Earnings Call Transcript - ARE Q1 2023

Operator, Operator

Good day, and welcome to the Alexandria Real Estate Equities First Quarter 2023 Conference Call. All participants will be in listen-only mode. After today’s presentation, there will be an opportunity to ask questions. Please note this event is being recorded. I would now like to turn the conference over to Paula Swartz with 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 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 Alexandria's first quarter '23 Earnings Call. With me today are Peter, Dean, Hallie and Dan. And first of all, I want to send a big thank you to our entire ARE family team for an operationally and financially strong first quarter in a tough and continuing tough macro environment. As you know, Alexandria is truly a one-of-a-kind S&P 500 company. And we're very pleased that we just received one of Newsweek's most trusted company awards. We have no peers. We're kind of a pure play, in our field. We first identified and pioneered the lab space niche back in 1994 and then through our disciplined execution of our original vision using the strategic architecture of our cluster model, which we customize to the life science industry. We have brought the mission-critical real estate infrastructure of the life science industry and integrated it with an unparalleled and world-class 24/7 operational excellence service component aimed to protect the hundreds of billions of dollars of leading-edge science, which is conducted 24/7 within our asset base. And we have brought this to a highly respected and recognized real estate product type today. Alexandria is definitely not a health care service facilities company nor a generic office company. Our disciplined core focus is our patented and trademark lab space. It's a premium priced, non-commodity product generally characterized by high barriers to entry markets, where we have a dominant franchise and we exercise pricing power, especially in our highly sought-after Alexandria-branded mega campuses. Those markets exhibit a deep science base, a deep life science talent base, a rich abundance of risk capital, and also are generally safe with excellent transportation access. What we saw in 1994, in the embryonic days of the life science industry, has multiplied geometrically today. As Steve Jobs said, the 21st century will be the century of the intersection of biology and technology innovation. We have 10,000 known diseases wreaking havoc on human beings each and every day, and the personal and economic costs of sickness, illness and today, the mental health crisis is continuing to skyrocket. Continued innovation in medicine is an absolute national priority and the transformative work of our tenants in the industry is critical to addressing the massive unmet medical need. Literally every day, we hear of great progress. One of our Greater Boston tenants, Morphic Therapeutics, which has an oral drug addressing moderate to severe ulcerative colitis, recently announced that it hit its Phase 2a clinical trial endpoint and their stock has been up 75% this year. The 10 most prevalent diseases in the U.S., heart disease, cancer, chronic respiratory disease, obesity, Alzheimer's, diabetes, substance abuse, infectious disease, chronic kidney disease, and mental illness are not being solved to date. We have a large mountain to climb, and the industry is really in its formative days. Weathering a tough macro environment, ARE posted a very solid first quarter. Our funds FFO per share is up 7%, as you see in revenues, top-line revenue is up almost 14%. Almost 100% collections bodes well for our continued strength and stability of the Company. We've maintained strong fundamentals while lowering uses and sources of capital, and we’ve had very solid leasing with the highest-ever rental rate increase, along with continuing strong operating and EBITDA margins. All stakeholders should recognize and appreciate that this management team took a highly disciplined approach over a multiyear period to create a fortress balance sheet to successfully weather the current self-inflicted economic storm caused by various policies we implemented over the last many years. We have taken judicious measures to cut our CapEx, while at the same time, making strong progress on our funding plan for 2023. Without any further hesitation, let me turn it over to Hallie, who's going to give you a bird's-eye view of our perspective on the life science industry. So, Hallie?

