Earnings Call Transcript - ARE Q4 2021

Operator, Operator

Good afternoon, and welcome to the Alexandria Real Estate Equities Fourth Quarter 2021 Conference Call. Please note this event is being recorded. I would now like to turn the conference over to Paula Schwartz of Investor Relations. Please go ahead.

Paula Schwartz, Investor Relations

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'd like to turn the call over to Joel Marcus, Executive Chairman and Founder. Please go ahead, Joel.

Joel Marcus, Executive Chairman and Founder

Thank you, Paula, and welcome, everybody, to our fourth quarter and 2021 year-end call. With me today are Peter Moglia, Steve Richardson and Dean Shigenaga. And with that, welcome. I wanted to thank you for joining, and wish everybody a happy Chinese New Year starting today, the year of the Tiger. We, at Alexandria, are very honored and pleased to report on truly historic and remarkable fourth quarter and 2021 year-end results, really demonstrating operational and strategic excellence by each and every metric. What I think is truly unique and audacious is that Alexandria has operated during this past 2 years, 2020 and 2021, which will be known as the COVID era, really at the highest operational tempo ever and at a sophistication and scale that few REITs could ever accomplish. In the words of Jim Collins, Alexandria has truly achieved 3 outputs that define a great company: superior results, distinctive impact and lasting endurance. I want to thank profoundly each and every one of the extraordinary Alexandria family team members for their sensational performance during 2021. Napoleon I said, strength and growth come only through continuous effort and struggle. Over the last 25 years, we went public in May 1997 and will have our 25th anniversary in May. We took this small company public 3 years after we started it with a $19 million Series A. As of the end of the year, December 31, 2021, we had reached a phenomenal total market cap of $44 billion. For the period of COVID, Alexandria's total shareholder return approximated 45-plus percent, exceeding by a wide margin the office index’s total return of minus 0.5%. Since our IPO 25 years ago, our total shareholder return has exceeded 2,500%, significantly outperforming the S&P 500 and office REIT indices at 939% and 552%, respectively. We’re always playing the long game. Speaking about fourth quarter and year-end, we achieved very robust results. Our life science markets, as evidenced by our fourth quarter and full-year results, truly experienced a blowout in many respects, particularly in leasing, which sets us up nicely for a very strong 2022 and beyond. The continued robust demand from one of the most innovative and transformative industries in the United States, the life science industry, not being cyclical but event-driven, enhances our strong positioning and pricing power in each of our cluster markets. This positions us well for a strong earnings growth year here in 2022 and into 2023 and 2024. We continue to create highly accretive value creation opportunities to meet the current demand of over our 850 innovative tenants and, importantly, provide a path for future growth. Although we've reiterated our 2022 guidance of $8.26 to $8.46 FFO per share, we will clearly revisit that in the first quarter earnings release. We have very strong momentum at our backs. As most of you know, with 10,000 known diseases to humankind, less than 10% have addressable therapies today, and we are truly in the early days of the golden age of biotechnology and biology. Advances in innovation are happening at unprecedented speed, driving human health and quality of life in a positive direction. Steve Jobs commented years ago that the biggest innovations of the 21st century would be the integration of biology and technology. We've achieved historic milestones, as highlighted in the press release and supplement, showcasing the highest leasing volume in the company's history at 9.5 million square feet, just an incredible achievement. We’ve doubled annual revenues ahead of schedule and concluded the largest acquisition in the company's history during 2021, notably leasing over 1 million square feet to our longtime tenant, Moderna. Importantly, our historically high leasing value-creation pipeline foreshadows outside growth in the upcoming years, including 2022. Nearly 8 million rentable square feet under construction are expected to generate over $610 million of incremental annual revenue, which we believe positions us extraordinarily well. So with that, let me turn it over to Steve for some important commentary.

