American Assets Trust, Inc. (AAT) Q4 2017 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the American Assets Trust Incorporated Fourth Quarter 2017 Earnings Conference Call. At this time all participants are in a listen-only mode. Later we will conduct question-and-answer session. [Operator Instructions] And as a reminder, this conference maybe recorded. I would now like to turn the conference over to Mr. Adam Wyll, Senior Vice President and General Counsel. Sir, you may begin.

Good morning. I’d like to thank everyone for joining us today for American Assets Trust 2017 fourth quarter earnings conference call. Joining me on the call are Ernest Rady and Bob Barton. These and other members of our management team are available to take your questions at the conclusion of our prepared remarks. Our 2017 fourth quarter supplemental disclosure package provides a significant amount of valuable information with respect to the company’s operating and financial performance. The document is currently available on our website. Certain matters discussed on this call may be deemed to be forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements include any annualized or projected information as well as statements referring to expected or anticipated events or results. Although we believe the expectations reflected in such forward-looking statements are based on reasonable assumptions, our future operations and our actual performance may differ materially from the information contained in our forward-looking statements, and we can give no assurance that these expectations will be attained. Risks inherent to these assumptions include, but are not limited to future economic conditions, including interest rates, real estate conditions and the risks and costs of construction. The earnings release and supplemental reporting package that we issued yesterday and our annual report filed on Form 10-K and our other financial disclosure documents provide a more in-depth discussion of risk factors that may affect our financial conditions and results of operation. Additionally, this call will contain non-GAAP financial information, including funds from operations or FFO; earnings before interest, taxes, depreciation and amortization or EBITDA; and net operating income or NOI. American Assets is providing this information as a supplement to information prepared in accordance with Generally Accepted Accounting Principles. Explanations of such non-GAAP items and reconciliations to net income are contained in the company’s supplemental operating and financial data for the fourth quarter of 2017 furnished to the Securities and Exchange Commission, and this information is available on the company’s website at www.americanassetstrust.com. I’ll now turn the call the call over to our Chairman, President and CEO, Ernest Rady, to begin our discussion the fourth quarter results. Ernest?

Thanks, Adam and good morning everyone. Thank you for joining American Assets Trust fourth quarter 2017 earnings call. Let me begin by saying the recent volatility in the stock market has been just as dramatic for us and certainly for myself as I imagine it has been for you and other real estate investment trusts. The recent volatility is an example of how great real estate can be priced cheaper on Wall Street as opposed to Main Street. I continue to be a buyer [indiscernible] because I personally believe in the intrinsic net asset value of our portfolio. Our belief is that this is where high-quality, high-barrier-to-entry real estate portfolios with strong demographics especially in the coastal West Coast markets combined with a strong and dedicated transparent management team will continue to do well in creating increase at net asset values total shareholder returns and dividends for its shareholders. Our quality diversification allows us to capitalize on each market at different times that presents the best opportunities. Each of our properties are specialty and subject to different market dynamics. For example, we have enjoyed close to 15 years of solid same-store growth at our Waikele regional shopping center to the point where I’ve seen our larger retailers rent being reset to a lower market rent as explorations have come up for renewal. We are in the process of revitalizing that center with the hopeful lease of a national grocer, we’ve been working on combined with the renovation of the existing Kmart box once it vacates at the end of June 2018. This property consists of 43 acres fee-simple, half-mile of frontage on the H1, which bodes very well for its future. And Bellevue, Washington the City Center Bellevue we are seeing strong lease absorption and increasing rates. According to the Broderick Group in Bellevue office vacancies for the entire Eastside markets are a landlord favorable 9.46%, the lowest vacancy since 2006. We have back filled our turnover and we are now at 97.5% leased. In the Lloyd District, our Hassalo on Eighth apartment project experience soft rents and increasing concessions in the fourth quarter largely due to the temporary oversupply in the marketplace. In spite of this we are currently 97.7% leased as of the beginning of this week. The office market in the Portland CBD and the Lloyd District is strong. We continue to see increasing rents in these markets. In San Francisco, our Landmark at One Market Street continues to reinforce it’s A-plus location and a high-barrier-to-entry market that continues to command premium brands and prospects are excellent when [indiscernible] leases at current rent rates expire. In San Diego, we are beginning to realize the benefits of repositioning efforts as we’ve completed the reservation of Torrey Plaza with a view of the Pacific Ocean is now more relevant to the current marketplace. In addition, our newly completed 88,000 square foot office complex at Torrey Point with unobstructed views of Torrey Pines State Beach was completed at the end of 2017 and already has approximately 48,000 square feet leased, we’re moving in the right direction. As we begin 2018 our focus will be on first leasing, second renovation and lease of the Kmart building at the Waikele regional shopping center in Hawaii on the island of Oahu. The transformation of one of our existing buildings at Oregon Square into creative office space. Continued focus on growth of the net asset value for our shareholders, which we believe will ultimately result in increasing cash flow and dividends paid to our stockholders. And lastly maintain a low leverage and investment [indiscernible]. Our diversification by product and geography will serve us well. On behalf of all of American Assets, we thank you for your confidence in allowing us to manage your Company, and we look forward to continued support. I’ll now turn it over to Bob Barton, our EVP and CFO. Please Bob.

