Fitch Ratings has affirmed the Long-Term Issuer Default Ratings (IDRs) for American Assets Trust, Inc. (NYSE: AAT) and American Assets Trust L.P. at 'BBB'.

The Rating Outlook is Stable.

The ratings and Outlook reflect Fitch's expectation that the company will return to metrics appropriate for the level within the forecast period, including leverage of approximately 6.0x, fixed charge covered above 2.0x, and 2.0x unencumbered asset coverage. AAT's stabilized office assets continue to generate strong internal growth, and the West Coast-focused portfolio is diversified by asset type, mitigating risks from any one segment or submarket.

Key Rating Drivers

Investment Grade Credit Metrics: Over the forecast period through 2025, Fitch expects REIT leverage (net debt excluding preferred/recurring operating EBITDA) to trend toward 6.0x. The company's long-term leverage policy is 5.5x, compared to 6.8x at 1Q22, and the pace of improvement will depend on the recovery at its mixed-use assets and the successful lease up of developments under construction.

In the long run, Fitch anticipates fixed-charge coverage to remain in the 2.5x range, and as of March 31, 2022, AAT's unencumbered assets (defined as unencumbered NOI divided by a stressed 8% capitalization rate) covered net unsecured debt by 1.9x, metrics which are appropriate for the 'BBB' rating.

Diversified Tenant & Industry Exposures: The company's retail exposure is well-diversified by tenant, with no tenant accounting for more than 1.5% of total annualized base rent (ABR). As of March 31, 2022, the portfolio's two largest retail tenant industry exposures were Lowe's (1.4% of total ABR) and Nordstrom Rack (0.8%). Grocers within its top 10 retail tenants include Sprouts Farmers Market (0.8%), Vons (0.5%), and Safeway (0.4%). AAT's two largest office tenants are Google and LPL Holdings, Inc. comprising 9.6% and 7.2% of total ABR, respectively. These exposures are both concentrated in a single lease with each operator, which are notable concerns from a credit perspective, even as these leases are both relatively long-term (approximately seven to eight years remaining).

AAT's mixed-use property located in Hawaii, Waikiki Beach Walk Retail and Embassy Suites Hotel, has lagged the broader portfolio, given its dependence on local government restrictions and tourism from the APAC region, but has been recovering. Fitch expects operating results should continue to pick up as travel restrictions ease. Strong domestic leisure travel in the US has picked up some of the slack, and increased vaccinations and recovering international tourism should drive continued improvement. Cash NOI at AAT's Hawaii assets was $7.5 million in 1Q22, 86% of 1Q19 levels, up from 55% in 2021.

Asset Concentration Mitigated by Tenant Quality: Fitch generally considers concentration in an individual asset above 10% as high. The company has high individual office/retail asset concentrations, with La Jolla Commons representing 17% of ABR and The Landmark at One Market representing 15% as of 1Q22. Asset concentration risk is mitigated by the strong tenant profile as The Landmark is entirely leased to Google and Autodesk.

West Coast Office Driving Growth: The office segment TTM 1Q22 saw robust new leasing spreads of 13% on a cash basis and 19% on a straight-line basis. Fitch expects same store NOI growth in 2022 in the low-single digits due in particular to strong office leasing activity. AAT also plans to grow NOI from the office segment with the development of One Beach Street in San Francisco and La Jolla Commons in UTC, San Diego, which are expected to stabilize in 2023 and 2024, respectively. Although delivering new office supply may be challenging in the current environment, companies looking for space have generally been more receptive to the newest, high quality assets in good locations.

The broad rollout out of work from home (WFH) since the onset of the pandemic has led to the possibility that demand for office space will not return to prior levels, or could diminish over time. Several prominent tech companies have stated their employees will be allowed additional WFH flexibility, even after the pandemic has subsided. However, it appears that the majority of employers, initially will look to maintain similar square footage footprints as prior to the pandemic; therefore, a hybrid working model will not necessarily reduce demand for office space.

