Alexandria Actual Property: A Blue Chip REIT With Strong Upside
Posted On March 8, 2023
Today I want to cover Alexandria Real Estate Equities (NYSE:ARE) which is an office REIT, but not a typical one. The company has returned a stunning 1,675% since its IPO in 1997, ahead of legendary Berkshire Hathaway (988%) and almost triple the return of the S&P 500 over the same period (628%). Moreover, the company’s focus on biotech and life sciences makes it largely immune to the current work-from-home trend, making ARE stock a good candidate for a relatively safe growth investment. Let’s see how it does based on our usual criteria for evaluating REITs.
Alexandria is a different kind of an office REIT. It owns 432 properties with a total of 47 Million sft and generates over $2 Billion in annual revenue, making it one of the larger REITs out there. If focuses solely on high-quality research facilities for life sciences and biotech usually focused into large clusters/campuses in growing urban areas. The company has a very good track record of being the first mover into an area that later becomes a research hub and focuses on the markets it knows and understands.
Most of ARE’s revenue comes from leasing their buildings in Greater Boston (36%), followed by the Bay Area (23%) and San Diego (16%). The vast majority (93%) of leases are triple net. The company has a very resilient and diversified tenant mix with 48% of total revenue coming from investment-grade or publicly traded large tenants. No tenant accounts for more than 3.5% of total revenue and notable tenants include large well-known companies such as Pfizer (PFE), Moderna (MRNA), Amgen (AMGN) and Novartis (NVS) and also renowned universities such as Harvard, MIT and NYU. It is this type of tenants that makes the company very immune to the work-from-home trend, as research cannot easily be done remotely. The company also knows how to maintain good relationships with their tenants as confirmed by a very high tenant retention of over 80% over the last five years.
The company has a great leasing track record. In 2022 they managed to lease 8.4 Million sft of space equal to 17% of their total space which was the second highest volume ever. 74% of this volume came from renewals and lease expansions from existing clients, reiterating very good landlord/tenant relationships. I also want to point out that the company didn’t get these tenants to stay by providing discount and incentives. Quite the opposite, as rents on lease-renewals increased by 31% in 2022 (and 22% on a cash basis). Strong leasing translates into stable occupancy which currently stands at 95%, only marginally below their 10-year average of 96%.
Tenants want to rent from Alexandria, which has translated into a highly leased development pipeline. The company expects to deliver 7.6 Million sft of space over the next three years, 72% of which has already been leased. As someone with a real estate development background, I can tell you that this is outstanding.
The company continued to recycle capital last year as they sold about $2 Billion worth of real estate at an average cap rate of 4.5%. In addition to real estate, the company also holds some key investments in life science and biotech firms, some of which are their own tenants. These have a carrying value of around $1.6 Billion, which is only a fraction of ARE’s enterprise value, but it is another factor that shows that the company is very comfortable in the sector.
There is very little to not like about ARE’s BBB+ rated balance sheet. Most notably they have no maturities until 2025. This is great because it means no refinancing risk and no interest expense surprises as 99% of their debt has a fixed rate. Their average interest rate stands at just 3.5% which is considerably below 10-year treasury yields and one of the lowest in the REIT sector.
The most important REIT measure – funds from operations (FFO) increased by 8.5% YoY in 2022, driven by same store NOI growth of 6.6% (9.6% on a cash basis) and outstanding lease renewals. Same store rent growth has very good visibility as 96% of leases contain rent escalation clauses that average 3% per year.
Guidance for 2023 calls for an FFO increase by 6.4% YoY to $8.86 to $9.06. This is expected to be driven by continued strong lease renewals as well as same store NOI growth of 2-4%. Given what the company has accomplished until now, and very good visibility thanks to a highly leased pipeline of new developments, I think this is very achievable.
Dividend investors will be pleased to hear that ARE has a 12-year history of increasing its dividend. Over the last 5 years the dividend has grown at an average of 6.5% per year and I expect no less going forward. Currently the annual dividend stands at $4.84 which represents a yield of 3.3%. This is on the lower side for REITs but fair given the quality and growth prospects of the company. The dividend is very well covered with a forward payout ratio of just 54%.
Alexandria doesn’t really have any peers that make a good comparison. The closest we can get are quality office REITs such as Boston Properties (BXP), but frankly BXP’s occupancy and rents are under significantly more pressure due to WFH. Therefore it makes sense that ARE trades at a premium compared to other office REITs, because it is in a league of its own.
It’s useful to look at the implied cap rate that Alexandria trades at, which is 5.1% and compare it to the cap rates that it achieved on its recent disposals. Disposals in 2022 averaged a cap rate of 4.5%, with only two transactions slightly above the 5% mark. There is no massive discount here, but frankly given the quality of the company I wasn’t expecting it. This suggests that ARE is currently fairly valued.
Second, in terms of its historical performance, ARE currently trades a P/FFO multiple of 17.1x which is below its 13-year average of 19.4x. I am confident that the valuation will normalize at some point over the next say three years and when it does investors will see a 13% upside from multiple expansion. That’s not bad coupled with FFO growth of around 6% per year. This leads me to set a relatively conservative price target at $195 per share.
So with that said what can we reasonably expect from ARE?
3.3% dividend yield growing at 5-6%
FFO growth of 6%
4.2% annual growth from multiple expansion
-> total annual return of around 13.5%
Remember how I generate alpha:
start with a thesis why a given industry/sector should outperform
stay overweight in those sectors for as long as the thesis is valid
look for companies with sound fundamentals that are either undervalued or fairly valued with exceptional growth prospects
if a company becomes overvalued, trim the position and rotate into another stock/sector that is still undervalued
if a company becomes increasingly undervalued and the thesis is still valid, add to the position
generate alpha and repeat
My total return then comes from the dividend yield, EPS growth, and multiple expansion as the valuation normalizes over time. I always target a total return in excess of market returns (>8%) to generate alpha.
What things do I look for when selecting individual stocks to buy?
strong and safe fundamentals
good management teams with a track record of caring about shareholders
healthy EPS growth
discount relative to peers and/or historical fair multiples
Alexandria is a high quality REIT in an interesting niche. Their focus on life sciences and biotech combined with very strong landlord/tenants relationships and a proven expertise in the sector makes the company very resilient to the work-from-home trend which has led to a continued bleed in office REITs.
Management is confident they will continue to grow their FFO by 6% per year going forward and having seen their highly leased pipeline and rent escalation clauses in existing leases, I think there is very little that could derail this plan. Moreover, with no debt maturities until 2025 and nearly all debt fixed, this is one of the safest REITs currently in the market. As such we shouldn’t expect a massive discount, but still the stock trades below its historical P/FFO multiple and can reasonably be expected to return 13% per year. That’s solid at this level of quality. Therefore, I rate ARE stock as a “BUY” here at $145 per share with a conservative PT of $195 per share.