2Q14 10Q-DOC
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
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x | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended June 30, 2014
or
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o | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from to
Commission file number: 001-35030
AMERICAN ASSETS TRUST, INC.
(Exact Name of Registrant as Specified in its Charter)
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| Maryland (State of Organization) | 27-3338708 (IRS Employer Identification No.) |
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| 11455 El Camino Real, Suite 200, San Diego, California (Address of Principal Executive Offices) | 92130 (Zip Code) |
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(858) 350-2600
(Registrant’s Telephone Number, Including Area Code)
Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. x Yes o No
Indicate by check mark whether the Registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the Registrant was required to submit and post such files). x Yes o No
Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
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Large Accelerated Filer | x | | Accelerated Filer | o |
Non-Accelerated Filer | o | (Do not check if a smaller reporting company) | Smaller reporting company | o |
Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). o Yes x No
The number of Registrant’s common shares outstanding on August 1, 2014 was 42,615,331.
AMERICAN ASSETS TRUST, INC.
QUARTERLY REPORT ON FORM 10-Q
FOR THE QUARTER ENDED June 30, 2014
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PART 1. FINANCIAL INFORMATION | |
Item 1. | Financial Statements | |
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Item 2. | | |
Item 3. | | |
Item 4. | | |
PART II. OTHER INFORMATION | |
Item 1. | | |
Item 1A. | | |
Item 2. | | |
Item 3. | | |
Item 4. | | |
Item 5. | | |
Item 6. | | |
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PART 1 - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
American Assets Trust, Inc.
Consolidated Balance Sheets
(In Thousands, Except Share Data)
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| | | | | | | |
| June 30, | | December 31, |
| 2014 | | 2013 |
| (unaudited) | | |
ASSETS | | | |
Real estate, at cost | | | |
Operating real estate | $ | 1,926,204 |
| | $ | 1,919,015 |
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Construction in progress | 116,498 |
| | 67,389 |
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Held for development | 9,084 |
| | 9,013 |
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| 2,051,786 |
| | 1,995,417 |
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Accumulated depreciation | (341,760 | ) | | (318,581 | ) |
Net real estate | 1,710,026 |
| | 1,676,836 |
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Cash and cash equivalents | 78,859 |
| | 48,987 |
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Restricted cash | 10,766 |
| | 9,124 |
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Accounts receivable, net | 4,940 |
| | 7,295 |
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Deferred rent receivables, net | 33,956 |
| | 32,531 |
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Other assets, net | 53,876 |
| | 57,670 |
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TOTAL ASSETS | $ | 1,892,423 |
| | $ | 1,832,443 |
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LIABILITIES AND EQUITY | | | |
LIABILITIES: | | | |
Secured notes payable | $ | 952,847 |
| | $ | 952,174 |
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Term loan | 100,000 |
| | — |
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Line of credit | — |
| | 93,000 |
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Accounts payable and accrued expenses | 38,885 |
| | 37,063 |
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Security deposits payable | 5,323 |
| | 5,163 |
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Other liabilities and deferred credits | 57,675 |
| | 58,465 |
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Total liabilities | 1,154,730 |
| | 1,145,865 |
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Commitments and contingencies (Note 9) |
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EQUITY: | | | |
American Assets Trust, Inc. stockholders’ equity | | | |
Common stock, $0.01 par value, 490,000,000 shares authorized, 42,615,331 and 40,512,563 shares issued and outstanding at June 30, 2014 and December 31, 2013, respectively | 426 |
| | 405 |
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Additional paid-in capital | 759,158 |
| | 692,196 |
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Accumulated dividends in excess of net income | (54,186 | ) | | (44,090 | ) |
Accumulated other comprehensive loss | (1,093 | ) | | — |
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Total American Assets Trust, Inc. stockholders’ equity | 704,305 |
| | 648,511 |
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Noncontrolling interests | 33,388 |
| | 38,067 |
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Total equity | 737,693 |
| | 686,578 |
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TOTAL LIABILITIES AND EQUITY | $ | 1,892,423 |
| | $ | 1,832,443 |
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The accompanying notes are an integral part of these consolidated financial statements.
American Assets Trust, Inc.
Consolidated Statements of Comprehensive Income
(Unaudited)
(In Thousands, Except Shares and Per Share Data) |
| | | | | | | | | | | | | | | |
| Three Months Ended June 30, | | Six Months Ended June 30, |
| 2014 | | 2013 | | 2014 | | 2013 |
REVENUE: | | | | | | | |
Rental income | $ | 58,793 |
| | $ | 59,705 |
| | $ | 119,275 |
| | $ | 118,927 |
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Other property income | 3,392 |
| | 3,209 |
| | 6,863 |
| | 6,167 |
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Total revenue | 62,185 |
| | 62,914 |
| | 126,138 |
| | 125,094 |
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EXPENSES: | | | | | | | |
Rental expenses | 16,500 |
| | 16,686 |
| | 33,120 |
| | 32,972 |
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Real estate taxes | 5,129 |
| | 5,476 |
| | 11,155 |
| | 10,276 |
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General and administrative | 4,635 |
| | 4,426 |
| | 9,247 |
| | 8,627 |
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Depreciation and amortization | 18,209 |
| | 16,953 |
| | 34,550 |
| | 33,966 |
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Total operating expenses | 44,473 |
| | 43,541 |
| | 88,072 |
| | 85,841 |
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OPERATING INCOME | 17,712 |
| | 19,373 |
| | 38,066 |
| | 39,253 |
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Interest expense | (13,439 | ) | | (14,744 | ) | | (27,071 | ) | | (29,480 | ) |
Other income (expense), net | 1,078 |
| | (65 | ) | | 1,014 |
| | (344 | ) |
NET INCOME | 5,351 |
| | 4,564 |
| | 12,009 |
| | 9,429 |
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Net income attributable to restricted shares | (94 | ) | | (133 | ) | | (164 | ) | | (265 | ) |
Net income attributable to unitholders in the Operating Partnership | (1,544 | ) | | (1,354 | ) | | (3,530 | ) | | (2,849 | ) |
NET INCOME ATTRIBUTABLE TO AMERICAN ASSETS TRUST, INC. STOCKHOLDERS | $ | 3,713 |
| | $ | 3,077 |
| | $ | 8,315 |
| | $ | 6,315 |
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EARNINGS PER COMMON SHARE | | | | | | | |
Earnings per common share, basic | $ | 0.09 |
| | $ | 0.08 |
| | $ | 0.20 |
| | $ | 0.16 |
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Weighted average shares of common stock outstanding - basic | 41,816,379 |
| | 39,460,086 |
| | 41,202,993 |
| | 39,247,729 |
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Earnings per common share, diluted | $ | 0.09 |
| | $ | 0.08 |
| | $ | 0.20 |
| | $ | 0.16 |
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Weighted average shares of common stock outstanding - diluted | 59,721,636 |
| | 57,429,837 |
| | 59,110,450 |
| | 57,244,174 |
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DIVIDENDS DECLARED PER COMMON SHARE | $ | 0.22 |
| | $ | 0.21 |
| | $ | 0.44 |
| | $ | 0.42 |
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COMPREHENSIVE INCOME | | | | | | | |
Net income | $ | 5,351 |
| | $ | 4,564 |
| | $ | 12,009 |
| | $ | 9,429 |
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Other comprehensive loss - unrealized loss on swap derivative during the period | (811 | ) | | — |
| | (1,557 | ) | | — |
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Comprehensive income | 4,540 |
| | 4,564 |
| | 10,452 |
| | 9,429 |
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Comprehensive income attributable to non-controlling interest | (1,305 | ) | | (1,354 | ) | | (3,066 | ) | | (2,849 | ) |
Comprehensive income attributable to American Assets Trust, Inc. | $ | 3,235 |
| | $ | 3,210 |
| | $ | 7,386 |
| | $ | 6,580 |
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The accompanying notes are an integral part of these consolidated financial statements.
American Assets Trust, Inc.
Consolidated Statement of Equity
(Unaudited)
(In Thousands, Except Share Data)
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| American Assets Trust, Inc. Stockholders’ Equity | | Noncontrolling Interests - Unitholders in the Operating Partnership | | Total |
| Common Shares | | Additional Paid-in Capital | | Accumulated Dividends in Excess of Net Income | | Accumulated Other Comprehensive Loss | |
| Shares | | Amount | | |
Balance at December 31, 2013 | 40,512,563 |
| | $ | 405 |
| | $ | 692,196 |
| | $ | (44,090 | ) | | $ | — |
| | $ | 38,067 |
| | $ | 686,578 |
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Net income | — |
| | — |
| | — |
| | 8,479 |
| | — |
| | 3,530 |
| | 12,009 |
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Common shares issued | 2,110,485 |
| | 21 |
| | 69,888 |
| | — |
| | — |
| | — |
| | 69,909 |
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Issuance of restricted stock | 117,983 |
| | 1 |
| | (1 | ) | | — |
| | — |
| | — |
| | — |
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Forfeiture of restricted stock | (941 | ) | | — |
| | — |
| | — |
| | — |
| | — |
| | — |
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Conversion of operating partnership units | 11,852 |
| | — |
| | (133 | ) | | — |
| | — |
| | 133 |
| | — |
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Dividends declared and paid | — |
| | — |
| | — |
| | (18,575 | ) | | — |
| | (7,878 | ) | | (26,453 | ) |
Stock-based compensation | — |
| | — |
| | 1,526 |
| | — |
| | — |
| | — |
| | 1,526 |
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Shares withheld for employee taxes | (136,611 | ) | | (1 | ) | | (4,318 | ) | | — |
| | — |
| | — |
| | (4,319 | ) |
Other comprehensive loss - change in value of interest rate swap | — |
| | — |
| | — |
| | — |
| | (1,093 | ) | | (464 | ) | | (1,557 | ) |
Balance at June 30, 2014 | 42,615,331 |
| | $ | 426 |
| | $ | 759,158 |
| | $ | (54,186 | ) | | $ | (1,093 | ) | | $ | 33,388 |
| | $ | 737,693 |
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The accompanying notes are an integral part of these consolidated financial statements.
American Assets Trust, Inc.
Consolidated Statements of Cash Flows
(Unaudited)
(In Thousands)
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| Six Months Ended June 30, |
| 2014 | | 2013 |
OPERATING ACTIVITIES | | | |
Net income | $ | 12,009 |
| | $ | 9,429 |
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Adjustments to reconcile income from operations to net cash provided by operating activities: | | | |
Deferred rent revenue and amortization of lease intangibles | (2,806 | ) | | (1,874 | ) |
Depreciation and amortization | 34,550 |
| | 33,966 |
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Amortization of debt issuance costs and debt fair value adjustments | 2,031 |
| | 1,966 |
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Stock-based compensation expense | 1,526 |
| | 1,393 |
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Other, net | (368 | ) | | (481 | ) |
Changes in operating assets and liabilities | | | |
Change in restricted cash | (673 | ) | | (818 | ) |
Change in accounts receivable | 2,379 |
| | (1,073 | ) |
Change in other assets | (377 | ) | | (38 | ) |
Change in accounts payable and accrued expenses | 1,013 |
| | 2,662 |
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Change in security deposits payable | 160 |
| | 238 |
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Change in other liabilities and deferred credits | 890 |
| | 303 |
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Net cash provided by operating activities | 50,334 |
| | 45,673 |
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INVESTING ACTIVITIES | | | |
Capital expenditures | (61,261 | ) | | (21,204 | ) |
Change in restricted cash | (969 | ) | | 433 |
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Leasing commissions | (1,628 | ) | | (1,344 | ) |
Net cash used in investing activities | (63,858 | ) | | (22,115 | ) |
FINANCING ACTIVITIES | | | |
Change in restricted cash | — |
| | (1,400 | ) |
Repayment of secured notes payable | (784 | ) | | (1,839 | ) |
Proceeds from term loan | 100,000 |
| | — |
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Repayment of line of credit | (93,000 | ) | | — |
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Debt issuance costs | (1,957 | ) | | — |
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Proceeds from issuance of common stock, net | 69,909 |
| | 24,922 |
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Dividends paid to common stock and unitholders | (26,453 | ) | | (24,380 | ) |
Shares withheld for employee taxes | (4,319 | ) | | — |
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Net cash provided by (used in) financing activities | 43,396 |
| | (2,697 | ) |
Net increase (decrease) in cash and cash equivalents | 29,872 |
| | 20,861 |
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Cash and cash equivalents, beginning of period | 48,987 |
| | 42,479 |
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Cash and cash equivalents, end of period | $ | 78,859 |
| | $ | 63,340 |
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The accompanying notes are an integral part of these consolidated financial statements.