Steve Richardson, Executive Vice President

Thank you, Joel, and good afternoon, everyone. 2021 was indeed a year of historic demand, as Joel has just outlined in the life science industry. The Alexandria team achieved 9.5 million square feet of total leasing, a record-shattering figure, and the 4.1 million square feet during Q4 alone doubled the previous highest quarterly leasing run rate. The highlight may have been the 3.8 million square feet of leasing in the value creation, development and redevelopment pipeline with an emphasis on quality. We had 2 large-scale ground-up Class A facilities featuring long-term leases to credit tenants — specifically, the 462,000 rentable square-foot facility at 325 Binney leased to Moderna for their lab headquarters and the 231,000 rentable square-foot facility at 751 Gateway for Genentech Roche's lab facility. Important to note, both Moderna and Genentech Roche are long-time lab tenants of Alexandria, and I want to extend a hearty shout out to our teams for a superb year during 2021. Moreover, the 9.5 million square feet of total leasing provides over $6 billion of contractual triple-net base rents, which is a significant financial metric. More importantly, the meaningful expansion of the formidable moat the Alexandria team has created since the company's inception is critical. This 9.5 million square feet comprised 318 lease transactions with 280 different life science tenants in our core clusters. Our laser focus on the life science industry isn’t a sidecar initiative for the company. As we execute on creative and longstanding relationships to drive growth in core markets, our dominant presence in mega campuses offers a compelling narrative in the life science real estate market with our stellar reputation for delivering high-quality infrastructure and on-time, on-budget lab operations. The core continues to outperform with impressive renewal and re-leasing spreads of 22.6% cash and 37.9% GAAP during 2021. We now have significant embedded upside, with mark-to-market at over 31%, nearly double last year's mark. Our annualized revenue collection for 2021 was 99.9%, a huge commendation for our best-in-class operations teams for their continued close relationships with our tenants throughout COVID. We achieved 82% early renewals during 2021 compared to our historical rate of 71%. Finally, the exceptional health of Alexandria's value creation pipeline, with a remarkable 7.4 million square feet, positions us strongly amongst our REIT peers, with a lease negotiating percentage of 83%. Now let me turn to supply and demand. We've highlighted throughout our Investor Day that Alexandria's compelling proposition for our tenant base at our unique mega campuses enables us to capture a large market share with high-quality tenants. On the demand side, we foresee no major supply disruptions in 2022 and 2023, while large-scale supply delivery is highly uncertain in 2024 and beyond for potential new entrants. They face significant risks, including entitlement, operational challenges, market risks and more. So as we start 2022, we feel enthusiastic about the highly disruptive therapies on the horizon for our 850 innovative tenants and we look forward to updating you on our progress in the coming months. With that, I'll hand it off to Peter.

Peter Moglia, Executive Vice President

Thanks, Steve. I'm going to update you all on the value creation pipeline and touch on construction costs and supply chain issues before summarizing our Q4 asset sales, highlighting the excellent opportunity investors have to benefit from the disconnect between our stock price and NAV, due to the misunderstanding of our fundamentals in favor of macro themes. Even amid volatility, we’ve posted exceptional results, invoking comparisons to our peers. Currently, projects under construction or commencement in the next 6 quarters are projected to deliver over $610 million in incremental rental revenues from the first quarter of this year through 2024. The current so-called Golden Age of biotech, driven by accelerated discovery and the development of effective new modalities, continues to bolster demand for life science real estate. Last year, we delivered just over 2 million square feet in 14 projects, each located in core markets, indicative of the breadth of demand across our locations. In Q4 alone, we delivered 600,000 square feet across 10 markets, expected to yield about $34 million in NOI upon full delivery. Stabilized yields for these projects averaged 6.2% on a cash basis, which is strong relative to the cap rates in our partial interest sales. The current projects under construction are largely pre-committed, with 75% of space leased and 82% leased or under negotiation. Near-term projects expected to commence construction in the next 6 quarters total 10.2 million square feet, already 67% pre-committed, and 83% leased or in negotiation. We're monitoring construction costs and supply chain disruptions rigorously. As we've mentioned previously, 2021 experienced inflation exceeding 13%, primarily from materials cost and a labor shortage. However, improving conditions are expected in 2022 based on discussions with general contractors. Notably, steel prices increased by approximately 27% in 2021, with expectations for pressure to ease in 2023. Delays arising from supply chain issues are a concern, but we can mitigate them through early commitments on design and specifications, allowing us a level of flexibility that many in this space do not have. In Q4, we completed the previously disclosed recapitalization of significant projects, yielding nearly $800 million in proceeds at a sub-4% cap rate, achieving profits of approximately $450 million over cash invested. These sales support my earlier statement about the disconnect between our stock price and the real assets we possess, with many premium life science assets generating scarcity in the market. We are a bargain right now. With that, let me pass it over to Dean.

