Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)  

Alexandria Real Estate Equities, Inc. (NYSE:ARE)

Q4 2007 Earnings Call

February 12, 2008, 11:00 am ET

Executives

Rhonda Chiger

Joel S. Marcus – Chief Executive Officer

James H. Richardson - President

Dean A. Shigenaga – Chief Financial Officer, Vice President

Peter J. Nelson – Secretary, Senior Advisory Consultant

Analysts

Steve Sakwa – Merrill Lynch

Anthony Paolone – J. P. Morgan

Michael Bilerman – Citigroup

Irwin Gusman – Citigroup

Philip Martin – Cantor Fitzgerald

Operator

Please stand by. We are about to begin.

Good day and welcome, everyone, to the Alexandria Real Estate Equities’ fourth quarter 2007 conference call. Today’s call is being recorded. At this time for opening remarks and introductions I’d like to turn the call over to Rhonda Chiger. Please go ahead, Ma’am.

Rhonda Chiger

Good morning and thank you for joining us today. This conference call contains forward-looking statements, including earnings guidance within the meaning of the federal securities laws. Actual results may differ materially from those projected in the forward-looking statements. Additional information concerning factors that could cause actual results to differ materially from those in the forward-looking statements is contained in our annual report on Form 10K and other periodic reports filed with the Securities and Exchange Commission.

And now I would like to turn the call over to Joel Marcus. Please go ahead.

Joel S. Marcus

Thanks, Rhonda. Welcome, everybody. With me today are Jim Richardson, Dean Shigenaga, and Pete Nelson. I’m going to skip my macro comments on the broad life science industry and try to get right into the meat of the presentation.

Starting with earnings guidance and dividend policy, we’re pleased with a truly stellar operating performance for the company in 2007 given, obviously, the macro-economic environment, the residential real estate sub-prime prices, the broad debt crisis, creeping inflation, the economic slow-down, and what now appears to be a recessionary bear stock market.

Our total return performance of over 711% from the IPO through the 12/31/07 is among the best in the REIT universe and we’re very, very honoured and pleased about that. We’re also pleased about our total positive return performance in 2007 of over 4% when REITs were down approximately 20%.

Similar to 1998 when we were one of the few companies to post positive return, Dean will talk about our unbroken streak of positive same-store results quarterly and our positive GAAP rental rate increases on an annual basis. We’re enormously proud of these accomplishments and I think we believe and have continued to believe that ARE is a safe haven for all investor styles with our really unique business model and multiple platforms for growth, continuing high operating margins, excellent collectability of rents, no bad debts, strong tenant base with substantial credit, a well-diversified tenant base within the broad life science sector, and, I think, AAA quality buildings and AAA quality locations in the best diversified coastal sub-markets, and now with increasingly international exposure.

Our FFO increased 9% in the fourth quarter and overall about 10% last year. I wanted to get to initial guidance right away. I would consider this initial guidance in light of the deteriorating macro situation, as I said, the creeping inflation which is worrisome in the bear market. Our initial guidance is cautious, but we feel very comfortable for 2008 guiding at $6.10 per share diluted, which is approximately 7% growth over 2007 and when combined with our dividend we feel is a good benchmark.

As you can see from the press release and the supplemental, we have sold numerous outfits since the beginning of ’07 in excess of $136 million and over 500,000 rentable square feet at a nice net gain and obviously to be re-invested in our very accreted redevelopment pipeline, which should begin yielding strong cash flows in ’09, ’10 and ’11.

As such, our initial guidance for ’08 also contemplates a continuing string of opportunistic and also significant sales of assets. Our strategic objective is to be aggressive in future sales of assets shrinking the asset base a bit for gains, but recycling that precious capital into our future value add programs, as well as obviously to finance our international expansion.

I think we’re very fortunate that we are one of the very few REITs that can almost double our asset base from our crown jewel development pipeline we have in hand today. So we look for significant future earnings growth in the ’09, ’10, and ’11 years driven by, in particular, Mission Bay, which both myself and Jim will talk about, Cambridge, East River, and International.

On the dividend policy, as you see from the press release, the board increased the dividend about 5.4% this past year. We would consider the board to consider similar increases in ’08 given our one of the lowest debt ratios in the entire universe.

On the operating statistics it was a very successful year by all measures, both operationally and financially. Again, strong, consistent, reliable, and predictable.

Overall occupancy has maintained itself in a very stable fashion. We’ll talk a little bit more about that. There has been a small slide quarter to quarter, but that’s due primarily to a significant acquisition because of development land where we had to buy an office building that’s about 25% vacant. Remember, when you see the occupancy statistics they are not rent weighted.

We had a strong leasing quarter. Jim’s going to detail that. We had 12.4% the full year at 9-8 and a million-five leased, which is again very, very good.

Dean will detail same-store. Again, strong at 3.5 and 3-7 for the year. We delivered timely, on time, on budget, a little over 250,000 square feet this year out of the redevelopment pipeline with our usual strong yields. We delivered our flagship building at Mission Bay on time and on budget with strong yields on cost and the first silver LEED certified core and shell lab and office building to Genentech in California. We’ve continued to expand our crown jewel development pipeline by over 2 million square feet this year and initiated four new projects.

I want to talk a little bit about Mission Bay, and Jim’s going to talk as well. We initiated the second building and we have a 50,000 square foot anchor tenant. I think because of very strong demand it is likely we will kick off potentially two more buildings with anchor tenants this year. Again, Jim will highlight that a little bit more detail.

