American Assets Trust (NYSE: AAT) has gone on quite a run over the past year. Shares of the diversified REIT (real estate investment trust) focused on the West Coast have railed nearly 60% over the last 12 months. Add in its dividend, and the REIT's total return is above 65%.
However, zoom out a bit further, and we see a different story as the REIT barely created any value for investors over the last five years. With those factors in mind, here's the bull and bear case for buying shares of American Asset Trust these days.
The case for buying American Assets Trust
The primary reason shares of American Assets Trust have been red-hot over the past year is that the company's operations are recovering from the pandemic. The REIT's funds from operations (FFO) per share was up 6% year over year in the second quarter and 34% sequentially. That's due to a significant improvement in net operating income (NOI).
NOI at its office properties jumped 11.9% due to a strong rental collection rate (99%) and higher lease rates on new contracts, which came in 9% above expiring leases on a cash basis. Meanwhile, retail NOI jumped 85.2% due to a higher collection rate (92%). That more than offset some weakness in its multifamily portfolio.
Meanwhile, the company has been taking advantage of opportunities to expand its portfolio. The REIT bought the Eastgate Office Park in July for $125 million, a 280,000-square-foot multi-tenant office campus in Bellevue, Washington. The property is 95% leased, with an average remaining term of about three years at below-market rates.
The company has received rezoning approval that will allow for significant development opportunities. The REIT followed that up by purchasing Corporate Campus East II, which is also in Bellevue. It paid $84 million for the 161,000-square-foot multi-tenant office campus that's 86% leased at below-market rates. These acquisitions should provide a near-term income boost and potential upside from higher rental rates, improved occupancy, and development opportunities.
The case against buying American Assets Trust
While American Assets Trust's diversification has helped cushion the pandemic's blow, the company has significant exposure to industries facing long-term headwinds. More than half of its NOI comes from office properties, which face uncertainty about when companies will fully return to the office. The delta variant forced many companies to delay their plans, which could weigh on office demand for some time.
American Assets Trust has experienced this firsthand. Occupancy across its office portfolio has fallen from 94.4% to 90.3% over the past year. While new and renewal lease rates are rising, that might not continue if it keeps losing tenants.
Meanwhile, its retail portfolio -- which supplies 29% of its NOI -- is facing headwinds from the accelerating adoption of e-commerce. These properties are also experiencing falling occupancy (from 94.7% to 91.1% over the past year) and lower rates (new lease rates were down 20.3% on a cash basis in the second quarter). These factors could keep some pressure on FFO in the coming quarters.
Finally, American Asset Trust's balance sheet isn't on the firmest foundation. While the REIT has investment-grade credit, it’s right on the bottom rung. That’s due in part to an elevated leverage ratio of more than 6.0 times debt-to-adjusted EBITDA, and that’s before buying two more office properties. Those deals used up a large portion of its $368.3 million of cash on hand at the end of the second quarter. That elevated leverage ratio could limit its financial flexibility in the future.
It's hard to get too excited by this REIT
While American Assets Trusts owns a solid real estate portfolio, it doesn't stand out from the pack. It's not the bargain it once was following the 60% rally over the past year. That's helped push its dividend yield close to the sector's average of around 3%. Meanwhile, it has significant exposure to the office and retail sectors, which are facing continued headwinds. Add in its balance sheet, and the American Assets Trust doesn't seem like a compelling buy these days.