Office real estate investment trusts (REITs) have had a cloud over their heads since the pandemic proved the efficacy of working from home. Remote working employees are happy to save on commuting time, while employers are able to cut occupancy expenses. We have seen some office REITs report continually declining occupancy levels, while others have been recovering.
Alexandria Real Estate Equities (ARE -0.45%) is reporting higher rents and occupancy. What is it doing differently?
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Alexandria focuses on life sciences office spaces
Alexandria Real Estate Equities is an office REIT that focuses on tenants in the life sciences and technology sectors. As of Dec. 31, 2022, the company had 74.6 million square feet of space either in operation or development. Alexandria Real Estate Equity's "innovation clusters" are used by pharmaceutical and biotech companies, government agencies, academic research institutions, and tech companies. Its campuses are located in urban hubs like Boston, New York City, the Washington DC area, and the San Francisco Bay Area.
The life sciences industry requires sophisticated laboratory spaces, which means that an operator needs to be abreast of the latest regulatory rules and regulations, and needs a long history of developing these properties in order to earn the tenant base's trust. This makes it difficult for other office REITs to move into this sector. Alexandria's biggest tenants include Bristol-Myers Squibb (BMY 0.83%), Moderna (MRNA 1.44%) and Eli Lilly (LLY 1.27%).
Alexandria sees continued investment in the life sciences space
On the earnings conference call, Alexandria Real Estate Equities laid out some of the differences in its markets. First, the pharmaceutical industry has outperformed the S&P 500 by a wide margin over the past year. These companies have $300 billion to deploy into research and development (R&D). In addition, venture capital funding has remained robust, with $58 billion in 2022, of which 70% went into an Alexandria Real Estate Equities cluster. Fundraising for the venture capital space has continued, with $160 million raised for tech and life sciences funds.
Alexandria Real Estate Equities sees the next decade being driven by big pharma R&D spending as patents expire, as well as treatments like mRNA and cell therapies moving from the pre-clinical stage to commercial production. The company sees continued investment in research and development spending, which will drive growth in demand for laboratory space.
Alexandria believes that a remote environment is simply not as conducive to the life sciences industry as it is to tech or financial companies. The need for laboratory space along with a collaborative environment makes the company less vulnerable to a drop in occupancy and rents.
Occupancy is returning toward historical averages
At the end of 2022, Alexandria's occupancy percentage was 94.8%, and its 10-year average was 96%. At the end of 2021, Alexandria's occupancy percentage was 94%. The company has also been seeing increases in rent, and estimates the mark-to-market on its portfolio to be 27% to 32% on a generally accepted accounting principles (GAAP) basis and 11% to 16% on cash.
Alexandria Real Estate Equities is guiding for 2023 funds from operations (FFO) per share to come in between $8.86 and $9.06, which puts the stock on a multiple of 19.1 times guided FFO per share. REITs tend to use FFO to describe earnings, instead of earnings per share under GAAP. This is because depreciation and amortization is a big deduction under GAAP but isn't really a cash charge. This understates the cash flow of the company.
Alexandria hiked its dividend twice in 2022, and currently pays an annual dividend of $4.84. This is well-covered by expected FFO per share, and its low payout ratio shows that Alexandria is reinvesting cash in the business. Investors who want to bet on life sciences real estate might find Alexandria Real Estate Equities worth a look.