In South San Francisco we’re making good progress on the construction side of the two buildings we’re building on the water next to Genentech; 162,000 square feet and in discussions with our possible first tenant. The 135,000-square-foot building in the heart of the South San Francisco corridor where we signed an anchor tenant for 65,000 square feet, they have the right to take the balance of the building during this year and we’re hoping that is the case.

In South China we kicked off two buildings under construction near Macau. Our anchor joint venture tenant for about 50,000 square feet. The balance will be delivered in kind of a tex-flex fashion. Core and shell with, we’re working on our leasing team and we hope that will be producing income starting in ’09. Our tenant fit out is, well, the core and shell is moving forward very quickly and we’ll start our tenant fit out pretty soon. We’re likely to start another Mission Bay-like project in China this year with our first two buildings coming out of the ground potentially by year end at another AAA location.

In Seattle we kicked off our first building – again, Jim will talk about this – in the Lake Union area. We think we have the best available product in the market when it comes on line.

A bit about East River. We hope to begin delivery of space right around Valentine’s Day of ’10 and thereafter. The second building will be about six to nine months behind. We’ve kicked off this unique and pioneering effort in New York City. This past year we’re hiring for completion of our internal leasing team is underway and we hope to finalize the contract with our external leasing team by the end of March.

The large institutional prospective tenant for about 150,000 square feet of the 400,000-square-foot west tower has advised us that we’ll know more the end of February. So we’ll see what happens in our next quarterly call. But we are working on preliminary stages of numerous size requirements for the East Tower office and office-lab for about, well, the total tower being 300,000 square feet and I think we have reasonably good preliminary interest. No leases to announce at this point. Again, our formal marketing and leasing launch will be in the second quarter and we’re continuing our joint venture discussions with the minority partner, which we’re likely to conclude this year.

Status of other international development matters. Edinburgh, we’re in the final stages of due diligence for the purchase of a number of lots. We will probably start our first building there and sometime probably in the first quarter of ’09. In Bangalore we’re working through preliminary due diligence, contract negotiations, and site work for up to 8 million square feet and potentially could kick off small early part of that development later in the year.

Continental Europe, as I reported last time, we’re working through the final stages of due diligence and negotiation regarding a modest investment and a joint venture and a key cluster location on the continent, a city-centre location.

Jim will highlight acquisitions and dispositions, but we anticipate being very active on the asset sales side and not really on the acquisitions side. And just begin to note the one significant acquisition in the Cambridge market was made in order to complete our land aggregation in East Cambridge as opposed to buying a stabilized income-producing asset.

Finally, moving on, well, two items: the balance sheet and the capital plan, which Dean will detail, but we ended the quarter and the year with a continued strong and flexible balance sheet. We’re well advanced in resolving the debt maturities in ’08 and ’09, as Dean will highlight.

And then finally, we continue to build value and future cash flow. The key acquisition in Cambridge was necessitated by the need for a critical development parcel which completes our significant East Cambridge acquisition. As I said, this was not an acquisition for existing lab product. The building we acquired was 74% occupied and all office.

Significant new short-term development at Mission Bay, again, Jim will highlight. And international acquisitions in progress, which will bring our potential international development pipeline to something north of 12 million square feet, but we’re obviously very mindful in our capital plan to be very disciplined about how we commit capital over the coming two years, assuming the capital markets will be closed.

I think finally we’re well positioned in this downturn and we feel good about our position at year end and our go-forward game plan for 2008.

I’d like to turn comments over to Dean Shigenaga.

Dean A. Shigenaga

Thanks, Joel. Again, our results for the fourth quarter and year ended December 31, 2007, reflect the strength of our unique road map for growth in our continued ability to execute and deliver consistent and predictable results period after period.

The fourth quarter of 2007 represents our 42nd consecutive quarter in growth in FFO per share diluted; excluding D42 charges our 42nd consecutive quarter of positive same-property growth on a GAAP basis, and our 10th full calendar year with positive leasing activity.

As Joel had highlighted, our fourth quarter FFO per share diluted results were $1.46, up 9% over the fourth quarter of ’06.

Let me quickly cover a few important items starting with our guidance for 2008, then our balance sheet, then our 2008 capital plan, and then I’ll cover our solid fundamental operating results.

First with our guidance. Our guidance for 2008 was based on various assumptions and is reflective of the ongoing strength of our core operations balanced by our cautious tone on the overall macro-environment. Our cautious view of the volatility in interest rates, including LIBOR in the forward-LIBOR curve, and the impact of asset sales since January 1 of 2007 through this month.

As I’ll highlight shortly, our unique (inaudible) for growth continues to generate insistent and predictable operating results, which is a key component to our guidance for 2008. From our solid leasing activity year after year to positive same-property performance quarter after quarter, to our solid quadruple net lease structure that provides for the recovery of the majority of our off-backs and major cap-backs, to our unique ability to underwrite the life science industry and client tenants. These key attributes have proven to be an important component to our strong and consistent operating performance and will provide for a solid base for our growth into ’08, ’09, and 2010.

We have also witnessed a unique interest rate environment recently with significant amount of volatility with movement both up and down in treasuries and LIBOR in 2007, and more significant volatility in the short period to date in 2008. As a result, we remain cautious about the interest rate environment over the next 12 to 24 months.

In addition, our asset sales in 2007, sales-to-date in 2008, and future opportunistic asset sales will have a dilutive impact on FFO per share. Since January 1 of 2007 we have completed the sale of primarily non-core income-producing assets aggregating over 500,000 square feet and a few land parcels with an aggregate sale price of $136 million. The net proceeds from these sales were used to reduce the outstanding borrowings under our revolving credit facility.

