Yahoo Finance Alexandria Real Estate Equities, Inc. (NYSE:ARE) Q1 2024 Earnings Call Transcript
Alexandria Real Estate Equities, Inc. (NYSE:ARE) Q1 2024 Earnings Call Transcript April 23, 2024
Alexandria Real Estate Equities, Inc. isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).
Operator: Good day, and welcome to the Alexandria Real Estate Equities First Quarter 2024 Conference Call. All participants will be in listen-only mode. [Operator Instructions] After today's presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note, this event is being recorded. I would now like to turn the conference over to Ms. Paula Schwartz with Investor Relations. Please go ahead, ma'am.
Paula Schwartz: Thank you, and good afternoon, everyone. This conference call contains forward-looking statements within the meaning of the federal securities laws. The company's actual results might differ materially from those projected in the forward-looking statements. Additional information concerning factors that could cause actual results to differ materially from those in the forward-looking statements is contained in the company's periodic reports filed with the Securities and Exchange Commission. And now I would like to turn the call over to Joel Marcus, Executive Chairman and Founder. Please go ahead, Joel.
Joel Marcus: Thanks, Paul, and welcome, everybody to Alexandria's first quarter '24. With me today are Hallie, Peter and Marc. First of all, a thank you and congratulations to our ARE's family team for a very solid first quarter against a continuing tough macro with stubbornly high interest rates and continuing non-transitory inflation instigated by the federal governments really uncontrolled spending. In fact, our annual debt service now is greater than our defense budget crazy. Also huge congratulations to the entire team as Alexander has once again been named one of the most trustworthy companies in America by Newsweek, and nominated as such by our 3 constituencies, our customers, our investors and our employees. Guided by Alexandria's core values of integrity, mutual respect, egoless leadership, humility, transparency, teamwork and trust, we have established ourselves at the Vanguard in the heart of the $5 trillion secularly growing life science industry.
We're very honored that Newsweek has again recognized us with this important award, which is a testament to company's values and to the trust that our tenants, investors and employees have in our one of a kind brand. And as we said before, as Jim Collins has said, Alexandria has achieved the 3 outputs that define a great company, superior results, distinctive impact and lasting endurance. We remain unwavering in our efforts to build upon these outputs and to continue to maintain our stellar reputation and the most trusted brand for life science real estate providing essential infrastructure enabling the development of new safe and effective medicines. Remember over 90% of diseases have yet to have addressable therapies or cures. Remember 2, the top causes of death in the United States remain cancer, heart disease and the third fentanyl and methamphetamine and that is a profoundly sad statement of fact.
So my quick take on the first quarter, Alexandria is a one of a kind company with a great brand as I said, scale, dominance and our unique cluster strategy together with the fortress balance sheet. We've posted 7.6% year-over-year NOI growth which is I think very solid in this environment, 7.3% year-over-year FFO growth, 5% dividend growth and our collections 99.9%. We had a strong leasing quarter with solid leasing spreads and we continue strong occupancy despite recently acquired vacancy. We also posted very solid same store growth and also very solid guidance. We are particularly laser focused on leasing for the 2025 pipeline as well as redevelopment space to be delivered in 2025 and of course the leasing of vacant space in 2025, which is the fastest space to deliver to our growing tenants.
And much like we did during the great financial crisis, we're pushing forward our pipeline because of the need for Alexandria's Labspace coupled with solid indicators of positive rebound for life sciences in 2024 which Hallie will address. Lease expirations for 2024 and 2025 on a combined basis are down as well as unresolved expirations for both 2024 and 2025 on a combined basis being down as well. Peter will talk about capital recycling, but for the quarter so far, we've had approximately $275 million of noncore assets sold or pending and we're about so that means we're about 20% through our targeted $1.4 billion of recycling of capital for our business for 2024, and we feel very comfortable where we are today. And then finally before I turn it over to Hallie, I mentioned in our last earnings call our decision to sell 219 East 42nd Street, New York City, the former Pfizer headquarters building ultimately for residential use.
A very good decision reinforced by the continuing. My own view and competence of the State of New York and the City of New York in continuing to incentivize and foster empty one-off buildings for so called life science use while turning their backs on fundraising of startup companies, which is the heart and soul of the New York City life science ecosystem and which is so badly needed. There has been of all the regions no lab leasing in New York City in the first quarter whatsoever and yet the state and the city are proposing fostering more and encouraging more people to deliver space. We sit in a very good position with our campus, but nonetheless when you have local and state governments who are not mindful of using funding better spent on funding startups and also the health, welfare and safety of the citizens, that's very disconcerting.
