Alexandria Real Estate: Thanks To The Bears, I'm Buying Shares

Summary

  • Let’s look at Alexandria Real Estate, an office REIT with over 25 years under its belt. Its focus is on A-class science and tech properties.
  • ARE has an interesting portfolio and client mix. And above all, it’s one of only three REITs with a 100 iREIT quality score.
  • We’ll explore why that is and why, at the right price, you should consider buying Alexandria Real Estate.
  • Looking for a portfolio of ideas like this one? Members of iREIT on Alpha get exclusive access to our model portfolio. Learn More »

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This article was coproduced with Wolf Report.

Let’s start out with a quote from Benjamin Graham (emphasis added):

“The intelligent investor realizes that stocks become more risky, not less, as their prices rise – and less risky, not more, as their prices fall. The intelligent investor dreads a bull market, since it makes stocks more costly to buy.

“And conversely (so long as you keep enough cash on hand to meet your spending needs), you should welcome a bear market, since it puts stocks back on sale.”

With that established, let’s discuss office real estate investment trusts ((REITs)).

Admittedly, that space is a complex segment, especially with the current macro we're moving deeper and deeper into. Uncertainty about where we're going exactly, how, and why is high.

As such, investors need to be very clear as to what we're investing in.

You may recall an article iREIT published last week titled "REITs to the Rescue," which explained how:

"... office REITs are in somewhat of a tug-of-war. So we want to focus on the highest-quality, best-situated assets outperforming… Those with the best balance sheets, modest floating-rate debt, and well-laddered maturities."

Included in our top office sector picks at the time was Alexandria Real Estate Equities, Inc. (NYSE:ARE). Today, we want to do a deeper dive on why it’s an outlier worth considering.

Top office sector REIT picks

(iREIT on Alpha)

Alexandria Real Estate – An Outlier!

Alexandria Real Estate started out with a fairly unique vision, choosing to only serve clients in the life-science industry.

It was established and listed 28 years ago and, today, its market capitalization is over $24 billion. Also worth pointing out is how it's a member of the S&P500… and how it has a BBB+ S&P Global credit rating and a Baa1 from Moody's.

Alexandria Real Estate Overview

(ARE Investor Presentation)

Admittedly, its yield is only around 3.2% after a two-month drop. Moreover, even 3.2% is well above what it usually offers.

Those who know their REITs immediately recognize that’s not the most attractive amount ever. Yet it’s not the lowest, either.

Alexandria Real Estate and peers dividend yield

(iREIT)

So let’s explore exactly why…

ARE earns annual revenues of around $2.1 billion. Its earnings before interest, taxes, depreciation, and amortization (EBITDA) are $1.34 billion. And its interest expenses are around $142 million.

As such, ARE has EBITDA-based interest-rate coverage of 9.4x and a fixed-charge coverage of 3.1x. Net debt/EBITDA, meanwhile, stood at around 6.3x for 2021.

In addition, higher yields automatically trigger assumptions of risk, with good reason. Lower yields do the opposite… which is very justified, as we can easily see.

Alexandria Real Estate social responsibility

(ARE Investor Presentation)

Among U.S. REITs, it’s among the top 10% in total equity capitalization. This helps it borrow at a blended interest rate of 2.51%...

Which even the latest macro hasn't done much to increase on average even though its main markets are:

  • Boston – 35%
  • San Francisco – 25%
  • San Diego – 16%
  • Seattle – 6%
  • Maryland – 6%

All put together, ARE has 426 properties with a gross leasable area of 47.4 million square feet. Occupancy was 94.7% as of the latest quarter with renters like:

  • Bristol Myers Squibb (BMY)
  • Moderna (MRNA)
  • Eli Lilly (LLY)
  • Sanofi (SNY)
  • Takeda Pharma (TAK)

These are some extremely strong companies that aren't going anywhere.

More Money-Making Facts About ARE

The tenants above – which are mostly A graded or better, mind you – are all part of Alexandria’s top annualized base renters list. Yet even all put together, they represent less than 15% of total ABR.

Alexandria Real Estate credit rating

(ARE Investor Presentation)

That’s a good thing, showing that Alexandria has "doubled down" on safety.

