2023-08-05 07:00:00 ET
Summary
- Arbor Realty is up over 50% since the short report.
- Medical Properties is up over 20% since May.
- Digital Realty is up over 25% since my last article.
- Now we have another short to debunk.
My track record for debunking shorts has been good…
Take for example, Arbor Realty (ABR) that was the target of a short report and in an article dated April 19, 2023 ,
“The stock has been so beaten down over the past year that at today’s prices you would receive a total annual return of 40.20% assuming that by the end of 2024 the stock reverts to its 5-year normal P/E of 8.4x.”
The only thing wrong with that article is that it only took around 90 days as shares are up just under 50% since that article in mid April.
Another battleground REIT that’s been the subject of two short reports is Medical Properties Trust (MPW). In an article in early May 2023 I explained that,
“I've been strategically dollar-cost-averaging shares as a means to lower my cost basis and more quickly get into a profitable position. Of course, this practice is advisable only if you're certain that stock was cheap when bought originally.”
To be clear, MPW is up around 20% since that article in early May, however, I’m still a tad underwater (-5%) after dollar cost averaging my previous buys. Next week we’ll know exactly how MPW’s management team has done, and given what I know now, I suspect to see continued momentum higher.
One final short that I’ve debunked lately is Digital Realty (DLR).
You may recall an article I penned on May 15, 2023, explaining,
“DLR's five-year normal P/AFFO is 20.61x but currently they are trading at an AFFO multiple of 16.06x. If DLR returns to its normal valuation it would result in a total annual rate of return of 27.15% over a two-year holding period. At iREIT we rate Digital Realty a Strong Buy.”
Well, well…
I didn’t take long, thanks to AI, shares in DLR are up over 25% (since my last article).
Now, that’s a pretty good track record don’t ya think?
But to be clear, I have no time for celebrating a so-called victory lap because I need to provide my loyal readers with yet another Strong Buy that also happens to be the subject of another short report.
The Big Short
Back in June 2023 Land and Building published a white paper titled " The Work From Home Hurricane Has Hit Life Science Offices."
In the article the activist firm said that “if the path for life science follows traditional office… Alexandria could trade at valuations similar to traditional coastal office REITs, which suggests 30%-40% downside from current levels.”
As most of my readers know, I’ve been long Alexandria Real Estate (ARE) f or quite some time, and when the above referenced article was published, I immediately responded as follows:
“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.”
Since my article was published, ARE shares have surged +9% and now that Q2-23 earnings are in the rear view mirror, I’m maintaining a Strong Buy, as I explained on June 20:
“…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."
The Basic Business Model
ARE is a self-managed REIT that owns, operates and develops life science properties through a “cluster model” in which it owns and operates life science/technology campuses in markets that it believes have the location, capital, talent and infrastructure to support a successful life science industry.
These clusters include Greater Boston, the San Francisco Bay Area, San Diego, Seattle, Maryland, and North Carolina’s Research Triangle. Nearly three-fourths of exposure comes from its three biggest markets: Boston, Bay Area, and San Diego.
ARE counts 850 tenants as customer and has a total asset base of 76.5 million square feet, which includes 41.9 million square feet of operating properties, 5.5 million square feet under construction, 9.7 million square feet if near and intermediate development projects and 18.5 million square feet of future development projects.
ARE provides strategic capital to life science, agrifood tech, climate innovation, and technology companies through its venture capital platform. The company was founded in 1994, went public in 1997 and joined the S&P 500 Index in 2017.
Biotech funding appears to be recovering and life science VCs are sitting on substantial dry powder from the second-highest fundraising year on record in 2022 ($37.3 billion), as funds typically take five years to deploy.
While new supply will be elevated – unleased new supply is 18.1% of existing stock in ARE’s markets, mostly delivering through 2025 – we believe that the demand will catch up over time.
The innovation for the treatment and cure of diseases is still in its early innings. According to the FDA, of the approximately 7,000 known rare diseases, less than 10% have been FDA-approved treatment.
Capital flows into life science should continue to drive growth that outpaces the broader economy by a meaningful margin and provides a runway for demand that will exist so long as there are diseases without effective treatments.
The Latest Quarter Results
In Q2-23 ARE reported $714 million in revenues, an 11% increase over the same period in 2022. FFO was $382 million, more than 515 higher than last year.
ARE CEO Peter Moglia said that the firm saw an increase in demand for life science offices and labs “ranging from 15% to 20% in our top three markets, a sign that perhaps investors are seeing the light at the end of the tunnel when it comes to economic uncertainty.”