So with that I'm going to turn it over to Hallie for a number of important comments. Hallie?
Hallie Kuhn : Thank you, Joel, and good afternoon, everyone. This is Hallie Kuhn, SVP of Life Science and Capital Markets. Today, I'm going to review the fundamentals of the $5 trillion secularly growing life science industry, what these fundamentals mean for the health of our diverse life science base, and how our tenant science dictates the need for Alexandria's Labspace infrastructure. In 2008, on the heels of the great financial crisis, the size of the public biopharma industry was around $2.5 trillion and approximately $11 billion in venture capital was invested in private life science companies. There was no cure for hepatitis C, obesity was considered too complex to ever treat with an effective therapy and gene and cell therapies were a hope not a reality.
Today, the industry is valued at over $5 trillion venture capital is on pace to reach 4x the levels deployed in 2008. 600 additional novel therapies have been approved by the FDA and countless lives have been improved, extended and saved. Coming out of this bear cycle, albeit with stops and starts along the way, the life science industry is in a profoundly different place compared to previous cycles with a fundamentally strong framework to accelerate long-term growth of the industry and demand for Alexandria Labspace. With the long-term perspective as a backdrop, let's step through first quarter trends in the life science industry. First, with respect to life science venture investment, nearly $11 billion of deployed capital was announced in the first quarter and $100 million plus mega rounds accounted for 34 deals, the highest number in the last 8 quarters and any quarter prior to 2021.
These trends bode well for demand from new and existing private biotechnology tenants, which account for 10% of our ARR. Moving on to our pre-commercial and commercial public biotech tenants, which represent 9% and 16% of our ARR respectively. Follow-on and PIPE financings achieved one of the highest quarters on record, totaling $15.5 billion of which one in every $4 was raised by an Alexandria tenant. This past week, long time Alexandria Tenant Intracellular Therapies announced clinical data for their first-in-class therapy lumateperone, for treatment of depression and went on to raise $500 million. The story here is that demand is milestone based and for companies that achieve their target milestones, typically clinical data, they have access to meaningful capital to accelerate their science and expand.
Third, are our multinational our multinational pharmaceutical companies, which represent 20% ARR. M&A is a key headline for this segment. 2023 was a record for acquisitions and first quarter continued at a strong pace, eclipsing $40 billion in announced deals. This activity reflects large pharma strong balance sheets and pressure to expand their pipelines with innovative therapies to counter the over $200 billion in revenue at risk from patent expirations through 2030. M&A is a robust sign of the health of the industry and as capital is recycled back to investors and entrepreneurs, it will be redeployed into the next generation of life science companies. Last our life science products, service and device tenants, which represent 21% ARR. A trend we are watching closely is pressure from Congress to limit utilization of Chinese CDMOs under the proposed BIOSECURE Act.
Whether or not the legislation passes, this is positive for our U.S. based CDMO tenants, which analysts expect to see a substantial increase in demand and will help ensure we maintain our national competitive edge in such a critical industry. Switching gears, let's put on our lab coats and examine how our tenants research dictates their lab requirements. Illustrating with a real world example, consider a private biotech Company developing precision oncology medicines that is expanding into 20,000 square feet. Working directly with Alexandria's in-house lab operations team, they placed 328 pieces of equipment in the lab ranging from bench top centrifuges to freezers, cryo tanks, DNA sequencers and advanced microscopes. 10 pieces of equipment, including negative 80 degree freezers, require emergency power as it is critical this equipment operates 24x7 to ensure hundreds of thousands of dollars of experimental samples are safeguarded.
Now where this equipment is placed is not based simply on the square footage required, but the process flow of their experiments. A single cell biologist utilizes equipment spanning multiple benches, chemical fume hoods, tissue culture suites and microscopy rooms. Beyond that, she moves back and forth through the lab and adjacent non-technical space, conference rooms and communal kitchen throughout the day. Labspace cannot be equated to traditional office steps dictated solely by the number of workers, but is more tend to a data center where the space needs are driven by the physical equipment. While highly trained scientific talent is required to oversee the science, it's the scientific workflow and instrumentation used that dictates the lab footprint.