Hallie Kuhn, Senior Vice President of Science and Technology and Capital Markets

Thank you, Joel, and good afternoon, everyone. Today, I want to discuss the life science industry in light of the collapse of Silicon Valley Bank. The strength of ARE's exceptional life science tenant base and innovation will drive long-term growth in this sector. There are some misconceptions regarding the long-term effects of SVB's collapse on the industry. SVB was a primary banking option for many venture-backed companies, particularly in tech. Although SVB served a niche market, it was also part of a community where early-stage startups frequently chose SVB simply because it was the prevalent option, rather than a lack of alternatives. Many banks, including large global institutions, have been trying to establish themselves in this market for years. In the aftermath of the collapse, we engaged with over 100 companies, some of which were SVB customers, while others had multiple banking arrangements. Fortunately, within about 72 hours of the bank run, companies regained access to all their deposits, reducing immediate concerns like payroll. In terms of long-term risks associated with regional bank instability, unlike tech firms with substantial cash and deposit accounts, our tenants primarily utilize safe third-party custodial and sweep accounts. The biotech sector also does not depend heavily on venture debt as tech does, and other options for venture debt are available beyond SVB. We anticipate that the life science sector will face minimal impact moving forward, as shown by the venture financing rounds that concluded in March and are expected to continue into April. Now, regarding our tenant base, it's essential to note how our life science real estate differs from traditional office spaces. The office sections of our life science buildings complement laboratory work. Scientists frequently alternate between lab and office tasks to analyze data and strategize experiments, meaning the office cannot be compared to traditional office spaces but is crucial for successful laboratory operations. This work is not suited for remote environments. Now onto the health of our diverse life science tenant base. To illustrate the current environment, we can refer to the saying, 'In God we trust; all else bring data.' Regarding pharma, which represents 18% of our annual recurring revenue, this segment remains strong with solid balance sheets and significant cash flow. Pharma is less affected by rising interest rates. In 2022, biopharma invested about $267 billion in research and development. Consequently, companies like Eli Lilly are turning this research into life-changing medicines. Mounjaro, aimed at treating obesity in type 2 diabetes, is projected to generate over $50 billion in global revenue annually. To put that into context, nearly one in four U.S. health care dollars is spent on diabetes care, while obesity contributes to over $480 billion in direct health costs and about $1.2 trillion in indirect costs due to decreased productivity. Treatments like Mounjaro not only save lives but also have the potential to lower overall health care costs. Moving on to private venture-backed biotech, which accounts for 8% of our total revenue, we are witnessing a reset in venture funding to levels prior to 2020 and 2021. Although funding has decreased from its peak, it remains robust by historical terms. Investors are now more discerning and demanding regarding future investments, focusing on companies with experienced management and differentiated technologies that show potential for near-term value. We continue to evaluate all tenants closely, and our private biotech clients are maintaining strength compared to the broader market. In fact, this tenant group has raised over $1.9 billion from venture capital and pharmaceutical partnerships since the start of the year, including $800 million after SVB's collapse. With a week left in April, our rent collection from private biotech tenants stands at 99.7%. Next, our public biotech tenants with marketed products constitute 14% of our revenue and generated $150 billion in 2022, including companies like Amgen, Gilead, Vertex, and Moderna. Moderna continues to showcase how innovative platforms can deliver new therapies. Recently, Moderna's personalized mRNA cancer vaccine, alongside Merck’s immunotherapy, showed positive results in clinical trials for aggressive skin cancer. Companies are also setting ambitious innovation goals. For instance, Gilead plans to achieve 20 new drug approvals by 2030, which will involve advancing their pipeline, particularly in oncology, alongside strategic mergers and acquisitions. In the preclinical and clinical stage biotech sector, which makes up 10% of our revenue, strong clinical data remains critical. Tenants like [indiscernible] and Biomea Fusion have recently secured additional funding based on promising clinical results. Prometheus Biosciences, though not a tenant, illustrates how data drives industry success, having seen its stock rise over 600% after announcing impressive data, culminating in a $10.8 billion acquisition by Merck. While failures will always occur in the journey of developing new medicines, this risk is accounted for in our business model. With our extensive tenant relationships across the industry and premium properties, we can preemptively address potential tenant challenges to maintain and improve our portfolio. Reflecting this, we have collected 100% rent from our preclinical and clinical stage public biotech tenants in April. Moving to our academic and institutional tenants, which represent 12% of our revenue, it's crucial to emphasize that innovation—the cornerstone of the life science sector—is progressing steadily. There is significant bipartisan support for life science research, evidenced by the NIH's 2023 budget of $47.5 billion, a 21% increase from 2019. Academic and medical institutions remain productive, as demonstrated by the volume of new intellectual property. In 2021, U.S. academic institutions reported 20,000 invention disclosures and nearly 1,000 new startups. This activity is vital for long-term funding for these institutions; for example, Prometheus Bio originated from Cedars-Sinai, which stands to gain nearly $800 million from recently announced mergers. To sum up, since most of our academic and institutional revenue comes from investment-grade tenants with multiyear funding timelines, this sector remains insulated from broader economic fluctuations. To finish, I want to highlight some key aspects of the life science industry's long-term growth. The American Society of Cell and Gene Therapy reports over 3,700 gene, cell, and RNA therapies in development. For chronic diseases, which are the primary focus of health care spending in the U.S., more than 800 medications are in clinical trials. The result is ongoing FDA approvals, with 14 novel therapies approved so far this year, including a new ALS therapy from Biogen announced this morning. Overall, nearly 60 new medicines are set for FDA review in 2023, reflecting a pace similar to the record year of 2018. In conclusion, we recognize the challenges posed by previous years of easy capital, and the divide between successful and struggling companies will widen as the industry shifts toward technologies and medicines that deliver value to patients and investors. However, as Winston Churchill said, 'Never let a good crisis go to waste.' Although this market requires extreme caution, it offers a chance for the best companies to focus on their long-term fundamentals and prosper. This is precisely what our tenants and Alexandria are demonstrating. With that, I'll turn it over to Peter.