ARE reported 1.3 million square feet in leasing volume in Q2-23, and 2.6 million square feet in the year’s first half, which it said was “in line with pre-COVID leasing volume.”
ARE said occupancy at its North American properties was 93.6%, and expects it to rise to 95% by then of the year.
Rental rate growth on lease renewals rose 16.6%. And 49% of annual rental revenue is generated from investment-grade or large-cap publicly-traded tenants, and this statistic represents one of the highest quality client rosters in the REIT industry today.
Also in Q2-23 ARE’s FFO per share diluted as adjusted was $2.24, up 6.7% over Q2-22 and the company said it’s “on track to generate another solid year of growth in FFO per share growth of 6.4% at the midpoint of guidance for the year."
As shown below, ARE has generated solid AFFO per share growth, averaging 10% annual growth since 2017:
Analysts forecast 8% compound FFO/sh growth through 2026, which is stronger than current valuation reflects.
FAST Graphs
Meanwhile, ARE has been a consistent dividend grower, averaging 6% growth over the last five years (as shown below):
ARE Investor Presentation
Looking back further, you can see that ARE has consistently increased its dividend after a cut in 2009 as a result of the GFC.
As you can see below, ARE’s payout ratio is in great shape today, at around 70% (based on AFFO per share):
ARE is projecting $375 million, representing a three-year run rate of over $1.1 billion in net cash flows from operating activities after dividends for reinvestment.
The Balance Sheet
ARE’s management team is highly disciplined as evidenced by the recent $1 billion increase on the company’s senior line of credit facility, from $4 billion to $5 billion.
This further adds to the REIT's significant liquidity of $5.3 billion. The amended deal can be expanded to up to $6 billion under an accordion feature. The maturity date of Jan. 22, 2028, was unchanged.
As show below, ARE has a very strong Investment Grade rating from S&P (BBB+) and Moody’s (Baa1), just one notch below A-rated. There are no debt maturities prior to 2025 and the debt is 99.2% fixed rate.
In addition, ARE has disposed of more than $700 million in real estate related to its life science campuses – and is poised to sell $1 billion more. It has another $178 million in non-core real estate sales to close and $874 million in targeted sales in the second half of the year. The pending sales total $1,052 billion.
Silly Rabbit, Shorting Is For Kids
ARE took issue with the Land & Building short report. Jenna Foger, a senior vice president for the REIT, said critical research and development can’t be done from home. She said energy use by life science tenants, a key measure of life science R&D, hasn’t changed since before the pandemic.
“T he scientific throughput occurring in our spaces at any point in time is not correlated with the volume of people flowing in and out of our buildings and campuses.”
Clearly Land & Building overlooks the fact that the core of jobs (scientific research) cannot be done from home and that the adjoining office space is complimentary to the job function rather than nonessential.
Also, even as physical utilization was declining post-2020, life science companies leased a record amount of space in 2022/2023, as ARE’s average quarterly leasing of 2.2 million square feet nearly doubled the 1.2 million average from 2018/2019.
This highlights the fact that scientific development , rather than changes in work behavior, will drive demand .
Much like the other REITs I highlighted earlier, I’ll take the opportunity to increase my stake in ARE as a result of the silly short report . I added to my ARE position when the Land & Building report was released and am even more confident now after the Q2 earnings release.
As you can see (above), shares have moved back up (black line is the price line) and now trade at 18.4x P/AFFO (still cheap). The normal multiple is around 30x P/AFFO, however, that includes the COVID-19 runup. We believe that a realistic FV for ARE is around 22x, which translates into a 20% annualized total return (from now).
In closing, I’ll remind readers that shorting REITs is dangerous, and if you’re going to pursue such a strategy, make sure that you do your homework.
As you can see, our batting average is above average with defending shorts, and that’s because we pay close attention to fundamentals. As Benjamin Graham said,
"You are neither right nor wrong because the crowd disagrees with you. You are right because your data and reasoning are right."
He added,
“Obviously it requires strength of character in order to think and to act in opposite fashion from the crowd and also patience to wait for opportunities that may be spaced years apart."
Note: Brad Thomas is a Wall Street writer, which means he's not always right with his predictions or recommendations. Since that also applies to his grammar, please excuse any typos you may find. Also, this article is free: Written and distributed only to assist in research while providing a forum for second-level thinking.
For further details see:
Alexandria Real Estate: Silly Rabbit, Shorting REITs Is For Kids