On a related topic, given the immense volume and complexity a data require to inform AI algorithm. Many AI centric tenants have heavy equipment needs that require significant laboratory footprint. A great example is South San Francisco based tenant, insitro with whom we announced a significant early extension this quarter. AI is an amazing tool, but the laboratory is still the workbench. So circling back to where we began, in the past 15 years the Life Science industry has doubled in size, along the way improving countless lives. Projecting 15 years into the future, the growth trajectory of this industry is massive as companies work to cure diseases such as Alzheimer's, autoimmune disease, and the nearly 7,000 rare diseases that affect 1 in 10 Americans.
As a trusted partner to the world's leading life science companies, our job is to safeguard our tenants' mission critical research and support and catalyze discoveries that will shape the future of medicine. With that, I will pass it to Peter.
Peter Moglia : Thanks, Hallie. I know myself, family and friends benefited from innovation that has occurred since 2008. So appreciate the context you just gave us. I'm going to go ahead and discuss our development pipeline leasing supply and asset sales, and then I'll hand it over to Marc. In the first quarter, we delivered 343,445 square feet into our high barrier to entry submarkets covering 5 projects. The annual incremental NOI delivered during the quarter aggregated to $26 million. Development and redevelopment leasing during the quarter was approximately 100,000 square feet. In addition to the executed leases, we signed 162,000 square feet of LOIs during the quarter which will see future development and redevelopment pipeline leasing.
Base leased or under negotiation in our current and near-term projects under construction increased by 3% over last quarter to 63% and projects delivering in 2024 and 2025 are 80% leased. From the second quarter of 2024 through the end of 2027, we expect to deliver approximately $480 million of stabilized NOI from the current pipeline. Transitioning to leasing and supply, as we noted last quarter, the bottom of demand was reached during the first half of 2023 and it continues to incrementally recover in our core markets. We expect that the lack of funding activity in early 2023 will continue to be an overhang to full recovery for a quarter or two, but we have strong conviction that a recovery will be achieved in the near-term given the key fundamentals Hallie outlined.
Alexandria is well-positioned to weather these storms given the moat enduring competitive advantages we continue to widen and build. We leased 1,142,857 square feet during the first quarter, consistent with our pre-pandemic velocity. GAAP and cash rental rate increases were extraordinarily strong at 33% and 19% respectively and the related tenant improvements and leasing commissions trended down 16% compared to our 2023 leasing costs. Our teams continue to closely track competitive supply building by building in our proprietary databases. As noted in last quarter's call, we expect 2024 to be the peak year for new deliveries and then begin to dissipate in 2025. In Greater Boston, unleased competitive supply estimated to be delivered in 2024 decreased significantly from 7% of market inventory in the fourth quarter to 1.6% due to 3.3 million square feet of competitive projects delivering in the first quarter.
Approximately 1.17 million square feet of those projects were moved from an estimated 2023 delivery to a 2024 delivery last quarter. The unreleased delivered space is reflected in the direct vacancy numbers I'm going to present. In 2025, the unleased competitive supply in Greater Boston will increase market inventory by another 2% which is an expected slowdown from the 2024 levels. In San Francisco Bay, unleased competitive supply estimated to be delivered in 2024 is 9.6% of market inventory which is a 1.1% decrease driven mostly by reclassifying a 0.5 million square foot project from a 2024 to 2025 delivery due to a temporary delay in construction. In 2025, the unleased competitive supply in San Francisco will increase market inventory by 3.7%, a 1.5% increase over last quarter due to that reclassification.
In San Diego, unleased competitive supply estimated to be delivered in 2024 is 5.1% of market inventory, a 1.6% decrease from last quarter due to moving 2 projects from an estimated 24 delivery to 2025. In 2025, the unleased competitive supply will increase market inventory by another 3.8%, a 1.1% increase due to that reclassification, but offset somewhat due to first quarter leasing at those projects. To update you on direct and sublease vacancy, direct vacancy in Greater Boston is up 593 basis points to 12.98% due to the previously mentioned 1Q '24 deliveries. It has climbed more moderately in San Francisco up 175 basis points to 14.11% propelled by 147,000 square foot spec delivery in San Carlos. In San Diego, direct vacancy increased by 244 basis points to 10.41% driven primarily by the inclusion of space not vacant today, but now known will be vacant soon.