Like we said earlier, it began by focusing only on life science and tech… then tightened its standards further by leasing significant amounts to only the best in the business – yet in such a way that its top tenant, BMY, represents less than 3.6% of its total ABR.

And ARE’s latest quarterly report goes a long way to ensure that this safety continues. The REIT saw renewal rent spreads increase 16.5% year-over-year for 864,000 square feet, and same-property net operating income (NOI) increase 7.6% on a GAAP basis.

Meanwhile, core funds from operations (FFO) was up 7.4% YoY. And the company’s ongoing development pipeline is more than half-finished going into this new environment.

ARE also managed to issue $1.8 billion worth of senior unsecured notes with a due date in 2023-2025 – before most of its macro and interest issues.

Alexandria Real Estate annual rental revenue

(ARE Investor Presentation)

Based on a Q1-22 run rate, annual 2022 revenue should come in at $300 million above 2021, at revenues of close to $2.5B, with EBITDA of above $1.55B. This would imply an EBITDA/interest coverage of 13.3x and a fixed charge coverage of up to 3.5x.

It would also decrease leverage down to the 6x mark. That and mark down the AFFO payout ratio to close to 75%.

This should give ample room to increase the company's conservative dividend.

Overall, ARE has executed very strongly on leasing, development, and its pipeline… leading to very good visibility for future growth.

Our Attraction Grows

ARE owns and develops some of the most attractive properties in this entire sector… in the entire nation... and around the globe.

Just take Alexandria Point as an example. It involves the second-largest lease in the company's history and deepens its relationship with BMY in San Diego.

Alexandria Real Estate - iconic development at Alexandria point

(ARE Investor Presentation)

ARE has proven its ability at managing its portfolio in general for its 28 years. That’s how, in 2021, ARE's annual leasing volume was twice that of pre-pandemic levels and therefore their absolute highest ever.

Quarterly leasing for Q4-21 alone was nearly annual levels of preceding years. And the company also completed its largest acquisition ever in the Alexandria Center for Life Science – as part of its upcoming Fenway Mega Campus – for around $1.5 billion.

Naturally, this has spurred some truly unprecedented levels of growth. ARE still has 4.8 million square feet of leasable space under construction, with 2.6 million square feet expected to be finished in the next six quarters or so.

The pre-lease on these square feet, either leased or in negotiation, is already close to 90%. So we’re looking at even further confirmation of ARE’s near-and-mid-term upside, with incremental annual rental revenue increases of $610 million.

The REIT had an industry-leading adjusted EBITDA margin of 72% in 2021. And it continues to make improvements to its credit rating — which is now in the top 10% of all publicly-traded REITs.

The downside to all of this, naturally, is price. 2021 was simply too strong a year. In fact, if we had shares in it back then, we probably would have taken gains when they hit over 25X P/FFO.

No company, no matter how good, deserves that sort of premium.

Alexandria Real Estate stock

(Yahoo Finance)

But this year is a very different story, as we’ll show below.

ARE Stock Valuation

Now, based on fundamentals, Alexandria Real Estate does deserve to trade at a premium, which it typically does. However, it began trading above 25x FFO last year, and that was too much.

ARE Stock Valuation

(FAST Graphs)

Now, the chart above could imply that ARE isn’t a good investment considering how much it lost in less than seven months. However, that’s like being upset because you bought something worth $5 at a $10 price tag.

Valuation is a pillar to being an intelligent investor! It’s the metric we always spend the longest time calculating and looking at.

Over the last 20 years, ARE has averaged a P/FFO of 17.5x. And for the past 10, it’s around 21x.

We think that’s justified and something that will remain consistent going forward. The cost of building has increased, for one thing. So established REITs like ARE with world-class clients and assets deserve higher premiums.

As such, ARE trading below 18.5x is intriguing for a few reasons.

First and foremost, it has a very high-quality and visible overall pipeline of revenue and EBITDA increases hailing from new leases and properties over the next 3-5 years. So even if we see significant inflation headwinds and interest rate increases…

ARE’s re-leasing trends, efficiencies, and growth will result in profitable FFO/EBITDA growth. Its 20x-22x P/FFO premium therefore remains intact.

The upside for ARE – even based on a lower 20-year average of 17x-18x – is now almost 11% annually, beating market expectations. And if we consider normalization to a premium, that upside grows. Quickly.