Good morning and thank you Ernest. Last night we reported fourth quarter 2017 FFO of $0.46 per share. Net income attributable to common stockholders was $0.15 per share for the fourth quarter. The company’s Board of Directors has declared a dividend on its common stock of $0.27 per share for the quarterly period ending March 31, 2018. The dividend will be paid on March 29, 2018 to stockholders of record on March 15, 2018. Now, let’s dive right into the unanticipated events, which impacted the fourth quarter 2017 results to be approximately $0.07 per FFO share below Bloomberg consensus. The following three items had the most impact on these results. First, G&A expense increased by approximately $0.035 per FFO share as a result of a non-cash non-recurring modification of previously granted restricted stock awards. In December our independent compensation committee approved and implemented a modification of previously granted restricted stock awards to adjust vesting based on their analysis of our relative total shareholder return over a three year period instead of the prior metric of a relative forward FFO multiple that they believe better aligned our employees with our shareholders. Second, we reserved approximately $0.015 per FFO share against the straight line rent of one of our office tenants based in our Lloyd Center Tower and as a non-cash adjustment. It was publicly announced in the Oregon newspapers in the last week of December that Oregon second largest Medicaid carrier FamilyCare will shut down after FamilyCare and state officials failed to agree on a contract for 2018. Their rent is current through February and we are working with FamilyCare to accommodate their requests to downsize their space. We are seeing a robust office leasing market in Portland and we are currently seeing a lot of interest in their space in the Lloyd Center Tower. As you can see the first two items represent approximately $0.05 per FFO in non-cash adjustments. Third, we experienced approximately $0.01 per FFO share in lower NOI at Hassalo on Eighth our 657 multi-family unit project in the Lloyd District and Portland, Oregon. In our view the lower NOI was primarily the result of a combination of lower rent and increased concessions in the fourth quarter due to the current temporary oversupply in the marketplace. Although our occupancy is strong, we have also noticed in January 2018 that rates have increased and concessions have decreased, while maintaining strong occupancy. Now more specifically, our retail portfolio ended the quarter at 96.8% leased combined with the highest Daniel Ice base rents amongst our peers. On a year-over-year basis our retail occupancy was up approximately 20 basis points from the fourth quarter of 2016 leaving approximately 103,000 square feet vacant in our 3 million-plus square foot retail portfolio. A significant portion of the retail vacancy is primarily attributed to the space that had been leased to the Sports Authority at Waikele Center, which consisted of approximately 50,000 square feet. And we continue to believe will ultimately be occupied by national grocer. Progress has been made by both sides with the building and signage design and space planning of this building for the national grocer. And as Ernest mentioned, the lease is with the lawyers now. Without question finalizing the lease is taking much longer than we expected. But we’re still hopeful and expect to have positive news in the coming weeks. During the trailing four quarters 72 retail leases were signed representing approximately 333,000 square feet or 10% of our total retail portfolio. Of these leases sign 62 leases consisting of approximately 309,000 square feet were spaces previously leased. On a comparable basis the annual cash basis rent decreased 3% over the prior leases, primarily as a result of the renewable of the 155,000 square foot Lowe’s space at Waikele Center in Q2 2017. Excluding the Lowe’s renewable we leased approximately 154,000 comparable retail square feet had an average cash basis rent increase of 7.5% during the 12 month period ended December 31, 2017. Our office portfolio ended the quarter at approximately 88.4% leased down approximately 170 basis points on a year-over-year basis primarily due to decreases in occupancy at Torrey Reserve and City Center Bellevue. The approximately 12% vacancy in the office portfolio is comprised of three parts. First, Oregon Square and the Lloyd District portfolio in Oregon is approximately 139,000 square feet. As you may recall, Oregon Square consists of four older concrete buildings, which we have deliberately non-renewed the existing tenants over the last 18 months to be in a position to redevelop the site. It’s a terrific location across the street from the state of Oregon building and adjacent to our Hassalo on Eighth 657 unit multi-family development. We have a 12 to 1 FAR combined with the ability to build a variety of different uses subject to design review. We believe there is a potential for more multi-family down the road after the current oversupply is absorbed. We have had interest on a build to suit building on one of the sites from various prospective tenants from time to time. Currently we are commencing our efforts on taking one of the approximately 33,000 square foot buildings at Oregon Square and renovating it into creative office space that we believe will be well received in the marketplace. Secondly, Torrey Reserve Plaza in San Diego comprise approximately 97,000 square feet of our total office vacancy resulting primarily from a tenant that vacated on January 1, 2017. In the fourth quarter, we completed our renovation of this building to make it more like, bright and energetic for a new market of tenants. We have been active showing this space and it has been well received since our completion of the project late in the fourth quarter of 2017. We are hopeful to get this project leased in the coming months. Third is our City Center Bellevue office building in Washington state, included in our vacancy is approximately 52,000 square feet from one tenant vacating two floors on October 31, as expected. As you may recall on our prior earnings call, we also had another three floors that were vacating on December 31, 2017 