2023-06-20 07:30:00 ET
Summary
- The great thing about summer travel is that you don’t have to pack a lot of stuff.
- I’m taking two pairs of jeans, one suit, and some gym clothes….
- What about shorts?
This article was published at iREIT® on Alpha on Sunday June 18, 2023.
It’s summertime in which many people are headed to various destinations for some much-needed R&R (rest and relaxation).
One of my kids is headed to France this week…
One of our interns is returning from a trip to Europe this week…
Another one of our interns is traveling to South Korea this week…
One of our senior analysts, Nick Ward, is headed to Nebraska to watch some college baseball…
And I’ll be traveling to Florida later this week myself (mostly business though)…
The great thing about summer travel is that you don’t have to pack a lot of stuff.
I’m taking two pairs of jeans, one suit, and some gym clothes…
What about shorts?
Where Did the Shorts Go?
Don’t worry, I’ll pack some shorts for my trip.
However, I think you clicked on this article because you wanted to hear about the REIT shorts.
Have you noticed?
They’re missing…
Medical Properties Trust ( MPW ) is up 27% (vs VNQ that’s +5%).
Last 30 Days
Arbor Realty ( ABR ) is up 34% (vs VNQ that’s 3.4%):
Since April 15 th
Digital Realty ( DLR ) is up 17% (vs VNQ that’s +3.4%)
Since May 24th
Of course, our team has been laser-focused on fundamentals while taking advantage of the various short reports. I explained this in my new REITs For Dummies book:
“…short selling actions can be dead wrong. It’s an exceptionally risky practice that relies on market timing. I don’t recommend anyone trying it out. This is especially true for investing novices, but it’s put plenty of experienced individuals and entities in very bad places too.
The most you can earn on a short is 100 percent of however much you put in — and that’s only if the stock goes to zero. But the potential losses are limitless if the stock goes up.”
Over the years I’ve been somewhat successful buying on fear however, as I pointed out in my book,
“I wouldn’t ignore short-seller analysis altogether. It can end up being an important part of research, bringing serious issues to light such as operating deficiencies and financial fraud.”
Last week we heard about yet another short report in REIT-dom and this one happens to be a company about which our team is super bullish. Our members asked us for an update which also serves as a timely rebuttal of Alexandria Real Estate ( ARE ).
The "Litt Piece"
Last week shares in Alexandria Real Estate fell around 4.5% and Land & Buildings disclosed a short position . The CEO, Jonathan Litt explained that,
“a closer look at the flexible policies of Alexandria’s largest tenants, such as Bristol-Meyers Squibb, Pfizer and Samoi, illustrates the point given heir generous work from home policies, while few, if any, of ARE’s top tenants require employees to be in five days a week.”
Litt and his team are using anonymous cell phone data to generate property-level information in which "the company revealed that cell phone presence in Alexandria’s lab/office buildings is down 50% as compared to pre-pandemic cell phone presence.”
Our team has also used cell phone data before to determine traffic flows.
During COVID-19 we analyzed 38 of Tanger Factory Outlet ( SKT ) properties using Orbital Insight technology to validate phone location datapoints to understand foot traffic at areas of interest.
As illustrated below, it's calculated by unique daily device activity sourced through anonymized and aggregated geolocation data.
The initial findings indicated that there was a 100% recovery across the portfolio beginning June 7, 2020, and that Grade-A centers recovered more than B and C, naturally. However, C's saw slightly more traffic while shelter-in-place orders were in effect.
Based on Orbital Insight's analysis,
..."we can see that Tanger's business model is alive and well. In some instances, there's even more traffic than before. And while Arizona has been impacted the worst, cell phone records suggest that rent levels could be in the range of 75%-80% even there."
Orbital Insight
This data was extremely useful for our team as we relied upon it to make tactical recommendations in which Tanger has seen shares grow by over 270% (since March 2020).
So, I certainly understand how cell phone data can be useful in determining traffic flows in and out of certain properties, however, in Litt's latest short report we believe the research is flawed due to a basic lack of understanding with regard to the business model.
Understand the Business Model
As Benjamin Graham taught, what's paramount is that all investments should be logically sound from a business owner’s perspective.
Thus, before investing in a stock, the prospective owner (or short seller) should examine the current competitive position within that industry, and the “economic moat” around the company to determine if there's a sustainable competitive advantage that helps preserve long-term pricing power and profitability.
Overall, there are over 10,000 diseases known to mankind, and only an estimated 10% of these diseases actually have therapies to treat them; the rest remain largely unaddressed, which imparts an exorbitant opportunity (and responsibility) to create new and better medicines.
