ARE - Alexandria Real Estate Q3 Earnings Preview: Expecting Continued Strength In Leasing And Occupancy

2023-10-23 06:30:00 ET

Summary

• Alexandria Real Estate is scheduled to report Q3 earnings on Monday following the market close.
• Shares have been under pressure over the last six months, down over 20%.
• Operational metrics, however, have remained healthy despite a challenging operating environment.
• Heading into earnings, I am expecting leasing activity to remain above 1 MSF, with occupancy levels in the mid-90% range.
• At current trading levels, ARE stock presents attractive upside potential at a significantly discounted price.

Life science-focused REIT, Alexandria Real Estate ( ARE ), is scheduled to release its third fiscal quarter earnings report on Monday after the market close.

In past coverage on the stock, I’ve maintained a bullish position due to what I view as their perpetually depressed trading valuation. I’ve also outlined my disagreement with a short report from activist investor and founder of Land and Buildings, Jonathan Litt.

With shares down over 20% since my last update , my views haven’t yet held water. Despite this, I remain bullish. And with shares at new 52-week lows, I’ve also recently initiated a new position in the company’s shares. With the current dividend yielding over 5% and supported by a strong track record of growth and safety, the stock made for a compelling addition, in my view.

Looking ahead to the release, here’s what to watch when ARE reports Q3 results on Monday

ARE Key Stock Metrics

ARE currently trades at just 10.6x their 2023 projected funds from operations (“FFO”) midpoint of $8.96/share. While this is represents a premium to other office operators, such as SL Green ( SLG ), Vornado ( VNO ), and Highwoods ( HIW ), which all trade between 5x and 8x, I believe ARE warrants the premium because of their portfolio composition.

Unlike other pure-play office operators, ARE’s portfolio is comprised of mission-critical lab space. Others, namely those short on the stock, would disagree with this statement. But their tenant composition, which is overwhelmingly centered around pharmaceutical and biotechnology companies, provide weight to this position.

The trend in ARE’s occupancy percentage is also dissimilar with other office operators. Despite the challenging operating environment, occupancy has held within the mid-90% range. This compares to notable declines elsewhere in the sector.

In addition to favorable operating metrics, ARE continues to maintain a fortress-like balance sheet. And earlier this year, ARE secured an increase to their credit facility, resulting in a total overall liquidity position of +$6.3B. The financial capacity is supported further by a debt composition that is effectively entirely fixed at a low weighted average rate of 3.7%, with nothing due prior to 2025.

Current Guidance

On their Q2 release, ARE narrowed their full-year guidance for FFO but left the midpoint unchanged at $8.96/share. This would represent YOY growth of 6.4%, a respectable build on top of last year’s 8.5% increase.

Elsewhere, ARE is expecting year end occupancy to land at a midpoint of 95.1%. And from a leasing perspective, ARE is forecasting overall double-digit rental rate increases of between 12% and 17% on a cash basis.

What To Expect When Alexandria Real Estate Reports Q3 Earnings

Leasing Volume Staying Above 1 MSF : Despite what is viewed as a tough operating environment, ARE has continued to report strong leasing figures . In Q2, the team reported total leasing volume of 1.3 MSF. Not only was that above their five-year pre-2021 average, but it was also their 13 ^th consecutive quarter of turning in overall volume in excess of 1 MSF.

I expect Q3 to be the 14 ^th consecutive quarter of over 1 MSF of leasing volume, led by continued strength in Seattle and in the Northeastern pockets of the U.S. I also am expecting strong cash rental rate growth, supported in part by elevated levels of liquidity in the life-sciences sector following strong fundraising activity over the past two years and a large pipeline of R&D-based spending

Stable Occupancy Levels: ARE has maintained stable occupancy levels. And I expect this to continue in Q3 and beyond. Some have speculated as to physical occupancy and have concluded that ARE’s space is physically occupied at the same rate as other administrative spaces.

While it’s a discussion worth having, ARE did somewhat address this in their prior earnings call by releasing data regarding energy consumption. Investors should expect further commentary in Q3 from management, more-or-less consistent with what had been previously stated.

More Favorable Supply Outlook: ARE does operate in high barrier to entry markets. But even then, supply has been on the uptrend. In Q2, for example, ARE reported rising supply in their Greater Boston and San Francisco markets. In San Francisco, the supply outlook was compounded by a notable increase in sublease vacancy to 6.2%. This is in addition to the unleased competitive supply expected to be delivered in 2024, estimated at about 6.6% market inventory.

ARE will likely provide an update regarding new supply to be delivered in 2025 after providing their 2024 update last quarter. In my view, I expect the supply to be lower due principally to the unfavorable operating market for new development. Construction costs, for instance, are still high. And financing is harder to come by for most. This, in my view, should keep a ceiling on the amount of new supply coming online in the next few years.

Is ARE Stock A Buy, Sell, Or Hold?

At this point in the economic cycle, I consider ARE to be one of the best additions to any long-term focused portfolio. The stock has been pressured over the last year from high-profile short interest, as well as from a general malaise in the office sector, the sector which ARE continues to be associated with; wrongly, in my view.

Attractive yields on risk-free alternatives have also reduced the appeal of those investors who otherwise would have invested in real estate for its income appeal. But on this, I believe ARE provides long-term investors an attractive opportunity to lock in a fairly high yield for ARE’s caliber.

At present, the payout yields over 5% and is backed by a fortress-like balance sheet and safety position. Additionally, the payout is growing at a 3-year compound growth rate of about 5.5%. Sure investors can lock in attractive yields on Treasuries at present. But those yields are unlikely to grow at the same rate of ARE’s dividend payout.

In addition to the dividend, I believe ARE presents outsized upside potential based on its current implied cap rate. I’ve noted this in past coverage on the stock. And this continues to ring true.

Earlier in the year, ARE was disposing of properties at cap rates in the mid 4% range. Even if one were to consider a 5.5% rate as fair, that would still take shares to the $150 mark, right around current Wall Street estimates . Looking ahead, I can see ARE reaching this potential on continued leasing strength and the maintenance of occupancy levels in the mid-90% range.

With shares under pressure and at new 52-week lows ahead of a Q3 print where expectations are likely low, I continue to view ARE as an attractive addition to any long-term focused portfolio.

For further details see: