Short-term interest rate hikes have caused a whole host of “bond proxies” to sell off.
American Assets Trust is a small-cap diversified REIT that is offering a generous dividend yield relative to historical levels.
If you can stomach AAT’s exposure to physical retail, now may be a good time to buy into the name and secure a growing 2.9% dividend yield.
American Assets Trust (AAT) is a diversified, internally-managed real estate investment trust, which focuses on “acquiring, improving, developing and managing premier retail, office and residential properties throughout the United States in some of the nation’s most dynamic, high-barrier-to-entry markets.” The company has been operating for over 50 years, primarily under the leadership of Ernest Rady, who founded the predecessor company of American Assets Trust in 1967. During that time, the company has shown a particular interest in acquiring properties on the West Coast of the country, as illustrated below.
Source: AAT 3Q 2017 Supplemental Information
American Assets Trust Spans Multiple REIT Sectors
Taking the net operating income from the 3rd Quarter of 2017 as an overall proxy for the company, we can see that AAT’s properties span several sectors, with particular concentrations in Retail and Office real estate.
Source: AAT 3Q 2017 Supplemental Information (Chart by Author)
While American Assets Trust’s properties span many different sectors of REIT-dom, they all tend to share certain characteristics. American Assets Trust looks to acquire or develop properties that are well-located within metro areas are well-positioned to take advantage of future growth trends. These areas include Portland, OR, San Diego, CA, and San Antonio, TX. In order to better illustrate the quality of AAT’s portfolio, I will highlight a few of its properties.
First & Main: Distinctive High-Rise Office Space In The Heart Of Portland, OR.
Source: Company Website
First & Main is a flashy, modern office property, which was constructed in 2010. It is located within walking distance of many of Portland’s most popular eating, business, and shopping destinations. It has also been awarded the prestigious new LEED Platinum certification by the U.S. Green Building Council, in recognition of the many energy-saving features incorporated in the building’s design.
First & Main hosts some of AAT’s largest tenants in terms of percentage of annualized base rent. These tenants include the Veterans Benefits Administration, Clearesult Operating, LLC, and a Treasury call center. Having government agencies as significant tenants should give First & Main less volatility in its cash flows, as government tenants are less susceptible to the ebbs and flows of the economy.
Currently, First & Main has maintained a strong occupancy rate of 98.7% while keeping annualized base rent steady. Its first major lease expirations are expected in August of 2020, when both the Veterans Benefits Administration and the Treasury Call Center leases will expire.
Imperial Beach Gardens: Attractively Located Middle Market Residential Property
The next property, which we will briefly examine, is less upscale than First & Main, as the picture below shows:
Source: Company Website
Despite its relatively middle-market status, however, American Assets Trust has applied the same strategy to Imperial Beach Gardens as it has to First & Main. Imperial Beach Gardens is located a mere 2 blocks from the beach, and also directly adjacent to a mass transit route. This charming community of 160 townhouse-style homes was built in 1959, but was recently renovated in 2008, ensuring that the units will remain marketable for many years to come.
Source: Imperial Beach Gardens Website
Perhaps the greatest testament to the ability of American Assets Trust to manage older, middle-market investments are the operating metrics which properties such as Imperial Beach Gardens have been able to generate. Thanks to its location within the San Diego metro area, as well as its advantageous proximity to the beach, Imperial Beach Gardens has been able to consistently lease over 96% of its available space. Additionally, annualized base rent has slowly, but steadily, trended upwards.
Alamo Quarry Market: High Occupancy Rates Suggest Resilience To Headwinds
AAT has also been judicious in its choice of retail exposure, which accounts for around 40% of its Net Operating Income. One example of this is Alamo Quarry Market, a former cement factory in San Antonio, TX that was converted into an open-air shopping center.
Source: Company Website
As with the other AAT portfolio properties which we have examined, location plays a critical role in the business value of Alamo Quarry Market; the average income of the 113,935 people who live within 3 miles of Alamo is $75,594 – suggesting that the complex serves a population with ample disposable income.
Of course, investors should take care to examine the tenant base of any retail – focused properties, especially since e-commerce has put retail property operators squarely on the defensive. Looking at the store directory for Alamo Quarry Market below, I see a mixed bag.
Source: Alamo Quarry Market Directory Map
Alamo appears to have a pretty standard mix of retail tenants, with “Old Retail” companies such as Bed, Bath, & Beyond (NASDAQ:BBBY) well-represented in the tenant mix. However, it is also important to point out that the shopping center also hosts a Whole Foods location. Now that Whole Foods is owned by Amazon (NASDAQ:AMZN), it is reasonable to assume that Whole Foods locations will play a critical role in Amazon’s plans to disrupt the physical retail sector.
As such, having Whole Foods as a tenant should help to cushion Alamo Quarry Market from the headwinds, which are facing the physical retail space. Alamo’s desirable location within a high-income market also ensures that, regardless of the problems faced by its tenants, its prime retail space will always be in demand.