Dean Shigenaga, Chief Financial Officer

Thanks, Peter. Good afternoon, everyone. 2021 was a historic and record year of financial and operating performance for Alexandria. We are positioned exceptionally well for another outstanding year. Our strong brand and high operational standards benefit us through strategic relationships with over 850 tenants. Excelling in same-property NOI growth, we have strong visibility into future performance, anticipating an incremental annual rental revenue increase of $610 million from our value creation pipeline. We've consistently delivered FFO per share growth year-on-year and boast one of the strongest balance sheets in the REIT industry. In 2021, we reported total revenues of $2.1 billion, a 12.1% increase over 2020. Our adjusted FFO per share was $7.76 for the full year, outperforming our initial outlook by $0.06 per share. Core growth in key financial metrics was impressive. Cash NOI growth of $280 million brought total to $1.4 billion, supported by our high-quality tenant roster, which includes 51% of our annual rental revenue from investment-grade rated or large-cap public companies. We achieved an industry-leading EBITDA margin of 71%, underscoring our operational efficiency. Occupancy grew by 100 basis points for the full year, excluding impacts from newly acquired properties, with 48% of these properties poised to commence occupancy and rental revenue within the next two quarters. Looking at 2022, we anticipate continued strong rental rate growth, with occupancy guidance at 95.5%, a 150 basis point increase from 2021’s rate. Record leasing volume of 9.5 million rentable square feet speaks to strong demand from our tenant relationships, with rental rate growth of 37.6% exceeding expectations. Our outlook for 2022 anticipates further rental rate growth, with same-property NOI growth should be 6.5% to 7.5% depending on average guidance. Reviewing leasing trends in Q4, while there were a few leases extending that altered some statistics, net effective rent has remained up 50% on average for these leases. Our position is strong with visibility for future growth with over $610 million from 7.4 million rentable square feet of development and redevelopment projects that are already largely leased or engaged in advanced contracts. Notably, a remarkable 94% of projects nearing completion are from existing relationships. During 2021, we achieved record leasing with 3.9 million rentable square feet of development and redevelopment space leased, with significant growth expected in NOI from these projects as we move into 2022. Our venture investments performed highly, generating $216 million in realized gains, and looking ahead, gains are expected to remain relatively stable. Our credit rating, now in the top 10% of the REIT industry, presents opportunities for issuing long-term fixed-rate debt at favorable levels. As we wrap up our guidance for 2022—diluted EPS of $2.65 to $2.85 and FFO per share as adjusted of $8.26 to $8.46—let's turn it back to Joel.

Joel Marcus, Executive Chairman and Founder

Thank you very much, and let's open it up for questions, please.

Operator, Operator

Our first question will come from Sheila McGrath of Evercore ISI.

Sheila McGrath, Analyst

I was wondering if you could go into a little bit more detail on some of the recent acquisitions and your vision or the opportunity you see, specifically the land purchases in Research Triangle and maybe comment on the demand drivers in RTP. The acquisition of the Strip Center in San Diego. And finally, Texas, what drove this new market decision?