American Assets Trust, Inc.
Notes to Consolidated Financial Statements
June 30, 2014
(Unaudited)
NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Business and Organization
American Assets Trust, Inc. (which may be referred to in these financial statements as the “Company,” “we,” “us,” or “our”) is a Maryland corporation formed on July 16, 2010 that did not have any operating activity until the consummation of our initial public offering on January 19, 2011. The Company is the sole general partner of American Assets Trust, L.P., a Maryland limited partnership formed on July 16, 2010 (the “Operating Partnership”). The Company’s operations are carried on through our Operating Partnership and its subsidiaries, including our taxable real estate investment trust ("REIT") subsidiary ("TRS"). Since the formation of our Operating Partnership, the Company has controlled our Operating Partnership as its general partner and has consolidated its assets, liabilities and results of operations.
We are a full service vertically integrated and self-administered REIT with approximately 118 employees providing substantial in-house expertise in asset management, property management, property development, leasing, tenant improvement construction, acquisitions, repositioning, redevelopment and financing.
As of June 30, 2014, we owned or had a controlling interest in 23 office, retail, multifamily and mixed-use operating properties, the operations of which we consolidate. Additionally, as of June 30, 2014, we owned land at five of our properties that we classify as held for development and/or construction in progress. A summary of the properties owned by us is as follows:
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Retail |
Carmel Country Plaza | Del Monte Center | |
Carmel Mountain Plaza | Geary Marketplace | |
South Bay Marketplace | The Shops at Kalakaua | |
Rancho Carmel Plaza | Waikele Center | |
Lomas Santa Fe Plaza | Alamo Quarry Market | |
Solana Beach Towne Centre | | |
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| | |
Office |
Torrey Reserve Campus | Lloyd District Portfolio | |
Solana Beach Corporate Centre | City Center Bellevue | |
The Landmark at One Market | | |
One Beach Street | | |
First & Main | | |
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Multifamily |
Loma Palisades | | |
Imperial Beach Gardens | | |
Mariner's Point | | |
Santa Fe Park RV Resort | | |
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Mixed-Use | | |
Waikiki Beach Walk Retail and Embassy Suites™ Hotel | |
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Held for Development and Construction in Progress |
Solana Beach Corporate Centre – Land | | |
Solana Beach – Highway 101 – Land | | |
Sorrento Pointe – Land | | |
Torrey Reserve – Land | | |
Lloyd District Portfolio – Land | | |
American Assets Trust, Inc.
Notes to Consolidated Financial Statements—(Continued)
June 30, 2014
(Unaudited)
Basis of Presentation
Our consolidated financial statements include the accounts of the Company, our Operating Partnership and our subsidiaries. The equity interests of other investors in our Operating Partnership are reflected as noncontrolling interests.
All significant intercompany transactions and balances are eliminated in consolidation.
The accompanying consolidated financial statements of the Company have been prepared in accordance with the rules applicable to Form 10-Q and include all information and footnotes required for interim financial statement presentation, but do not include all disclosures required under accounting principles generally accepted in the United States (“GAAP”) for annual financial statements. In the opinion of management, all adjustments (consisting of normal recurring adjustments, except as otherwise noted) considered necessary for a fair presentation have been included. These financial statements should be read in conjunction with the audited consolidated financial statements and notes therein included in the Company's annual report on Form 10-K for the year ended December 31, 2013.
The preparation of financial statements in conformity with GAAP requires us to make estimates and assumptions that in certain circumstances affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities, and revenues and expenses. These estimates are prepared using our best judgment, after considering past, current and expected events and economic conditions. Actual results could differ from these estimates.
Any reference to the number of properties and square footage are unaudited and outside the scope of our independent registered public accounting firm’s review of our financial statements in accordance with the standards of the United States Public Company Accounting Oversight Board.
Consolidated Statements of Cash Flows—Supplemental Disclosures
The following table provides supplemental disclosures related to the Consolidated Statements of Cash Flows (in thousands):
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| Six Months Ended June 30, |
| 2014 | | 2013 |
Supplemental cash flow information | | | |
Total interest costs incurred | $ | 29,121 |
| | $ | 30,326 |
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Interest capitalized | $ | 2,050 |
| | $ | 846 |
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Interest expense | $ | 27,071 |
| | $ | 29,480 |
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Cash paid for interest, net of amounts capitalized | $ | 25,244 |
| | $ | 27,021 |
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Cash paid for income taxes | $ | 319 |
| | $ | 585 |
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Supplemental schedule of noncash investing and financing activities | |
| | |
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Accounts payable and accrued liabilities for construction in progress | $ | 656 |
| | $ | (1,407 | ) |
Accrued leasing commissions | $ | 154 |
| | $ | 389 |
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Reduction to capital for prepaid offering costs | $ | — |
| | $ | 437 |
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Significant Accounting Policies
We describe our significant accounting policies in Note 1 to the consolidated financial statements in Item 8 of our Annual Report on Form 10-K for the year ended December 31, 2013. There have been no changes to our significant accounting policies during the six months ended June 30, 2014.
Concurrent with the closing of our amended and restated credit facility on January 9, 2014 (Note 6), we entered into an interest rate swap agreement with a notional amount of $100.0 million. The interest rate swap is intended to fix the variable portion of our $100.0 million term loan at approximately 3.08% from January 9, 2014 through January 19, 2019. Interest rate swaps designated as cash flow hedges involve the receipt of variable-rate amounts from a counterparty in exchange for our making fixed-rate payments over the life of the agreements without exchange of the underlying notional amount.
American Assets Trust, Inc.
Notes to Consolidated Financial Statements—(Continued)
June 30, 2014
(Unaudited)
We assess effectiveness of our cash flow hedges both at inception and on an ongoing basis. The effective portion of changes in fair value of the interest rate swaps associated with our cash flow hedges is recorded in accumulated other comprehensive income/loss and is subsequently reclassified into interest expense as interest is incurred on the related variable rate debt. Our cash flow hedges become ineffective if critical terms of the hedging instrument and the debt instrument do not perfectly match such as notional amounts, settlement dates, reset dates, calculation period and LIBOR rate. In addition, we evaluate the default risk of the counterparty by monitoring the credit-worthiness of the counterparty. When ineffectiveness exists, the ineffective portion of changes in fair value of the interest rate swaps associated with our cash flow hedges is recognized in earnings in the period affected. Hedge ineffectiveness has not impacted earnings as of June 30, 2014, and we do not anticipate it will have a significant effect in the future.
Segment Information
Segment information is prepared on the same basis that our management reviews information for operational decision-making purposes. We operate in four business segments: the acquisition, redevelopment, ownership and management of retail real estate, office real estate, multifamily real estate and mixed-use real estate. The products for our retail segment primarily include rental of retail space and other tenant services, including tenant reimbursements, parking and storage space rental. The products for our office segment primarily include rental of office space and other tenant services, including tenant reimbursements, parking and storage space rental. The products for our multifamily segment include rental of apartments and other tenant services. The products of our mixed-use segment include rental of retail space and other tenant services, including tenant reimbursements, parking and storage space rental and operation of a 369-room all-suite hotel.
Recent Accounting Pronouncements
In February 2013, the Financial Accounting Standards Board (the "FASB") issued ASU 2013-2, Comprehensive Income (Topic 220): Reporting Amounts Reclassified Out of Accumulated Other Comprehensive Income. ASU 2013-2 requires entities to disclose certain information relating to amounts reclassified out of accumulated other comprehensive income. This pronouncement became effective for us in the first quarter of 2013 and did not have a significant impact on our consolidated financial statements.
In April 2014, the FASB issued ASU-2014-08, Presentation of Financial Statements (Topic 205) and Property, Plant, and Equipment (Topic 360): Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity. ASU 2014-08 revises the definition of a discontinued operation to a disposal, sale or held-for-sale component or group of components that represents a strategic shift that will have a major effect on an entity's operations and financial results. This pronouncement is effective in 2015, however, calendar year-end companies may early adopt during the first quarter of 2014. We have chosen to early adopt this pronouncement and it became effective for us in the first quarter of 2014. This pronouncement did not have a significant impact on our consolidated financial statements.
In May 2014, the FASB issued Update No. 2014-09, Revenue from Contracts with Customers. Update No. 2014-09 establishes that companies may recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. This pronouncement is effective for annual reporting periods beginning after December 15, 2016, including interim reporting periods within that reporting period; early adoption is not permitted. We are in the process of evaluating the impact this pronouncement will have on our consolidated financial statements.
American Assets Trust, Inc.
Notes to Consolidated Financial Statements—(Continued)
June 30, 2014
(Unaudited)
NOTE 2. ACQUIRED IN-PLACE LEASES AND ABOVE/BELOW MARKET LEASES
The following summarizes our acquired lease intangibles and leasing costs, which are included in other assets and other liabilities and deferred credits, as of June 30, 2014 and December 31, 2013 (in thousands):
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| | | | | | | |
| June 30, 2014 | | December 31, 2013 |
In-place leases | $ | 62,303 |
| | $ | 62,813 |
|
Accumulated amortization | (41,073 | ) | | (38,279 | ) |
Above market leases | 28,239 |
| | 28,279 |
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Accumulated amortization | (22,164 | ) | | (20,880 | ) |
Acquired lease intangible assets, net | $ | 27,305 |
| | $ | 31,933 |
|
Below market leases | $ | 76,472 |
| | $ | 76,502 |
|
Accumulated accretion | (31,131 | ) | | (28,592 | ) |
Acquired lease intangible liabilities, net | $ | 45,341 |
| | $ | 47,910 |
|
NOTE 3. FAIR VALUE OF FINANCIAL INSTRUMENTS
A fair value measurement is based on the assumptions that market participants would use in pricing an asset or liability. The hierarchy for inputs used in measuring fair value is as follows:
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1. | Level 1 Inputs—quoted prices in active markets for identical assets or liabilities |
| |
2. | Level 2 Inputs—observable inputs other than quoted prices in active markets for identical assets and liabilities |
| |
3. | Level 3 Inputs—unobservable inputs |
Except as disclosed below, the carrying amounts of our financial instruments approximate their fair value. The financial liability whose fair value we measure on a recurring basis using Level 2 inputs is our deferred compensation liability included in other liabilities and deferred credits on the consolidated balance sheet. We measure the fair value of this liability based on prices provided by independent market participants that are based on observable inputs using market-based valuation techniques.
