Alexandria Real Estate Equities Is Compelling Even At This Price

The life sciences market is one of the largest parts of the global economy, accounting for $2.83 trillion in value at this time. With impressive advances in technology, both when it comes to life sciences directly and when it comes to other technologies like AI that can have an impact on it, we are certain to see the space continue growing for the foreseeable future. Naturally, growth in this space, because of the specialized conditions in order for progress to be made, should bode well for companies that own real estate dedicated to the industry. One player that definitely deserves attention in this regard is Alexandria Real Estate Equities (NYSE:ARE), a rather sizable REIT with a market capitalization of $17.1 billion as of this writing. Operationally speaking, Alexandria Real Estate Equities has had a really great run over the past few years. Its growth has continued into this year and is almost certain to continue for the foreseeable future.

A niche REIT

The beautiful thing about REIT investing is that you can find almost any combination of assets and business emphasis to fit the interests and investment philosophy of just about any investor. Categorized largely as an office REIT, Alexandria Real Estate Equities has made a name for itself by acquiring assets that are specialized for the life sciences space and ensuring that the tenants at least amount to fit this description. It is also true, however, that some amount of the company's exposure is to agricultural technology and technology in general. The bulk of its exposure is to the rapidly growing life sciences market.

I understand that many investors are worried at this point in time when it comes to office REITs and, to a lesser extent, REITs in general because of high interest rates. But the good news is that this is an area that is almost certain to grow for the foreseeable future. By the end of 2022, the life sciences market in the US alone had a property footprint of about 181.6 million square feet. That's a 50% increase over the span of only five years. And according to one source, we're expected to see this footprint grow to 220 million square feet by 2025. While this always poses some risk of overbuilding, that is a better problem to deal with than one where vacancy rates are high.

The same source also looked at the top 13 markets for life sciences research and development real estate, with those markets decided based on square feet. At the top of the list was the Boston/Cambridge market, with 52.7 million square feet of space. The San Francisco Bay Area was a distant second at 33.7 million square feet, while San Diego came in third at 23.9 million square feet. If you look at the image below, you can see exposure for Alexandria Real Estate Equities for its major areas as of the end of last year. All three of those top areas were the same three largest from an exposure perspective for Alexandria Real Estate Equities. In fact, if the data we have is correct, Alexandria Real Estate Equities' footprint represents about 26.9% of the total real estate space in the Boston/Cambridge area that's dedicated to life sciences.

Given the rapid growth experienced in this market in recent years, it wouldn't be a surprise to see Alexandria Real Estate Equities grow rapidly as well. From 2020 through 2022, revenue for the company expanded from $1.89 billion to $2.59 billion. This came as the number of properties jumped from 338 to 432 and as square footage expanded from 35.16 million to 47.37 million. Naturally, a rise in revenue should bring with it higher profits as well. As you can see in the chart below, operating cash flow has grown from $882.5 million to $1.29 billion. But of course, there are other profitability metrics to pay attention to. Interestingly, FFO, or funds from operations, has actually fallen over this three-year window. But if we look at the picture through the lens of the adjusted FFO that management reported, we would get an increase from $923.8 million to $1.36 billion. Meanwhile, EBITDA for the company grew from $1.27 billion to nearly $1.80 billion.

The growth for the company has continued into the current fiscal year. Revenue of $1.42 billion came in materially higher than the $1.26 billion reported the same time last year. This was driven largely by an increase in property count. As of the end of the second quarter, Alexandria Real Estate Equities owned 414 properties. This is down from what it had at the end of last year. However, management did say that they would sell off assets worth between $1.65 billion and $1.85 billion this year. But those who are worried shouldn't be. That's because this should be more than offset with acquisitions of between $175 million and $275 million, while construction-related spending should be around $2.94 billion.

As can be expected, the increase in revenue resulted in higher profitability. Operating cash flow jumped from $530.1 million to $784 million. FFO surged from $331.8 million to $589.6 million, while the adjusted figure for this grew from $663.4 million to $756.1 million. And finally, EBITDA for the business expanded from $883.1 million to $980.9 million. All of this profitability has brought with it a greater ability for the company to pay distributions. Back in 2020, the firm spent $533 million uncommon distributions. This number grew to $757.7 million last year. In the first half of this year, distributions totaled $418.5 million. That's up soundly from the $371.5 million reported one year earlier.

Using the data that's available, it looks as though FFO this year will be around $1.36 billion. This should translate to adjusted FFO of $1.53 billion. My estimate for operating cash flow is $1.46 billion, while for EBITDA we get $2.02 billion. Using these figures, I was able to price the company as shown in the chart above. In the grand scheme of things, even if we use the more conservative results from 2022, the stock does not look particularly pricey. But I would also say that it doesn't fall into the value territory necessarily. As part of my analysis, I also decided to compare the company to five similar firms. The results of that comparison can be seen in the table below.

As you can see, when it comes to the price to operating cash flow approach, Alexandria Real Estate Equities ended up being the second most expensive of the group. And when we use the EV to EBITDA approach, we find that three of the five companies ended up being more expensive than our target. At first glance, this may make you think that I am saying that Alexandria Real Estate Equities is an inferior opportunity compared to the other companies that we are looking at. But I don't think that's necessarily the case.

You see, as I was researching for this article, one thing that kept popping into my mind is that exposure is everything in the office space world. High vacancy rates across the country are likely to become even higher as time goes on. However, my view has been that both government tenants and life sciences tenants would be far more likely to need more and more space as time goes on. This is because of the accessibility to the citizens required on the government side and these specialized facilities that are required for the life sciences market. Neither one of those models works well when people work from home.

A true apples-to-apples comparison between Alexandria Real Estate Equities and the five companies that I compared it to is not really possible with the data that we have. This is because each company has a different definition for the categories that it serves. As an example, Alexandria Real Estate Equities caters not only to life sciences but also agricultural technology firms and technology companies in general. Boston Properties says that 8.6% of its exposure involves the life sciences market. However, it also has another category for technology and media companies that accounts for 22.3% of its business. Media does not seem to apply to the technology category that Alexandria Real Estate Equities caters to. So unless we can find some way to break up the data better, there will be some issues with comparability.

What I can say is that none of the companies seem to have even close to 50% exposure to this market, with the exception of our prospect. Perhaps the closest would be Ventas. 6.9% of its business is dedicated strictly to life sciences. But if you include health systems and medical office buildings to the mix, this brings exposure up to 29.8%. If we include all things tied to health care, Ventas would have the most exposure, and that's largely because of the 66.3% of its business that's dedicated to senior housing communities. Regardless, there are enough differences to make a perfect comparison impossible.

Takeaway

In my opinion, Alexandria Real Estate Equities is a very solid company that has done well in the past and that will likely continue to do well for at least the next couple of years. Relative to similar enterprises, the stock does look quite lofty. But as I mentioned already, there are comparability issues here. A firm that is essentially pureplay in this market should be far more stable than companies that have other office-related assets. And frankly, I would say that is probably worth some sort of relative premium. At the end of the day, this all leads me to feel comfortable with a 'buy' rating, which is a rating that indicates my belief that shares of Alexandria Real Estate Equities should generate returns that exceed what the broader market should over the next few years.

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