Again, the majority of these assets were non-core assets generally with solid yields due to our low cost basis. However, due to the declining borrowing cost on our credit facility these sales will have a dilutive impact on FFO in 2008. More importantly, the net proceeds from the sales will be re-invested into our value-add redevelopment and development programs and will yield much higher returns.

Our initial guidance assumes minimal acquisitions and a continuing program to opportunistically sell non-core assets. G&A is projected in 2008 to be in the approximately 7% to 8% range of total revenues.

Our guidance is based on various assumptions, including the key points I just summarized and is $6.10 for FFO per share diluted and $3.27 for earnings per share diluted. Although we are not providing guidance at this time for 2009, 2010, or 2011, we feel good about the overall growth going forward given our redevelopment and development programs and solid and consistent quarter-to-quarter same-property performance and positive year-to-year leasing activity.

Moving next to our balance sheet, as of year-end we had approximately $1.1 billion outstanding under our $1.9 billion unsecured term and revolving facilities. Our debt to total market cap was approximately 45.1% and our un-hedged variable-rate debt was approximately 23% of total debt. Consistent with our ongoing policy to mitigate our risk to variable interest rates, we will continue to evaluate opportunities to execute additional interest rate swap agreements to extend contracts that are ending in 2009 and thereafter.

Moving next to our capital plan, we have been and continue to be good and disciplined stewards of our precious capital. Our capital plan going forward will continue to include a variety of sources of capital, particularly including any opportunistic sales of non-core assets.

As noted in prior calls, our $1.9 billion unsecured credit facility contains unique features that provide borrowing capacity for non-income producing assets like our land, our embedded development pipeline, and our active ground-up development projects. We believe our credit facilities provide important capital for our business as we continue to focus on strategic value-add developments.

A significant capital need is our East River Science Park project development in New York City. As we noted in prior calls and as Joel just highlighted, our goal is to bring in a minority partner. We will also be seeking project financing for this project.

In December of 2007 we completed a non-recourse pre-construction loan for this 4A development project and along with medical submarket of Boston. We really believe this is a positive sign in this challenging capital environment.

We continue to work with various lenders on our debt maturities in 2008 and in 2009. We have four loans maturing in the current year. The largest maturity of $76 million is due in October of 2007 and we are close on a term sheet for this refinancing. The second largest loan totalling approximately $34 million was paid off in January and a third loan approximately $32 million is at the very early stage of refinancing with a life company as our target lender.

We are also focused on our 2009 debt maturities and anticipate certain refinancing opportunities in late 2008 and early 2009, ahead of constructural maturities. Combining the loan maturities in 2008 and 2009, plus two other key loans under discussion with life companies, we have an estimated total opportunity to generate proceeds of up to $200 million in excess of current loan balances.

Our run-rate for construction related redevelopment and development items was approximately $90 million for the fourth quarter. Again, our capital plan going forward will continue to include a variety of sources of capital, including opportunistic sales of non-core assets, joint venture opportunities, project financing, and secured debt from life companies.

Moving next to certain important stats reflecting our strong fourth quarter performance, same-property results continue to be positive quarter after quarter for 42 consecutive quarters and we’re 3.5% on a GAAP basis and 9.7% on a cash basis with increases in same-property results driven by both increases in rental rates and occupancy.

A couple of items driving our cash same-property performance for the quarter included free rent in 2006 related to a couple of leases we acquired from MIT in the Tech Square transaction and a few larger rent steps in 2007 in a few leases. Same-property occupancy was solid at approximately 95.8% at year end.

Our policy has been to exclude 100% of properties under partial or full redevelopment from our same-property statistics. We believe this methodology is appropriate in order to prevent significant increases in same-property performance as a result of redevelopment activities.

Our leases contain key provisions that contribute to our strong and consistent operating results quarter after quarter. As of quarter end approximately 88% of our leases were triple-net leases and an additional 9% of our leases require our tenants to pay the majority of operating expenses.

Guidance for growth and same-property performance for 2008 remains in the 3% to 4% range on a GAAP basis. We continue to expect increases in same-property rental rates to be the primary driver of same-property performance while we also expect same-property growth through an increase in occupancy.

Next let me briefly cover a few key operating stats. Occupancy for our operating asset base was solid at 93.8% as of yearend. Our year-end occupancy was slightly impacted by approximately 58,000 square feet of vacant office space related to a property we acquired in Cambridge in the fourth quarter that had both an operating and a future development component. Occupancy as of yearend without this office vacancy would have been about 94.3%, really reflecting an increase in occupancy in both eastern mass and our total operating base, asset base, as compared to both the third quarter of ’07 and the fourth quarter of ’06. We continue to forecast an opportunity to grow internally through an increase in overall occupancy through 2008.

As mentioned in prior calls, certain assets – including a significant portion of our fourth quarter acquisitions – consisted of office vacancy and indebted developable square feet that contains space for future redevelopment and currently, as I mentioned, contains vacancy. These spaces have a negative impact on our overall occupancy stats, our operating margins, and operating results, but clearly provide for future growth through our value-add redevelopment program. These assets will also have an impact on operations until we complete our redevelopment.

With that said, margins continue to remain very solid at approximately 75% for 2007. Going forward on a prospective basis we are projecting margins to be in the 74% to 77% range. Straight line rent adjustments for the quarter were approximately $4.6 million. Going forward, a good run rate is about $4 million per quarter.

