2023-07-25 12:23:41 ET
Summary
- Alexandria Real Estate just released their Q2 results, which came in ahead of expectations.
- In the ongoing debate of whether their properties are more reflective of traditional offices than lab space, results clearly support the latter view.
- In my view, the valuation of the shares is disconnected with the value being assigned to their properties in the disposition market.
- At current trading levels, I believe the stock has an upside potential of approximately 30%.
Alexandria Real Estate ( ARE ) is viewed as an overvalued office operator by some and as an undervalued owner of high-quality lab space by others. The debate is worth having. In my view, their Q2 results were more representative of the views among those in the latter camp.
Alexandria Real Estate Q2 Earnings Summary
ARE reported a YOY increase in cash basis net operating income ("NOI") of 11.1%. And on a same-property basis, YOY cash NOI grew 4.9%. This was led by expectations beating revenue growth of 10.9%. ARE also beat on the bottom line, with Q2 funds from operations ("FFO") of $2.24/share or about 6.7% better than consensus.
At the portfolio level, North American occupancy ended the period at 93.6%, unchanged from last quarter. This was on total quarterly leasing volume of 1.3M RSF, most of which was attributable to renewals, at cash spreads of 8.3%. The volume during the quarter brings their first half total to over 5.0M RSF, in line with their pre-COVID leasing volume.
Looking ahead, ARE expects an additional +$225M in proceeds from dispositions and sales of partial interests. This raises the midpoint of their guidance range for dispositions and sales of partial interests to +$1.75B. This coincides with their strategy of selling non-core properties.
ARE also decided to seek a new partner for one of their active development projects. This resulted in an increase in expected construction spending at share of $210M.
Guidance elsewhere was largely retained, though FFO was narrowed, albeit no change to the midpoint, which still stands at $8.96/share, a penny above expectations .
Market Reaction To Alexandria's Q2 Results
ARE traded higher by about 1% in extended trading immediately following the release. YTD, shares are still down nearly 15%. The weakness is in-line with overall YTD returns in the broader office sector, but it is significantly worse than the 5% YTD gain in the FTSE NAREIT Equity REITs index . It is also far off the broader S&P ( SPY ), which is up nearly 20% in the same time span.
The stock has been under pressure due in part to a negative association with the broader office sector. This is despite its unique characteristics centered around lab space. The company, nevertheless, is viewed by some no differently than any other office operator. Activist Investor and founder of Land and Buildings, Jonathan Litt, is one with a notable short position on the stock relating to this view.
The stock was recently upgraded at Jefferies to a "buy" on positive sentiment surrounding the life science industry. But the upgrade did little to change the overall direction of the stock. Shares are up 10% on the month, but these gains were largely recognized prior to the upgrade.
Key Takeaways Of ARE's Q2 Results
No Evident Deterioration In Portfolio Metrics: Those bearish on ARE seem to view the company no differently than a traditional office. In Litt's short report, for example, he pointed to cell phone data, which showed physical occupancy levels at ARE's properties at similar levels to what one would expect to see in administrative spaces as opposed to in specialized lab space.
ARE appeared to counter this with data surrounding electricity consumption. Comparing the full 2022 fiscal year with 2019, ARE showed that electricity consumption and occupancy were essentially the same in the two comparative periods.
ARE Q2FY23 Investor Supplement - Comparative Summary Of Occupancy/Electricity Consumption Of Comparable Space in 2022 Versus in 2019
If physical occupancy was as low as the cell phone data would indicate, one would expect to see lower consumption via decreased utilization. That doesn't appear to be the case, according to ARE's quarterly presentation.
And in terms of the raw reported data, compared to other office operators, ARE is continuing to operate at higher reported occupancy levels. Though the occupied percentage is lower than the pre-pandemic period, at a projected midpoint of 95.1%, occupancy is still expected to be the highest it has been since the end of 2019.
The higher occupancy rates are aided in part by strong quarterly leasing activity, which remains in line with their historical averages. The company is also realizing healthy spreads on these signings and is locking tenants in at attractive terms with escalators of approximately 3%.
Recent Dispositions Highlight Overall Portfolio Quality: ARE is generating annualized NOI of about +$2.0B. At their current market cap, shares command an implied cap rate of over 6.0%. This appears disconnected in relation to what buyers are paying for their properties in the open market.
Recent sales, for example, averaged in the mid-4% range, with a greater disparity on the two opposing coastlines. Still, the rate buyers are paying for their properties appears to be more than what investors currently believe shares are worth.
ARE Q2FY23 Investor Supplement - Recent Disposition Cap Rates By Region
Rate Growth Is Slowing But Concessions In-Line: While cash rents on signings grew modestly, the rate of growth was a step down from prior periods. In Q1, for example, ARE realized cash spreads of 24%. And in the same period last year, ARE reported over 30% growth. The 8.3% growth captured in the present, therefore, appears weak.
Some may cite the weaker growth as evidence of ARE's waning pricing power in the wake of the revelations contained in Litt's short report. But I am less concerned since most other metrics are in-line, namely concessions, such as tenant allowances.
Pure-play office operators are bearing the brunt of these concession woes, as prospective tenants negotiate a longer free rent period and more allowances relating to conversions. ARE, however, has largely been immune. In fact, allowances through the first half of 2023 are currently tracking more than $2.00/RSF lower than in 2022. In my view, this is a testament of the quality and reusability of their space.
Is ARE Stock A Buy, Sell, Or Hold?
Alexandria is trading at an implied cap rate that is approximately 150 basis points above the fair value of their properties, as assessed by recent disposition data. I expect this spread to narrow in ARE's favor in the coming months, especially as more sales data presents itself to prospective investors.
In my view, the stock can support a price of $160/share. This would indicate an implied cap of just above 5.2% on annualized cash NOI of +$2.0B. The viewpoint assumes an occupied percentage in the mid-90s with annualized leasing volume in-line with historical averages and no significant uptick in concessions.
My view is also premised on the notion that the company's properties are materially different from traditional office space. A recent short report indicates otherwise via cell phone data. ARE's data on electricity consumption is a good counter. And I expect a further rebuttal later on the conference call.
With an estimated upside potential of nearly 30% from current trading levels, I continue to see ARE as a high-quality addition to any long-term portfolio focused on REITs.
For further details see:
Alexandria Real Estate: Q2 Results Distinguish It As An Undervalued Lab Operator