Alexandria Real Estate Equities (NYSE:ARE) has been dubbed biotech's biggest landlord, a distinction that provides founder and executive chairman Joel Marcus with envy-inspiring industry insight. In this week's episode of The Motley Fool's Industry Focus: Healthcare, Marcus joins host Shannon Jones and contributor Todd Campbell to discuss:

  • How Alexandria Real Estate grew into a Goliath from a garage
  • What's supporting life science companies' demand for real estate
  • A bold five-year plan for growth
  • What worries him most about the industry
  • What Alexandria's venture capital business is up to

Marcus also plays a lightning round of buy, sell, or hold, a Motley Fool game of predictions! Listen in to hear if he thinks the direction of venture capital spending in healthcare is heading higher, if Cambridge and California will remain hotbeds of biotech innovation, and if the budget at the National Institute for Health is likely to grow.

A full transcript follows the video.

This video was recorded on Feb. 27, 2019.

Shannon Jones: Welcome to Industry Focus, the show that dives into a different sector of the stock market every day. Today is Wednesday, February 27th, and we're talking Healthcare. I'm your host, Shannon Jones. First up, I'm joined via Skype today by healthcare guru Todd Campbell. Todd, as always, welcome! So glad to always chat with you!

Todd Campbell: Great to be back here once again and to do something slightly different for this week's show. 

Jones: Oh, yeah! We have a very special treat, indeed. As wonderful as Todd is, we've got another guest joining us this week, and that is none other than Joel Marcus, the executive chairman and founder of Alexandria Real Estate Equities, Inc, ticker ARE, a company that's affectionately been called "biotech's biggest landlord." I kind of like that title there, Todd, what do you think? 

Campbell: [laughs] I think so, too! It's absolutely a powerhouse company. I'm really excited. Joel, thank you for taking the time to talk to us and our listeners about what's going on in Alexandria. I thought, maybe just to kick things off, for some of our listeners that maybe aren't so familiar with Alexandria, could you give us an elevator pitch explanation of the business and perhaps take a second and educate us all on the idea of clustering?

Joel Marcus: Sure. And it's a pleasure to be here, both Shannon and Todd. Thank you very much! Yeah, Alexandria, I think we are the biggest, but we certainly hope to pride ourselves on being the best, the highest quality, delivering the best environments for creative genius to create the medicines of the future, to hopefully cure a lot of pretty tough diseases that have not been challenged. 

Before I kick off, as you said, the elevator pitch and a little bit about clustering, I would say, keep in mind, there are 10,000 known diseases to humankind today, but only about 500 have been addressed by therapies, and very few of those are cures. You can see, we're in the really early days of the biology revolution to understand very complex systems within the human body. 

Alexandria, if you think about us with three kind of pillars. One is our unique strategy. We came up with the idea of laboratory assets that could be bought, developed, redeveloped, and leased to the very inventive research industry, which is creating medicines. We started back in 1994 really as a garage start-up, $19 million series A. We started much like a lot of the healthcare start-ups today. The second thing is our people. I think that really distinguishes us. We have one of the lowest turnovers in corporate America. We have, I think, very fortunately attracted and retained a tremendous group of people, very long-tenured people. I think the model that we try to fashion ourselves after is Jim Collins and Level Five egoless leadership and the egoless execution of what we do every day. 

The third pillar to the company is really the financial strategy. We started as a private company, we went public. We got our investment-grade rating right after the big recession. We've tried to keep very low leverage and lots of dry powder to grow the business. I think we've been very successful with combining that unique business strategy, and a very unique talent base with a very conservative financial strategy. 

When you talk about clusterization, the company was a single asset either we acquired, we built, or we redeveloped. Then, in 2004, 2005, 2006, we actually pivoted the company from single assets to the concept of cluster locations. That was based on the learnings of Michael Porter, the famous Harvard professor who really did the definitive work on clusterization. His thesis was, when industries cluster together, they're more productive, you can attract better people, and they operate in a much better fashion when collaborating and innovating together. That really is the hallmark of the life science industry. 

In '04, we started Mission Bay in San Francisco, which today is an amazing place of well over five million square feet of commercial space. And then there's another similar amount UCSF's principal research headquarters. In '05, we started our New York campus with Mayor Bloomberg. Today, that's almost a million square feet in the heart of the Eastside Medical Corridor. In '06, we bought TechSquare from MIT. We also started a two million square foot development in the heart of East Cambridge. Those were pretty influential pivot points for the company. 

