Office real estate investment trusts (REITs) have struggled over the past year as COVID-19-driven shutdowns have increased vacancy rates and tenant delinquencies. Retail spaces within these buildings have suffered as well. The pandemic also demonstrated the viability of working from home for many industries, which is making investors question the investment thesis for these companies.
That said, all office tenants are not the same. This is why Alexandria Real Estate Equities (NYSE:ARE) is one of my favorites.
Alexandria's tenants are a who's who of pharma and biotech
Office REITs have a relatively simple model; they construct office buildings and rent out the space, usually in a long-term lease. Alexandria concentrates its offices in what it calls "AAA innovation clusters," which are urban campus locations with limited space, high barriers to entry, and high barriers to exit. Alexandria focuses on life sciences, agtech (agricultural technology), and technology where workers with in-demand skill sets are concentrated. Its biggest markets are greater Boston, San Francisco, New York City, and San Diego.
Alexandria has a portfolio of 338 properties with 31.9 million rentable square feet, with another 17.8 million square feet in construction, redevelopment, or set for future development. Its top clients in terms of revenue are a who's who of pharma and biotech, including Bristol Myers Squibb, Takeda Pharmaceutical, Illumina, Sanofi, and more. Facebook is its largest client outside the life sciences. While the COVID-19 crisis was a boon for the biotech industry in general, Alexandria really benefited. During the three full quarters of the pandemic last year, Alexandria actually topped its average 10-year occupancy rate of roughly 96%. From April 1 through Dec. 31, the company collected 99.8% of rent due.
Most office REITs saw a substantial decrease in funds from operations (FFO) between 2019 and 2020. Only a handful, including Kilroy Realty and Alexandria, saw increases, and that was driven by their exposure to life sciences tenants. Needless to say, the COVID-19 pandemic was good for life sciences businesses in general, and it turns out that the life sciences companies prefer to have everyone on site.
While most of its competitors reported decreases in funds from operations, Alexandria saw a big jump
During 2020, Alexandria Real Estate Equities' adjusted funds from operations (AFFO) grew 18% to $924 million. (Real estate investment trusts tend to use funds from operations, rather than earnings per share, because real estate companies have a lot of depreciation, a non-cash charge that understates cash flow.)
While Alexandria saw a big jump, most other office REITs saw declines. Boston Properties saw a 10% decline, SL Green Realty fell 7%, and Vornado Realty Trust dropped by 25%. Kilroy (which also has heavy life sciences exposure) did see a small increase of 4%. Last year was rough on office REITs, but Alexandria's client base helped it outperform its competitors.
Alexandria pays a $1.09 quarterly dividend and was one of the few REITs in general to increase dividends last year. This works out to be a 2.6% dividend yield, which is kind of on the small side for a REIT. That said, Alexandria pays out about 60% of its FFO, while using the remaining funds for growth. Because of that growth and performance, Alexandria is on the expensive side compared to its peers, trading at 23 times 2020 funds from operations. That said, it deserves a premium valuation given the company's focus on life sciences and tech.