Strong Markets: Fitch views AAT's West Coast markets as having attractive long-term growth dynamics and strong asset liquidity and leveragability. As of 1Q22, the company's core markets in terms of cash NOI include Southern California (46%), Washington (13%) and Northern California, Oregon and Hawaii (12% each).

Derivation Summary

AAT's diversified portfolio of office, retail and multifamily assets focused in U.S. West Coast markets narrows its peer set.

AAT's market exposure lends comparison to a number of property-sector-focused REITs, including shopping center owner Retail Opportunity Investments Corp (BBB/Stable), which owns a portfolio of high-quality grocery anchored shopping centers in several West Coast markets. Hudson Pacific (HPP; BBB-/Stable) is a West Coast owner and operator of class A office assets with a significant concentration in San Francisco. HPP has a financial policy of sustained leverage in the low to mid 6.0x range and a fixed-charge coverage (FCC) in the low to mid 3.0x range.

Vornado Realty Trust (VNO; BBB/Negative) owns and operates a similar property mix but is focused primarily in New York City. AAT's mid-5x long term leverage target and low-2x fixed charge coverage compare well to VNO's high-6x to low-7x leverage and similar fixed charge coverage; however, VNO's stronger, more established capital markets access and the strong contingent liquidity of NYC commercial real estate justify its higher leverage at the same rating. VNO is significantly larger than AAT and has historically enjoyed better capital markets access.

Fitch rates the IDRs of the parent REIT and subsidiary operating partnership on a consolidated basis, using the weak parent/strong subsidiary approach and open access and control factors, based on the entities operating as a single enterprise with strong legal and operational ties. No Country Ceiling or operating environment aspects have an impact on the rating.

Key Assumptions

Fitch's Key Assumptions Within Our Rating Case for the Issuer:

Occupancy growth of 70bps in fiscal 2022, 110bps in 2023, and with 50bps of recovery in 2024-2025;

SSNOI growth in the low-to-mid-single digit range;

Recurring capex returns to normalized range consistent with guidance in fiscal 2022;

Development capex of $84 million in fiscal 2022 and $60 million 2023;

No disposition activity in the forecast period;

Annual dividend of $1.28 in 2022, growing at 3%-4% over forecast period.

RATING SENSITIVITIES

Factors that could, individually or collectively, lead to positive rating action/upgrade:

Fitch's expectation of leverage sustaining below 5.5x;

Fitch's expectation of FCC sustaining above 3.0x;

Continued access to the unsecured debt markets, in particular execution of public unsecured debt offerings consistent with higher-rated peers.

Factors that could, individually or collectively, lead to negative rating action/downgrade:

Fitch's expectation of leverage sustaining above 6.5x;

Fitch's expectation of FCC sustaining below 2.0x.

Best/Worst Case Rating Scenario

International scale credit ratings of Non-Financial Corporate issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of four notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from 'AAA' to 'D'. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit https://www.fitchratings.com/site/re/10111579.

Liquidity and Debt Structure

Adequate Liquidity: Fitch estimates AAT's base case liquidity coverage at 1.2x through YE 2023, which is adequate for the rating. Liquidity coverage improves to 1.4x if the company were to refinance 80% of its secured maturities.

Fitch defines liquidity coverage as sources of liquidity divided by uses of liquidity. Sources include unrestricted cash, availability under unsecured revolving credit facilities and retained cash flow from operating activities after dividends. Uses include pro rata debt maturities, expected recurring capex and forecast (re)development costs.

Issuer Profile

American Assets Trust, Inc. real estate investment trust, whose core markets include San Diego; the San Francisco Bay Area; Portland, Oregon; Bellevue, Washington; and Oahu, Hawaii. As of March 31, 2022, the company's portfolio was comprised of twelve retail shopping centers; twelve office properties; a mixed-use property consisting of a 369-room all-suite hotel and a retail shopping center; and six multifamily properties.

REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING

The principal sources of information used in the analysis are described in the Applicable Criteria.

ESG Considerations

Unless otherwise disclosed in this section, the highest level of ESG credit relevance is a score of '3'. This means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity. For more information on Fitch's ESG Relevance Scores, visit www.fitchratings.com/esg.

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