at City Center Bellevue that are not included in vacancy at year end. I am happy to report that all five floors have been released as of last week and ahead of our 2018 guidance. We are now 97.5% leased at City Center Bellevue. Steve Center, our new Vice President of Office Properties has done a great job in his first few months as he has replaced Jim Durfey who recently retired after 14 years with American Assets Trust. During the trailing four quarters 58 new office leases were signed representing approximately 368,000 square feet or 14% of our total office portfolio. Of these leases signed during the year 41 leases consisting of approximately 270,000 square feet were spaces previously leased. On a comparable basis the annual cash basis rent increase 16.4% over the prior leases. Let’s talk about same-store NOI for a moment. Same-store retail cash NOI increased in the fourth quarter to 4.4% the increase primarily relates to increased rents at Carmel Mountain Plaza were Dick’s Sporting Goods replace the former Sports Authority and also increased rents at Del Monte Center on the Monterey Peninsula by Pebble Beach Golf Course. Same-store office cash NOI decreased 9.4% in the fourth quarter, primarily due to the expiration of a two-floor tenant at our City Center Bellevue property on October 31, 2017, combined with the termination fee that was received from a tenant at City Center Bellevue in Q4 2016 without a comparable termination fee received in Q4 2017. As noted above, the two-floor tenant has already been re-leased during the first five weeks of 2018. Same-store multifamily NOI was up 2.5% on a cash basis for the fourth quarter. The increase in NOI was achieved in spite of the 21 units at our Loma Palisades Apartments in San Diego being off-line during renovation for most of 2017. These 21 units are back online, and just recently became available for rent. Waikiki Beach Walk, our mixed-use property consisting of the Embassy Suites Hotel and Waikiki Beach Walk retail, reported a combined decrease in same-store cash NOI of 2% for the fourth quarter. Broken down further, this represents the Embassy Suites Hotel up 4.9% due to higher occupancy at the Waikiki Beach – higher occupancy. And the Waikiki Beach Walk retail was down approximately 7.2% due to three tenants that vacated in 2017. Tenant sales continue to exceed $1,000 per square foot for the rolling 12 months as our tenants continue to benefit from the excellent location and a good economy. Restaurants do very well at Waikiki Beach Walk, and their renewals are the primary driver of strong cash basis re-leasing spreads of approximately 34% in the fourth quarter. This is also one of the few properties in Waikiki that is on fee ownership. Turning to our fourth-quarter results, FFO decreased approximately $0.06 to $0.46 per FFO share compared to the third quarter. The fourth-quarter results included the following activity. First, as previously discussed, G&A expenses increased in Q4 over Q3, primarily due to a one-time non-cash charge of approximately $0.035 per FFO share as a result of the modification in the vesting of restricted stock to our employees who participate in our equity incentive award plan. Secondly the Embassy Suites at Waikiki Beach Walk NOI decreased approximately $0.02 due to the seasonality of the hotel in the fourth quarter. And third, City Center Bellevue decreased approximately $0.01 per FFO share, primarily due to an expected vacancy of a two-floor tenant at City Center Bellevue on October 31. Now as we look at our balance sheet and liquidity at the end of the fourth quarter, we had approximately $330 million in liquidity, comprised of $83 million of cash and cash equivalents, and $250 million of availability on our line of credit, which has now increased to $350 million as of the beginning of 2018. Our leverage, which we measure in terms of net debt to EBITDA, was 7.1 times, which is high by our standards. Adjusting our EBITDA for the non-cash, non-recurring stock compensation modification, our net debt to EBITDA would have been 6.8 times, which is still high by our standard. We have a roadmap to get our net debt to EBITDA down to 5.5 times or less within eight quarters, which would take us to Q4 2019. That plan consists of paying down our existing secured debt as it matures, combined with organic growth in our portfolio. Our interest coverage and fixed charge coverage ratio ended the quarter at 3.2 times. As discussed in our press release dated January 9, 2018, we have amended and restated our existing credit agreement and amended our existing term loan agreement. Highlights of these changes include, among other things, an amendment to the credit agreement which decreased our pricing spreads and increased revolving line of credit from $250 million to $350 million. When we consider this increase to our revolving line of credit, our total liquidity of approximately $330 million, discussed above, would increase to $433 million. Also, the amendment to the term loan agreement decreased pricing spreads by 50 basis points, effective March 1, 2018. Both the revolving line of credit and term loan are unsecured. Lastly, we are reaffirming our 2018 FFO guidance range of $2.01 to $2.09 per FFO, share with a midpoint of $2.05 per FFO share. Our Q3 earnings call script provides the detail of our 2018 guidance, including a bridge to 2019. As always, our guidance excludes any impact from future acquisitions, dispositions, equity issuances and repurchases, future debt refinancings, or repayments other than what we have already discussed. Our guidance does assume that we will receive all of Kmart’s lease revenue obligations due in 2018 at Waikele Center, in accordance with the terms of its lease which expires at the end of June 2018; and also that we will repay the indebtedness on Loma Palisades with cash on hand in March or April 2018. We will continue our best to be as transparent as possible and share with you our analysis, interpretations of our quarterly numbers. We are well prepared, with an even stronger balance sheet than in prior years, to capitalize and execute on the opportunities that we believe will present themselves over the coming quarters. Operator, I’ll now turn the call over to you for questions.