Peter Moglia, Chief Operating Officer

Thanks, Hallie. I just celebrated my 25th anniversary with the Company. In addition to that milestone, it was a reminder of how fast time moves by and brought back a nostalgic look at my time at Alexandria. I recall my interview with Joel, where I learned about the novel idea of forming a real estate company to serve the life science industry, which made me both nervous since nobody had ever done it before, and equally inspired to help enable an industry that was hell-bent on changing the world. After serious contemplation, I decided that if I was going to make a difference in the world, this was an incredible opportunity to do it. Plus, after having been in real estate for about eight years at that point, I could see tremendous value in offering mission-critical facilities over commodity products. I could not have made a better decision as it all proved out. Alexandria has played a critical role in the evolution of the life science industry over the last three decades by creating and growing the ecosystems and clusters that ignite and accelerate the world's leading innovators in their pursuit of advanced human health, which is our solid mission. Additionally, we've built an irreplaceable world-class asset base of robust and highly differentiated properties and campuses that attract a diversified, best-in-class tenant base who values our expertise and operational excellence by providing 75% to 85% of our leasing quarter-to-quarter. The result of all this is we have built a brand without peer that puts us in a position where we don't rely on third parties to bring us tenants; they come to us directly as we are a trusted partner with a long successful track record of developing and operating mission-critical facilities. This is an important distinction in any part of the cycle, but perhaps even more so when things have slowed down. Our results prove it. Thank you for indulging me on that retrospective. I'm going to briefly touch on our development pipeline, construction costs, leasing, and asset sales and then hand it over to Dean. In the first quarter, we delivered 453,511 square feet in five projects into our high barrier-to-entry submarkets. Annual NOI for these deliveries totals $23 million, and the initial stabilized yield is strong at 7.3%. At quarter-end, projects under construction and near-term projects expected to commence construction over the next four quarters totaled 7.6 million square feet and are 74% leased or under negotiation. This is very similar to last quarter, but in response to the uncertainty and volatility in the markets, we have made a strategic decision to reduce 2023 construction spend by $250 million by pausing or delaying projects that had been classified as under construction, so we can focus our capital on the most strategic projects with the most attractive terms, enabling our highly vetted and vast tenant base. The reduction in spend results in NOI from deliveries primarily commencing from the second quarter of '23 through the first quarter of '26 to be approximately $610 million. After commenting on construction costs for the past two years, I can still say they remain volatile but are on their way to stabilizing. The availability and price of commodities such as steel, copper, aluminum, and concrete continue to fluctuate due to shortages of raw materials, low yields for mines, high demand from electrification, or low capability utilization rates in the mills and fabrication shops due to labor shortages. Cost of materials and supply chain volatility were the initial drivers of construction inflation, but now the primary driver is labor, with a triple whammy of wage increases, shortage of workers, and the inefficiency of the remaining labor force due to the retirement of older, more skilled labor. There are currently 330,000 open construction jobs today, and the time it takes to train new entrants to be highly skilled as measured in years means these inefficiencies will be with us for a while. Specific to life science buildings, availability of switchgear and equipment such as HVAC units and generators has slightly improved, but lead times are still extraordinarily long, with custom air handlers taking 27 weeks longer to get than before COVID and switch gear and generators taking an astounding 64 weeks longer. Even worse is the availability of large transformers provided by the utility companies, which can take as long as three years to obtain. What's driving these delays are chip shortages and demand from electrification projects happening all over the world as investors, governments, and end-users demand improvements in carbon emissions. As you can imagine, the cost of this equipment is reflective of these shortages and paired with high labor costs, making new laboratory and office projects more expensive to build than ever before. The upside for us is that 84% of our costs for our active development and redevelopment projects are under GMP or other fixed contracts with contingencies behind that. So, we are largely locked in. Anyone contemplating speculative development these days will have to contend with these delays and associated high costs, which will put the feasibility of building and financing the project at considerable risk. One reason we will likely not see the supply many are expecting beyond what is under construction today. Transitioning to leasing, our strong brand loyalty, mega campus offerings, and operational excellence continue to drive strong leasing numbers in a challenging market. The 1.2 million square feet leased in the first quarter is above our five-year pre-2021 average and is the 12th consecutive quarter with leasing volume above 1 million square feet. We achieved attractive economics