In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, for disclosure purposes, the level within which the fair value measurement is categorized is based on the lowest level input that is significant to the fair value measurement.
The fair values of the interest rate swap agreements are based on the estimated amounts we would receive or pay to terminate the contracts at the reporting date and are determined using interest rate pricing models and interest rate related observable inputs. The fair value of our swap at June 30, 2014 was a liability of $1.6 million and is included in "other liabilities and deferred credits" on our consolidated balance sheets. For the three and six months ended June 30, 2014, the change in valuation on our interest rate swaps was a decrease of $0.8 million and $1.6 million, respectively. The effective portion of changes in the fair value of the derivatives that are designated as cash flow hedges are being recorded in accumulated other comprehensive loss and will be subsequently reclassified into earnings during the period in which the hedged forecasted transaction affects earnings.
The Company incorporates credit valuation adjustments to appropriately reflect both its own non-performance risk and the respective counterparty’s non-performance risk in the fair value measurements. In adjusting the fair value of its derivative contract for the effect of non-performance risk, the Company has considered the impact of netting and any applicable credit enhancements, such as collateral postings, thresholds, mutual puts, and guarantees.
American Assets Trust, Inc.
Notes to Consolidated Financial Statements—(Continued)
June 30, 2014
(Unaudited)
Although the Company has determined that the majority of the inputs used to value its derivatives fall within Level 2 of the fair value hierarchy, the credit valuation adjustments associated with its derivatives utilize Level 3 inputs, such as estimates of current credit spreads to evaluate the likelihood of default by itself and its counterparties. However, as of June 30, 2014 the Company has assessed the significance of the impact of the credit valuation adjustments on the overall valuation of its derivative position and has determined that the credit valuation adjustments are not significant to the overall valuation of its derivatives. As a result, the Company has determined that its derivative valuation in its entirety is classified in Level 2 of the fair value hierarchy.
A summary of our financial liabilities that are measured at fair value on a recurring basis, by level within the fair value hierarchy is as follows (in thousands):
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| | | | | | | | | | | | | | | | | | | | | | | | | |
| June 30, 2014 | | December 31, 2013 |
| Level 1 | Level 2 | Level 3 | Total | | Level 1 | Level 2 | Level 3 | Total |
Deferred compensation liability | $ | — |
| $ | 865 |
| $ | — |
| $ | 865 |
| | $ | — |
| $ | 769 |
| $ | — |
| $ | 769 |
|
Interest rate swap | $ | — |
| 1,557 |
| $ | — |
| $ | 1,557 |
| | $ | — |
| $ | — |
| $ | — |
| $ | — |
|
The fair value of our secured notes payable is sensitive to fluctuations in interest rates. Discounted cash flow analysis using observable market interest rates (Level 2) is generally used to estimate the fair value of our secured notes payable, using rates ranging from 3.3% to 4.9%.
Considerable judgment is necessary to estimate the fair value of financial instruments. The estimates of fair value presented herein are not necessarily indicative of the amounts that could be realized upon disposition of the financial instruments. A summary of the carrying amount and fair value of our secured financial instruments, all of which are based on Level 2 inputs, is as follows (in thousands):
|
| | | | | | | | | | | | | | | |
| June 30, 2014 | | December 31, 2013 |
| Carrying Value | | Fair Value | | Carrying Value | | Fair Value |
Secured notes payable | $ | 952,847 |
| | $ | 997,201 |
| | $ | 952,174 |
| | $ | 990,296 |
|
Term loan | $ | 100,000 |
| | $ | 100,000 |
| | $ | — |
| | $ | — |
|
Line of credit | $ | — |
| | $ | — |
| | $ | 93,000 |
| | $ | 93,000 |
|
NOTE 4. OTHER ASSETS
Other assets consist of the following (in thousands):
|
| | | | | | | |
| June 30, 2014 | | December 31, 2013 |
Leasing commissions, net of accumulated amortization of $21,427 and $19,606 respectively | $ | 17,443 |
| | $ | 18,071 |
|
Acquired above market leases, net | 6,075 |
| | 7,399 |
|
Acquired in-place leases, net | 21,230 |
| | 24,534 |
|
Lease incentives, net of accumulated amortization of $2,775 and $2,590, respectively | 925 |
| | 1,110 |
|
Other intangible assets, net of accumulated amortization of $1,637 and $1,554, respectively | 543 |
| | 655 |
|
Debt issuance costs, net of accumulated amortization of $3,559 and $2,985, respectively | 4,015 |
| | 2,632 |
|
Prepaid expenses and other | 3,645 |
| | 3,269 |
|
Total other assets | $ | 53,876 |
| | $ | 57,670 |
|
American Assets Trust, Inc.
Notes to Consolidated Financial Statements—(Continued)
June 30, 2014
(Unaudited)
NOTE 5. OTHER LIABILITIES AND DEFERRED CREDITS
Other liabilities and deferred credits consist of the following (in thousands):
|
| | | | | | | |
| June 30, 2014 | | December 31, 2013 |
Acquired below market leases, net | $ | 45,341 |
| | $ | 47,910 |
|
Prepaid rent and deferred revenue | 7,915 |
| | 7,506 |
|
Interest rate swap liability | 1,557 |
| | — |
|
Deferred rent expense and lease intangible | 718 |
| | 829 |
|
Deferred compensation | 865 |
| | 769 |
|
Deferred tax liability | 233 |
| | 233 |
|
Straight-line rent liability | 931 |
| | 1,145 |
|
Other liabilities | 115 |
| | 73 |
|
Total other liabilities and deferred credits | $ | 57,675 |
| | $ | 58,465 |
|
Straight-line rent liability relates to leases which have rental payments that decrease over time or one-time upfront payments for which the rental revenue is deferred and recognized on a straight-line basis.
NOTE 6. DEBT
The following is a summary of our total secured notes payable outstanding as of June 30, 2014 and December 31, 2013 (in thousands):
|
| | | | | | | | | | | | |
| Principal Balance as of | | Stated Interest Rate as of June 30, 2014 | | Stated Maturity Date |
Description of Debt | June 30, 2014 | | December 31, 2013 | |
Waikele Center (1) | 140,700 |
| | 140,700 |
| | 5.15 | % | | November 1, 2014 |
The Shops at Kalakaua (1) | 19,000 |
| | 19,000 |
| | 5.45 | % | | May 1, 2015 |
The Landmark at One Market (1)(2) | 133,000 |
| | 133,000 |
| | 5.61 | % | | July 5, 2015 |
Del Monte Center (1) | 82,300 |
| | 82,300 |
| | 4.93 | % | | July 8, 2015 |
First & Main (1) | 84,500 |
| | 84,500 |
| | 3.97 | % | | July 1, 2016 |
Imperial Beach Gardens (1) | 20,000 |
| | 20,000 |
| | 6.16 | % | | September 1, 2016 |
Mariner’s Point (1) | 7,700 |
| | 7,700 |
| | 6.09 | % | | September 1, 2016 |
South Bay Marketplace (1) | 23,000 |
| | 23,000 |
| | 5.48 | % | | February 10, 2017 |
Waikiki Beach Walk—Retail (1) | 130,310 |
| | 130,310 |
| | 5.39 | % | | July 1, 2017 |
Solana Beach Corporate Centre III-IV (3) | 36,590 |
| | 36,804 |
| | 6.39 | % | | August 1, 2017 |
Loma Palisades (1) | 73,744 |
| | 73,744 |
| | 6.09 | % | | July 1, 2018 |
One Beach Street (1) | 21,900 |
| | 21,900 |
| | 3.94 | % | | April 1, 2019 |
Torrey Reserve—North Court (3) | 21,228 |
| | 21,377 |
| | 7.22 | % | | June 1, 2019 |
Torrey Reserve—VCI, VCII, VCIII (3) | 7,151 |
| | 7,200 |
| | 6.36 | % | | June 1, 2020 |
Solana Beach Corporate Centre I-II (3) | 11,389 |
| | 11,475 |
| | 5.91 | % | | June 1, 2020 |
Solana Beach Towne Centre (3) | 37,963 |
| | 38,249 |
| | 5.91 | % | | June 1, 2020 |
City Center Bellevue (1) | 111,000 |
| | 111,000 |
| | 3.98 | % | | November 1, 2022 |
| 961,475 |
| | 962,259 |
| | | | |
Unamortized fair value adjustment | (8,628 | ) | | (10,085 | ) | | | | |
Total Secured Notes Payable Outstanding | $ | 952,847 |
| | $ | 952,174 |
| | | | |
| |
(2) | Maturity Date is the earlier of the loan maturity date under the loan agreement, or the “Anticipated Repayment Date” as specifically defined in the loan agreement, which is the date after which substantial economic penalties apply if the loan has not been paid off. |
| |
(3) | Principal payments based on a 30-year amortization schedule. |
Certain loans require us to comply with various financial covenants. As of June 30, 2014, we were in compliance with these financial covenants.
American Assets Trust, Inc.
Notes to Consolidated Financial Statements—(Continued)
June 30, 2014
(Unaudited)
Credit Facility
On January 9, 2014, we entered into an amended and restated credit agreement (the "Amended and Restated Credit Facility") which amended and restated the then in-place credit facility. The Amended and Restated Credit Facility provides for aggregate, unsecured borrowing of $350 million, consisting of a revolving line of credit of $250 million (the "Revolver Loan") and a term loan of $100 million (the "Term Loan"). The Amended and Restated Credit Facility has an accordion feature that may allow us to increase the availability thereunder up to an additional $250 million, subject to meeting specified requirements and obtaining additional commitments from lenders.
Borrowings under the Amended and Restated Credit Facility initially bear interest at floating rates equal to, at our option, either (1) LIBOR, plus a spread which ranges from (a) 1.35%-1.95% (with respect to the Revolver Loan) and (b) 1.30% to 1.90% (with respect to the Term Loan), in each case based on our consolidated leverage ratio, or (2) a base rate equal to the highest of (a) the prime rate, (b) the federal funds rate plus 50 bps or (c) the Eurodollar rate plus 100 bps, plus a spread which ranges from (i) 0.35%-0.95% (with respect to the Revolver Loan) and (ii) 0.30% to 0.90% (with respect to the Term Loan), in each case based on our consolidated leverage ratio. If we obtain an investment-grade debt rating, under the terms set forth in the Amended and Restated Credit Facility, the spreads will further improve.
The Revolver Loan initially matures on January 9, 2018, subject to our option to extend the Revolver Loan up to two times, with each such extension for a six-month period. The Term Loan initially matures on January 9, 2016, subject to our option to extend the Term Loan up to three times, with each such extension for a 12-month period. The foregoing extension options are exercisable by us subject to the satisfaction of certain conditions.
Concurrent with the closing of the Amended and Restated Credit Facility, we drew down on the entirety of the $100 million Term Loan and entered into an interest rate swap agreement that is intended to fix the interest rate associated with the Term Loan at approximately 3.08% through its maturity date and extension options, subject to adjustments based on our consolidated leverage ratio.
