nine months ended September 30, 2023. Core FFO is a key metric for real estate investment trusts (REITs) that shows the cash generated by their core business and excludes gains or losses from sales of properties. The company’s FFO has benefited due to better operational performance, with higher rental revenue and reduction in costs, but has not reached pre-pandemic levels.
Balance Sheet: American Asset’s balance sheet is generally strong with a high interest coverage ratio, low leverage and a reasonable debt to equity ratio.
Debt: The company carries significant amounts of debt and needs to be able to navigate interest changes. Debt to total assets is approximately 39%, which is relatively conservative for a REIT.
Earnings Per Share (EPS): EPS was $0.66 for three months ended September 30, 2023. Earnings were lower than that of the prior year, as a result of increased interest expenses.
Dividends: AAT has a history of consistent dividends. AAT recently paid its dividend for Q3 2023 and for all of 2023 it is paying $1.10, same as previous year.
Share repurchases: AAT bought back 4.3M of shares between December 2022 and October 2023.
Accounting Changes: In the past few years there have been accounting changes, such as the elimination of amortization of goodwill and other intangibles, that need to be taken into account.
Guidance: The company’s revised guidance for 2023 is $2.45-$2.50 for earnings and $1.43-$1.48 for core FFO per share.

Recent events have made the interest rate environment uncertain. Rising rates can increase the cost of debt, thereby limiting a company’s ability to make new acquisitions. AAT also faces an uncertain office environment and has said that the recent increase in interest rates might have an effect on the ability to refinance debt. A slowdown in the economy might lead to lower rates and occupancy for their properties.

Moat Rating Justification: 2.5/5

Limited Moat: While AAT operates in favorable markets and possesses a well-managed portfolio, its competitive advantages do not give a huge edge over competitors. The business does have some differentiation due to the location and tenant diversity of its assets, and its large, diversified portfolio.
Brand: AAT has not shown itself to have a notable brand, they have not reached a size that has given them any specific differentiation.
Switching Costs: Switching costs are low in the real estate industry. If a tenant is unhappy they are always able to find another space.
Network Effects: Network effects in this industry are limited. While local presence is a factor, a network effect on a grander scale is not a factor for this business.
Cost Advantages: Some of AAT’s properties might be cheaper to operate than its peers but it is not a substantial advantage. The company does have lower interest rates due to its stability and lower levels of debt.
Intangibles: Other than having some knowledge of the local area they are operating in, there are no considerable intangible assets that are not available to other companies.

Based on the limited moats, the company’s future growth is tied mainly to the health of the real estate industry and its economic performance.

Moat Risks & Business Resilience

Interest Rate Risk: The biggest risk is the rising interest rates as this would make it harder for the company to acquire new properties and put stress on existing loans.
Geographic Concentration: Their properties are geographically concentrated which makes them vulnerable to localized events.
Industry Downturn: The real estate industry experiences downturns with its cycles. AAT’s performance is therefore tied to broader macroeconomic trends and is vulnerable to an economic recession.
Tenant concentration: Although the portfolio is very diversified, any particular property can have tenant concentration risks.

Business Understandability: 2/5

AAT is moderately complex to understand, because:

Numerous Variables: There is a lot to keep track of with numerous inputs and their effect on real estate. It is very important to understand how different types of property revenue and how the management is planning to utilize them. Understanding the overall dynamics of the market is also important.
Accounting and Financial Reporting: Understanding REIT accounting, especially with impairments, debt structure and taxation is challenging.
External Factors: Many external factors can affect the performance of real estate companies. These include economic conditions, inflation, interest rate fluctuations, and government regulations.

Even though the general idea of a REIT is simple, calculating metrics like FFO, and incorporating future market conditions makes the business moderately complicated.

Balance Sheet Health: 4/5

AAT’s balance sheet is healthy and is conservatively managed. The company has a good credit rating, a relatively low amount of debt, and good cash reserves.

Low Leverage: A debt-to-capital ratio of approximately 39% is conservative for a REIT.
High liquidity: Their current ratio of assets/liabilities is greater than 1, this is a sign that they have more liquid assets than current liabilities.
Consistent cash flow: The nature of the business allows for steady cash flows, helping in covering liabilities.

The company’s debt is mostly fixed-rate, and should not be greatly impacted by changes in interest rates. The company has a decent amount of cash to fall back on if markets decline. The company is in compliance with all its debt covenants.

The company is conservatively managed and has decent liquidity and solvency, making its balance sheet strong.