primarily from our vast tenant base, accounting for 85% of the leasing this quarter, resulting in a rental rate increase of 48.3%, which was the highest in company history and a strong cash rate of 24.2%. As we have noted previously, demand has normalized from the record year of 2021. Depending on who you ask, demand is slightly below or slightly above pre-COVID levels. There are fewer tenants actively seeking space in the market today, which we believe is being significantly driven by uncertainty in the economy. As Hallie put it, this market is and will continue to warrant extreme prudence. However, we're not dependent at all on broker deal flow. There are pending opportunities from our tenant base that the broader market likely does not see due to our direct relationships with company management teams. Such relationships are a huge differentiator for us and will continue to drive solid leasing even in tough environments. Some private and preclinical clinical stage companies are making do with the space they have today until they can better understand their ability to raise capital on its cost. Capital is available, but as Hallie mentioned, VCs are becoming more discriminate, disciplined, and demanding of future investments. Companies with tenured management teams, strong differentiated technologies, and near-term value inflection milestones are the ones that will rise above the fray. Those are the haves, who by and large are Alexandria's tenants, which we have underwritten and placed into our world-class asset base, differentiated from the have-not tenant base of others who fill space with hope as their underwriting strategy. On the supply side, we track high-quality projects that we believe are competitive with ours in the high barrier-to-entry submarkets. Accordingly, we're tracking direct vacancy in Greater Boston to be 2.8%. On-lease sublease space is at 3.9%, and unleased space directly competitive with our AAA locations and building quality is expected to be 1.5% to be delivered in 2023 and 5.1% to be delivered in 2024, reflecting a 1.3% total increase in availability from last quarter. In San Francisco, direct vacancy is 3.5%, sublease space is at 5.8%, and unleased supply directly competitive with our assets continues to be the highest across all our markets at 6.6% and 8.9% to be delivered in '23 and '24, respectively. This total represents a 3.4% increase in overall availability over last quarter, primarily driven by speculative building in South San Francisco. In San Diego, direct vacancy is at 4.1%, sublease space is at 2.3%, and unleased competitive supply is 3.2% in 2023 and 5.4% in 2024, with a slight increase of 0.2% over last quarter. Overall, supply across all submarkets is likely to remain muted beyond what is currently under construction due to high construction costs, which I referenced, higher costs of capital, and decreasing demand from generic tenants. We primarily focus on high barrier-to-entry markets where supply is inherently limited. I'll conclude with some commentary on our value harvesting and recycling progress. As we all know, the rapid rise in interest rates has increased investors' cost of capital, creating a lot of uncertainty and causing many to remain on the sidelines. Adding to the difficulty of executing in this environment is the increasing desperation of a number of office building owners trying to raise cash to stay afloat by offering quality long-term leased assets with credit tenants at cap rates of 6.5% to 7.5%. Despite these challenges, demand for high-quality life science assets, which is vastly different from office assets, continued in the quarter. We were pleased to transfer an 18% interest in our current JV at 15 Necco, which we controlled and owned 90% prior to the sale. The asset is under construction and will not be delivered until the end of this year, with cash flow commencing in mid-2024. The buyer will fund the remaining construction costs to deliver the property to our tenant until they reach a 37% ownership, which is expected to coincide with the remainder of the cost to deliver the project. Given that cash flow receipt is over a year away, it's difficult to translate the valuation to an operating cap rate. However, to give you some context, the parties agreed on a valuation at closing to be $576 million or $1,665 per square foot, which is an initial yield of 5.25% on their investment based on in-place NOI. We also agreed to credit our partner $5.5 million in fees payable. Because we sold 33% of the total 37%, our partner purchased, those fees equate to approximately $15 million in value. Stripping that $15 million from the purchase price gets you to a total valuation of $561 million with an increased cap rate of 5.4%. If you want to tie this to the supplemental, the $66 million price for the 18% means if you add the other $119 million to be funded to completion and divide it by the 33% we sold, you get $561 million. This was a great outcome for Alexandria as we were able to partner with a world-class investor to monetize value creation and secure capital for the remaining spend in an accretive manner while retaining control of the asset and all management fees. We have not yet closed on the other transaction we signed an LOI on in the fourth quarter, but we expect to complete that in the second quarter. In addition to this transaction, we have signed letters of intent or purchase and sale agreements for a number of assets, including the office campus referenced in the press release, aggregating to a total sales price of $799.3 million. These future transactions and 15 Necco account for approximately 57% of the progress needed to meet the midpoint of our disposition guidance. With that, I'm going to hand it over to Dean.