Joel Marcus, Executive Chairman and Founder

Yes, Sheila. Let me start with your questions regarding North Carolina. We've substantially increased our holdings in several ways, and our recent land parcels are aimed at creating and expanding the mega campus, which was the former Glaxo campus that we bought and have turned into a mega campus. Leasing has been very strong there, and we're adding adjacent land to expand our campus capabilities. You asked about the demand drivers in North Carolina, particularly in the Triangle. The Triangle is named for the three factors that define clusters: first, you have to have research institutions, and the Triangle is anchored by UNC, Duke, and North Carolina State. Second, a strong talent pool, which is essential for the life science, agricultural tech, and technology industries. North Carolina offers a blend of highly skilled individuals who are in great demand. Third, capital investment is also key, and there’s a healthy presence in the market fueling companies. Lastly, there's a solid foundation for translational scientific work coming from the labs to the companies. The same applies to next-gen manufacturing in North Carolina. Lilly, for example, announced a significant investment just outside Charlotte. You also asked about San Diego? We are investing heavily there, as Dean has been working on that project in the heart of University Town Center, which has been pivotal to our presence there since 1998 and aims to create a mini campus in a prime location. About Texas, for legal reasons, I can’t say much until the first quarter, but like our efforts in New York, we aim to establish a solid footing for commercial life science in Texas, where currently there is none.

Operator, Operator

The next question comes from Jamie Feldman of Bank of America.

Jamie Feldman, Analyst

Alexandria recently put out a press release saying that you are the number one most active corporate investor in biopharma in terms of new deal volume, I believe it’s for the last 5 years. I want to get your thoughts on your appetite for investment now. Our economists are calling for 7 rate hikes this year and more next year. How does Alexandria think about deploying capital in a rising rate environment and what are your views on deal flow and capital raising we will see in biotech and biopharma in this landscape?

Joel Marcus, Executive Chairman and Founder

Yes, Jamie, thanks for your question. It’s a really good one. As noted previously, and as I mentioned in my earnings commentary, the industry is not cyclical. The mature companies generate substantial revenue and operate at scale, thus are not really influenced by cyclicality in the manner that extremely interest rate-sensitive industries are. The second point to consider is that the industry typically requires years of development to bring new therapies to market to address a wide range of medical challenges. This contrasts starkly with other sectors such as technology, where products can be rolled out instantaneously. When we began our work with Moderna back in 2011, it was a tough year, and we were just securing our investment-grade rating. Investing now for future benefits is quite positive, given the accelerating modalities that are changing the future of healthcare. We're very bullish about this and remain mindful of economic conditions. We've endured various upheavals, from the early 2000 tech bust to the 2008 financial crisis, so we take a judicious approach to capital allocation while searching for promising opportunities.

Jamie Feldman, Analyst

Have you sensed any changes in the competitive investment market given the recent pullback in stocks? Although it hasn’t been a long time, any changes observed?

Joel Marcus, Executive Chairman and Founder

Absolutely. The public markets have made notable adjustments in valuations over the last three quarters. We believe this adjustment may begin to influence the private market, as companies with clinical programs could be selling at compelling prices, creating strong investor interest. The froth in the private markets is likely to decrease. The same is likely occurring in the tech sector, where public market resets may push private market valuations down. However, strong companies will secure funding, as extensive venture capital has been raised in recent years, ensuring availability for the next few years.

Jamie Feldman, Analyst

In terms of demand for your portfolio, do you think there will be a noticeable change or no?

Joel Marcus, Executive Chairman and Founder

I can’t say we will match the record-setting leasing figures of 9.5 million square feet from 2021, or the 4 million square feet from Q4 alone. However, as Peter and Steve mentioned, we have tremendous momentum, with over 850 innovative tenants sustaining present and future needs. Thus, we feel comfortable about our position. Our value-creation pipeline remains highly leased, minimizing risk.

Operator, Operator

The next question comes from Rich Anderson of SMBC Nikko.

Rich Anderson, Analyst

Earlier on the call, I believe you mentioned that this was an incredible quarter and year of leasing, and that you would take another look at guidance, though you're not making commitments right now. Isn't it true that when you issued your guidance on December 1st, you either were aware of what was happening then or what you're reporting today was a surprise, effectively meaning you might be able to provide an earn-in update for 2022 as the late successes in Q4 carry forward?

Joel Marcus, Executive Chairman and Founder

I'll let Dean address that, but in general, we strive for a conservative approach when projecting the future until we have clearer indicators. December was indeed a record-breaking leasing month. We expect leasing momentum to carry into 2022, while we gave ourselves a reasonable range for projections. In Q1, we will provide a fuller update.