Sublease vacancy decreased in Greater Boston by about 3 quarters of a percent to 5.17% increased in San Francisco Bay by 0.5% to 6.28% and increased by a third of a percent in San Diego to 5.7%. Again, 2024 is the peak year of disruption from supply. Alexandria is studying 94.6% occupancy is another data point supporting the effectiveness of our wide moat and enduring competitive advantages. I'll conclude with an update on our value harvesting asset recycling program. After a busy quarter four 2023 schedule where we closed on $439 million in asset sales marketed and negotiated throughout the year, we spent the first quarter priming our disposition and partial interest sales pipeline for what will likely be a closing schedule heavily weighted towards the third and four quarters.
Early progress is reflected in pending transactions subject to letters of intent or purchase and sale agreement negotiations of $258.1 million and there are a number of other ongoing active sales efforts. Buyers of noncore assets are generally private equity, family office, local operators and institutionally backed real estate partnerships looking to diversify their asset mix with life science real estate. During the quarter, we closed on assets totaling $17.2 million inclusive of 99 A Street in the Seaport, which executive management deemed to no longer be strategic due to its one off profile and our pivot to 285, 299, 307, 347 Dorchester Avenue acquired during the quarter, which is nearby with similar red line access, but has the scale to be a future mega campus.
We remain committed to our self-funding strategy and our offerings remain attractive to investors looking for exposure to life science real estate given the promising outlook for the industry how we presented despite near-term supply challenges. With that, I'll pass it over to Marc.
Marc Binda : Thank you, Peter. This is Marc Binda, CFO. Hello, and good afternoon, everyone. We reported very strong operating and financial results for the first quarter and our team is off to a great start to 2024. Total revenues and NOI for 1Q 2024 was up 9.7% and 11.5% respectively over 1Q '23, primarily driven by solid same property performance and continued execution of our development and redevelopment strategy. FFO per share diluted as adjusted for the quarter was $2.35 up 7.3% over 1Q '23 and was ahead of consensus. We also reiterated the midpoint of our full year 2024 guidance for FFO per share diluted as adjusted of $9.47 which is up 5.6% over 2023. Our solid operating results for the quarter were driven by our disciplined execution of our mega campus strategy, tremendous scale and our differentiated business.
Our tenants continue to appreciate our brand, collaborative mega campuses and operational excellence by our team. 74% of our annual rental revenue comes from our collaborative mega campuses. We have high quality cash flows from 52% of our annual rental revenue from investment grade or publicly traded large cap tenants. Collections remain very high at 99.9% and adjusted EBITDA margins were very strong at 72%. Leasing volume in the first quarter was strong at 1.1 million square feet for the quarter, which is up 30% over the average of the last two quarters and consistent with our historical quarterly average period from 2013 to 2020. We continue to benefit from our tremendous scale, high quality tenant roster and brand loyalty with 77% of our leasing activity over the last 12 months coming from existing deep tenant relationships.
Rental rate growth for lease renewals and releasing space in 1Q '24 was strong at 33% and 19% on a cash basis. Our outlook for rental rate growth for the full year 2024 remains solid at 11% to 19% and 5% to 13% on a cash basis. And reflects our view that given the relatively small amount included the renewals of releasing from any particular quarter compared to the full year and the mix of lease expirations in any particular quarter, we do expect some variation in rental rate growth from quarter to quarter. The overall mark-to-market for cash rental rates for our entire portfolio remains very solid at 14%, which is unchanged from the prior quarter, which is impressive given the strong realized rental rate growth experienced in the first quarter.
Our nonrevenue enhancing expenditures, including TIs on second generation space, have averaged 15% of net operating income over the last 5 years and are expected to be below that in the 12% to 13% range in 2024, which really highlights the durable nature of our laboratory infrastructure. Same property NOI growth for 1Q 2024 was solid at 1% and 4.2% on a cash basis, driven by strong rental rate growth and leasing volume. Our outlook for full year same property growth was unchanged since our last update at 1.5% and 4% on a cash basis at the midpoint. Occupancy for the quarter was solid at 94.6%, which is consistent with the prior quarter. And during the quarter, we continued to execute on our development and redevelopment strategy by delivering 343,445 square feet from the pipeline, which will generate $26 million of incremental annual net operating income.