ARE Stock Upside

FAST Graphs

ARE here has an estimated – and likely – 2024 upside of close to a 60% rate of return. There are REITs with more upside, but there are very few REITs with portfolios and client diversification as well as quality such as this one.

In Conclusion…

The chance that any of ARE’s top clients find themselves unable to pay their leases is close to zero. That’s part of why it gets a coveted "100" quality score from us.

And take a look at how its coverage ratios have developed since 2016.

Alexandria Real Estate EBITDA interest coverage

(ARE EBITDA Interest Coverage – REIT/BASE)

Now look at its AFFO-based dividend payout ratio (considering the pandemic an outlier, of course).

Alexandria Real Estate Dividend coverage

(ARE Dividend Coverage – REIT/BASE)

ARE is very skilled at keeping its payout under control while delivering growth.

Its subsector contains a lot of risky REITs, admittedly. But ARE isn't one of them.

That's why its EBITDA/interest coverage, fixed-charge coverage and safety metrics are close to 1.8x-2x the sector average. Incidentally, the sector average for total debt/book is close to 41%, while ARE has 28%.

The only metric where ARE doesn't exactly shine is straight yield. The sector average is now close to 5%, whereas ARE is at around 3.2%, as noted earlier.

But we argue that, in terms of safety, very few REITs come close to matching it. And in terms of valuation, we consider it a "Buy."

Our target comes to $170, which gives us a margin of safety of around 12% with plenty of room to add. In fact, I already added shares to my family trust portfolio.

The earnings conference call is on Tuesday, July 26th. I will be interviewing the CEO, Joel Marcus, on Wednesday for iREIT on Alpha members.

Alexandria Real Estate Q2 2022 Earnings Update

We edited this section as ARE has since released Q2-22 earnings after the original article was published at iREIT on Alpha (shares +1.2% after hours). ARE now expects 2022 FFO per share of $8.38-$8.44 vs. previous range of $8.33-$8.43, and exceeding the consensus estimate of $8.38.

Net operating income (cash basis) of $1.6B, annualized, compares with $1.5B in the prior quarter; increased 24.3% Y/Y; same-property NOI rose 7.5% Y/Y in Q2 vs. 7.6% in Q1. On a cash basis, same-property NOI increased 10.2% Y/Y vs. 7.3% in Q1.

Alexandria Real Estate dividend growth

ARE Q2-22 Investor Deck

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This article was written by

Brad Thomas profile picture
103.6K Followers
Author of iREIT on Alpha
The #1 Service For Safe and Reliable REIT Income

Brad Thomas is the CEO of Wide Moat Research ("WMR"), a subscription-based publisher of financial information, serving over 6,000 investors around the world. WMR has a team of experienced multi-disciplined analysts covering all dividend categories, including REITs, MLPs, BDCs, and traditional C-Corps.

The WMR brands include: (1) The Intelligent REIT Investor (newsletter), (2) The Intelligent Dividend Investor (newsletter), (3) iREIT on Alpha (Seeking Alpha), and (4) The Dividend Kings (Seeking Alpha). Thomas is also the editor of The Forbes Real Estate Investor and the Property Chronicle North America.

Thomas has also been featured in Forbes Magazine, Kiplinger’s, US News & World Report, Money, NPR, Institutional Investor, GlobeStreet, CNN, Newsmax, and Fox. He is the #1 contributing analyst on Seeking Alpha in 2014, 2015, 2016, 2017, 2018, and 2019 (based on page views) and has over 102,000 followers (on Seeking Alpha). Thomas is also the author of The Intelligent REIT Investor Guide (Wiley). 

Thomas received a Bachelor of Science degree in Business/Economics from Presbyterian College and he is married with 5 wonderful kids. He has over 30 years of real estate investing experience and is one of the most prolific writers on Seeking Alpha (2,800+ articles since 2010). To learn more about Brad visit HERE.

Disclosure: I/we have a beneficial long position in the shares of ARE either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: Author's Note: Brad Thomas is a Wall Street writer, which means he's not always right with his predictions or recommendations. Since that also applies to his grammar, please excuse any typos you may find. Also, this article is free: written and distributed only to assist in research while providing a forum for second-level thinking.

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