Capitalization of interest for the quarter was approximately $16.6 million and really reflects our ongoing efforts with our important value-add development and redevelopment projects, including our strategic effort to move along preconstruction activities for our indebted future developable square footage. The increase in capitalized interest over the prior quarter is primarily due to a significant increase in construction activities related to our ground-up development projects, including the East River Science Park and preconstruction activities related to projects in Cambridge.

With that, I’ll turn the call over to Jim.

James H. Richardson

Thanks, Dean. I’ll start with some brief comments on the overall health of our markets. The conditions in our core markets continue to be generally strong and are trending positively. Vacancy rates are low and continue to move incrementally downward as new supply remains very modest. Threats to supply shock appear to be very nominal, as well, absent, obviously, a major farm restructuring or a merger. New development opportunities are really limited in these core locations.

Tenant demand is very diverse and fairly robust. Much of ’07 and a current activity thus far is in the 5,000 to 30,000 square foot range. Each of the markets do have larger requirements in the 100,000-square-foot-plus range and with the limited opportunities in the Class A sector we expect a number of these transactions to land in 2008.

Rents are also expected to continually and generally rise on an incremental basis and are either stable or increasing in every one of our core submarkets.

User activity has also continued to increased in the academic, institutional, and governmental realms of our client base. There is a continued migration of technology companies to the brain trust cluster locations. A recent substantial commitment to the South Lake Union area by both Amazon and Microsoft are great examples of this phenomenon.

Values remain high with very few land opportunities in these core markets subtracting substantial interest and pricing power.

I guess finally, kind of a broader comment, the market conditions in the Class A or high-end tech space sectors in our core markets have really seemed to maintain their relative strength, although transaction velocity appears to have slowed on both the leasing and sales side.

Turning to leasing performance in the fourth quarter, this, as highlighted by both Joel and Dean, represented a continuation of our very consistent solid activity with 433,000 square feet of new leases at 12.4% mark-to market rental rate increases consistent with our impressive performance on a quarter-by-quarter and year-to-year basis.

Consistent with my previous remarks, the diversity of users, intermediate size, these markets in our premier locations and the diversity of the offerings provides the opportunity for this consistent performance. The transaction size ranged between 10,000 and 20,000 square feet. We had 10 transactions in the quarter. And in the smaller segment of 4,000 to 10,000 square feet we had another 10 transactions, again exhibiting the diversity of the activity that we’ve been experiencing.

It was also reasonably well distributed across the country with about 57% of the transactions occurring on the east coast and the remainder on the west coast. As well as in our core regions, Massachusetts, Maryland, and the San Francisco Bay area comprised about 82% of the transactions in the fourth quarter.

Just a quick footnote; the average lease term for the 200,000 square feet of new and renewal leases was lower than our typical rate at 2.8 years, which was primarily the result of a large short-term renewal for a user that is in the process of programming its longer term requirements. Overall for the quarter the average lease term was nearly six years.

So in all, the fourth quarter closed out another very strong year of leasing activity and achievements characterized by nearly 1.6 million square feet of total leasing activity, mark-to-market increases at the top end of our projected range of 10%, very balanced activity with about a 55:45 ratio between leases on new space versus redevelopment and development project, a 60:40 ratio between east and west coast leasing, and very good distribution among all the regions with Maryland performing particularly well with nearly 30% of the activity. And the result was occupancy on a year-over-year basis increasing by 70 basis points with strong gains in San Diego, the Bay area, the Southeast region, and Seattle.

We had a decrease in occupancy in Maryland year over year which was due to the addition of a single-user building within our Shady Grove Life Science Centre complex, but we’ve had good and varied activity on that building and expect to have it committed in ’08. And both Joel and Dean have commented about the newest acquisition in Massachusetts and the impact of the existing vacancy on the decrease in occupancy there.

So besides significant volatility in the capital markets in ’07 our performance quarter to quarter continued to exhibit the extraordinarily unique operating model and value proposition. As we enter into ’08 we anticipate and are confident that the consistency that we have demonstrated in the past three years in particular will continue.

As we talk about ’08 we’ve got 846,000 square feet that is rolling over, currently scheduled to roll over with the Barrie and Massachusetts each representing about a third of that space. As we project out and look today, about 60% of that inventory is leased or in late-stage negotiations. The remainder, about 15% of that total, is from one asset in South San Francisco that will ultimately go into redevelopment leaving about 30% at this stage unresolved. Again, we project gains on roll over ranging between 5% and 10% for calendar year ’08.

Let me turn to Mission Bay. As we talked last quarter, 1700 Owens has been extraordinarily successful. We’re now at approximately 96% leased and/or committed. We have kicked off development on 1500 Owens and, as Joel mentioned, we’ve got an executed LOI for about 40% of the building and have good substantial interest on the remainder. And we’re well advanced in discussions with several large institutional users for significant portions of the additional four buildings that are most advanced in our pipeline. As a reminder from last quarter’s call, these four buildings will allow for approximately 900,000 square feet of additional space.

The recent expansion of our target market in Mission Bay has really been well received in the broad technology community for the reasons that we had originally projected, which include the lack of high quality, large campus environments in the Bay are generally. The proximity of a highly educated technical labour base, the accessibility via both public transportation and a robust freeway system, the 24/7 live-work community preferences that have really evolved up in the Bay area, and then very importantly and obviously, the proximity to premier academic research engine, which is UCSF. So while certainly much work lies ahead, Mission Bay is really beginning to take shape, as we had hoped at the outset of our investment in this premier cluster location.