Jones: It's just fascinating, this concept of these clusters. Having worked in one of those clusters, Research Triangle Park, to your point, you've got talent, you've got resources, that can really help and grow these businesses as they're clustered. 

One of the other fascinating things is how this company got started. Joel, you mentioned this got started in a garage. How in the world did this all come about? 

Marcus: Actually a little worse than a garage. I was doing a public offering. I was an attorney, a partner in a large West Coast law firm specializing in biotech and technology. I was doing a public offering for a group. The chairman called me over at a meeting and said, "Gee, we have this idea," this was Joe Jacobs, who founded Jacobs Engineering, "we want to create a real estate company. Jacobs has lots of clients in this industry, but we're a service company. We'd like to invest. Would you help us put together a business plan, a financial model?" I did that. After about a year of putting that together, they said, "We're too old to run it. Will you come in and run it?" And I turned them down three times, and then finally said yes. They were very persistent. 

The focus was to create a new real estate category, the office laboratory property. In those days, it really wasn't identified as a separate asset class like you might think of with apartments, industrial, shopping centers, etc. It just was never on anybody's radar. We raised $19 million, family and friends and a few sophisticated investors led by Jacobs Engineering, and really started the company from scratch. When we opened the doors in January of 1994, we actually had a business plan and a financial model and a strategy and $19 million, but we had no other assets. We're very proud that today, the company is almost a $20 billion total enterprise company, spanning all the great East Coast and West Coast life science clusters. We think, we hope, it's not only providing infrastructure, but venture, thought leadership, and we're very focused on corporate social responsibility. We really try to be a mission-driven company.

Campbell: From humble beginnings, right?

Marcus: And we try to stay that way. We always think of ourselves as Avis, not Hertz, in the old days. Jim Collins teaches in his famous book, How the Mighty Fall, you don't want to be a company like Kodak hanging out in Rochester, New York, not able to recruit young, really innovative people and not taking on the digitization of photography. We try to stay leading edge. That's why we have a team of scientists and technologists. We try to stay at the leading edge of the learnings in our focus area. 

Campbell: I imagine that's incredibly important. I want to shift gears slightly to flesh that out a little bit more. We know that this is a very innovative industry that you're serving. Tremendous amount of innovation that's going on, and it seems to be happening faster and faster and faster. You've got a specialty niche here. The real estate that you're building out is very specific. It's specific to these types of tenants. So, of course, one of the questions then that would come up would be, what are the levers that drive or the pillars that support occupancy rates within your buildings? My assumption would be that if these pillars were weaker, then it would be tougher to fill those spots, because they are so specialized. 

Marcus: That's a really critical question. We really attacked that very early on. It's kind of a funny story. When we went for our Series B round, we have 30 meetings set up by our investment bank, and literally 28 or 29 of them, we got tossed out, some even saying when we came in -- I think it was a GE pension fund said, "Oh, my God, we own one of these buildings and it's a disaster. We'd never invest in this." And finally, there was one pension fund that decided to fund our Series B that bridged us to an IPO. 

But it turns out, we investigated that and thought, "Gee, what's this building?" Well, it turned out, they owned an industrial building that had printing solutions, and it had nothing to do with research of biology or chemistry. It was a misperception, totally. 

But, the concept is, this is a specific industry. The buildings we buy on occasion, we mostly develop, and we do some redevelopment, are above-standard. They're more expensive than office buildings. They have specific infrastructure which bring water, gases, substantial air, to the laboratory bench. If you build one of these and you put this infrastructure in and somebody moves out, you don't want to rip all that infrastructure out. That would be a huge waste of money. So, we decided that we needed to focus on dense areas where these companies cluster so that if one tenant moves out, you don't then have to lease to a Goldman Sachs or a JP Morgan or a traditional office tenant. That would not be a very good outcome. 

That's where the cluster theory really emerged in a very dramatic way. When you operate in the clusters, you have great depth of tenant base, multiple types of tenants, from early stage to late-stage to mid-stage, and it's a very, very important factor. 

Jones: Let's talk about where the company is headed maybe over the next five to 10 years, and maybe some of the factors that are driving your growth strategy moving forward.

Marcus: That's a great question! Let me go back to the other one before. Because we're involved in the key clusters -- Seattle, San Francisco, San Diego, Cambridge, New York City, the Maryland area and North Carolina in the ag tech area -- the depth of the tenant base is such that when one tenant moves out, another tenant can move in, and we don't have to spend a lot of money to retenant and refit the properties. That's been very helpful.