Additionally, the Amended and Restated Credit Facility includes a number of customary financial covenants, including:
| |
• | A maximum leverage ratio (defined as total indebtedness net of certain cash and cash equivalents to total asset value) of 60%, and during any material acquisition period the maximum leverage ratio allowable is 65%, |
| |
• | A maximum secured leverage ratio (defined as total secured debt to secured total asset value) of 45% at any time prior to December 31, 2015, and 40% thereafter, during a material acquisition period the maximum secured leverage ratio is increased to 50% at any time prior to December 31, 2015 and 45% thereafter, |
| |
• | A minimum fixed charge coverage ratio (defined as consolidated earnings before interest, taxes, depreciation and amortization to consolidated fixed charges) of 1.50x, |
| |
• | A minimum unsecured interest coverage ratio of 1.75x, |
| |
• | A maximum unsecured leverage ratio of 60%, and during any material acquisition period the maximum unsecured leverage ratio allowable is 65%, |
| |
• | A minimum tangible net worth of $721.16 million, and 75% of the net proceeds of any additional equity issuances (other than additional equity issuances in connection with any dividend reinvestment program), and |
| |
• | Recourse indebtedness at any time cannot exceed 15% of total asset value. |
The Amended and Restated Credit Facility provides that our annual distributions may not exceed the greater of (1) 95% of our funds from operations or (2) the amount required for us to (a) qualify and maintain our real estate investment trust ("REIT") status and (b) avoid the payment of federal or state income or excise tax. If certain events of default exist or would result from a distribution, we may be precluded from making distributions other than those necessary to qualify and maintain our status as a REIT.
As of June 30, 2014, we were in compliance with the Amended and Restated Credit Facility financial covenants.
American Assets Trust, Inc.
Notes to Consolidated Financial Statements—(Continued)
June 30, 2014
(Unaudited)
NOTE 7. EQUITY
Stockholders' Equity
On May 6, 2013, we entered into an at-the-market (“ATM”) equity program with four sales agents in which we may, from time to time, offer and sell shares of our common stock having an aggregate offering price of up to $150.0 million. The sales of shares of our common stock made through the ATM equity program are made in "at-the-market" offerings as defined in Rule 415 of the Securities Act of 1933, as amended. During the three and six months ended June 30, 2014, the following shares of common stock and related proceeds were sold through the ATM equity program (in thousands, except per share data):
|
| | | | | | | |
| Three Months Ended June 30, 2014 | | Six Months Ended June 30, 2014 |
Number of shares of common stock issued through ATM program | 675,270 |
| | 2,110,485 |
|
Weighted average price per share | $34.46 | | $33.51 |
| | | |
Proceeds, gross | $ | 23,266 |
| | $ | 70,713 |
|
Sales agent compensation | (233 | ) | | (708 | ) |
Offering costs | (51 | ) | | (96 | ) |
Proceeds, net | $ | 22,982 |
| | $ | 69,909 |
|
We intend to use the net proceeds from the ATM equity program to fund our development or redevelopment activities, repay amounts outstanding from time to time under our revolving credit facility or other debt financing obligations, fund potential acquisition opportunities and/or for general corporate purposes. As of June 30, 2014, we had the capacity to issue up to an additional $53.3 million in shares of our common stock under our ATM equity program. Actual future sales will depend on a variety of factors including, but not limited to, market conditions, the trading price of our common stock and our capital needs. We have no obligation to sell the remaining shares available for sale under the ATM equity program.
Noncontrolling Interests
Noncontrolling interests in our Operating Partnership are interests in the Operating Partnership that are not owned by us. Noncontrolling interests consisted of 17,905,257 common units (the “noncontrolling common units”), and represented approximately 29.8% of the ownership interests in our Operating Partnership at June 30, 2014. Common units and shares of our common stock have essentially the same economic characteristics in that common units and shares of our common stock share equally in the total net income or loss distributions of our Operating Partnership. Investors who own common units have the right to cause our Operating Partnership to redeem any or all of their common units for cash equal to the then-current market value of one share of our common stock, or, at our election, shares of our common stock on a one-for-one basis.
During the six months ended June 30, 2014, approximately 11,852 common units were converted into shares of our common stock.
Dividends
The following table lists the dividends declared and paid on our shares of common stock and noncontrolling common units during the six months ended June 30, 2014:
|
| | | | | | | | |
Period | | Amount per Share/Unit | | Period Covered | | Dividend Paid Date |
First Quarter 2014 | | $ | 0.22 |
| | January 1, 2014 to March 31, 2014 | | March 28, 2014 |
Second Quarter 2014 | | $ | 0.22 |
| | April 1, 2014 to June 30, 2014 | | June 27, 2014 |
Taxability of Dividends
Earnings and profits, which determine the taxability of distributions to stockholders and holders of common units, may differ from income reported for financial reporting purposes due to the differences for federal income tax purposes in the treatment of revenue recognition and compensation expense and in the basis of depreciable assets and estimated useful lives used to compute depreciation.
American Assets Trust, Inc.
Notes to Consolidated Financial Statements—(Continued)
June 30, 2014
(Unaudited)
Stock-Based Compensation
We follow the FASB guidance related to stock compensation which establishes financial accounting and reporting standards for stock-based employee compensation plans, including all arrangements by which employees receive shares of stock or other equity instruments of the employer, or the employer incurs liabilities to employees in amounts based on the price of the employer's stock. The guidance also defines a fair value-based method of accounting for an employee stock option or similar equity instrument.
On March 25, 2014, we awarded 112,119 shares of restricted common stock pursuant to our 2011 Equity Incentive Award Plan (the “2011 Plan”), which are subject to performance-based vesting. Up to one-third of the shares of restricted stock may vest on November 30, 2014, 2015 and 2016 based upon pre-defined market specific performance criteria.
In addition, on the date of each annual meeting of our stockholders, each non-employee director who continues to serve on our board of directors (the "Board") following such annual meeting will be granted restricted shares of our common stock pursuant to the 2011 Plan. On June 17, 2014, we awarded a total of 5,864 shares of restricted common stock pursuant to our 2011 Plan to our non-employee directors. These awards of restricted stock will vest subject to the director's continued service on the Board on the earlier of (i) the one year anniversary of the date of grant or (ii) the date of the next annual meeting of our stockholders, if such non-employee director continues his or her service on the Board until the next annual meeting of stockholders, but not thereafter, pursuant to our independent director compensation policy.
For the performance-based stock awards, the fair value of the awards were estimated using a Monte Carlo Simulation model. Our stock price, along with the stock prices of a group of peer REITs, is assumed to follow the Multivariate Geometric Brownian Motion Process. Multivariate Geometric Brownian Motion is a common assumption when modeling in financial markets, as it allows the modeled quantity (in this case, the stock price) to vary randomly from its current value and take any value greater than zero. The volatilities of the returns on the stock price of the Company and the group of REITs were estimated based on a three year look-back period. The expected growth rate of the stock prices over the “derived service period” of the employee is determined with consideration of the risk free rate as of the grant date.
The following table summarizes the activity of restricted stock awards during the six months ended June 30, 2014:
|
| | | | | | |
| Units | | Weighted Average Grant Date Fair Value |
Nonvested at January 1, 2014 | 629,058 |
| | $ | 15.58 |
|
Granted | 117,983 |
| | 30.17 |
|
Vested | (311,862 | ) | | 15.50 |
|
Forfeited | (941 | ) | | 29.96 |
|
Nonvested at June 30, 2014 | 434,238 |
| | $ | 19.57 |
|
We recognize noncash compensation expense ratably over the vesting period, and accordingly, we recognized $1.5 million and $1.4 million, respectively, in noncash compensation expense for the six months ended June 30, 2014 and 2013, which is included in general and administrative expense on the consolidated statements of comprehensive income. Unrecognized compensation expense was $3.7 million at June 30, 2014.
Earnings Per Share
We have calculated earnings per share (“EPS”) under the two-class method. The two-class method is an earnings allocation methodology whereby EPS for each class of common stock and participating security is calculated according to dividends declared and participation rights in undistributed earnings. The weighted average unvested shares outstanding, which are considered participating securities, were 431,059 and 630,374 for the three months ended June 30, 2014 and 2013, respectively, and 419,024 and 630,784 for the six months ended June 30, 2014 and 2013, respectively. Therefore, we have allocated our earnings for basic and diluted EPS between common shares and unvested shares as these unvested shares have nonforfeitable dividend equivalent rights.
American Assets Trust, Inc.
Notes to Consolidated Financial Statements—(Continued)
June 30, 2014
(Unaudited)
Diluted EPS is calculated by dividing the net income applicable to common stockholders for the period by the weighted average number of common and dilutive instruments outstanding during the period using the treasury stock method. For the three and six months ended June 30, 2014 and 2013, diluted shares exclude incentive restricted stock as these awards are considered contingently issuable. Additionally, the unvested restricted stock awards subject to time vesting are anti-dilutive for all periods presented, and accordingly, have been excluded from the weighted average common shares used to compute diluted EPS.
The computation of basic and diluted EPS is presented below (dollars in thousands, except share and per share amounts):
|
| | | | | | | | | | | | | | | |
| Three Months Ended June 30, | | Six Months Ended June 30, |
| 2014 | | 2013 | | 2014 | | 2013 |
NUMERATOR | | | | | | | |
Income from operations | $ | 5,351 |
| | $ | 4,564 |
| | $ | 12,009 |
| | $ | 9,429 |
|
Less: Net income attributable to restricted shares | (94 | ) | | (133 | ) | | (164 | ) | | (265 | ) |
Less: Income from operations attributable to unitholders in the Operating Partnership | (1,544 | ) | | (1,354 | ) | | (3,530 | ) | | (2,849 | ) |
Net income attributable to common stockholders—basic | $ | 3,713 |
| | $ | 3,077 |
| | $ | 8,315 |
| | $ | 6,315 |
|
Income from operations attributable to American Assets Trust, Inc. common stockholders—basic | $ | 3,713 |
| | $ | 3,077 |
| | $ | 8,315 |
| | $ | 6,315 |
|
Plus: Income from operations attributable to unitholders in the Operating Partnership | 1,544 |
| | 1,354 |
| | 3,530 |
| | 2,849 |
|
Net income attributable to common stockholders—diluted | $ | 5,257 |
| | $ | 4,431 |
| | $ | 11,845 |
| | $ | 9,164 |
|
DENOMINATOR | | | | | | | |
Weighted average common shares outstanding—basic | 41,816,379 |
| | 39,460,086 |
| | 41,202,993 |
| | 39,247,729 |
|
Effect of dilutive securities—conversion of Operating Partnership units | 17,905,257 |
| | 17,969,751 |
| | 17,907,457 |
| | 17,996,445 |
|
Weighted average common shares outstanding—diluted | 59,721,636 |
| | 57,429,837 |
| | 59,110,450 |
| | 57,244,174 |
|
| | | | | | | |
Earnings per common share, basic | $ | 0.09 |
| | $ | 0.08 |
| | $ | 0.20 |
| | $ | 0.16 |
|
Earnings per common share, diluted | $ | 0.09 |
| | $ | 0.08 |
| | $ | 0.20 |
| | $ | 0.16 |
|
NOTE 8. INCOME TAXES
We elected to be taxed as a REIT and operate in a manner that allows us to qualify as a REIT for federal income tax purposes commencing with our initial taxable year. As a REIT, we are generally not subject to corporate level income tax on the earnings distributed currently to our stockholders that we derive from our REIT qualifying activities. Taxable income from non-REIT activities managed through our TRS is subject to federal and state income taxes.
We lease our hotel property to a wholly owned TRS that is subject to federal and state income taxes. We account for income taxes using the asset and liability method, under which deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between GAAP carrying amounts and their respective tax bases. Additionally, we classify certain state taxes as income taxes for financial reporting purposes in accordance with ASC Topic 740, Income Taxes.