I’m going to talk a little bit about development, although Joel hit many of these items already. In addition to the activity at Mission Bay we have initiated a new development project in Seattle in the fourth quarter. This is in the midst of our East Lake neighbourhood of operating assets and it really was initiated in response to the significant growth of our tenant base and the dearth of alternatives in the broad South Lake Union Market area. The project is 100,000-plus square feet and we are in discussions and negotiations with several large users comprising more demand currently than the building could accommodate. So in the context of the aforementioned current volatile capital market environment, we initiated this project in response to real and substantial demand and are highly confident that we will do a substantial level of releasing.

On the acquisitions side I want to highlight two in the fourth quarter. The first is the one that has been mentioned, the 370,000 square foot historic office building with a variety of office and technology users. Upon acquisition it was about 74% occupied. It has the adjacent land parcel that can accommodate nearly 400,000 square feet of new development and is a part of our larger project in Cambridge. We’re in the process of redeveloping parts of the new building to optimize its positioning for future tech-related and office/lab requirements.

We also acquired a joint venture interest in a property in the Longwood Medical area of Boston with $70 million in costs through a $62 million acquisition loan. We’re in the middle of the design entitlement process for the project which ultimately should include about 350,000 square feet. We’ve had substantial preliminary tenant interest in this market, which is the densest institutional clinical research and academic submarket in the country. Our objective is to commence construction in the fourth quarter o this year with shell completion and tenant occupancy targeted for late 2011.

So consistent with all of our major external growth initiatives, each of these projects we believe are in the best science and technology submarkets in the country.

We made great progress on the disposition side of non-core assets in our various regions. Our objective, just to remind listeners in these transactions is to reduce leasing exposure, capture embedded gains, enhance our balance sheet flexibility, and importantly, to match fund franchise enhancing opportunities.

In ’07 we concluded the disposition of a variety of buildings and land parcels totalling $73 million and subsequently an additional four properties in the first quarter this year at $63.5 million. These assets in the first quarter included buildings in San Diego and the East Bay market of the Bay area. We had determined that the East Bay submarket no longer fits our franchise growth profile and are pleased with the financial outcome of these sales given the turbulent capital markets.

We will continue to consider in advance additional non-core sales. Thus far we haven’t observed a substantial diminution of value in these non-core transactions. In the event that dynamic changes either broadly or relative to specific assets we will defer appropriately.

So just quickly in conclusion, fourth quarter concluded a very active and successful year for ARE further distinguishing ourselves as a premier global developer and operator in this niche. We increased the operating portfolio by 12%, the land bank by nearly 15%, and our scope of operations in two new countries while at the same time have continued a very disciplined focus on creating best of class operating platform and extraordinary, experienced people.

With that, I think we’re ready to go to questions.

Joel S. Marcus

To the operator for Q&A, please.

Question-and-Answer Session

Operator

Thank you, Sir. (Operator Instructions). And we’ll go to Steve Sakwa with Merrill Lynch.

Steve Sakwa – Merrill Lynch

Good morning. I just want to circle back on the disposition question just to make sure I understand it. You sold $136 million since the beginning of ’07 and it sounds like 64, so that was in 1Q ’08. Does your guidance of 210 assume additional acquisitions and, if so, can you just give us kind of a range of what you think that dollar figure may be this year?

Joel S. Marcus

Steve, could you clarify that? There was some static when you asked your question whether it was acquisitions or dispositions that you referred.

Steve Sakwa – Merrill Lynch

Sorry. On the disposition front. You said you sold $136 million since the beginning of 2007, some of which occurred in the beginning part of ’08. I’m just trying to figure out whether your expectations of 610 include further dispositions to be on the $64 million.

Joel S. Marcus

Yeah. The answer is absolutely yes. I’m not sure we can easily quantify that for you, especially given some of the accounting rules related to assets held for sale. So I’m not sure I want to give precise numbers, but I would say it is significant.

Steve Sakwa – Merrill Lynch

Okay.

Joel S. Marcus

So the answer is yes.

Steve Sakwa – Merrill Lynch

Okay. And then maybe just talk a little bit more about kind of what you’re hearing from tenants just in terms of the decision-making process, Joel. It sounds like maybe in some cases things are taking a bit longer or at least we’re hearing that in other sectors. What is your experience in dealing with folks trying to commit the space and if they are pushing out maybe just give us a little bit of colour there?

Joel S. Marcus

Well, let me give you a couple of my impressions and ask Jim to maybe give you maybe more specific ones. I think we’re still seeing pretty good velocity and decision making and transactions regarding, I would say, more institutional-type users, but I would say the smaller size tenants probably have taken a little bit more time. But I would say fundamentally we haven’t seen a significant shift in slow down. But I think there is clearly a focus on cost issues given the macro markets that Jim can highlight more in-depth.

James H. Richardson

Yeah, I think that’s right. I think, Steve, as I look back at our stats over the last several years it’s been strikingly stable how consistently we’ve done these leasing transactions in the size range I’ve described. I would say that there really hasn’t been a significant slow down there. There’s a steady state of those transactions. We have the right kinds of spaces and the right locations for those tenants and so I haven’t seen a dramatic slow down there.

I think on the larger tenant front Joel’s exactly right. Cost is a key consideration. The flip side is that there are few legitimate Class A opportunities where these tenants want to be, so all the transactions seem to be taking longer. They’re not evaporating and ultimately, as I indicated in my remarks, I think they’re going to be done and I think you’ll see a number of large institutional transactions done this year in our markets by us as well as others.