At the same time, the biology and genomics revolution of the past several decades has exponentially increased our understanding of human biology and disease and shed light on the power of several new modalities that have transformed drug discovery and development, including mRNA, gene editing, cell and gene therapy, single cell analytics, and many more.
At the highest level, the unmet need matched with an increasing armamentarium of new and improved tools, provides a limitless opportunity set for the life science industry.
When we think about drivers of demand, in additional to the immense opportunity set noted above, lab space is mission critical.
Life science companies and related scientific research must be conducted in dedicated spaces in compliance with stringent lab safety requirements and CANNOT be performed from home.
The vast majority of the office space in ARE's lab buildings IS highly integrated, adjacent space and a critical component of laboratory design and workflows to support researchers in the lab.
A scientist does not spend all day at a bench , but spends time moving back and forth between lab and adjacent office in order to, for example, analyze data, plan the next set of experiments, and meet with colleagues.
Unlike traditional office space, the value of life science real estate that ARE operates is in the research that transpires in the space – the specialized infrastructure and equipment that enables the research and of course the people that drive this innovation day in and day out.
ARE Annual Report
Life science tenants ranging from multinational pharma companies to academic institutions to public and private biotech companies want to be in these buildings and on campuses because they want to be located in core centers of innovation.
And there is a unique desire among life science entities to cluster together in campus ecosystems like ARE has pioneered in order to drive productivity and collaboration, to recruit and retain top talent, to attract strategic capital, and to ensure best-in-class, 24/7 operations of their mission-critical real estate.
Drilling down to the drivers of demand and funding sources...
At least 80% of leasing comes from existing ARE tenants , and the company is highly selective in underwriting new tenants (conducted by scientifically-trained Science & Technology team of two dozen PhD/MD/MBA/MA with industry experience that critically analyze each prospective and active tenant in terms of scientific differentiation, IP, unmet need/market opportunity, management teams, financing plans and cash runway).
The market size of the life science industry is robust, with multinational pharma, public biotech and public diagnostics & research tools companies having an estimated market value in excess of $5 Trillion.
Annual funds flowing to the life science sector from sources including pharma R&D, venture capital, public market funding, government funding and medical research philanthropy totals somewhere in the range of $450 Billion to $500 Billion YoY.
The FDA continues to approve new drugs at a steady pace , with over 250 new drugs approved over the past 5 years, contributing meaningfully to the lives of patients around the world, and bringing in billions of new revenue for the sector.
2023 is on pace to be a record-setting year for new drug approvals with 60 PDUFAs dates (i.e. deadlines for the FDA to approve new drugs) scheduled for this calendar year.
In the context of ARE's tenant base, the company has over 850 tenants across the following segments (breakdown by % ARR).
I will briefly contextualize the funding sources that tend to fuel demand for each segment:
Multinational pharma – 18%
In aggregate, multinational pharma companies have a total estimated market capitalization of ~$3.2 TRILLION.
- Pharma continues to perform well and contribute trillions in market value (as above)
- 17 of the Top 20 Pharma (by R&D Spend) are ARE tenants
- Over $250B in annual R&D spend, often going to external innovation (funding to partner with other biotechs, to execute licensing deals with academia, etc.)
Institutional (Academic/Medical/Government ) – 12%
These are high quality academic medical and government institutions with large endowments and some of the largest recipients of NIH and other private/philanthropic funding sources.
NIH – strong bipartisan support with nearly $50 BILLION annual budget that supports mostly academic and early-stage research and often inspires translation from academic discoveries to commercial development of new therapies (often a catalyzing source of capital to start a new life science company)
Life Science Product, Service & Device – 22%
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- In aggregate, publicly traded diagnostics and research tools companies have a total estimated market capitalization of ~$900 BILLION.
- These are by and large publicly traded, revenue-generating companies (e.g., Illumina, LabCorp, Quest) that provide critical research tools and services to the rest of the life science ecosystem.
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Public Biotech
In aggregate, public biotechnology companies have a total estimated market capitalization of ~$1.5 TRILLION.
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Public Biotech - Approved or Marketed Products – 14%
- These are also revenue-generating segment of our tenant base and a major source of new innovation and partnering across the ecosystem. These include companies such as Amgen, Vertex, Moderna, etc...
