The Landlord Of Pharma: Alexandria Real Estate (Issue #45)
Biotech and Pharmaceuticals are two of the most exciting and can be some of the best-returning industries to invest in. However, with FDA and other regulations, high budgets and specific materials and/or labs are necessary. Alternatively, REITs are an interesting and often high-returning asset class, giving investors access to many of the virtues of real estate without many of the risks. Alexandria combines these two sectors by renting real estate to the largest and most successful Biotech and Pharma companies.
Source: Alexandria Investor Relations
The company has been able to operate at very high ratings from both S&P Global and Moody’s. On top of this, they have received a silver or gold award from Nariet every year since 2015.
Alexandria has extremely high market share in many key pharma and biotech markets around the world especially research hubs like Cambridge, MA, San Francisco, New York City, Seattle, and more. They use a “cluster model” for their holdings which means they group holdings (buildings) in a few concentrated areas that have a consistent focus within them. This makes them act as almost mini monopolies in each of their geographic markets.
Source: Alexandria Investor Relations
While many investors have become bearish on office space REITs due to “work from home”, Alexandria has been able to get around that by providing space that has specially equipped labs. This is a key moat of the industry because lab work and research are not things that can be done remotely or from a home office. As the pharmaceutical and biotech industries develop and grow they will only require as much if not more lab space. For most key markets where these labs exist Alexandria holds high market share–thanks to their cluster model–making them the top beneficiary from this growth.
Source: Alexandria Investor Relations
Cambridge is by far the best example of the cluster model in action and how well Alexandria understands the market that it serves. To begin with, this area is some of the most expensive real estate in the world, includes both Harvard and MIT, and is across the river from Boston. It is also the largest concentration of biotech in the world. The image above shows in blue all of the buildings they own. Keep in mind that almost all of the pharma and biotech research resides on the “near” side of the river in that picture. Included in the picture above is the 462k square foot Moderna headquarters and primary R&D building which is owned by Alexandria.
Company Outlook
Alexandria has been very successful so far and has gained sizable market share in all of the regions it competes in, but how does it look going forward? Over the past 5 years, Alexandria has more than doubled annual rental revenue from ~$800m to ~$1.7b. During that same time, the company also doubled the asset base by square footage. More than 10% of Alexandria’s assets are cash meaning there is a lot they can do to invest in new markets and expand as well as pay a higher dividend to investors. We have already seen dividend growth over the past 5 years by 30% as the company starts to mature as a REIT. This maturing process should show a shift in returns from share price to dividends. While Pillars and Profits is not overly focused on dividends they can be a compelling bonus. In addition, a few companies in the portfolio pay decent dividends like Home Depot and Hingham Institution For Savings.
There is still plenty of plans for expansion in action for the company too. For example, Alexandria is currently developing and acquiring an additional 1 million square feet campus to be rented in the greater Boston Area according to Investor Relations.
Source: Alexandria Investor Relations - New Developments
All of Alexandria’s loans are variable interest rate loans. This is a double-edged sword. Generally, for the past ~10 years this has advantaged them with low-interest rates, but recent rate changes with far higher rates create a headwind for the company expansion. This will be important to watch for debt rolling over in the next 5 years. As I already mentioned the company does hold a significant amount of cash which will allow them to make it through these more expensive times.
Valuation
From 2017-2021 Net Asset Value grew by 54%, Funds From Operations (FFO) grew by 29%, and dividends grew by 30%. The company currently trades at 17.5x Price/FFO and 22x Price/AFFO. For those who are not familiar with REITs as an investment Price/FFO and Price/AFFO are the real estate equivalent of Price/Earnings and Price/Cash Flow. Both of these multiples seem reasonable for a company that still has a lot of growth potential and is making strong returns. This is made only more compelling when we see Net Asset Value (Book Value for REITs, essentially) increasing meaningfully.
The company’s balance sheet is also very healthy with 0.6x Debt/Equity and as I mentioned before 10% of their assets being cash. This cash will be important for debt maturing in the near future because higher interest rates for refinanced loans will increase the company’s interest expense.
Debt is the number one risk to any real estate business, especially with increased interest rates. Alexandria realizes this importance and spends a significant portion of all their reports talking about debt and whether or not they can refinance or take out new loans with higher interest rates. However, Alexandria doesn’t have any debt maturing until at least 2025 giving them some time to wait out the storm. On top of this, they are currently holding a high amount of cash to cushion interest payments even further.
Investment Thesis
Alexandria is not yet in the portfolio, but it is a front-runner for new investment because of their strong returns, growth potential, and strategy of the cluster model. On top of this, it follows the Pillars which means it has both long-term growth opportunities as well as a strong margin of safety shown on their very liquid balance sheet that is accompanied by safe credit ratings. Look out for updates to see if this stock gets added to the portfolio.
Until Sunday,
Soren