Steve Sakwa – Merrill Lynch

Okay. And then if I can just ask one final question of Dean. Can you just maybe in summary format walk through the exact capital needs this year and the sources? If you could just put them in buckets given the large development and redevelopment pipeline you’ve got. If you can kind of sum it all together.

Dean A. Shigenaga

Yeah, I think one of my comments during the call, Steve, was our fourth quarter run rate on construction spending was approximately $90 million. I think if you had to forecast out into 2008 that that number will grow through the four quarters to slightly above $100 million a quarter.

As far as sources of capital, I think we’ve touched on it in different aspects during the call, but asset sales will continue to provide some important capital for us to recycle into the company. We’ve got our credit facility, which is $1.9 billion, plus a $500 million accordion that will provide important capital. I mentioned loans that we are in the process of refinancing that over the next four quarters looks like we can tap about $200 million of additional equity which is in excess. So proceeds in excess of current loan balances and that will also provide an additional source of capital.

Joel had highlighted our ongoing efforts with joint venture opportunities with New York. And project financing will also play an important source of capital for us.

I think that is the menu that we’re looking at at the moment and we’ll continue to pursue all aspects of that capital plan.

Steve Sakwa – Merrill Lynch

Okay. That’s helpful. Thanks.

Operator

We’ll go to Anthony Paolone with J. P. Morgan.

Anthony Paolone – J. P. Morgan

Thank you. Just following up on what you’re seeing in the environment out there and how that ties into your guidance. Can you put some parameters around – you talked about your 610 being cautious? What do you think are the biggest drivers, either on the up side or down side, to that number as you look at the environment out there?

Joel S. Marcus

Well, I think it’s pretty clear that interest rates could be an important driver and my sense is if inflation starts to ramp up the fed has got to address that in a reversal of its current thinking. So that’s certainly an important factor. I think a dominant factor is asset sales that we’re looking at. I think we’ve had very good success over the past couple of months, especially with stabilized assets. As Jim mentioned, we exited a market that we’ve long been thinking about, but we short kind of an opportune time in the East Bay, we think, which has the possibility to be a little weaker than some of our strong core markets at cap rates we felt were very, very acceptable. So I think the asset sale program and velocity is something that certainly has a material impact on that issue.

And then, I think as Jim said, clearly leasing issues to be a little cautious on the rate of leasing. Not necessarily the success of leasing, but kind of how we are leasing both in roles and on delivery. So I think those are several components that certainly make some sense. But if you look at core growth, we feel very good about the same-store growth, very good about lease role growth, very good about, again, the core operating fundamentals of what the company’s trying to do.

And really, I view 2007 and 2008 as kind of transition years where we are really exiting a number of non-core assets and some non-core submarkets and really putting much more emphasis on capital into critical core locations. For example, Cambridge, Longwood Medical Centre, our international operations, Mission Bay, etcetera. So those are just kind of a potpourri of items.

Anthony Paolone – J. P. Morgan

I mean, it sounds as if variable rate debt or interest rates are a big factor. Can you give us what your LIBOR assumption is in your 610?

Dean A. Shigenaga

Tony, it’s Dean here. As we’ve all witnessed, LIBOR has moved so dramatically in 2008 it’s actually been very surprising for most of us. So we’re not any better honestly at forecasting the curve, so we tend to watch the LIBOR curve that’s forecasted out by others and make some adjustments to that. So we tend to be close to that and from time to time we’ll make different assumptions to soften that impact.

Joel S. Marcus

Yeah, keep in mind that some of our assumptions are based on a, were into a, we believe a, at least the knowledgeable people on the economy believe we’re into a recession. We can’t be so foolish as to believe that can’t help, well, it will clearly impact everybody’s operating assumption. So we’d rather be cautious than overly optimistic.

Anthony Paolone – J. P. Morgan

Okay. In terms of the portfolio in light of substantial dispositions. Can you characterize what portion of the portfolio is kind of in that $200 a square foot roughly price point that seems to be more akin to conventional office versus some of the stuff you’ve bought or have developed in recent years which seems to be double or so that in many instances in terms of per pound pricing?

Joel S. Marcus

Well, that would be hard to do without going building by building. A lot of it really is driven of of market rents so that the markets that have the highest triple net rents in those properties are the ones that drive the highest values. So I’d say generally, whether they’re core or non-core, suburban markets, truly suburban markets have lower valuations. That doesn’t mean that they’re either core or non-core, it’s just the reality of kind of the real estate economics. So yeah, it would be hard to tell you that all of our non-core assets would fall into that pricing range or the converse.

Anthony Paolone – J. P. Morgan

Maybe a different way to think about it then, what about just, say, non-core assets or say assets that are still heavily weighted toward conventional office that you might contemplate selling. What portion of the portfolio is that?

Joel S. Marcus

Well, I wouldn’t think that is significant. I think the sale decision actually relates. Sometimes we may have assets we think are important in somewhat of a more suburban environment, but have made a decision or are thinking, I have to be careful here on discontinued operations accounting, or are thinking of a decision-making tree that would enable us to, say, exit maybe a suburban or non-dense urban market because we feel the future is brighter in the dense urban market than it is in the suburban market as far as future increases in rental rates and valuations. I think that maybe is more the analysis.

As opposed to, I mean, we don’t have a huge number of pure offices. The buildings we sold in the East Bay were by and large all large lab/office buildings. But we’ve looked at the overall submarket as one we felt the timing was right to exit. I think in some of our markets that are not necessarily the ones that we are as highly focused on, like Mission Bay, like East Cambridge, like Longwood Medical Centre. I think we’re more likely to think about alternatives in those markets over the coming quarters than we would have in past, but that doesn’t mean they weren’t historically maybe relatively core, if you follow my kind of thinking.