This hypothesis is borne out by the extraordinarily high occupancy rate that Alamo enjoys. Over the past year, Alamo’s occupancy rate has never dipped below 99.5%! That is an outstanding performance, especially considering the fact that annualized base rent has not fallen dramatically over the past year. Were ABR in a downtrend, it may signal that tenants were staying put only because they were negotiating their rental rates downward. Fortunately, this is not the case at Alamo Quarry Market.
It will be important to watch for future lease expirations/renewals in order to get a sense of whether Alamo will be able to continue this level of operational excellence going forward. Old Navy and Nordstrom Rack are two large Alamo tenants whose leases are scheduled to expire in late 2022, suggesting that investors will have to wait a while longer to see what the future holds for Alamo’s rental income in the Age of Amazon.
American Assets Trust’s focus on quality properties, which can deliver high occupancy rates and slow but steady rent growth has resulted in a laudable record of dividend growth since its IPO. Over the past 6 years, the dividend has increased at a CAGR of about 8%, handily outpacing inflation during that time.
That being said, it is important to note that the overall rate of dividend growth is skewed by the massive jump in the dividend payout in 2011, when it rose from $0.17 per quarter to $0.21 per quarter. AAT’s most recent dividend increase was a more moderate 3.8% bump-up in the payout – still a respectable rate of increase in an environment of relatively low inflation.
Interest Rate – Driven Selloff Has Boosted Yield
Over the past few weeks, bonds have been selling off, causing interest rates to spike around the world. This has sent ripples into the equity markets, with the usual suspects – bond alternatives such as utility stocks and REITS – registering a marked decline.
A look at a chart of AAT’s historical dividend yield shows that this selloff is a blessing in disguise for prospective investors. At roughly 2.9%, American Assets Trust’s current dividend yield is at multiyear highs, a rarity in today’s market.
Interest Rates Could Rise Above Comfortable Levels For REIT Investors
Spikes in interest rates have helped to cause the current selloff in American Assets Trust and other equities, which act as bond proxies. While this is a good thing for investors looking to pick up shares in these companies at lower prices, it is also important to acknowledge the fact that, in purchasing bond proxies at current levels, investors may be catching a falling knife. If interest rates increase sharply, bond proxies such as REITs could continue to fall in value in the short to medium term.
It is also worth pointing out that, while AAT’s current floating-rate debt appears to have all been hedged via interest rate swaps, it may become more expensive to purchase interest rate swaps should market expectations for monetary tightening become more hawkish.
Another possible point of risk comes from the fact that AAT’s properties are concentrated in a few geographical areas. Going back to the map of AAT’s portfolio, we can see that much of it is located on or near the West Coast. If a natural disaster or series of natural disasters were to occur on the West Coast, the property markets in which AAT operates would be disrupted, to say nothing of the possibility of damage to AAT’s properties in excess of the insurance, which it carries on them.
Source: AAT 3Q 2017 Supplemental Information
Retail Lease Expirations
Some of AAT’s most valuable tenants are due to renegotiate their leases this year. Most notably, Kmart, the daughter brand of ailing retail has-been Sears Holdings (SHLD) has a 119,590 square foot lease scheduled to expire on June 30 of this year. This is the largest single lease in AAT’s book of business, comprising 2.7% of the company’s entire annualized base rent.
With Sears hovering at the brink of defaulting on its debt, it is uncertain that Kmart will be either willing or able to renew this lease at the same rate, in which case AAT must either accept a reduction in operating income or go find another “Big Box” tenant to fill a 119,590 square foot hole in its Waikele Center in West Oahu, Hawaii.
As the Retail Apocalypse continues to run its course, additional situations such as the Waikele lease expiration will probably occur. Those who choose to invest in American Assets Trust are choosing to believe that the quality of the properties the Trust owns will attract new tenants to replace those, which are victims of the changing world of physical retail.
American Assets Trust is an intriguing, underfollowed small-cap real estate investment trust, which is diversified across the Retail, Office, and Multifamily real estate sectors. Rising short-term interest rates and continued uncertainty surrounding the future of physical retail have helped to depress the price of AAT’s stock, which – in concert with a recently announced 3.8% dividend hike – has boosted AAT’s dividend yield to a multi-year high.
Less intrepid investors should probably wait for a higher dividend yield (perhaps something in the 3.5-4 percent range). However, those who believe that American Assets Trust’s focus on quality properties in desirable locations will allow it to navigate the short- to medium-term headwinds facing the company would be well-served to consider AAT for inclusion in a diversified income portfolio.
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Disclaimer: Use my work as a starting point for your own due diligence, not as a substitute. All investments involve the risk of loss of income as well as principal. Consider consulting with an investment adviser before making any investment. I am not a tax professional or investment adviser. Please consider consulting with a tax professional before making any investment.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.