Things can get a little crazy in both bull and bear markets, as we all know these are usually times when it seems like 1+1 somehow equals 69 in terms of valuations. We definitely were at this point in late 2021, with bulls chanting “to the moon” and a plethora of stocks and cryptocurrencies marching higher and higher for seemingly no reason.
I would argue that we may be heading in the opposite direction into “WTF” territory when we talk about certain companies caught in the 2022 bear market. In this article I want to talk about Alexandria Real Estate (NYSE: ARE) and why I believe the recent sell-off in equities was overdone, even in an environment of potentially recessionary and rising interest rates.
Alexandria Real Estate is by far the largest life science-based REIT in the world. The Company focuses on the real estate and infrastructure needs of pharmaceutical, biotechnology and other life sciences companies.
The company uses a cluster model for its developments because it believes that the vast majority of innovation, talent and capital in the life sciences market will be concentrated in attractive, talent-rich centers in the United States. The primary markets for Alexandria are currently in San Francisco, Seattle, Boston, San Diego, New York City, Maryland and the North Carolina Research Triangle.
This unique focus on high quality and attractive development locations has left Alexandria with a tenant roster that is the envy of the market, with a full 50% of revenue coming from publicly traded or investment grade tenants in one of the most recession-proof industries on the planet.
One of the reasons the company has been so successful is that it remains firmly attuned to the evolving needs of its customers as the entire business is purposefully focused on the life sciences industry. Alexandria can plan and accommodate changing laboratory needs as new therapeutic modalities are developed. Additionally, Alexandria knows what talented and in-demand employees want in a workplace and can provide attractive and in-demand features in its locations long before they become commonplace.
Thanks to its partnership relationship with its tenants, the Company also enjoys fairly unparalleled earnings visibility from its development pipeline, with a full 78% of its near-term development pipeline being leased or negotiated.
That near-term development pipeline isn’t small either, amounting to potential annual revenue of $665 million, which, from its estimated baseline of $2.59 billion for 2022, represents nearly 26% revenue growth from these developments alone is equivalent to.
In addition to the development pipeline, the company’s existing property rental rates have skyrocketed recently, averaging a 33.9% increase on a cash basis in the second quarter of 2022. This ability to both raise rents by more than a third and close pre-release -term developments is a two-headed monster for internal growth that is unlikely to slow down in the near term, regardless of interest rates or a recession.
The life sciences market is notorious for its recession-resistant nature, and given the list of tenants that Alexandria leases to are generally not speculative biotechs that could be wiped out in liquidity stress, the company appears to be in relatively calm waters, even if the Overall economy is hit by the hurricane.
Rating of ARE stock
So far in 2022, all of the above attributes of tenant security, internal growth, and the company’s excellent execution have seemingly meant absolutely nothing to the stock price. As of today, the company is down a whopping 36% year-to-date.
To be clear, the company was certainly a bit overwhelmed late last year, the price of AFFO was inflated at 27.06 on Jan 3rd, 2021, but the resulting pullback has come in tandem with the sustained growth it has experienced so far this year brought valuations well below the company’s 10-year moving average of 21.75 P/AFFO.
Even excluding the exuberance during the bull years of 2019, 2020 and 2021, based on 2022 estimates the company is still well below the 2012-19 P/AFFO average of 18.23, currently at 17. 22 lies.
Is the company absolutely dirt cheap? No it is not. To be honest, it never has been, but neither is this a company whose future is in serious doubt and that’s headed for a recession. Nor is it a company that will be forced to refinance debt in an unfavorable interest rate environment.
Alexandria Real Estate is arguably in the best financial shape it has ever been thanks to a highly disciplined management team and the continued reinvestment of its cash flows back into its developments.
This is the profile of a company entering turbulent times in a position of extreme strength. With zero debt maturing at least 2025 and a remaining debt maturity of 13.6 years, the company can be strategic in accessing the debt capital market over the next few years. That’s a position the vast majority of REITs simply can’t achieve, giving the company another edge over its peers when it comes to dominating the life sciences market.
Alexandria also has an exemplary history of dividend growth that shows no sign of stopping anytime soon, averaging 6.8% over the past 10 years. The dividend yield currently stands at 3.26%, and while that may not seem overly attractive, please keep in mind that the yield is currently at its highest level since 2016 and remains an important part of the total return the company offers.
High-quality, growth-oriented REITs like Alexandria rarely come up for sale, and when they do, historically, this has been a good time to buy shares as a long-term investor. Yes, interest rates are rising fast and a recession could be imminent, but nothing on Alexandria’s profile indicates that any of these headwinds are likely to derail the company in any meaningful way.
A whole lot of things will have to go wrong in the world before companies like Bristol-Myers Squibb (BMY) default on a lease on their state-of-the-art technology center and laboratory space. Sure, the company has the potential to fall further, and one of the company’s less secure tenants could default in a severe recession, but this REIT has a safety net in its tenant quality, the industry’s historic recession resistance, and its resilient balance sheet, I think. which is very difficult to reach.
Given the stock’s recent decline, I have continued to add to my position in this name with proceeds from the sale of STORE Capital (STOR), adding this stock to my top 5 holdings and currently having a cost basis of just under $150. I firmly believe that 11-12% total returns can be achieved over the long term, even without a return to historical valuations.
I look forward to your comments below. Thanks for reading and good luck everyone!