Dean Shigenaga, CFO

Thanks, Peter. Dean Shigenaga here. Good afternoon, everyone. We reported excellent operating and financial results that exceeded consensus with strong core results, and our team is off to a strong start toward solid growth for 2023. Our client tenants have continued to make timely payment of rent year-to-date through April, and we have a very strong balance sheet. We have meaningfully reduced uses of capital for 2023, made excellent progress on dispositions and sales of partial interest, have a conservative FFO payout ratio, a growing dividend, and we are the go-to brand for life science real estate. Our balance sheet is robust, with $5.3 billion in liquidity and no debt maturities until 2025. Our team has made significant progress on our dispositions and sales of partial interest just four months into 2023. As Peter highlighted, we've advanced transactions aggregating $865 million, which are either completed or subject to executed LOIs or purchase agreements, including a new JV partner for our build-to-suit project for Eli Lilly. Many of the ongoing transactions are targeted to close on or about June 30. We have identified additional dispositions and sales of partial interest to bring our total for the year to $1.5 billion. While the macro environment remains challenging, we are reasonably optimistic that we can execute on our disposition plan in 2023 at attractive values and cap rates. We will provide values and cap rates quarter-to-quarter as we close transactions, since we're unable to disclose those sooner while transactions are still in process. In addition to the $1.5 billion in dispositions and sales of partial interest, new JV capital forecasted for the full year of 2023 will contribute over $300 million towards construction spend this year, including most of the $119 million of contributions from the new partner we added to our build-to-suit project for Eli Lilly. Turning to our outstanding financial and operating results, we saw strong growth of $342.9 million or up 13.9% in total revenues for the first quarter annualized compared to the first quarter of 2022. Adjusted EBITDA on a trailing 12-month basis was up $246.2 million or 15.4%, showing robust growth of 6.8% in FFO per share for the quarter compared to the first quarter of 2022. We are off to a strong start and on track for 6.4% growth in FFO per share for 2023. Key highlights of our continued strong operating and financial performance included strong growth in revenues, adjusted EBITDA, and FFO per share, driven by continued strength across key areas of our unique and differentiated business. We maintained a 99.9% rent collection rate from our client tenants for the first quarter and 99.7% for April, just three weeks into the month. This is truly remarkable. Continued strength in same-property NOI growth of 3.7%, 9% on a cash basis, reflects the benefit of strong rental rate growth on leasing in recent quarters, contractual annual escalations in rent, and the burn-off of some free rent. Our outlook for strong same-property NOI growth for 2023 is projected at 3% on a GAAP basis, and 5% on a cash basis, generally consistent with our strong 10-year average for same property growth. Now turning to record rental rate growth and strong leasing volume, our rental rate growth continued into 2023 at 48.3% on a GAAP basis and 24.2% on a cash basis from lease renewals and re-leasing the space in the first quarter. This exceptional rental rate growth on a GAAP basis is the highest in the Company's history. Both GAAP and cash rental rate growth were higher than the strong rental rate growth from 2022 and 2021. The leasing volume for the first quarter was strong, standing at 1.2 million rentable square feet, slightly ahead of the strong quarterly leasing volume prior to the exceptional record levels experienced in both 2021 and 2022. The key takeaway is that the scale of our high-quality tenant roster, combined with operational excellence from our team, positions us well to benefit from the unique pool of demand from our client tenants, even in this unusual macro environment. Our strong occupancy was in line with our expectations, sitting at 93.6% as of March 31, which aligns with expectations and the comments provided during our year-end earnings call. There are three key takeaways