Thank you. [Operator Instructions] And the first question will come from the line of Haendel St. Juste with Mizuho. Your line is now open.

Good morning, Haendel.

Good morning, good morning guys. A couple quick questions; I guess first on your biggest office and retail tenant. I guess on the office side, salesforce, you are number one-tenant there. I’m wondering what perhaps the latest conversations are over that space? Understand their tower in San Francisco is now complete. And so I’m wondering what the plan there is to backfill. I’m assuming that salesforce is likely to leave, given the expiration over the next couple years in your portfolio. So just curious what the recent conversations are, and maybe some context on what current market rent is.

Haendel, it’s Ernest. I’m reluctant to provide you the details of the conversations, but there are extensive conversations, and it does appear that salesforce will be leaving that building for their new building. On the other hand, we have a significant amount of interest from tenants at rents that will be higher than what salesforce is paying. And other than that, I’m reluctant to say anything, because there’s nothing concrete that I can report, other than we – Steve is very busy and we have a lot of conversations going, and we’re very optimistic.

Any context around what the market rent is? Looks like your average rent for salesforce is around $57 gross, so just curious if you can provide some context.

Steve, you want to provide some color on what’s the market rents in San Francisco are for a building like this? Which is, by the way, one-of-a-kind: it’s right on the Embarcadero. It’s the style that is very appealing to tenants in San Francisco. So we’re not sure what the upside is, but there’s lots of activity. Steve, do you want to say something?

Well, to Ernest’s point, the market is strong in general, and the building is very unique. It’s authentic; it was built in 1960, so you have the authentic brick nature of it. You’ve got high clearance and you’ve got large floor plates, all things which the tenants in the Bay Area desire. So we’re – as Ernest said, we’re very optimistic about our pricing ability of that building in that location.

Appreciate that. And then on the number one – on the retail side, Kmart; we’ve talked a bit about that for a while and the empty box. Looks like they are paying rent until June of this year. I think you guys had previously talked about that space expecting to be dark for maybe another year or two. Bob, I think you might have said – and forgive me if I missed this – that you’re looking at a redev for a grocer. So I’m curious if you can give us any more color on that front, maybe an idea of capital spend, yield, timing, et cetera.

First of all, when Kmart officially vacates that space, we’re prepared. And we want to go in and demolish it on the same day that they vacate. It’s just a nonfunctional building. And then there is a lot of discussion and negotiation [indiscernible] who would occupy that space. The grocer is not going in that space. Sully, you want to cover some of that?

Haendel, the grocer is going to be in the Sports Authority space, which is on the other side, on the freeway side, if you remember when we took you up there.

Yes.

And then on the Kmart side, as I say, we’re in very active discussions and space planning and all sorts of things with the usual suspects who you would think would fill that building. So activity is still pretty strong in Hawaii. It’s just getting people positioned in their seats. It takes a process. There’s lots of pieces that have to get set in place to pull it all off. But I’m confident it will get done. We’re spending – I spend probably half my day on it.

That building butts against a street – so there’s no – if a new tenant comes in, there is no access for them to bring in their merchandise. So that building has got to go, and we’re planning on that. And we’re going to be shovel-ready as soon as they vacate.

Got it, got it. And one last one: Ernest, I guess getting back to the diversified nature of the portfolio, given the discount that you guys have traded at historically, and more recently that’s been widened a bit here, some folks have questioned the diversification of the portfolio. And given some of the recent challenges throughout the various pieces of your portfolio in the office, retail, mixed-use, I’m curious if you still are just as firm a believer today that diversification in your portfolio is the way to go? Or perhaps there should be more of an asset concentration in your portfolio. Thanks.