Dean Shigenaga, Chief Financial Officer

Yes, Rich. To reiterate, we had strong tailwinds this time last year, allowing us to exceed many guidance assumptions, including overall FFO per share performance. We're off to a good start in 2022 with favorable momentum. So while we are optimistic, please stay tuned to future updates.

Rich Anderson, Analyst

You mentioned the $906 per square foot valuation on your stock. Could you clarify that for me? There are several ways to evaluate that analysis based on different assumptions.

Peter Moglia, Executive Vice President

It’s a back-of-the-napkin approach that we’ve discussed before. Take our total market cap at the end of the year—around $39.5 billion—and adjust for our development projects, venture assets, cash and restricted cash, giving an estimated value for our properties divided by our operational square footage. This is a rough estimate. Even with variations, there remains a substantial disconnect.

Rich Anderson, Analyst

In many of your acquisitions, there's often a mix of operating assets along with opportunities for future development or redevelopment. How do you determine the allocation of total costs among various transaction components?

Dean Shigenaga, Chief Financial Officer

Rich, I wish it were straightforward, but each transaction is unique. The allocation between operating and value creation depends on each specific situation, making generalized guidance difficult. However, we did include acquisition details in our disclosures, including NOI for Q4 acquisitions and the exact average dates when they were added.

Operator, Operator

The next question comes from Manny Korchman of Citi.

Michael Bilerman, Analyst

Peter, returning to the valuation question, I recognize this is a point you’ve emphasized for some time as your stock has traded below your asset sales and private market values. How do you think about the effect of issuing about 30% of your shares over the last two years at significant discounts to what you perceive the value to be? How do you consider that dilution in contrast to investments you're making?

Joel Marcus, Executive Chairman and Founder

Dean, would you like to take that first? After which, Peter can provide additional color.

Dean Shigenaga, Chief Financial Officer

Michael, the challenge you’ve pointed out is common for fast-growing companies like Alexandria. As we grow cash flows consistently, the stock price should reflect that rise over time. However, waiting too long to utilize stock can create equity overhang. We strive for balance, and Peter highlights the stock's performance to attract investor attention. While we execute our business strategy effectively, we manage growth through diligent use of debt and equity to minimize common equity issuance.

Joel Marcus, Executive Chairman and Founder

Dean’s remarks are salient – we’ve been monitoring historical equity levels closely, noting common equity has historically funded about 40% to 42% of growth, compared to the higher range of 65% or more. We emphasize the reinvestment of cash flow, along with recycling capital through transactions and EBITDA growth, to remain strong.

Michael Bilerman, Analyst

Peter, when you mention value or being a bargain, does your valuation reflect the entirety of your portfolio at $1,500 per square foot? Given the variability, how do you price it? You recently issued shares at $186; did you have an expected equity level when doing that?

Joel Marcus, Executive Chairman and Founder

We were at an all-time high and felt comfortable with the market risk in issuing equity before what we anticipate will be a volatile year. NAV is subjective, but we were highly confident going into that round of issuance, where our competitive advantage will allow great future activity.

Operator, Operator

The next question comes from Michael Carroll of RBC Capital Markets.

Michael Carroll, Analyst

I wanted to discuss leasing statistics. With strong volume in both the operating and development portfolios, I noted that occupancy dipped slightly. Was this because leases were signed but not commenced yet, or is it due to extensions that Dean mentioned?

Joel Marcus, Executive Chairman and Founder

I believe it stems mainly from acquisitions, but Dean, do you want to provide further details?

Dean Shigenaga, Chief Financial Officer

Indeed. Acquisitions have been a driver of reported occupancy, but we’ve effectively increased our overall occupancy when excluding recent acquisitions. For instance, we had a 100 basis point growth in occupancy for the year, excluding acquired property vacancy, with expectations for a 150 basis point growth looking ahead, which we anticipate to maintain going forward.

Michael Carroll, Analyst

That’s clear, appreciate it. I also noticed our new disclosure highlighting that about 63% of your operating properties are within mega campuses. Can you quantify the significance of having these larger campuses? Do they drive stronger revenue growth compared to those outside?