We also expect to see significant future growth in incremental annual net operating income on a cash basis of $101 million from executed leases as the initial free rent from recent deliveries burns off over the next 7 months on a weighted average basis. As a reminder, this contractual increase in cash flows will have a significant positive impact on NAV as these projects were previously delivered and no longer sit in CIP at the end of 1Q '24. As Peter highlighted, we have $5.5 million rentable square feet of development and redevelopment projects that are projected to generate $480 million of incremental annual net operating income over the next 4 years, including 2.1 million square feet delivering through 2025 that are 81% leased negotiating and are expected to generate $229 million of additional net operating income.
With projects committed and/or under construction and expected to generate significant NOI over the next few years, coupled with our future pipeline projects in preconstruction, we have the ability to grow our already large operating base of 42 million square feet by 78% over time. With significant construction activities as well as important pre construction activities adding value and focused on reducing the time from lease execution to delivery, we're required to capitalize a significant portion of our gross interest cost. Last year, we saw a peak in capitalized interest in the quarter preceding our record deliveries in the fourth quarter of 2023, which generated $265 million of incremental annual net operating income. These record deliveries have driven a decline in the average real estate basis subject to capitalization of $1.3 billion or 14% from all of 2023 on average to 1Q '24.
Capitalized interest as a percentage of gross interest has similarly declined from 83% for the entire year of 2023 to 67% for 1Q '24. In addition, capitalized interest has had an overall decline for 2 consecutive quarters coming off the peak of 3Q '22. Our outlook for capitalized interest for 2024 is consistent with our previous guidance and continues to assume a double-digit decline in average basis subject to capitalization for the full year ended 2024 compared to 2023. Transitioning to the balance sheet, we continue to have one of the strongest balance sheets amongst all publicly traded U.S. REITs. Our corporate credit ratings rank in the top 10% of all publicly traded U.S. REITs. Our leverage continues to remain low at 5.2 times for net debt to adjusted EBITDA on a quarterly annualized basis.
We have tremendous liquidity of $6 billion fixed rate debt comprising 98.9% of our total debt and a weighted average remaining debt term of 13.4 years. In addition, nearly a third of our total debt has at least 25 years remaining to maturity with a very advantageous blended rate of 3.86%. We remain disciplined with our strategy for long-term funding of our business with a focus on maximizing bottom-line growth, maintaining our fortress balance sheet and recycling capital from dispositions and partial interest sales to minimize the issuance of common stock. We're very pleased with the execution of our bond deal, which we completed during the quarter aggregating $1 billion with a weighted average interest rate of 5.48% and a weighted average maturity of 23.1 years.
Similar to the self-funding strategy that we executed in 2023, we expect to recycle capital into our highly leased development and redevelopment pipeline through outright dispositions and partial interest sales primarily focused on assets not integral to our mega campus strategy allowing us to enhance the quality of our asset base. As Peter mentioned, we completed $17 million dispositions during the quarter. We have $258 million of pending transactions at various levels of negotiation and we have a significant amount of additional target dispositions and partial interest sales that we're working on beyond that. Based on our current outlook, we expect our asset recycling program to be more heavily weighted towards outright dispositions of noncore assets rather than partial interest sales.
I'll turn to the dividends. We also expect to continue to fund a meaningful amount of our equity needs with retained cash flows from operating activities after dividends of $450 million at the midpoint for 2024 or an estimated $2.1 billion for the 5-year period through 2024. And our high quality cash flows continue to support the growth in our annual common stock dividends with an average annual increase in dividends per share of 5% since 2020 and we continue to have a very conservative FFO payout ratio of 54% in the first quarter. Realized gains from the venture investments included in FFO per share as adjusted for the quarter were $28.8 million relatively consistent with our historical average of $24 million per quarter going back to 2021.
Gross unrealized gains in our venture investment portfolio as of 1Q '24 were $320 million on a cost basis of just under $1.2 billion. We have updated our guidance as I mentioned for '24 for EPS of $3.60 to $3.72 and we tightened the range for FFO per share diluted as adjusted to $9.41 to $9.53 with no change to the midpoint of $9.47 which represents a solid 5.6% growth in FFO per share for 2024. With that, let me turn it back to Joel.
Joel Marcus : So operator, let's go to Q&A kindly.
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