Anthony Paolone – J. P. Morgan

Okay. And then just last question. I know the China project is fairly small in terms of dollars, but I just want to reconcile. I think in your commentary you mentioned a 40,000-square-foot lease and then the rest of it as being marketed.

Joel S. Marcus

A 50,000-square-foot requirement which may expand, but that’s the current tenant requirement with the joint venture tenant we have. So that’s 50 out 280.

Anthony Paolone – J. P. Morgan

I thought, did something change there? I was under the impression that it was majority committed with only a small amount that you had to go out and market.

Joel S. Marcus

No. No. I don’t think we ever said that. We always had a 50,000-square-foot requirement from our joint venture partner. That could grow over time, but that was the initial situation.

Anthony Paolone – J. P. Morgan

Okay. Thanks.

Joel S. Marcus

You’re welcome. Thank you.

Operator

We’ll go next to Michael Bilerman with Citi.

Michael Bilerman – Citigroup

Good morning. Irwin Gusman (sic) is on the phone with me as well. I want to go back to sort of the guidance question. At 610 it sounds like your interest rate forecast, given with current LIBOR at 3% you have $350 million of hedges that are coming due this year at LIBOR at 50. Then you have $650 million of pure floating rate debt, which obviously just went down 200 basis points. Granted, some of that positively affects cap interest. But I’m trying to understand why, how much higher are you expecting LIBOR to go in your forecast for you to be more cautious on your guidance? I would think this would be a huge boon for your guidance.

Dean A. Shigenaga

Well, actually, Michael, those are good questions. I think if you look at our LIBOR schedule, I’m sorry, our swap schedule in our press release, whatever is burning off in the current year has already been extended with a replacement contract and that does show up in the swap disclosures in our supplemental. So there’s no real benefit anticipated by swaps burning off.

Joel S. Marcus

And in point of fact, there will likely be, as Dean said, additional swaps placed on the un-hedged variable rate portion, which would then limit our exposure either positively or negative to future swings in interest rates.

Michael Bilerman – Citigroup

But what are you assuming in your guidance for LIBOR? What sort of curve are you using for the year? It obviously has a dramatic effect on underlying FFO.

Joel S. Marcus

We’re staying very close to the curve, Michael. I don’t have the curve that’s in our model with me, but we’ve taken the curve and, honestly, and like every company you’ve probably spoken to in this earning season, I think from what we hear from the companies that were providing us the curve, they were getting calls daily trying to figure out where the curve was headed because it was moving significantly through the month of January. And we were monitoring that very closely. So we’ve taken one of the curves that were provided most recently before we finalized our release and have used that as a basis for our model and have adjusted that back just slightly.

Michael Bilerman – Citigroup

Okay. Maybe we can talk a little bit more offline because I’m still a little bit confused as to why it wouldn’t be a big benefit for you given relative to where you were in 2007.

Joel S. Marcus

Well, I think relative year to year there’s been an improvement, but also keep in mind, Michael, that 100% of changes in our borrowing costs do not drop 100% dollar for dollar to the bottom line results as a result of our capitalized interest and our ongoing construction activities. Whether it’s a benefit in interest rates or a detriment to rates, it doesn’t drop one to one to the bottom line.

Michael Bilerman – Citigroup

Right, but it does drop. And I can understand that, but there should be some hiccup that you’re getting.

Joel S. Marcus

Yeah, and I think what we were also highlighting, there is a pick-up in interest rates, but what we also highlighted very carefully was the take away that our asset sales have been diluted to our FFO results for 2008. Or will be diluted for our guidance for 2008.

Michael Bilerman – Citigroup

Well, I guess this, it may circling back on guidance here, 90% of your leases are triple net. You only have 8% rolling this year and 70% of that’s already put away. We’ve had a discussion about interest rates. What else are you being cautious on and what else may have you pulled back for your growth forecast to be lower than your sort of high single-digit, low double-digit growth?

Joel S. Marcus

Well, let me say this. I think that at 610 we’re looking at guiding the street, as we said, initially and cautiously at about 7% core growth. Now what could add to core growth or above core growth would be obviously redevelopment and development, deliveries obviously the impact of leasing. But I think as initial cautious guidance this year in a market that is frankly one that not too many people have seen before, if ever, we thought it’s important to be more cautious than less cautious as our initial guidance here.

So people could second guess should the company be guiding at 8% or 9% in a recessionary year in a bear market. I would argue that I’d rather be at 7% and as the quarters go on and the year matures that we have up side benefit as opposed to down side guidance. So that’s just how our thinking is at a 30,000-foot level.

Michael Bilerman – Citigroup

Right. Joel, who’s the buyer of stabilized lab space assets today and what sort of cap rates are people buying at?

Joel S. Marcus

Yeah, I mean, the example of the East Bay sale was, I think, a cap rate that was in the seven range and it was a very well known, well respected local developer that teamed up with a pension fund and I think we’ve seen that in other locations in that combination. I think similar in San Diego as well. So I think it may be less for the product type, although this particular developer has had some experience with the product type, but I think looking for assets that had good income, there is decent credit there although there are maybe medium term or short to medium term roles that we were not interested in absorbing. I think they felt comfortable and maybe going into the market with that thinking.

Michael Bilerman – Citigroup

Thank you. Irwin has some questions.