here. First, occupancy is expected to improve in the back half of the year. Second, 371,000 rentable square feet of recent vacancy has shown significant rental rate growth of 110% on a GAAP basis and 115% on a cash basis; and third, 29% of this 371,000 rentable square feet has already been leased, with occupancy commencing in the third quarter of '23. For further details, please refer to Footnote 1 on Page 26 of our supplemental package. We also absorbed $71,000 of vacancy from a building located in Texas, which is undergoing redevelopment. We have made a strategic decision to hold off on further redevelopment of a second building, aggregating 71,000 rentable square feet, until we lease up the first building. We continued with a very strong adjusted EBITDA margin of 69%. Briefly on our high-quality tenant roster, Alexandria is renowned as the brand for life science real estate, fostering long-term trusted relationships and serving as a true partner to the life science industry. 90% of our top 20 tenants are investment-grade rated or large-cap publicly traded companies. Additionally, we highlighted continued strength in timely rent collections from our clients at 99.9% for the first quarter, which reflects the strength of our high-quality client tenants, important tenant relationships, and high-quality underwriting from our research team. Briefly on venture investments, realized gains from our venture investments included in FFO averaged about $25.8 million per quarter for the last eight quarters through the end of 2022, compared to $20.7 million for the first quarter of 2023. We expect realized gains in each quarter from our venture investments for the remainder of 2023 to be consistent, reflecting a slight uptick from the historical quarterly average of $25.8 million that I just highlighted. As of March 31, gross unrealized gains in our venture investments were $459 million on a cost basis of $1.2 billion. We have consistently grown our dividends from the high-quality cash flows generated by our business. We maintain a low and conservative FFO payout ratio of 55% for the first quarter annualized, with a 5.3% increase in common stock dividends over the last 12 months. We are projecting $375 million in net cash flows from operating activities after dividends for reinvestment. At this rate, this represents over $1.1 billion of capital for reinvestment over the next three years. Briefly on external growth, we anticipate $610 million of incremental net operating income from our pipeline of 6.7 million square feet that is 74% leased. Approximately 30% of this NOI is expected to commence in the remaining three quarters of 2023, about 40% in 2024, about 26% in 2025, and the remaining 4% thereafter. Now turning to guidance. We have updated our underlying guidance assumptions for 2023, which are disclosed on Page 4 of our supplemental package. Our per share outlook for 2023 has been adjusted to a range with a variance of plus or minus $0.05 from the midpoint of guidance, down from a previous margin of plus or minus $0.10. Our range of guidance for EPS is $2.21 to $2.31, and for FFO per share diluted as adjusted is $8.91 to $9.01, with no change at the midpoint of $8.96. This represents a strong 6.4% growth in FFO per share for 2023, following an excellent growth last year of 8.5%. Key updates on the underlying detailed assumptions included the following: a significant reduction of $325 million in both sources and uses of capital, including a $75 million reduction in the midpoint of acquisitions to $225 million and a $250 million reduction in construction spend to $2.725 billion. We also provided updates on significant dispositions and partial interest sales aggregating $865 million, including significant transactions that are under executed LOIs and purchase agreements. Additionally, rental rate growth on lease renewals and re-leases in this space has been increased by 1% for both GAAP and cash to a range of 28% to 33% for GAAP and 12% to 17% for cash. Occupancy was adjusted by 20 basis points to reflect vacancy from a 170,000 rentable square foot building located in Texas that is on hold while we lease up the adjacent building currently at 36% leased. Importantly, occupancy is expected to recover in the second half of 2023. With that, let me turn it back to Joel Marcus. Thank you.