No, our focus has always been on increasing net asset value. And the diversification now I think will prove to be a great benefit, because while retail is up, apartments are up, and [indiscernible] beautifully. There’s significant upside in our office portfolio, so that diversification is going to augur well for our stockholders. Now, if an opportunity came along to increase net asset value regardless of the outcome, we’d certainly consider it. But what we have today is I think the best of the best, and provide the most significant upside for our stockholders with a high degree of certainty.

Thank you.

Thank you, Haendel.

Thank you. And the next question will come from the line of Brian Hawthorne with RBC Capital Markets. Your line is now open.

Hi. First question: can you provide an update on Pacific Ridge? And are the operations now running more smoothly?

Yes, Pacific Ridge is now humming. We have not gotten on a track that we think we can produce the upside that is available there. But the operation is now firmly on its feet and functioning.

Great. And then the FamilyCare – so they are still operating; and they’re going to keep paying rent through 2018. Is that right?

Well, we hope they are. So right now – I think Bob covered it in his presentation – that there’s been public information available that says they are going to downsize. We have some security for them that will assure us of them paying at least some of the rent, and hopefully all of the rent. And then as Bob covered and Steve will outline, there’s been a lot of interest in that space. So we’re hopeful. Bob was very concerned that we not mislead anybody on that space. And I think you took a deduction for it for – yes. Steve, do you want to cover some of the activity that’s going on in a general way?

Sure. As Ernest said, the market is strong in Portland, and large blocks of space are scarce. So as soon as we heard of the news of FamilyCare, we took the space to market and we’ve got a number of suitors for the space. So we’re excited about the activity, and we think the rents will be on the upside relative to what’s in place.

Thank you.

Sure. Okay, then just last one, on the changing to the – the vesting changes in the comp plan – what brought that up? And then what kind of brought about the reason for making that change?

You kind of faded out there. Could you repeat your question, please?

Sure, yes. So just on the changes, the vesting changes in the comp plan, what brought that up? And what made you guys start even considering making that adjustment?

The Compensation Committee would have to answer that question. They are totally independent. I don’t sit in any of their meetings. Only the attorney sits in the meetings. They made the decision on their own. I have always told them that I don’t care what you pay me – I think others do care – because I’d pay to come to work. So they make the decision on their own without any influence from me whatsoever. And, believe me: they are independent with a capital I.

Okay, thank you.

Thank you.

Thank you. And the next question comes from the line of Todd Thomas with KeyBanc Capital Markets. Your line is now open.

Hi, Todd.

Hey good morning, guys. This is Drew on for Todd today. Just a quick question on the new lease spreads in the retail portfolio. They’ve been negative for a few quarters. I just wanted to see if you could comment on what’s going on there, and maybe when you expect things to stabilize and improve a little bit.

Well, the same-store – are you talking about the same-store growth?

I’m just talking about the cash basis leasing spreads, the new spreads in the retail portfolio.

I think the new spreads were, what, 34% in the fourth quarter. And – yes, so we – the increase in the re-leasing spreads on our retail side was a result the renewal of one of our leases at Waikiki Beach Walk shopping center in Hawaii. I mentioned it on the script, about how strong the rents are, how strong the sales are per square foot in Waikiki Beach Walk retail. If you translate that and look at our same-store growth, we also started growing; went to 4%, 4.4% same-store growth in Q4 2017. And I think that we’ll be probably in the 3% range by the end of 2018. A lot of that is – for instance, in the fourth quarter, is attributable to Dick’s which replaced Sports Authority in the prior year; and then also stronger rents up at Del Monte shopping center.

But make no mistake – and Sully will confirm, too – that retail is a – I wouldn’t say it’s a struggle, but it’s certainly a war. And the quality of our space is coming to the fore now because I think we’re doing better than average. Our retail is up in a market that is very confrontational and difficult. Sully, you want to add something to that?

No, it’s well-put. It’s a little buckle-up turbulence. Sometimes you’ll – sometimes we can get a pop on rents based on – if the tenant is under market or who we’re replacing. And sometimes it goes the other way. And that’s kind of always been the case in retail, but we’re hanging in there. We’re not in East Bakersfield, as I tell people.

Thanks, guys. I appreciate it. Just in terms of acquisitions, and just given where your cost of capital is today and the volatility in the markets that Ernest mentioned in his prepared remarks, how would you characterize your appetite for acquisitions in 2018? And then maybe if you could comment on your thoughts on stock buybacks as well, that’d be great. Thank you.

