Sometimes buying a stock at a historically cheap price is a value trap. A stock may be inexpensive due to a change in the macroeconomic environment, or it might become cheap as a result of problems in the overall sector. In the case of Alexandria Real Estate Equities (ARE +1.65%), you have a high-quality company operating in a sector that is under pressure. Is the stock a good value, or a value trap?
Alexandria focuses on life sciences office space
Alexandria Real Estate Equities is a real estate investment trust (REIT) that specializes in office properties for companies in life sciences, agtech, and technology. It has campuses in locations such as San Francisco, San Diego, Boston, New York City, Maryland, and the Research Triangle of North Carolina, totaling 74.6 million square feet of space.
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Alexandria's focus on life sciences companies has insulated it somewhat from the shift to work from home that has bedeviled other office REITs like SL Green Realty (SLG 0.19%). This is because life sciences companies generally require sophisticated laboratory spaces that simply aren't conducive to remote work. That said, Alexandria does have technology tenants, and many of them are beginning to reduce their workforces.
Occupancy is still below pre-pandemic levels
Alexandria's pre-pandemic occupancy rate was 96.8%, but that fell to 94% by the end of 2021. Occupancy has subsequently rebounded to 94.6% as of the end of 2022. This is better than companies like SL Green, which have yet to see any rebound in occupancy rates. Alexandria's tenant base probably benefited from one-time government spending during the pandemic, which could have helped support occupancy rates.
Investor sentiment is dour in the office commercial real estate market
Investor sentiment surrounding the office REIT sector is pretty pessimistic at the moment. We are seeing forecasts that office property prices will decline as much as 40% peak-to-trough and there are fears that 35% of commercial real estate mortgages coming due this year won't be able to be refinanced. Of course, all real estate is local, and that doesn't mean that Alexandria will be unable to roll over its debt. The mood surrounding the sector is highly negative, and even good companies can get slammed.
Alexandria Real Estate Equities has forecast 2023 funds from operations (FFO) to come in between $8.91 and $9.01 per share, a 6.4% increase at the midpoint of those estimates. REITs like to use FFO to describe earnings because it more accurately represents the actual cash flow of the company. Under generally accepted accounting principles (GAAP), companies are required to deduct depreciation and amortization from revenues. Depreciation and amortization is a huge expense for real estate companies, yet it is a non-cash charge. Companies don't write a check for D&A. This is why REITs will appear to have high price-to-earnings multiples.
At current levels, Alexandria Real Estate Equities is trading at 12.6 times projected FFO per share. This is historically a cheap multiple for the stock. The dividend yield of 4.4% is on the high side as well. Investors might be looking at Alexandria as cheap, and they would be correct. Still, high-quality companies (and Alexandria Real Estate Equities is a best-in-class operator) will suffer if the sector is going through a tough period. Increasing pain in the office sector will raise borrowing costs, which will hurt FFO. Investors who are eyeing Alexandria's historically cheap multiple need to be careful.