- They continue to perform well, drive revenues, and continue to build value in their clinical pipelines
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Public Biotech – Preclinical or Clinical – 10%
- This pre-commercial component of the tenant base is relatively strong, with positive clinical data being the currency of this segment. The follow-on equity market has rewarded public biotechs that continue to execute and meet meaningful clinical milestones, as in the recent cases of tenants Vaxcyte, Biomea Fusion, IntraCellular and others.
- Though the IPO window has narrowed, there's an uptick in new S1 filings and we should see a bit more activity throughout the balance of the year.
Private Biotech – 8%
This is also a relatively strong segment for ARE as the company has highly selective and generally strong pre-existing relationships with these private biotech companies across ecosystems.
Despite conflicting headlines, life science venture capital funding is still strong. And although ARE has come off the highs of 2021-2022, venture investment into life science companies in 2023 will be on par with the 2018-2019 pre-COVID level (likely in the $30-40B range), which were record-setting years up until that time.
Given the record-high fundraising that venture firms were able to secure in 2021-2022, there is ample dry powder to fund new and active private life science companies. There has certainly been a flight to quality and the size and valuations of each financing have come down off the highs of 2021-2022.
Investment-Grade/Large-Cap Tech – 8%
The majority of Investment-Grade or Large Cap Tech office space is purpose-built within core cluster mega campuses. There is also a significant amount of dry-lab and hardware components to these spaces, creating additional stickiness among tenants.
It is also the reason why many of these non-traditional lab tenants sought to locate specific innovative/research-focused divisions within ARE campuses, to both ensure seamless operational support as well as to help recruit and retain talent within the innovative campus ecosystems.
Rock Solid Fundamentals
Our team has been following ARE for a number of years - our very first research report was published in 2013 . Since that time shares have returned 9.25%. Over the last decade we have been impressed with ARE's management team for generating long-term value:
The secret to the success has been ARE's disciplined capital allocation strategy that has resulted in very steady and predictable earnings growth.
The balance sheet is stronger than ever , with $5.3 billion in liquidity, and no debt maturities until 2025. ARE is rated BBB+ with S&P and Baa1 with Moody's and is one of the top 10% credit ratings among all U.S. REITs.
ARE has an incredibly strong revenue model is which 99.9% of tenants paid rent in Q1-23. The robust development pipeline should achieve around $610 million of incremental NOI from 6.7 million square feet that is 74% leased.
Approximately 30% of this NOI will commence in 2023, about 40% will commence in 2024, about 26% in 2025 and the remaining 4% thereafter. As shown below, ARE's rental rate increase of 48.3% represents the highest quarterly rental rate growth in the company's history:
The company guided 2023 FFO per share diluted as adjusted is $8.91 to $9.01 with no change at the midpoint of $8.96, and that represents a strong 6.4% growth following excellent growth in 2022 of 8.5%.
ARE has purposely maintained a very low and conservative FFO payout ratio, 55% for Q1-23 annualized with 5.3% increases in dividends over the last 12 months.
Valuation
While cell phone data can be useful for examining traffic flows, we find Land & Buildings approach to be misguided. As outlined in this article, the demand drivers are in place for ARE to continue to grow earnings and the dividends - and these analysts agree:
FAST Graphs
In terms of valuation, shares are now trading at $115.45 with a P/AFFO multiple of 17.2x and a dividend yield of 4.3%. As seen below, we believe that ARE is being painted by the office brush, instead of the mission critical property brush.
Since 2009 shares have traded at an average of 21.7x, that includes years of modest growth (2010-2016). However, in 2023 the company is forecasted to grow AFFO per share by 16% and another 7% per year in 2024 and 2025.
In terms of peers, ARE has no direct pure play life science peers, so we must use this comp set:
- Ventas Inc. ( VTR ): 19.0x
- Welltower ( WELL ): 27.9x
- Boston Properties ( BXP ): 11.5x
- Alexandria: 17.2x
Now compare the growth estimates (using AFFO per share):
- Ventas: +2%
- Welltower: +4%
- Boston Properties: +4%
- Alexandria: +6%
In short, we're maintaining our STRONG BUY rating as our annual total return forecast for ARE is 30%.
While cell phone day can be useful, we don't just reply on one such data point and our sources have informed us that many employees cut off their phones when working inside these mission critical properties.
Most importantly, we find ARE's fundamentals very strong, and we believe this "moat worthy" REIT will generate superior returns in the months ahead. As I posted on Twitter, "shorting ARE not a very smart idea".
@rbradthomas
As always, thank you for reading and commenting...
And don't forget your shorts!
For further details see:
Alexandria Real Estate: Debunking The 'Litt Piece'