As far as acquisitions go, based on the availability of capital and the cost of it, we would have to sell something. We’d have to do a trade which would improve the overall quality and NAV for the stockholders. And we look at that virtually daily. We don’t have anything on the agenda right now. And as far as stock buyback goes, frankly I’d brought it up to the Board of Directors if they wanted to consider it, and they rejected it.

Interesting. Okay. That’s helpful. And then just one last quick one. I noticed that the leased percentage for Imperial Gardens came down almost 900 basis points sequentially. I know it’s a small asset, but I was just curious what went on there, and how come that lease percentage came down so much.

Some of the management turmoil that we had at Pacific Ridge carried over to Imperial Beach, and it’s something that we had to deal with. That new management is in place now and bringing it back up, and it does not speak negatively to the [indiscernible] asset. It speaks to the fact that the management was neglected for a short period of time.

Okay, thanks, guys. I appreciate the time.

Thank you. Appreciate your interest.

Thank you. The next question will come from the line of Rich Hill with Morgan Stanley. Your line is now open.

Hey, guys good morning. First of all, a question from me, in then I’m going to turn it over to Ron Kamdem to maybe ask a little bit more detailed question. Ernest, look, you do a lot of work on, as you said, independent with a capital I; NAVs and your share price is obviously below that. So there are really two questions, 1A and 1B from me. How much of this do you think is the market’s not maybe valuing your diversified portfolio across retail, office, and multifamily? And then maybe as you think about that, I’d love to get your perspective. You’ve been doing this for a long time and have a great perspective on this. Where do you think we are in the series cycle? After post-tax reform, do you think we have some ways to run? Or are you becoming a little bit more cautious than previously? How are you thinking about things?

Well, as far as my view of the economy goes, it’s on fire. And interest rates, we have projected, will go up. And as a result, we, I think, in the tail end of last year locked in our interest rates on our borrowings to the best extent we could. As far as the diversified portfolio goes, I love it. Frankly, I would hate to have all my eggs in one basket. I love the fact that we have now good performance in two of our categories, and the prospect of excellent performance in the third category. So we continue to provide the shareholders the returns that we in the first six years that we were public.

So Bob, maybe just following up on that before I turn it over to Ron. As you work through these independent NAVs, how are you thinking about the – how are you seeing the fee factor getting on the various different components, presumably retail being the weaker of the three components? Are you seeing any shifts there? And how should we be thinking about cap rates between those various different property types?

I think we get – because we are classified as a retail REIT, we get thrown into that category. And as I look around at the relative values in the REIT world, we’re not that much different than the discounted is in existence for other REITs that are not of the same quality. So I’m not sure that our diversified discount has not disappeared. And I think as this cycle plays out, and the opportunity we have through diversification, I think we will command more respect than we have in the past for our diversified strategy.

Rich, let me add to that. I think two things in – want to answer your question. Is one is that I think REITs will do well overall, even though we had temporary fluctuation going on here. But I think because we have the lower leverage compared to the private market, if you can maintain a low leverage balance sheet and maintain high quality, high barrier to entry, I think the REITs on the various sectors will do okay. There are obviously some sectors are going to be on fire, and some sectors are going to fare better than others depending on the market. But in terms of our NAV, the question you asked about the NAV, I mean we were wondering if we would – where our NAV will come out this June. We haven’t even started that process. And as you know, our NAV, we penciled it in Q2 at $50. And that’s based on third-party reports, based on third-party data points. We recently read a research report from one of the major investment banks. And I agree with its thesis that the high- quality, high-barrier-to-entry portfolios with low leverage are going to do well. There is so much global capital out there that will chase these, because these assets do not trade every day, are not available every day. We’re seeing other portfolios that have traded or are in the process of trading at low cap rates, like what we saw two years ago. So, I don’t think we’re that far off the mark, but we’ll see. We’ll re-up it.

Let me say something about Bob Barton. And he and I have been back to back and belly to belly for 20 years. If you want somebody to defend the quality of the balance sheet, you can find nobody who’s a better defender than Bob Barton. So that speaks to the ratios that he talked about. Second of all, I watch the values that we have in our portfolio. And I think that retail probably has somewhat of an increasing cap rate. On the other hand, our office is doing so well, it may very well make up for it. Bob does that study independently in mid-year, and I can hardly wait to see what he comes up with. So you’ll be the second to know. I want to be the first. He doesn’t include me in the process.

So I’m going to turn it over to Ron to ask a quick question.

Yes, you’ve got Ron here. Just two quick ones from me, one in the retail portfolio. Was looking at Solana Beach Town Center base rents were up about $1 million quarter-over-quarter. Just curious if you guys had any color what was driving that. And then the second question was in the office portfolio. It looks like rent abatements picked up in the second half of the year, and particularly in 4Q. Also would love some color on what’s going on there. Thanks.

Do you want to cover Solana Beach, Sully?

