PEAK - Alexandria Real Estate: Wonderful Stock At A Wonderful Price

2024-01-15 08:10:00 ET

Summary

• Long-term value investors can take advantage of market fluctuations by buying high quality companies at below average prices.
• Alexandria Real Estate Equities is a strong pick in the healthcare/office REIT sector, with a diverse set of tenants in the Life Science and AgTech segments.
• ARE has strong operating fundamentals, high tenant demand, and a self-funding model, making it an appealing investment with steady returns and an attractive dividend yield.

Long-term value investors know that they can use market gyrations to their advantage, and by buying above-average companies at below-average valuations, they are setting themselves up for potential out-sized returns over the long run.

This comes from the willingness to buy into sectors that are currently out of favor when the market is seemingly chasing tech growth stocks again to nosebleed valuations. As shown below, the Invesco QQQ Trust ETF ( QQQ ) has roared with a 48% price return over the past 12 months.

At the same time, unloved sectors remain materially down from where they were a year ago, and this brings me to the Alexandria Real Estate Equities, Inc. ( ARE ), which as shown below, currently sits 19% below where it was 12 months ago.

I last covered ARE here back in March of last year with a 'Strong Buy' rating, and noting its near-record leasing activity and rent spreads, and despite its strengths, ARE currently sits 9% below where it was since I visited it last, as fears around a slowdown in real estate has weighed on the stock. In this article, I provide an update and discuss why ARE remains a great pick at the current even cheaper price, so let's get started!

Why ARE?

Alexandria Real Estate is one of the older REITs on the market today with a history that dates back to 1984. While it can be considered as an Office REIT, it's quite differentiated from its peers in that it owns buildings that are leased to a diverse set of 1800 tenants in the Life Science and AgTech segments.

Its properties carry durable advantages in that they are located in what it calls "AAA" innovation cluster locations that include the SF Bay Area, Greater Boston, New York City, San Diego, Seattle, Maryland, and the Research Triangle in North Carolina. These locations are either adjacent or in close proximity to major research institutions, which act as a funnel of well-trained talent to the tenants in ARE's properties. This forms a virtuous cycle in which access to talent is what makes the properties so attractive to ARE's biotech and pharmaceutical tenants.

Moreover, life science is a growing segment among healthcare REITs and one that is seeing expansion in diversified ones like Healthpeak Properties, Inc. ( PEAK ) and Ventas, Inc. ( VTR ). As shown below, ARE has produced the second-best total return since 1997 compared to healthcare REITs, sitting behind Welltower Inc. ( WELL ).

Contrary to what its share price performance might suggest, ARE has continued to perform well, with same-store cash NOI growing by a solid 5.6% during the first nine months of last year, and occupancy is expected to land at 95% for the full year 2023. ARE's internal growth is driven by solid leasing activity and high tenant demand, which drove an impressive 20% lease spread on a cash basis and 29% spread on a GAAP straight-line basis. For reference, GAAP rent spreads will almost always be higher than cash basis, since the former takes the average of the rental amount over the course of the lease term.

As shown below, ARE's most recently reported leasing activity is in line with that of historical norms and comes on the back of exceptional leasing in the 2021-2022 timeframe.

ARE's strong operating fundamentals support management's guidance for 7% FFO per share growth for the full year 2023. Moreover, concerns around unneeded office space do not appear to be affecting life sciences tenants, as ARE's new leasing activity in its last reported quarter carried a long weighted average lease term of 13 years. Portfolio-wide, ARE has a weighted average lease term of 11 years, which is longer than that of most net lease REITs like Realty Income Corporation ( O ), which has a weighted average lease term of 10 years.

Looking ahead, ARE's growth prospects are supported by a good number of FDA drug approvals, which benefit the financials of its tenants. This is reflected by the fact that the FDA approved 55 novel drugs in 2023 across a wide range of disease areas from neurological conditions such as Alzheimer's disease to blood, kidney, and endocrine disorders. As a point of reference, this nearly surpassed the record 59 drugs that were approved in 2018.

ARE could also see near-term growth from development projects, most of which are expected to see initial yields ranging from 7% to 9.5%. One of ARE's developments is at its Cambridge, Massachusetts site, which is 100% leased. As shown below, this site carries moat-worthy attributes as it sits in very close proximity to the Massachusetts Institute of Technology. This leased rate also compares favorably to competitive supply under construction, which is 72% leased.

ARE's developments are supported by its self-funding model and a strong balance sheet, with a net debt and preferred stock-to-adjusted EBITDA ratio of 5.1x. It also carries investment-grade BBB+/Baa1 credit ratings from S&P and Moody's, had has one of the longest remaining debt terms in the REIT industry at 13.1 years. Notably, ARE carries a weighted average interest rate of just 3.7% and carries 99% fixed rate debt with no debt maturities until 2025.

Risks to the thesis include ever-present potential for drug price reform through expanded Medicare pricing negotiations, as that could affect the bottom line of ARE's tenants and their abilities to utilize funds from existing on-patent drugs to fund their R&D pipelines. Also, while ARE doesn't have near-term debt maturities, a persistently high interest rate environment in 2025 could raise its cost of debt. Plus, increased competition from new supply could pressure rent growth, although most of ARE's locations are well-insulated from competition due to their desirable locations.

Importantly for income investors, ARE currently yields 4.0% and the dividend is well-covered by a 70% payout ratio, based on management's guidance for FFO/share of $7.30 for the full year 2023. ARE has also raised its dividend for 13 consecutive years and has a 5-year dividend CAGR of 6%. As such, ARE could reasonably produce 10% annual total returns, which matches the long-term return of the S&P 500 ( SPY ), but with a much higher dividend yield and the stability of a moat-worthy asset base.

Lastly, I continue to see value in ARE at the current price of $126.25 with a forward P/FFO of 17.3, which sits below its normal P/FFO of 20.2 over the past 10 years, as shown below. Admittedly, ARE isn't cheap, but it remains appealing considering its strong balance sheet, high tenant demand, and internal growth drivers. While analysts expect just 4% to 5% annual FFO/share growth over the next 2 years, growth is expected to ramp up to 9% in 2026.

Investor Takeaway

ARE is a solid investment choice for those seeking stability and long-term growth in the healthcare/office REIT sector. Despite concerns around office space, ARE's life sciences tenants remain strong and show potential for further growth with FDA drug approvals on the rise. With a self-funding model, strong balance sheet, and attractive dividend yield, ARE is positioned to generate steady returns for income investors. Considering all the above and ARE's attractive valuation, I reiterate my 'Strong Buy' rating on the stock.

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