A deferred tax liability of $0.2 million as of June 30, 2014 and December 31, 2013 is included in our consolidated balance sheets in relation to real estate asset basis differences of property subject to the Texas margin tax and certain prepaid expenses of our TRS.
Income tax benefit (expense) is recorded in other income (expense), net in our consolidated statements of comprehensive income. For the three and six months ended June 30, 2014 we recorded an income tax benefit of $0.3 million and $0.2 million, respectively. For the three and six months ended June 30, 2013 we recorded an income tax expense of $0.1 million and $0.4 million, respectively.
American Assets Trust, Inc.
Notes to Consolidated Financial Statements—(Continued)
June 30, 2014
(Unaudited)
NOTE 9. COMMITMENTS AND CONTINGENCIES
Legal
We are sometimes involved in various disputes, lawsuits, warranty claims, environmental and other matters arising in the ordinary course of business. Management makes assumptions and estimates concerning the likelihood and amount of any potential loss relating to these matters.
We are currently a party to various legal proceedings. We accrue a liability for litigation if an unfavorable outcome is probable and the amount of loss can be reasonably estimated. If an unfavorable outcome is probable and a reasonable estimate of the loss is a range, we accrue the best estimate within the range; however, if no amount within the range is a better estimate than any other amount, the minimum within the range is accrued. Legal fees related to litigation are expensed as incurred. We do not believe that the ultimate outcome of these matters, either individually or in the aggregate, could have a material adverse effect on our financial position or overall trends in results of operations; however, litigation is subject to inherent uncertainties. Also, under our leases, tenants are typically obligated to indemnify us from and against all liabilities, costs and expenses imposed upon or asserted against us as owner of the properties due to certain matters relating to the operation of the properties by the tenant.
Commitments
At The Landmark at One Market, we lease, as lessee, a building adjacent to The Landmark under an operating lease effective through June 30, 2016, which we have the option to extend until 2026 by way of two five-year extension options.
At Waikiki Beach Walk, we sublease a portion of the building of which Quiksilver is currently in possession, under an operating lease effective through December 31, 2021, which we have the option to extend at fair rental value in the event the sublessor extends its lease for the space with the master landlord. The lease payments under the lease will increase by approximately 3.4% annually through 2017 and, thereafter, will be equal to fair rental value, as defined in the lease, through lease expiration.
Current minimum annual payments under the leases are as follows, as of June 30, 2014 (in thousands):
|
| | | | |
Year Ending December 31, | | |
2014 (six months ending December 31, 2014) | $ | 1,297 |
| |
2015 | 2,636 |
| |
2016 | 1,709 |
| |
2017 | 736 |
| (1) |
2018 | 740 |
|
|
Thereafter | 2,221 |
| |
Total | $ | 9,339 |
| |
| |
(1) | Lease payments on the Waikiki Beach Walk lease will be equal to fair rental value from March 2017 through the end of the lease term. In the table, we have shown the lease payments for this period based on the stated rate for the month of February 2017 of $61,690. |
We have management agreements with Outrigger Hotels & Resorts or an affiliate thereof (“Outrigger”) pursuant to which Outrigger manages each of the retail and hotel portions of the Waikiki Beach Walk property. Under the management agreement with Outrigger relating to the retail portion of Waikiki Beach Walk (the “retail management agreement”), we pay Outrigger a monthly management fee of 3.0% of net revenues from the retail portion of Waikiki Beach Walk. Pursuant to the terms of the retail management agreement, if the agreement is terminated in certain instances, including our election not to repair damage or destruction at the property, a condemnation or our failure to make required working capital infusions, we would be obligated to pay Outrigger a termination fee equal to the sum of the management fees paid for the two calendar months immediately preceding the termination date. The retail management agreement may not be terminated by us or by Outrigger without cause. Under our management agreement with Outrigger relating to the hotel portion of Waikiki Beach Walk (the “hotel management agreement”), we pay Outrigger a monthly management fee of 6.0% of the hotel's gross operating profit, as well as 3.0% of the hotel's gross revenues; provided that the aggregate management fee payable to Outrigger for any year shall not exceed 3.5% of the hotel's gross revenues for such fiscal year. Pursuant to the terms of the hotel management agreement, if the agreement is terminated in certain instances, including upon a transfer by us of the hotel or upon a default by us under the hotel management
American Assets Trust, Inc.
Notes to Consolidated Financial Statements—(Continued)
June 30, 2014
(Unaudited)
agreement, we would be required to pay a cancellation fee calculated by multiplying (1) the management fees for the previous 12 months by (2) (a) eight, if the agreement is terminated in the first 11 years of its term, or (b) four, three, two or one, if the agreement is terminated in the twelfth, thirteenth, fourteenth or fifteenth year, respectively, of its term. The hotel management agreement may not be terminated by us or by Outrigger without cause.
A wholly owned subsidiary of our Operating Partnership, WBW Hotel Lessee LLC, entered into a franchise license agreement with Embassy Suites Franchise LLC, the franchisor of the brand “Embassy Suites™,” to obtain the non-exclusive right to operate the hotel under the Embassy SuitesTM brand for 20 years. The franchise license agreement provides that WBW Hotel Lessee LLC must comply with certain management, operational, record keeping, accounting, reporting and marketing standards and procedures. In connection with this agreement, we are also subject to the terms of a product improvement plan pursuant to which we expect to undertake certain actions to ensure that our hotel's infrastructure is maintained in compliance with the franchisor's brand standards. In addition, we must pay to Embassy Suites Franchise LLC a monthly franchise royalty fee equal to 4.0% of the hotel's gross room revenue through December 2021 and 5.0% of the hotel's gross room revenue thereafter, as well as a monthly program fee equal to 4.0% of the hotel's gross room revenue. If the franchise license is terminated due to our failure to make required improvements or to otherwise comply with its terms, we may be liable to the franchisor for a termination payment, which could be as high as $6.4 million based on operating performance through June 30, 2014.
We had a property management agreement with Langley Investment Properties, Inc. (“Langley”) pursuant to which Langley managed and operated Lloyd District Portfolio, and we paid Langley a monthly management fee of 3.5% of “gross receipts,” as defined in the property management agreement, as well as leasing commissions and construction oversight fees in certain situations. The property management agreement was terminated on February 1, 2013 by mutual consent of both parties. Langley continued to provide development consulting services to us until June 30, 2013 and leasing services to us until December 31, 2013 pursuant to a development, consulting, leasing and transition services and management termination agreement.
Our Del Monte Center property has ongoing environmental remediation related to ground water contamination. The environmental issue existed at purchase and remains in remediation. The final stages of the remediation will include routine, long term ground monitoring by the appropriate regulatory agency over the next two to ten years. The work performed is financed through an escrow account funded by the seller upon purchase of the Del Monte Center. We believe the funds in the escrow account are sufficient for the remaining work to be performed. However, if further work is required costing more than the remaining escrow funds, we could be required to pay such overage, although we may have a contractual claim for such costs against the prior owner or our environmental remediation consultant.
In connection with our initial public offering, we entered into tax protection agreements with certain limited partners of our Operating Partnership. These agreements provide that if we dispose of any interest with respect to Carmel Country Plaza, Carmel Mountain Plaza, Del Monte Center, Loma Palisades, Lomas Santa Fe Plaza, Waikele Center or the ICW Plaza portion of Torrey Reserve Campus, in a taxable transaction during the period from the closing of our initial public offering through January 19, 2018, we will indemnify such limited partners for their tax liabilities attributable to their share of the built-in gain that existed with respect to such property interest as of the time of our initial public offering and tax liabilities incurred as a result of the reimbursement payment. Subject to certain exceptions and limitations, the indemnification rights will terminate for any such protected partner that sells, exchanges or otherwise disposes of more than 50% of his or her common units. We have no present intention to sell or otherwise dispose of the properties or interest therein in taxable transactions during the restriction period. If we were to trigger the tax protection provisions under these agreements, we would be required to pay damages in the amount of the taxes owed by these limited partners (plus additional damages in the amount of the taxes incurred as a result of such payment).
As of June 30, 2014, the Company has accrued approximately $6.6 million for transfer taxes that the Company expected to incur on its California properties in connection with its initial public offering. The Company believes that it has filed all necessary forms with the requisite taxing authorities, but can offer no assurances that the taxing authorities will agree with the Company's estimate above.
American Assets Trust, Inc.
Notes to Consolidated Financial Statements—(Continued)
June 30, 2014
(Unaudited)
Concentrations of Credit Risk
Our properties are located in Southern California, Northern California, Hawaii, Oregon, Texas, and Washington. The ability of the tenants to honor the terms of their respective leases is dependent upon the economic, regulatory and social factors affecting the markets in which the tenants operate. Twelve of our consolidated properties are located in Southern California, which exposes us to greater economic risks than if we owned a more geographically diverse portfolio. Tenants in the retail industry accounted for 36.9% of total revenues for the six months ended June 30, 2014. This makes us susceptible to demand for retail rental space and subject to the risks associated with an investment in real estate with a concentration of tenants in the retail industry. Furthermore, tenants in the office industry accounted for 35.9% of total revenues for the six months ended June 30, 2014. This makes us susceptible to demand for office rental space and subject to the risks associated with an investment in real estate with a concentration of tenants in the office industry. For the six months ended June 30, 2014 and 2013, no tenant accounted for more than 10% of our total rental revenue.
NOTE 10. OPERATING LEASES
Our leases with office, retail, mixed-use and residential tenants are classified as operating leases. Leases at our office and retail properties and the retail portion of our mixed-use property generally range from three to ten years (certain leases with anchor tenants may be longer), and in addition to minimum rents, usually provide for cost recoveries for the tenant’s share of certain operating costs and also may include percentage rents based on the tenant’s level of sales achieved. Leases on apartments generally range from 7 to 15 months, with a majority having 12-month lease terms. Rooms at the hotel portion of our mixed-use property are rented on a nightly basis.
As of June 30, 2014, minimum future rentals from noncancelable operating leases, before any reserve for uncollectible amounts and assuming no early lease terminations, at our office and retail properties and the retail portion of our mixed-use property are as follows (in thousands):
|
| | | |
Year Ending December 31, | |
2014 (six months ending December 31, 2014) | $ | 77,933 |
|
2015 | 153,467 |
|
2016 | 134,562 |
|
2017 | 117,141 |
|
2018 | 85,310 |
|
Thereafter | 178,610 |
|
Total | $ | 747,023 |
|
The above future minimum rentals exclude residential leases, which typically have a term of 12 months or less, and exclude the hotel, as rooms are rented on a nightly basis.