Irwin Gusman – Citigroup

Good morning. My question is on the redevelopment pipeline. Could you disclose what percentage of it is pre-leased? Specifically for the part that’s delivering in the next 12 to 18 months.

Joel S. Marcus

I’m not sure I can, I think, I don’t know that we have time to go through each of those.

Irwin Gusman – Citigroup

Well, maybe another way of asking it is it looks like the deliveries of your new redevelopment pipeline are now a little bit more weighted toward 2009 whereas before they were sort of an even split between ’09 and ’08 and I’m wondering if that’s –

Joel S. Marcus

Well that, I think that’s simply because we’ve added a couple that will come through in ’09, but I think by and large, well, Jim can give you some highlight there.

James H. Richardson

Yeah, I think again through ’08 and ’09 we’ve got probably a third of it that we’re negotiating or are committed on and the balance of it is too early to say at this stage.

Irwin Gusman – Citigroup

Okay. And my last question is, you have disclose the $1.1 billion of debt principle that’s been capitalized; can you break that out into the components of land development PIP and redevelopment spent?

James H. Richardson

Well, we would just refer you to the number on the balance sheet, which is kind of an aggregate number and I think that’s what we’d like to just leave it at that.

Irwin Gusman – Citigroup

Okay. Thank you.

James H. Richardson

Thank you.

Operator

We’ll go to Philip Martin with Cantor Fitzgerald.

Philip Martin – Cantor Fitzgerald

Good morning. I just want to talk a little bit about the international portfolio. I mean, obviously you’ve seen some incremental growth over the last 12 to 18 months. I would have to assume tenants and countries must be getting more comfortable with your capabilities, they’re getting more comfortable with you as a company. Is this generating better than expected opportunities for you than you thought?

Joel S. Marcus

Yeah, the answer, Philip, to that question is there are, I guess, the good news and the bad news. The good news is there are more opportunities out there on the horizon. The bad news is there are more opportunities out there on the horizon. So we have to be I think pretty judicious and disciplined about which ones we go after.

We felt Scotland was a big advantage both cost-wise and ultimately yield-wise because there is a significant scientific capability and commercial capability and government investment in the sector and an ability to acquire just absolute AAA location at a very low cost basis. So we felt that was compelling.

The other transaction in Europe we’re looking at is a city-center location where we were actually invited in based on our reputation and brand. So we feel very good about it.

We’ve had dozens of inquiries come to us from multiple locations, many of which we’ve just either turned down or deferred. In Asia, as I say, we’ve been working kind of long and hard on the South China transaction because of our tenant relationships. We’ve been working long and hard for well over a year now on India. It’s just a challenging and difficult process there, but we hope to be successful. And then we have some new opportunities emerging that are significantly in different key locations in China which we believe those two countries contributing one half of the world’s population to be not only huge ultimate consumer markets, but obviously a great demand market.

So we’re trying to be judicious and thoughtful about how we choose our spots and clearly we’re focused on Canada as well.

Philip Martin – Cantor Fitzgerald

Does it sound at some point in the next year or so to have a larger Alexandria presence in terms of an office internationally? Are those in your plans?

Joel S. Marcus

Well, we do. We have an operating office in the ground in South China. We will have an office on the ground in Scotland. We will have an office on the ground in Canada. So I think in locations where we are developing and really have a base of operations as opposed to a passive investment we’ll definitely have a carefully, in the Alexandria-style, you know, efficient overhead kind of operation, but one that is hopefully highly effective. I think Dean has taken account of that when he gave his guidance in G&A of about 7% to 8%. So I think that’s correct.

Philip Martin – Cantor Fitzgerald

Okay. And is a tougher credit and financing market leading at this point to, it doesn’t sound like it right now in your guidance, but do you see it leading to a potential increase in acquisition opportunities in your core markets? Or is the demand from, well, do you see the disruption in the credit markets leading to some better opportunities here for you?

James H. Richardson

Yeah, I don’t know, Phil, if I feel like we’ll see more of them. It’s certainly conceivable if things continue this way that yields will improve to the buyer, so that could in fact, so the spreads basically will improve as there’s less demand for product. I haven’t seen that manifest itself yet at all. The sale that Joel gave a little bit more colour on that we did in the East Bay and San Francisco I think is evidence of that. Kind of a secondary submarket with leases that were relatively short term and the cap rate is down in the 7% range I think shows that there’s still a lot of demand notwithstanding uncertainty in the credit markets. So yeah, in another 12 months or so that will be different, but I haven’t seen a significant shift yet.

Philip Martin – Cantor Fitzgerald

Okay. Okay. And my last question and, Jim, you did explain this pretty well. In terms of leasing in the fourth quarter the average lease term was 2.8 years. That was one larger lease. But you’re not seeing any trend towards shorter leases in this environment here that was just really an exception?

James H. Richardson

Exactly. You could go quarter to quarter, I think you have to look at maybe a longer term horizon to evaluate that in our case because there are unique situations that arise, but that is exactly the right analysis.

Philip Martin – Cantor Fitzgerald

Okay. Okay. Thank you, all.

James H. Richardson

Thank you very much.

Operator

And with no other questions in cue I’d like to turn the call back to Joel Marcus for any additional or closing comments.

Joel S. Marcus

Yeah, we just thank you very much for taking time this morning. We’ll look forward to giving you further updates on our first quarter call in early May. Thanks everybody.

Operator

And that does conclude today’s call. Again, thank you for your participation. Have a good day.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: Alexandria Real Estate Equities, Inc., Q4 2007 Earnings Call Transcript
This Transcript
All Transcripts