So you are saying you see a base rent tick-up in Solana Beach of how much? Hold on. Bob’s going back to the book here.

Yes. Ron, what I think it is that we have more expenses in the third quarter that outperformed in the fourth quarter. I think that’s what you’re seeing.

Got it.

Maybe [indiscernible] prior three quarters, it wasn’t there. So that was the pop-up.

Yes.

And as far as the free rent goes, each one of these leases is a calculation that we – that Steve does admirably, where he discounts it to present value. So if there’s a little free rent, there’s probably going to be a little higher rental. If there is a little higher rental, there may be a little less tenant improvement allowance. But it’s all calculated on a net property. Is that a fair statement, Steve?

Yes.

Great. Thanks so much.

Thank you. Thanks for your interest Ron.

Thank you. And the next question will come from the line of Craig Schmidt with Bank of America. Your line is now open.

Hey, Craig. Nice to see you again. You are looking good.

Thanks. I just wondered what your expectation for the pace of capital expenditures are in 2018 for the tenant improvement and leasing commissions for both office and retail.

Yes. In our 2018 guidance, which we put in the script for Q3, we said approximately $35 million, $38 million. Historically, we’ve done somewhere between $30 million to $40 million a year.

Okay. I was just wondering, I mean given what could happen with FamilyCare and possibly Kmart as well as salesforce, is that going to be enough?

Well, that would be – the operational CapEx would be enough for your standard operational CapEx. So the Kmart would be more of a redevelopment, and we’d add to that. So we’re still going through that. It’s probably somewhere in the $40 million, $50 million range for the Kmart building.

We through a thorough budget process for capital expenditures, but our view is that that’s a guide; that deferred maintenance is really not acceptable. If something needs to be spent, we’re going to spend it. And if something doesn’t need to be spent, regardless of it is in the budget, we’re still not going to spend it. And then if we do spend it on some significant CapEx, there’s going to be an increase in the net asset value because we’re going to add to net present value. So that’s really the strategy.

Okay. Thank you.

Don’t focus so much on the dollars spent. Focus on what the dollars spent create in net asset value.

Hey, Craig, we’ll give you more color on the Kmart building as we get leases signed. Because we’re still trying to design the building. First of all, Kmart has not moved out yet. And we can’t demolish it until they move out, which will begin July 1. Secondly, we got to understand what the tenant’s needs are once the leases are signed. So all of that comes into play. And we’ll give you more color on that as leases are signed.

And actually, even if we could demolish it sooner, because of Kmart’s occupancy we couldn’t demolish it sooner because of the requirement for all the preparation that has to go: the permitting, the soil examination, et cetera. So, they’re vacating that building is going to coincide time-wise with our ability to demolish. Couldn’t do it any sooner; don’t want to do it any later.

Okay, thank you.

Thanks, Craig.

Thank you. And the next question will come from the line of Vince Sibone with Green Street Advisors. Your line is now open.

Hey, guys. This is Chris in for Vince today. Just going back to the City Center Bellevue, I’m wondering if you can isolate how much of the overall office same-store decline this quarter was due to those two floors that vacated. And then also you mentioned you got those five floors leased. Just wondering when those leases might commence.

On the same-store, that was a large part of it. For the office same-store NOI, a large part of it was for the two floors that vacated.

Got you, thank you.

I was just going to say, what’s the second part of your question?

The second part you mentioned you had leased up, and just wondering when those leases might commence.

Yes. From a straight-line basis, we have a couple of the floors commencing June 1, and a couple of the other floors commencing October 1.

All right, it helpful. Thank you.

Thank you.

Thank you. And the next question comes from the line of Haendel St. Juste with Mizuho. Your line is now open.

Hey, just wanted to come back with a couple more. Ernest, earlier you mentioned you would pay to come to work. So I’m curious how much you’re willing to pay, and when are you able to start?

Haendel, if I get to associate with you, I’d pay a great deal. But I don’t want to put a price on it because you’ll demand more. So we’ll just have to settle for an unknown amount. It’s my pleasure; it’s my fun; it’s my life. I enjoy it.

And Haendel, that would sure improve my guidance for 2018.

My next question is about the buffet guidance. I was – just to piggyback on the last question. The Bellevue lease-ups that you recently just signed, that is n1ot currently in the guidance for this year, right?

No, it is; but we improved that. Our guidance for 2018 included that we would – or it made the assumption that we would re-lease those spaces. And we included approximately $200,000 of revenue in December of next year. That was part of our corporate operating model. Now we have improved that by moving up several of the floors. Two of the floors begin October 1, and three of the floors begin June 1 on a straight-line basis, with cash to follow in the following months.

Got it, got it, okay. And Ernest, just to follow back up on something else you said earlier, you mentioned that you proposed share buyback to the Board. It was rejected. I’m curious if you could perhaps give us a little bit of insight on their thought process, especially with the stock trading where it is, over six implied cap. Was the balance sheet and perhaps the leverage the overriding consideration?