We did our investor day on November 28th here in New York City. We gave earnings guidance, naturally, as companies do, for 2019. But we broke with tradition and gave a framework for a five-year plan that would enable us to double the rental revenues of the company on the assets we own today, not only the income-producing assets but the great land assets we have in the clusters I just mentioned. We took the analysts and institutional investors through our five-year plan and said, from the beginning of 2018 to the end of 2022, we have a good chance, assuming there are no terrible black swan macro-factors that would impede that, we can double the rental revenues. I think that's pretty unusual for any public company, let alone a REIT.

Jones: Yeah, definitely. Rental revenues is huge. I commend you for the challenging stretch goal there. 

Marcus: Thank you very much!

Campbell: Joel, you brought up a good point there. You talked about black swans, those things that just can come out of nowhere. I know that when I think about my business, I have some of these sleepless nights. I'm curious, what is it that makes it tough for you to get to sleep at night? What are those events that could happen? Is it simply rising interest rates and what the impact could be on building new buildings or economic recession? What are the things that worry you? 

Marcus: That's a good question! One thing that doesn't worry me is, our average lease is about 10 years. More than half our leases are investment-grade or large-cap companies. I wouldn't do this, but if we went to sleep as a management team, we could maintain half our revenues with the highest-quality tenants for 10 years. But we won't do that. So, we do feel good about sleeping at night. 

We're not so worried about interest rates. I think the Fed has done a good job of managing the careful unwinding -- in fact, Jerome Powell is testifying today to Congressional committees. They've done a good job of laying out the pathway to unwind the balance sheet and to carefully raise interest rates. I don't think you can assume that past interest rate levels are ones that we would have for the future. I think they're gauging that very carefully. 

We're also a very lowly levered company. Less than 5% of our debt is variable rate debt, meaning all of our debt today is fixed debt. We just got our upgrade from S&P, so both S&P and Moody's rate us a BBB+ investment credit, which is great. So, we don't have much exposure to variable rate interest. 

But what is an existential threat that is out there, and part of what's going on in Congress as well, is the health of the industry. We want to make sure that this country leads the world, as it is today, in biomedical innovation. You go back to my opening comment, if we have 500 addressable therapies, only a few of which are cures, out of 10,000 diseases, we've got a long way to go to really help humankind stay healthy. We need to see positive NIH funding, which we have; positive medical research philanthropy, which we've seen; a great regulatory environment for the FDA and Scott Gottlieb, a real shout-out for him and his entire team, they've done an absolutely first-class job; venture and public market capital flows being positive; and the companies, both biotech and pharma, reinvesting in R&D funding. This is where drug pricing comes in. Hopefully, one will see drug pricing is not just a list price by the manufacturer. 40% literally goes off the top to middlemen. And then, when the end user gets it, usually the hospitals, the hospital sometimes mark it up from 1X to 10X. They use that as a way to offset their losses through other mechanisms that they have, where they have their emergency rooms being used by people who can't pay and so forth. It's not the manufacturers, oftentimes, that are the problems. There have been some egregious crazy people, but the mainstream, really high quality, ethical groups, we want to make sure that they have an incentive to continue research and development and great breakthroughs, especially on the precipice of a generation of dementia and really serious neuroscience diseases that are going to take hold here over the next quarter of a century. 

Jones: Yeah, I totally agree. You really hit the nail on the head in talking about the importance of the U.S. being at the forefront of biomedical innovation. 

A couple of stats I came across as I was researching the company. Silicon Valley Bank recently ranked ARE as the most active biopharma investor by deal volume in 2017 and 2018. Forbes ranked your company as No. 1 in terms of venture capital in the healthcare sector, also on deal volume in 2018. Pretty impressive. What can you tell us about your venture capital arm, and maybe what are some of your specific focus areas, too?

Marcus: You're a good person to ask, because I know you have a neuroscience background, Shannon. I appreciate the question very much. Yeah, we are No. 1 by most active. We tend to focus on the earlier stages. We like series A, B. We're also doing a lot of work in the C stage because we think that trying to put together unique teams with unique opportunities to make breakthroughs in a whole range of diseases is important. We also have gone to the other end, we have done crossovers to IPOs and participated in IPOs. We manage a little bit under $1 billion by market value, which is a little less than 5% of the total assets of the company. We feel very good about our position.

We'd like to focus on the leading edge. We're pretty involved today in the next-generation cell therapy companies. A number of them that have recently been formed, we've been pretty deeply involved with. Some of the gene therapy companies you saw, Spark, a gene therapy company based in Philadelphia, which is pretty unusual, just get scooped up for over $5 billion. We're pretty focused on machine learning and artificial intelligence as it applies to the drug discovery process. We're also pretty focused on, can we detect at the absolutely beginning cellular level, before any metastasis or any aggregation of cells begin, the earliest signs of cancer beginning to grow within the cell? There are so many areas.

As you know, Shannon, having an undergraduate degree in neuroscience, you know that the key to unlocking dementia and a number of the intractable neuroscience diseases really still has not been found. That has eluded literally every company so far, and we still don't see any immediate breakthroughs on the horizon. 

Jones: Yeah, unfortunately, that is the case. But with companies that are investing in those areas with such a huge, significant, unmet need, this is what I think will ultimately be over the next five to 10 years, we'll start to see the needle move a little bit in those areas. But, yeah, that continues to be one of the marks that it just seems like many companies just can't hit. 

Marcus: It's been frustrating, for sure. 

Campbell: Joel, we here at The Fool love games. Right, Shannon?

Jones: Oh, we love games!

Campbell: Absolutely! We're hoping you might want to play one with us today. We'll keep it relatively simple. As we come into the homestretch of our conversation -- thank you, again, so much for joining us here on the show -- I wanted to do a lightning-round-style game for our listeners that we'll call buy, sell, or hold. What I'll do, if you're willing, is to give you a prediction. Then, I'm going to ask you to rate it either a buy, a hold, or a sell. So if you agree with the prediction, that would be a buy. If you're unclear, unsure, that'd be a hold. If you think there's no way that's happening, that would be a sell. So, what do you say? Are you game to play a game? 

Marcus: Of course!

Campbell: Great! Let's kick it off then! I'll tell you the statement, then maybe you can tell me the buy, sell, or hold. And if you have a thought on it, please feel free to add. First one: in five years, venture capital for healthcare will be bigger than it is today. 

Marcus: I honestly think that's an easy one. I think it's going to be massively bigger. If you just look at the baby boomer, the aging of the population, not only in the U.S. but worldwide, and then you look at just the neuroscience area, absolutely bigger. 

Campbell: OK, so we've got a buy on that. Absolutely bigger. In five years, a new market will unseat Cambridge, and California as the hotbed for life sciences innovation.

Marcus: No.

Campbell: OK, so that's a sell. Those will remain the biggest marketplaces for innovation in life sciences.

Marcus: Yep. Clusters take 25 years to grow. Nothing's going to happen in five years to unseat them.

Campbell: Perfect! Then, the last one. In five years, the NIH budget will be bigger than it is today. 

Marcus: Yes. It's almost $40 billion today, and they expect it to be bigger. There is one other factor that your audience should know. The government funds less than $1 billion for ag tech research. We're spending almost $40 billion on biomedical. If you look at China, who just bought Syngenta, we need to capture the lead research in the ag tech world, too. Human health is not only fighting disease, but it's good nutrition. So, I would say that's a big one we ought to pursue. 

Jones: Joel, that's an awesome closing thought here, and something we'll probably dig into more. I think China, in a lot of ways, is on investor minds as we watch their emerging space and as the regulatory framework out there continues to improve.

For you and your company right now, if you just had maybe one key takeaway that you'd want potential shareholders or current shareholders to know, what would that be? 

Marcus: The one that I mentioned before, we're in early innings of a biology revolution. I think the company has the framework to double rental revenues in five years. I don't think there's a stock out there in the real estate sector that can match that.

Jones: Fair point. Joel, thank you so much for taking time out of your busy day to chat with us! I will say, we'd love to have you on this show, maybe when you have those five-year goals, check back on you, see how you did with doubling the revenue. How does that sound?

Marcus: That sounds perfect! Thank you, guys, very much! It's always a pleasure!

Jones: Thank you, Joel! Thanks so much to you, listeners, as well! That's it for this week's Industry Focus: Healthcare show! As always, people on the program may have interest in the stocks they talk about, and The Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear. This show is produced by Austin Morgan. For Todd Campbell, I'm Shannon Jones. Thanks for listening and Fool on!