NOTE 11. COMPONENTS OF RENTAL INCOME AND EXPENSE
The principal components of rental income are as follows (in thousands):
|
| | | | | | | | | | | | | | | |
| Three Months Ended June 30, | | Six Months Ended June 30, |
| 2014 | | 2013 | | 2014 | | 2013 |
Minimum rents | | | | | | | |
Retail | $ | 17,448 |
| | $ | 17,236 |
| | $ | 34,740 |
| | $ | 34,587 |
|
Office | 20,200 |
| | 20,298 |
| | 40,436 |
| | 40,798 |
|
Multifamily | 3,897 |
| | 3,687 |
| | 7,731 |
| | 7,270 |
|
Mixed-use | 2,496 |
| | 2,257 |
| | 4,966 |
| | 4,677 |
|
Cost reimbursement | 6,906 |
| | 7,242 |
| | 13,710 |
| | 12,913 |
|
Percentage rent | 391 |
| | 402 |
| | 816 |
| | 820 |
|
Hotel revenue | 7,043 |
| | 8,178 |
| | 16,045 |
| | 17,026 |
|
Other | 412 |
| | 405 |
| | 831 |
| | 836 |
|
Total rental income | $ | 58,793 |
| | $ | 59,705 |
| | $ | 119,275 |
| | $ | 118,927 |
|
Minimum rents include $0.6 million and $0.5 million for the three months ended June 30, 2014 and 2013, respectively, and $1.6 million and $1.2 million for the six months ended June 30, 2014 and 2013, respectively, to recognize minimum rents on a straight-line basis. In addition, net amortization of above and below market leases included in minimum rents were $0.7 million and $0.2 million for the three months ended June 30, 2014 and 2013, respectively, and $1.2 million and $0.7 million for the six months ended June 30, 2014 and 2013, respectively.
The principal components of rental expenses are as follows (in thousands):
|
| | | | | | | | | | | | | | | |
| Three Months Ended June 30, | | Six Months Ended June 30, |
| 2014 | | 2013 | | 2014 | | 2013 |
Rental operating | $ | 6,432 |
| | $ | 6,430 |
| | $ | 12,958 |
| | $ | 12,744 |
|
Hotel operating | 4,973 |
| | 5,438 |
| | 10,526 |
| | 10,920 |
|
Repairs and maintenance | 2,872 |
| | 2,489 |
| | 4,994 |
| | 4,603 |
|
Marketing | 392 |
| | 344 |
| | 782 |
| | 696 |
|
Rent | 614 |
| | 611 |
| | 1,225 |
| | 1,224 |
|
Hawaii excise tax | 835 |
| | 952 |
| | 1,800 |
| | 1,891 |
|
Management fees | 382 |
| | 422 |
| | 835 |
| | 894 |
|
Total rental expenses | $ | 16,500 |
| | $ | 16,686 |
| | $ | 33,120 |
| | $ | 32,972 |
|
NOTE 12. OTHER INCOME (EXPENSE), NET
The principal components of other income (expense), net, are as follows (in thousands):
|
| | | | | | | | | | | | | | | |
| Three Months Ended June 30, | | Six Months Ended June 30, |
| 2014 | | 2013 | | 2014 | | 2013 |
Interest and investment income | $ | 50 |
| | $ | 26 |
| | $ | 98 |
| | $ | 34 |
|
Income tax benefit (expense) | 283 |
| | (91 | ) | | 171 |
| | (388 | ) |
Termination fee income, net | 745 |
| | — |
| | 745 |
| | 10 |
|
Total other income (expense), net | $ | 1,078 |
| | $ | (65 | ) | | $ | 1,014 |
| | $ | (344 | ) |
American Assets Trust, Inc.
Notes to Consolidated Financial Statements—(Continued)
June 30, 2014
(Unaudited)
NOTE 13. RELATED PARTY TRANSACTIONS
At ICW Plaza, we lease space to Insurance Company of the West, which is under the direct control of Ernest Rady, our Executive Chairman of the Board. Rental revenue recognized on the leases of $1.1 million for each of the six months ended June 30, 2014 and 2013, respectively, is included in rental income.
The Waikiki Beach Walk entities have a 47.7% investment in WBW CHP LLC, an entity that was formed to, among other things, construct a chilled water plant to provide air conditioning to the property and other adjacent facilities. The operating expenses of WBW CHP LLC are recovered through reimbursements from its members, and reimbursements to WBW CHP LLC of $0.5 million were made for each of the six months ended June 30, 2014 and 2013 and are included in rental expenses on the statements of comprehensive income.
NOTE 14. SEGMENT REPORTING
Segment information is prepared on the same basis that our management reviews information for operational decision-making purposes. We operate in four business segments: the acquisition, redevelopment, ownership and management of retail real estate, office real estate, multifamily real estate and mixed-use real estate. The products for our retail segment primarily include rental of retail space and other tenant services, including tenant reimbursements, parking and storage space rental. The products for our office segment primarily include rental of office space and other tenant services, including tenant reimbursements, parking and storage space rental. The products for our multifamily segment include rental of apartments and other tenant services. The products of our mixed-use segment include rental of retail space and other tenant services, including tenant reimbursements, parking and storage space rental and operation of a 369-room all-suite hotel.
We evaluate the performance of our segments based on segment profit, which is defined as property revenue less property expenses. We do not use asset information as a measure to assess performance and make decisions to allocate resources. Therefore, depreciation and amortization expense is not allocated among segments. General and administrative expenses, interest expense, depreciation and amortization expense and other income and expense are not included in segment profit as our internal reporting addresses these items on a corporate level.
Segment profit is not a measure of operating income or cash flows from operating activities as measured by GAAP, and it is not indicative of cash available to fund cash needs and should not be considered an alternative to cash flows as a measure of liquidity. Not all companies calculate segment profit in the same manner. We consider segment profit to be an appropriate supplemental measure to net income because it assists both investors and management in understanding the core operations of our properties.
American Assets Trust, Inc.
Notes to Consolidated Financial Statements—(Continued)
June 30, 2014
(Unaudited)
The following table represents operating activity within our reportable segments (in thousands):
|
| | | | | | | | | | | | | | | |
| Three Months Ended June 30, | | Six Months Ended June 30, |
| 2014 | | 2013 | | 2014 | | 2013 |
Total Retail | | | | | | | |
Property revenue | $ | 23,570 |
| | $ | 23,497 |
| | $ | 46,569 |
| | $ | 45,651 |
|
Property expense | (6,448 | ) | | (6,060 | ) | | (12,506 | ) | | (11,031 | ) |
Segment profit | 17,122 |
| | 17,437 |
| | 34,063 |
| | 34,620 |
|
Total Office | | | | | | | |
Property revenue | 22,433 |
| | 22,512 |
| | 45,264 |
| | 44,934 |
|
Property expense | (6,085 | ) | | (6,584 | ) | | (12,978 | ) | | (13,020 | ) |
Segment profit | 16,348 |
| | 15,928 |
| | 32,286 |
| | 31,914 |
|
Total Multifamily | | | | | | | |
Property revenue | 4,210 |
| | 3,974 |
| | 8,340 |
| | 7,849 |
|
Property expense | (1,554 | ) | | (1,416 | ) | | (2,981 | ) | | (2,858 | ) |
Segment profit | 2,656 |
| | 2,558 |
| | 5,359 |
| | 4,991 |
|
Total Mixed-Use | | | | | | | |
Property revenue | 11,972 |
| | 12,931 |
| | 25,965 |
| | 26,660 |
|
Property expense | (7,542 | ) | | (8,102 | ) | | (15,810 | ) | | (16,339 | ) |
Segment profit | 4,430 |
| | 4,829 |
| | 10,155 |
| | 10,321 |
|
Total segments’ profit | $ | 40,556 |
| | $ | 40,752 |
| | $ | 81,863 |
| | $ | 81,846 |
|
The following table is a reconciliation of segment profit to net income attributable to stockholders (in thousands):
|
| | | | | | | | | | | | | | | |
| Three Months Ended June 30, | | Six Months Ended June 30, |
| 2014 | | 2013 | | 2014 | | 2013 |
Total segments’ profit | $ | 40,556 |
| | $ | 40,752 |
| | $ | 81,863 |
| | $ | 81,846 |
|
General and administrative | (4,635 | ) | | (4,426 | ) | | (9,247 | ) | | (8,627 | ) |
Depreciation and amortization | (18,209 | ) | | (16,953 | ) | | (34,550 | ) | | (33,966 | ) |
Interest expense | (13,439 | ) | | (14,744 | ) | | (27,071 | ) | | (29,480 | ) |
Other income (expense), net | 1,078 |
| | (65 | ) | | 1,014 |
| | (344 | ) |
Net income | 5,351 |
| | 4,564 |
| | 12,009 |
| | 9,429 |
|
Net income attributable to restricted shares | (94 | ) | | (133 | ) | | (164 | ) | | (265 | ) |
Net income attributable to unitholders in the Operating Partnership | (1,544 | ) | | (1,354 | ) | | (3,530 | ) | | (2,849 | ) |
Net income attributable to American Assets Trust, Inc. stockholders | $ | 3,713 |
| | $ | 3,077 |
| | $ | 8,315 |
| | $ | 6,315 |
|
American Assets Trust, Inc.
Notes to Consolidated Financial Statements—(Continued)
June 30, 2014
(Unaudited)
The following table shows net real estate and secured note payable balances for each of the segments (in thousands):
|
| | | | | | | |
| June 30, 2014 | | December 31, 2013 |
Net Real Estate | | | |
Retail | $ | 644,811 |
| | $ | 651,707 |
|
Office | 751,171 |
| | 750,890 |
|
Multifamily | 116,513 |
| | 74,612 |
|
Mixed-Use | 197,531 |
| | 199,627 |
|
| $ | 1,710,026 |
| | $ | 1,676,836 |
|
Secured Notes Payable (1) | | | |
Retail | $ | 302,963 |
| | $ | 303,249 |
|
Office | 426,758 |
| | 427,256 |
|
Multifamily | 101,444 |
| | 101,444 |
|
Mixed-Use | 130,310 |
| | 130,310 |
|
| $ | 961,475 |
| | $ | 962,259 |
|
| |
(1) | Excludes unamortized fair market value adjustments of $8.6 million and $10.1 million as of June 30, 2014 and December 31, 2013, respectively. |
Capital expenditures for each segment for the three and six months ended June 30, 2014 and 2013 were as follows (in thousands):
|
| | | | | | | | | | | | | | | |
| Three Months Ended June 30, | | Six Months Ended June 30, |
| 2014 | | 2013 | | 2014 | | 2013 |
Capital Expenditures (1) | | | | | | | |
Retail | $ | 1,125 |
| | $ | 580 |
| | $ | 2,631 |
| | $ | 2,527 |
|
Office | 8,590 |
| | 11,439 |
| | 15,681 |
| | 19,301 |
|
Multifamily | 19,763 |
| | 206 |
| | 41,640 |
| | 349 |
|
Mixed-Use | 2,115 |
| | 83 |
| | 2,937 |
| | 371 |
|
| $ | 31,593 |
| | $ | 12,308 |
| | $ | 62,889 |
| | $ | 22,548 |
|
| |
(1) | Capital expenditures represent cash paid for capital expenditures during the period and include leasing commissions paid. |
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Forward-Looking Statements
The following discussion should be read in conjunction with the consolidated financial statements and notes thereto appearing elsewhere in this report. We make statements in this report that are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 (set forth in Section 27A of the Securities Act of 1933, as amended, or the Securities Act, and Section 21E of the Securities Exchange Act of 1934, as amended, or the Exchange Act). In particular, statements pertaining to our capital resources, portfolio performance and results of operations contain forward-looking statements. Likewise, all of our statements regarding anticipated growth in our funds from operations and anticipated market conditions, demographics and results of operations are forward-looking statements. You can identify forward-looking statements by the use of forward-looking terminology such as “believes,” “expects,” “may,” “will,” “should,” “seeks,” “approximately,” “intends,” “plans,” “pro forma,” “estimates” or “anticipates” or the negative of these words and phrases or similar words or phrases which are predictions of or indicate future events or trends and which do not relate solely to historical matters. You can also identify forward-looking statements by discussions of strategy, plans or intentions.