Joel Marcus, Executive Chairman and Founder

Certainly! As discussed during Investor Day, we showcased distinct examples where our mega campus leasing efforts significantly outperformed neighboring properties. The mega campuses allow for tailored amenities and facilities that cater to tenant needs, providing essential space for growth both now and in the future in a mission-critical industry.

Michael Carroll, Analyst

Regarding the development pipeline, do you have the percentage of buildings contributing to existing campuses versus those that create new ones?

Joel Marcus, Executive Chairman and Founder

We do track that data, but do not present it in specific disclosures. It varies by campus and situation.

Operator, Operator

The next question comes from Tom Catherwood of BTIG.

Tom Catherwood, Analyst

Steve, appreciate your insights on new supply within your markets. Demand is robust from your record leasing volumes, but can you give additional clarity on how demand is split between your core and emerging clusters?

Stephen Richardson, Executive Vice President

Tom, it’s Steve here. On the demand side, we’ve noted that demand spans broadly across our core clusters. It’s not isolated to just one or two. For instance, the Research Triangle exhibits encouraging demand alongside Maryland and Seattle, while San Diego, San Francisco, and Greater Boston also experience healthy traction. Indeed, we anticipate this feeling to continue.

Tom Catherwood, Analyst

With added emerging clusters, is it a matter of if you build it, they will come, or has demand remained steady after entering those markets?

Stephen Richardson, Executive Vice President

It's less about new markets and more about enhancing our core markets. We double down on existing strengths, such as at 325 Binney in Cambridge and our expansions in San Diego and Torrey Pines while ensuring we grow in adjacent markets.

Tom Catherwood, Analyst

Referencing the developments and redevelopments slated for the next 6 quarters, are there additional projects that could start based on pre-leasing or are you constrained by various approvals?

Dean Shigenaga, Chief Financial Officer

Yes, Tom, there’s scope beyond the highlighted 2.6 million square feet that are currently 89% leased or in negotiations. We anticipate potential starts beyond this but the added details are contingent on agreements and negotiations going forth.

Operator, Operator

The next question comes from Vikram Malhotra of Mizuho.

Vikram Malhotra, Analyst

On the topic of pricing power across your markets, it appears there's sustainability in your strong rent spreads. How do you view these spreads, especially from the perspective of mark-to-market evaluations and how life science tenants are paying rent versus their revenue?

Joel Marcus, Executive Chairman and Founder

Regarding mark-to-market, as Steve has previously mentioned, we expect our portfolio mark to be about 31% upwards. In general, life science companies demonstrate rent as a smaller fraction of their overall operating expenses. For large-cap biopharma firms, it's often in the realm of 1% to 2% and mid-cap companies around 5% to 6%. This offers a clear runway for ongoing growth.

Vikram Malhotra, Analyst

With your newer developments, are you seeing unsolicited interest from other sectors, such as tech, for your life science assets?

Joel Marcus, Executive Chairman and Founder

Absolutely. We've experienced interest flow from technology firms for well over a decade. For instance, our Mission Bay site is a prime example, where companies like Uber established a noteworthy presence. Attributes from our mega campuses across various locations do attract the attention of tech and science-spanning new ventures.

Operator, Operator

Our last question comes from Dave Rodgers of Baird.

Dave Rodgers, Analyst

Joel, I wanted to inquire about New York. Historical commentary around crowding in investment capital alongside demand has been insightful. Considering weaker conditions in the New York office market, have you detected increasing interest from tenants or investors in pursuing opportunities more aggressively in the New York area?

Joel Marcus, Executive Chairman and Founder

While we won the RFP for the first commercial life science campus in New York back in 2005 under Mayor Bloomberg, our presence has been developed significantly since then. Currently, we have over 800,000 square feet with promising prospects for expansion. New York presents itself as a niche market, historically smaller in size. The demand numbers illustrate that it requires time to reach its potential as we've only just entered the second decade of development. The challenges posed by recent events indicate a longer path ahead for growth and realization in this market beyond just corporate tax considerations. Thank you very much, and let's close with some final remarks. We look forward to updating you during our first-quarter call. Be safe and take care.

Operator, Operator

The conference has now concluded. Thank you for attending today’s presentation and you may now disconnect.