I don’t know what the overriding consideration in each of their minds was. But Bob’s certainly was the leverage, and that we think that the position we have in each of these pieces of real estate is excellent. And we wouldn’t want to put ourselves in a position where we’re not able to maximize our returns for them by having liquidity as a problem.

Haendel, I think some of the considerations – I can’t speak for what the Board decision was. But if you look at the use of the cash that we have; and we intend to pay down the secured debt on Loma Palisades. That’s at 6%. So I think it’s important to reduce the leverage where we are. The leverage spiked with the acquisition of Pacific Ridge and the additional unsecured debt last year, albeit at favorable rates. We got to get that leverage back down. And by using that cash to pay down a 6% secured debt in next 60 days, I think is an excellent use of the cash. Plus we have the CapEx going on at Waikele Center with the Kmart building. So we have uses for it that will create net asset value, although it’s worthy of discussion on stock buybacks.

Appreciate it. Thanks, Bob.

Thank you, Haendel. Good question.

Thank you. And our final question will come from the line of Michael Carroll with RBC Capital Markets. Your line is now open.

Good morning, Michael.

Yes. Thank you. I just wanted to follow the question line on guidance, real quick. With Seattle coming back in a little bit earlier than expected, how much more NOI are you expecting from that asset now versus your original guidance, which I thought was zero? And then what is the negative coming onto guidance? And so why did you not increase guidance? Why did you just affirm it where it is today?

Well, keep in mind that when the issue guidance in Q3, and it’s our best guess at that time. So what we’ve – we picked up possibly $0.02 at City Center Bellevue in additional revenue coming online, straight-line rent in cash revenue coming online in 2018 over the initial guidance. But then we’ve taken a more conservative stance on the lease up of Torrey Reserve here in San Diego. So we got to wait and see how it plays out. It’s all about the leasing. And I don’t want to overstate the expectations for 2018. And I think that the $2.05 midpoint is still a very good place where we should be focused on.

Okay. I think somebody talked about this a little bit earlier in the call, but can you talk about the apartment market in Portland? And how are you viewing those projects right now? Is the outlook still pretty positive as what you originally underwrote?

The apartments we built, the 657 apartments, cost, I think, $190 million. The replacement cost today – Jerry, is what? Approaching $200 million?

Easily.

Easily $250 million. So as – and this market was overbuilt. I saw a public statement that rental rates actually declined in Portland last year because it was overbuilt. So but in the long run, the project is gaining traction, gaining prestige in the community. And as you can see by the occupancy, it’s gaining commercial acceptance. In the end, we will get a return based on not only our cost but also on replacement cost. We also have the opportunity to build another 600 apartments there but the costs have raced up faster than the rental rate. So it’s something we’re always looking, but what we have, we’re delighted with. We think it’s going to be a great earner for our stockholders over the short-, medium-, and long-term. And we just have to see what the opportunities are on the remaining blocks of Oregon Square. I think Bob told you, we are going to reposition one building; another square block, we’re going to see if we can find an anchor tenant. Another square block, we have an opportunity to build apartments. So it’s – I’m glad we have the opportunity; we just hope to take advantage of that to the best and greatest extent possible.

Michael, let me just add to that. That Hassalo on Eighth, we’re still very positive on that development and we’re very, very proud of that development. The 97.5% leased status today really is speaking that this is a community that is accepted in the Lloyd District of Portland. So what we have to do is just burn through the oversupply. And I don’t know how quick that will be, or how slow it will be. But once that oversupply gets absorbed into the marketplace – and there is positive absorption happening – then you’ll see the rates start to tighten. So that’s what we’re looking for.

I think there are still a couple of progs that were built still have some vacancies. But short-term, it’s going to be good. Long-term, it’s going to be better than good. That’s my hope. That’s my view.

Great. Thank you, guys.

Thank you.

Thank you. At this time, I would like to turn the call back over to Mr. Ernest Rady, Chairman, for any closing remarks.

Again, thank you all. We’re really proud of the folks who work at American Assets Trust, and the great job they’ve done. We’re really dismayed at what’s happened to the stock price of American Assets Trust, and all our colleagues in the space. It doesn’t affect what we do on an operational basis, so we have to just put our head down and do the best we can with what we have. We think we are quick to do that. As we said earlier, our retail is up; our apartments are well positioned and on the trend up; and I think our office has significant upside. So again, we’re delighted with his portfolio. We’re happy to work at it, and produce the most we can for our stockholders now and in the future. Thank you all for your interest.

Ladies and gentlemen, thank you for participating in today’s conference. This does conclude your program. You may all disconnect. Everyone, have a great day.