Forward-looking statements involve numerous risks and uncertainties and you should not rely on them as predictions of future events. Forward-looking statements depend on assumptions, data or methods which may be incorrect or imprecise and we may not be able to realize them. We do not guarantee that the transactions and events described will happen as described (or that they will happen at all). The following factors, among others, could cause actual results and future events to differ materially from those set forth or contemplated in the forward-looking statements:
| |
• | adverse economic or real estate developments in our markets; |
| |
• | our failure to generate sufficient cash flows to service our outstanding indebtedness; |
| |
• | defaults on, early terminations of or non-renewal of leases by tenants, including significant tenants; |
| |
• | difficulties in identifying properties to acquire and completing acquisitions; |
| |
• | difficulties in completing dispositions; |
| |
• | our failure to successfully operate acquired properties and operations; |
| |
• | our inability to develop or redevelop our properties due to market conditions; |
| |
• | fluctuations in interest rates and increased operating costs; |
| |
• | risks related to joint venture arrangements; |
| |
• | our failure to obtain necessary outside financing; |
| |
• | general economic conditions; |
| |
• | financial market fluctuations; |
| |
• | risks that affect the general retail, office, multifamily and mixed-use environment; |
| |
• | the competitive environment in which we operate; |
| |
• | decreased rental rates or increased vacancy rates; |
| |
• | conflicts of interests with our officers or directors; |
| |
• | lack or insufficient amounts of insurance; |
| |
• | environmental uncertainties and risks related to adverse weather conditions and natural disasters; |
| |
• | other factors affecting the real estate industry generally; |
| |
• | limitations imposed on our business and our ability to satisfy complex rules in order for us to continue to qualify as a real estate investment trust, or REIT, for U.S. federal income tax purposes; and |
| |
• | changes in governmental regulations or interpretations thereof, such as real estate and zoning laws and increases in real property tax rates and taxation of REITs. |
While forward-looking statements reflect our good faith beliefs, they are not guarantees of future performance. We disclaim any obligation to publicly update or revise any forward-looking statement to reflect changes in underlying assumptions or factors, new information, data or methods, future events or other changes. For a further discussion of these and other factors, see the section entitled “Item 1A. Risk Factors” contained herein and in our annual report on Form 10-K for the year ended December 31, 2013.
Overview
References to “we,” “our,” “us” and “our company” refer to American Assets Trust, Inc., a Maryland corporation, together with our consolidated subsidiaries, including American Assets Trust, L.P., a Maryland limited partnership, of which we are the sole general partner and which we refer to in this report as our Operating Partnership.
We are a full service, vertically integrated and self-administered REIT that owns, operates, acquires and develops high quality retail, office, multifamily and mixed-use properties in attractive, high-barrier-to-entry markets in Southern California, Northern California, Oregon, Washington, Texas and Hawaii. As of June 30, 2014, our portfolio was comprised of eleven retail shopping centers; seven office properties; a mixed-use property consisting of a 369-room all-suite hotel and a retail shopping center; and four multifamily properties. Additionally, as of June 30, 2014, we owned land at five of our properties that we classified as held for development and/or construction in progress. Our core markets include San Diego; the San Francisco Bay Area; Portland, Oregon; Bellevue, Washington; and Oahu, Hawaii. We are a Maryland corporation formed on July 16, 2010 to acquire the entities owning various controlling and noncontrolling interests in real estate assets owned and/or managed by Ernest S. Rady or his affiliates, including the Ernest Rady Trust U/D/T March 13, 1983, or the Rady Trust, and did not have any operating activity until the consummation of our initial public offering on January 19, 2011. Our Company, as the sole general partner of our Operating Partnership, has control of our Operating Partnership and owned 70.2% of our Operating Partnership as of June 30, 2014. Accordingly, we consolidate the assets, liabilities and results of operations of our Operating Partnership.
Critical Accounting Policies
We identified certain critical accounting policies that affect certain of our more significant estimates and assumptions used in preparing our consolidated financial statements in our annual report on Form 10-K for the year ended December 31, 2013. We have not made any material changes to these policies during the periods covered by this report.
Concurrent with the closing of the amended and restated credit facility on January 9, 2014 (Note 6), we entered into an interest rate swap agreement with a notional amount of $100.0 million. The interest rate swap is intended to fix the variable portion of our $100.0 million term loan at approximately 3.08% from January 9, 2014 through January 19, 2019. Interest rate swaps designated as cash flow hedges involve the receipt of variable-rate amounts from a counterparty in exchange for our making fixed-rate payments over the life of the agreements, without exchange of the underlying notional amount.
We assess effectiveness of our cash flow hedges both at inception and on an ongoing basis. The effective portion of changes in fair value of the interest rate swaps associated with our cash flow hedges is recorded in accumulated other comprehensive income/loss and is subsequently reclassified into interest expense as interest is incurred on the related variable rate debt. Our cash flow hedges become ineffective if critical terms of the hedging instrument and the debt instrument do not perfectly match, such as notional amounts, settlement dates, reset dates, calculation period and LIBOR rate. In addition, we evaluate the default risk of the counterparty by monitoring the credit-worthiness of the counterparty. When ineffectiveness exists, the ineffective portion of changes in fair value of the interest rate swaps associated with our cash flow hedges is recognized in earnings in the period affected. Hedge ineffectiveness has not impacted earnings as of June 30, 2014, and we do not anticipate it will have a significant effect in the future.
Same-store
We have provided certain information on a total portfolio, same-store and redevelopment same-store basis. Information provided on a same-store basis includes the results of properties that we owned and operated for the entirety of both periods being compared except for properties for which significant redevelopment or expansion occurred during either of the periods being compared, properties under development, properties classified as held for development and properties classified as discontinued operations. Information provided on a redevelopment same-store basis includes the results of properties undergoing significant redevelopment for the entirety or portion of both periods being compared. Same-store and redevelopment same-store is considered by management to be an important measure because it assists in eliminating disparities due to the development, acquisition or disposition of properties during the particular period presented, and thus provides a more consistent performance measure for the comparison of the Company's stabilized and redevelopment properties, as applicable. Additionally, redevelopment same-store is considered by management to be an important measure because it assists in evaluating the timing of the start and stabilization of our redevelopment opportunities and the impact that these redevelopments have in enhancing our operating performance.
While there is judgment surrounding changes in designations, we typically reclassify significant development, redevelopment or expansion properties into same-store properties once they are stabilized. Properties are deemed stabilized typically at the earlier of (i), reaching 90% occupancy or (ii) four quarters following a property's inclusion in operating real estate. We typically remove properties from same-store properties when the development, redevelopment or expansion has or is expected to have a significant impact on the property's annualized base rent, occupancy and operating income within the calendar year. Our evaluation of significant impact related to development, redevelopment or expansion activity is based on quantitative and qualitative measures including, but not limited to the following: the total budgeted cost of planned construction activity compared to the property’s annualized base rent, occupancy and property operating income within the calendar year; percentage of development, redevelopment or expansion square footage to total property square footage; and the ability to maintain historic occupancy and rental rates. In consideration of these measures, we generally remove properties from same-store properties when we see a decline in a property's annualized base rent, occupancy and operating income within the calendar year as a direct result of ongoing redevelopment, development or expansion activity. Acquired properties are classified into same-store properties once we have owned such properties for the entirety of comparable period(s) and the properties are not under significant development or expansion.
In our determination of same-store and redevelopment same-store properties, Lloyd District Portfolio and Torrey Reserve Campus have been identified as same-store redevelopment properties due to the significant construction activity noted above. Office same-store net operating income decreased approximately 0.2% and 2.2%, respectively, for the three and six months ended June 30, 2014 compared to the same periods in 2013. Office redevelopment same-store net operating income increased approximately 2.7% and 1.3%, respectively, for the three and six months ended June 30, 2014 compared to the same periods in 2013.
Below is a summary of our same-store composition for the three and six months ended June 30, 2014 and 2013. For the three months ended June 30, 2014, two acquired properties were classified into same-store properties and two properties with significant redevelopment activity were removed from same-store properties when compared to the designations for the three months ended June 30, 2013. For the six months ended June 30, 2014, three acquired properties were classified into same-store properties and two properties with significant redevelopment activity were removed from same-store properties when compared to the designations for the six months ended June 30, 2013.
|
| | | | | | | | | | | |
| Three Months Ended June 30, | | Six Months Ended June 30, |
| 2014 | | 2013 | | 2014 | | 2013 |
Same-Store | 21 |
| | 21 |
| | 21 |
| | 20 |
|
Non-Same Store | 2 |
| | 2 |
| | 2 |
| | 3 |
|
Total Properties | 23 |
| | 23 |
| | 23 |
| | 23 |
|
| | | | | | | |
Redevelopment Same-Store | 23 |
| | N/A |
| | 23 |
| | N/A |
|
| | | | | | | |
Total Development Properties | 5 |
| | 5 |
| | 5 |
| | 5 |
|
Outlook
We seek growth in earnings, funds from operations and cash flows primarily through a combination of the following: growth in our same-store portfolio, growth in our portfolio from property development and redevelopments and expansion of our portfolio through property acquisitions. Our properties are located in some of the nation's most dynamic, high-barrier-to-entry markets primarily in Southern California, Northern California, Oregon, Washington and Hawaii, which allow us to take advantage of redevelopment opportunities that enhance our operating performance through renovation, expansion, reconfiguration and/or retenanting. We evaluate our properties on an ongoing basis to identify these types of opportunities.
We continue our ongoing redevelopment efforts at Lloyd District Portfolio and are currently under construction to include approximately 47,000 square feet of retail space and 657 multi-family units in addition to the existing 581,000 square feet of office space. Construction of the project is expected to be complete in 2015, with an anticipated stabilization date in 2017. Projected costs of the development are approximately $192 million, of which approximately $72 million has been incurred to date.
Additionally, we continue our ongoing redevelopment efforts at Torrey Reserve Campus and are currently under construction to increase rentable office space by approximately 81,500 square feet. Construction of the project is expected to be complete in the fall of 2014, with an expected stabilization date in 2015. Projected costs of the redevelopment are approximately $34 million, of which approximately $24 million has been incurred to date.
Additionally, we continue our development efforts at Sorrento Pointe with planned construction to increase rentable office space by approximately 88,000 square feet. Construction of the project is expected to be complete in 2016, with an expected stabilization date in 2017. Projected costs of the development are approximately $46 million, of which approximately $7 million has been incurred to date.
We intend to opportunistically pursue the development of future phases of Lloyd District Portfolio, Torrey Reserve Campus and Sorrento Pointe based on, among other things, market conditions and our evaluation of whether such opportunities would generate appropriate risk-adjusted financial returns. Our redevelopment and development opportunities are subject to various factors, including market conditions and may not ultimately come to fruition.
We continue to review acquisition opportunities in our primary markets that would complement our portfolio and provide long-term growth opportunities. Some of our acquisitions do not initially contribute significantly to earnings growth; however, we believe they provide long-term re-leasing growth, redevelopment opportunities and other strategic opportunities. Any growth from acquisitions is contingent upon our ability to find properties that meet our qualitative standards at prices that meet our financial hurdles. Changes in interest rates may affect our success in achieving earnings growth through acquisitions by affecting both the price that must be paid to acquire a property, as well as our ability to economically finance a property acquisition. Generally, our acquisitions are initially financed by available cash, mortgage loans and/or borrowings under our revolving credit facility, which may be repaid later with funds raised through the issuance of new equity or new long-term debt.
