Over the past year, the problems in the commercial real estate market have become more prominent. Ground zero for the commercial real estate issues is the office market. Office real estate has struggled since the COVID-19 pandemic began. That said, not all office real estate investment trusts (REITs) have been struggling. Alexandria Real Estate Equities (ARE 3.66%) has managed to buck the trend. What is it doing differently?
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Alexandria focuses on office space for the life sciences sector
Alexandria Real Estate Equities is an office REIT with a focus on the life sciences sector. The company has 825 tenants with an asset base of 74.9 million square feet of gross leasable area. It follows a cluster model, which means its locations are chosen based on the availability of capital and talent. Often these clusters are located close to academic institutions, which the company refers to as core hubs of innovation.
Alexandria's focus on life sciences distinguishes it from most other office REITs. The work-from-home experiment during COVID lockdowns worked so well that many companies found they suddenly needed less office space than they did pre-pandemic. Alexandria's focus on the life sciences space has insulated it from this phenomenon because lab spaces are not conducive to a work-from-home model. Alexandria's focus on lab spaces also means there are barriers to entry to its business. Alexandria's expertise is well-known, and 17 of the top 20 biopharmas lease space from the company.
Biopharmas are increasing their spend on research and development
The COVID-19 pandemic increased the amount of money biopharma companies have put into research and development (R&D). Alexandria said that in 2022, biopharma spent roughly $267 billion on R&D, which was a 57% increase compared to the 10-year average. It expects R&D spending to increase to $450 billion in 2023, which will continue to support demand for Alexandria's lab spaces.
While most office REITs did see a drop in occupancy during the pandemic's height, Alexandria's occupancy held up better than most, falling to 93.6%. The company is guiding for year-end 2023 occupancy to be above 95%, so it sees a lot of leases starting in the second half of 2023. In the second quarter, rents increased at 16.6%. While this is a decrease from the red-hot levels during the pandemic's height, it is still superior to what most office REITs are experiencing.
Alexandria is guiding for 2023 funds from operations (FFO) to come between $8.93 and $8.99 per share. REITs tend to use funds from operations to describe earnings, because depreciation and amortization (D&A) is a huge expense under net income as reported under generally accepted accounting principles (GAAP). Since D&A is a non-cash charge, net income tends to understate the actual cash flows of the company.
Alexandria's dividend is well-covered
At current levels, Alexandria is trading at a multiple of 14 times 2023 FFO per share. This is a pretty reasonable multiple for a market-leading REIT. Alexandria trades with a dividend yield of 3.9%. This is low for a REIT; however, Alexandria is plowing cash back into the business. The dividend is well-covered, with Alexandria spending only 55% of FFO on the dividend. This should translate into faster growth going forward.
Like most REITs, Alexandria has been negatively affected by rising rates. However, its focus on life sciences means it shouldn't be lumped in with the office REITs, which are struggling right now with falling demand for office space.
