• Alexandria Real Estate Equities has a strong real estate portfolio in triple AAA locations, a history of high rental occupancy and currently boasts long duration leases
• The company has a strong balance sheet and has an excess of available cash to cover its debt obligations over the next few years
• Alexandria is currently undervalued as it is priced around the cost of real estate minus its debt. This means that investors can get current property management, tenants in place and future rent increases as a bonus.
• Alexandria’s dividend is well covered by free cash flow even after paying out the debt obligations.

• Alexandria has a large concentration of real estate in a few select geographical regions. Major disruptions to these cities or real estate prices can significantly effect this company.
  
• The company is also focused on renting to the life science industry and is sensitive to changes in this industry.
  

Investing can be scary, especially when the entire sectors experience massive declines within the span of a few months. Real estate investment trusts (REITs) are companies that specialize in purchasing, financing, renovating and renting properties for a wide variety of uses. However, most REITs are sensitive to interest rates in part due to the high debt involved with real estate. So when money lending becomes tight and interest rates soar it becomes more difficult to refinance and borrow money. To make matters worse, tenants may also default on rents during these economic downturns.

Fortunately, not all REITs are equally susceptible to economic downturns. Some REITs have low debt, lots of cash available on hand (i.e. liquidity) and strong tenants that are well positioned to continue rent payments. One such company could include Alexandria Real Estate Equities, which below I will outline some reasons why this REIT could potentially be positioned to deliver strong returns over the long run.

Reason # 1) Alexandria Real Estate has a strong business model with a history of strong financial performance

Alexandria Real Estate Equities specialty is renting office and laboratory spaces to companies primarily in the life science space. The company has steadily grown its real estate empire, with Alexandria’s real estate value increasing by about 15.6% annually over the last 17 years. Currently, their latest annual report boasts about 432 properties in North America plus an additional 64 properties as part of joint real estate ventures. This translates to Alexandria owning about 47.7 million rentable square feet of property!

The majority of these properties are located in what the company describes as AAA locations. Alexandria’s properties are located in premier locations meant to attract white collar workers including the greater Boston area, San Francisco, New York city, San Diego, Seattle and Maryland. Indeed, the company rents to many major recognizable companies and institutions. Some of the larger tenants include Bristol-Myers Squibb, Moderna, Eli Lily and Company, Novatris AG, Uber Technologies, Roche, Amgen, Pfizer, MIT and Harvard.

Properties in triple AAA locations not only help attract high quality tenants, but also typically have higher tenant occupancy than other locations. Over the decade, Alexandria has had around 96% occupancy. Below, we can see that rent (revenue) and profits (funds from operations) have steadily grown 14 – 15% per year.

Currently, the average remaining long term lease for the company is about seven years and 96% of their leases have annual rent escalators. Between the expected rent increases and the numerous amount of new lease development, I think Alexandria is well positioned to continue to grow their profitability in the years ahead.

Reason # 2) Alexandria Real Estate has a strong balance sheet with easily manageable debt

As we discussed earlier, interest rates are critical for REITs due to nature of the high debt involved with real estate. Below, we have a graph showing Alexandria’s debt maturities over the next few years compared their estimated funds from operations. For illustrative purposes, I assumed that the funds from operations will grow a meager 3.5% per year due to rent increases from 2023. As we can see, the company is actually in very good shape with their debt. Alexandria currently has no debt due until 2025. Alexandria should also be able to easily meet these debt obligations based on their current FFO ($1,532 million) even after paying out dividends ($847 million).

Another advantage with the company’s debt structure is that practically all of their debt is fixed at about 4% interest. Additionally, their average weighted long term debt obligation is about 13 years. It is not surprising that Alexandria currently has a BBB+ credit rating and is in the top 10% credit ratings for all U.S. REITs.

Alexandria also has $5.3 billion available in cash and as part of their revolving credit facility. This will allow the flexibility for the company to deal with unexpected expenses or to pursue new investment opportunities. In the event where properties become available due to the economic downturn, this liquidity will allow Alexandria the option to pursue deals whereas their competitors with less liquidity may have to pass up.

Reason # 3) Alexandria Real Estate Equities is currently undervalued

The price to earnings ratio (P/E ratio) is commonly used to price companies, but in the case of REITs the price to FFO is used. This is partly due to the fact that earnings are reported before adding back depreciation, which is a huge part of owning real estate. Currently, Alexandria is trading at 11.6x price to FFO which is significantly less than their historic average over the last decade of 17.6x FFO.

Another important metric is the book value of the company. The current real estate value of Alexandria $31.712 billion, the value of their debt is $11.1 billion and the market value of the company is about $21 billion. This means that the total company can be purchased for about the total real estate value of the company minus the debt. Shareholders also benefit from the company’s real estate experts, property managers and tenants in place.

Alexandria is currently predicted to have about 5% growth in FFO per share over the next few years. I have decided to be more conservative and assume that the future growth will be closer to the historically grown of about 3.5% FFO annually compounded per share. With 3.5% FFO growth and assuming the company returns to a 15x price to FFO, the company’s shares have the potential to return around 14% over the next few years (assuming $120 stock price) which could be very rewarding to investors.

Reason #4) The compnay has a healthy dividend

When looking at the sustainability of a dividend, it’s important to understand the company’s dividend history. For Alexandria real estate equities, I noticed that the company had a dividend cut during the 2008/2009 recession. Below are the contractual obligations for the company compared to their FFO during the recession. As we can see, the debt due greatly exceeded the company’s FFO during 2008 – 2011. It is hard to imagine a scenario where Alexandria would not have to cut its dividend during that time period.

Currently, the company has an easily manageable debt, a very reasonable payout ratio and has been growing by about 10% annually over the last decade. Not only do I believe that the dividend is secure, but that it will likely continue over the upcoming years.

Conclusion

There are many strengths with Alexandria’s business model. The company has grown their funds from operation like clockwork over the last decade. This is reflected by the company’s high tenant occupancy, high tenant quality and long term leases. Additionally, the company boasts an impressive balance sheet with no near term debt due, nearly all of the long term debt at fixed interest rates and their debt is covered with their funds from operations. The downside to the company is the concentration of real estate in a few key locations and the reliance on the life science industry. Regardless, I believe the company is high quality and deserves a 4.5 out of 5 stars for quality.

The valuation of the company is also very compelling. Alexandria normally trades at a premium price to FFO ratio of around 17.6X. However, the current price to FFO ratio is around 12.5X. Considering that the company can easily support its current dividend and the excess funds available for the company to continue growing their real estate assets, I would rate the company as 4 out of 5 stars for valuation.

In conclusion, I consider this stock the opportunity to buy a good quality company at the value of its real estate assets and receive all of the experienced management, high quality tenants and future growth prospects as a bonus. As such, I plan to grow this position larger in the near future.

Disclaimer:

I currently own stocks mentioned in this article including Alexandria Real Estate Equities at the time of writing this post. Additionally, I am not a financial advisor and I am not providing financial advice. I am sharing my thoughts and processes of selecting stocks for my personal portfolio for fun and entertainment purposes only.

All information provided here is on a “best of my knowledge” basis and may be incorrect. All estimates and models are guesses and may not be accurate. Stocks mentioned here may have additional risks not covered in the post.

Investing in the stock market comes with serious risk of losing money, please consult a professional financial advisor and do your own due diligence before investing.