Leasing
Our same-store growth is primarily driven by increases in rental rates on new leases and lease renewals and changes in portfolio occupancy. Over the long-term, we believe that the infill nature and strong demographics of our properties provide us with a strategic advantage, allowing us to maintain relatively high occupancy and increase rental rates. We have continued to see signs of improvement for many of our tenants, as well as increased interest from prospective tenants for our spaces. While there can be no assurance that these positive signs will continue, we remain cautiously optimistic regarding the improved trends we have seen over the past few years. We believe the locations of our properties and diverse tenant base mitigate the potentially negative impact of the current economic environment. However, any reduction in our tenants' abilities to pay base rent, percentage rent or other charges will adversely affect our financial condition and results of operations.
During the three months ended June 30, 2014, we signed 25 retail leases for a total of 148,960 square feet of retail space including 81,909 square feet of comparable space leases (leases for which there was a prior tenant), at an average rental rate increase of 14.5% on a cash basis and an increase of 25.0% on a straight-line basis. New retail leases for comparable spaces were signed for 10,424 square feet at an average rental rate increase of 29.5% on a cash basis and 37.3% on a straight-line basis. Renewals for comparable retail spaces were signed for 71,485 square feet at an average rental rate increase of 12.2% on a cash basis and 23.2% on a straight-line basis. Tenant improvements and incentives were $64.20 and $29.80 per square foot of retail space for comparable new leases and comparable renewals, respectively, for the three months ended June 30, 2014. The
increase in tenant improvements and incentives for comparable new leases is mainly attributed to tenants at Alamo Quarry Market. The increase in tenant improvements and incentives for comparable renewals is mainly attributed to tenants at Carmel Mountain Plaza.
During the three months ended June 30, 2014, we signed 16 office leases for a total of 76,843 square feet of office space including 33,680 square feet of comparable space leases, at an average rental rate decrease of 6.6% on a cash basis and average rental decrease of 4.8% on a straight-line basis. New office leases for comparable spaces were signed for 14,459 square feet at an average rental rate decrease of 17.7% on a cash basis and decrease of 20.0% on a straight-line basis. Renewals for comparable office spaces were signed for 19,221 square feet at an average rental rate increase of 4.8% on a cash basis and 11.9% on a straight-line basis. Tenant improvements and incentives were $10.82 and $2.47 per square foot of office space for comparable new leases and comparable renewals, respectively, for the three months ended June 30, 2014.
The rental increases associated with comparable spaces generally include all leases signed in arms-length transactions reflecting market leverage between landlords and tenants during the period. The comparison between average rent for expiring leases and new leases is determined by including minimum rent and percentage rent paid on the expiring lease and minimum rent and, in some instances, projections of first lease year percentage rent, to be paid on the new lease. In some instances, management exercises judgment as to how to most effectively reflect the comparability of spaces reported in this calculation. The change in rental income on comparable space leases is impacted by numerous factors including current market rates, location, individual tenant creditworthiness, use of space, market conditions when the expiring lease was signed, capital investment made in the space and the specific lease structure. Tenant improvements and incentives include the total dollars committed for the improvement of a space as it relates to a specific lease, but may also include base-building costs (i.e. expansion, escalators or new entrances) which are required to make the space leasable. Incentives include amounts paid to tenants as an inducement to sign a lease that do not represent building improvements.
The leases signed in 2014 generally become effective over the following year, though some may not become effective until 2015 and beyond. Further, there is risk that some new tenants will not ultimately take possession of their space and that tenants for both new and renewal leases may not pay all of their contractual rent due to operating, financing or other matters. However, we believe that these increases do provide information about the tenant/landlord relationship and the potential fluctuations we may achieve in rental income over time.
Through the remainder of 2014, we believe our leasing volume will be in-line with our historical averages and result in overall overall positive increases in rental income. However, changes in rental income associated with individual signed leases on comparable spaces may be positive or negative, and we can provide no assurance that the rents on new leases will continue to increase at the above disclosed levels, if at all.
Capitalized Costs
Certain external and internal costs directly related to the development and redevelopment of real estate, including pre-construction costs, real estate taxes, insurance, interest, construction costs and salaries and related costs of personnel directly involved, are capitalized. We capitalize costs under development until construction is substantially complete and the property is held available for occupancy. The determination of when a development project is substantially complete and when capitalization must cease involves a degree of judgment. We consider a construction project as substantially complete and held available for occupancy upon the completion of landlord-owned tenant improvements or when the lessee takes possession of the unimproved space for construction of its own improvements, but not later than one year from cessation of major construction activity. We cease capitalization on the portion substantially completed and occupied or held available for occupancy, and capitalize only those costs associated with any remaining portion under construction.
We capitalized external and internal costs related to both development and redevelopment activities combined of $25.07 million and $6.11 million for the three months ended June 30, 2014 and 2013, respectively. We capitalized external and internal costs related to both development and redevelopment activities combined of $49.56 million and $13.58 million for the six months ended June 30, 2014 and 2013, respectively.
We capitalized external and internal costs related to other property improvements combined of $7.44 million and $4.34 million for the three months ended June 30, 2014 and 2013, respectively. We capitalized external and internal costs related to other property improvements combined of $12.35 million and $6.22 million for the six months ended June 30, 2014 and 2013, respectively.
We capitalized internal costs for salaries and related benefits for development and redevelopment activities and other property improvements of $0.03 million and $0.03 million for the three months ended June 30, 2014 and 2013, respectively. We capitalized internal costs for salaries and related benefits for development and redevelopment activities and other property improvements of $0.06 million and $0.06 million for the six months ended June 30, 2014 and 2013, respectively.
Interest costs on developments and major redevelopments are capitalized as part of developments and redevelopments not yet placed in service. Capitalization of interest commences when development activities and expenditures begin and end upon completion, which is when the asset is ready for its intended use as noted above. We make judgments as to the time period over which to capitalize such costs and these assumptions have a direct impact on net income because capitalized costs are not subtracted in calculating net income. If the time period for capitalizing interest is extended, however, more interest is capitalized, thereby decreasing interest expense and increasing net income during that period. We capitalized interest costs related to both development and redevelopment activities combined of $1.21 million and $0.49 million for the three months ended June 30, 2014 and 2013, respectively. We capitalized interest costs related to both development and redevelopment activities combined of $2.05 million and $0.85 million for the six months ended June 30, 2014 and 2013, respectively.
Results of Operations
For our discussion of results of operations, we have provided information on a total portfolio and same-store basis.
Comparison of the three months ended June 30, 2014 to the three months ended June 30, 2013
The following summarizes our consolidated results of operations for the three months ended June 30, 2014 compared to our consolidated results of operations for the three months ended June 30, 2013. As of June 30, 2014 and 2013, our operating portfolio was comprised of 23 retail, office, multifamily and mixed-use properties with an aggregate of approximately 5.8 million rentable square feet of retail and office space, including the retail portion of our mixed-use property, 922 residential units (including 122 RV spaces) and a 369-room hotel. Additionally, as of June 30, 2014 and 2013, we owned land at five of our properties that we classified as held for development and/or construction in progress.
The following table sets forth selected data from our unaudited consolidated statements of comprehensive income for the three months ended June 30, 2014 and 2013 (dollars in thousands):
|
| | | | | | | | | | | | | | |
| Three Months Ended June 30, | | Change | | % |
| 2014 | | 2013 | |
Revenues | | | | | | | |
Rental income | $ | 58,793 |
| | $ | 59,705 |
| | $ | (912 | ) | | (2 | )% |
Other property income | 3,392 |
| | 3,209 |
| | 183 |
| | 6 |
|
Total property revenues | 62,185 |
| | 62,914 |
| | (729 | ) | | (1 | ) |
Expenses | | | | | | | |
Rental expenses | 16,500 |
| | 16,686 |
| | (186 | ) | | (1 | ) |
Real estate taxes | 5,129 |
| | 5,476 |
| | (347 | ) | | (6 | ) |
Total property expenses | 21,629 |
| | 22,162 |
| | (533 | ) | | (2 | ) |
Total property income | 40,556 |
| | 40,752 |
| | (196 | ) | | (1 | ) |
General and administrative | (4,635 | ) | | (4,426 | ) | | (209 | ) | | 5 |
|
Depreciation and amortization | (18,209 | ) | | (16,953 | ) | | (1,256 | ) | | 7 |
|
Interest expense | (13,439 | ) | | (14,744 | ) | | 1,305 |
| | (9 | ) |
Other income (expense), net | 1,078 |
| | (65 | ) | | 1,143 |
| | (1,758 | ) |
Total other, net | (35,205 | ) | | (36,188 | ) | | 983 |
| | (3 | ) |
Net income | 5,351 |
| | 4,564 |
| | 787 |
| | 17 |
|
Net income attributable to restricted shares | (94 | ) | | (133 | ) | | 39 |
| | (29 | ) |
Net income attributable to unitholders in the Operating Partnership | (1,544 | ) | | (1,354 | ) | | (190 | ) | | 14 |
|
Net income attributable to American Assets Trust, Inc. stockholders | $ | 3,713 |
| | $ | 3,077 |
| | $ | 636 |
| | 21 | % |
Revenue
Total property revenues. Total property revenue consists of rental revenue and other property income. Total property revenue decreased $0.7 million, or 1%, to $62.2 million for the three months ended June 30, 2014 compared to $62.9 million for the three months ended June 30, 2013. The percentage leased was as follows for each segment as of June 30, 2014 and 2013:
|
| | | | | |
| Percentage Leased (1) June 30, |
| 2014 | 2013 |
Retail | 98.8 | % | | 96.6 | % |
Office | 88.5 | % | | 92.9 | % |
Multifamily | 98.8 | % | | 97.7 | % |
Mixed-Use (2) | 99.5 | % | | 93.8 | % |
| |
(1) | The percentage leased includes the square footage under lease, including leases which may not have commenced as of June 30, 2014 or June 30, 2013, as applicable. |
| |
(2) | Includes the retail portion of the mixed-use property only. |
The decrease in total property revenue was attributable primarily to the factors discussed below.
Rental revenues. Rental revenue includes minimum base rent, cost reimbursements, percentage rents and other rents. Rental revenue decreased $0.9 million, or 2%, to $58.8 million for the three months ended June 30, 2014 compared to $59.7 million for the three months ended June 30, 2013. Rental revenue by segment was as follows (dollars in thousands):
|
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Total Portfolio | | Same-Store Portfolio(1) |
| Three Months Ended June 30, | | Change | | % | | Three Months Ended June 30, | | Change | | % |
| 2014 | | 2013 | | 2014 | | 2013 | |
Retail | $ | 23,287 |
| | $ | 23,073 |
| | $ | 214 |
| | 1 | % | | $ | 23,272 |
| | $ | 23,062 |
| | $ | 210 |
| | 1 | % |
Office | 20,923 |
| | 21,442 |
| | (519 | ) | | (2 | ) | | 14,764 |
| | 15,140 |
| | (376 | ) | | (2 | ) |
Multifamily | 3,899 |
| | 3,688 |
| | 211 |
| | 6 |
| | 3,899 |
| | 3,688 |
| | 211 |
| | 6 |
|
Mixed-Use | 10,684 |
| | 11,502 |
| | (818 | ) | | (7 | ) | | 10,684 |
| | 11,502 |
| | (818 | ) | | (7 | ) |
| $ | 58,793 |
| | $ | |