Joel Marcus, Executive Chairman and Founder

So operator, can we go to questions, please?

Operator, Operator

We will now begin the question-and-answer session. The first question today comes from Steve Sakwa with Evercore. Please go ahead.

Steve Sakwa, Analyst

Joe, I can appreciate that you still haven't closed a lot of these deals, but I think the market would appreciate any range of commentary you could provide on how to think about cap rates? I realize you aren't singling out individual deals, but is there a way to bracket them against maybe where your implied cap rates are today or maybe against the deal that Peter discussed?

Joel Marcus, Executive Chairman and Founder

I believe it's important to note that we have been posting low 4% cap rates on Class A facilities in recent years, and Peter provided a clear explanation of the transaction in Greater Boston, which is around 5.4%. You could consider adjusting cap rates during this transition period by approximately 100 basis points. This perspective might be helpful, and I think our second quarter call will impress people. Peter, do you have any comments?

Peter Moglia, Chief Operating Officer

Yes, I agree with that assessment. We will see things that are still lower than 5% potentially when there's a good mark-to-market opportunity that can be monetized. But if it's stable, high-quality assets, they're likely to have a five handle on them like this one did.

Joel Marcus, Executive Chairman and Founder

Dan, any other comments you would add?

Dan Ryan, Chief Financial Officer

No, I think Peter said it perfectly.

Joel Marcus, Executive Chairman and Founder

Okay. Steve, hopefully, that's helpful.

Steve Sakwa, Analyst

Yes. No, that's great. And then, Joel, maybe you and Hallie could just comment. I saw that in the last supplemental, you talked about dealing with 1,000 tenants. This time, you mentioned 850. My sense is that half of that reduction consists of retail tenants that may be moving to another asset. But I suspect that some of them are not retail. How are you changing your underwriting in the tenants you're willing to do business with today versus a couple of years ago?

Joel Marcus, Executive Chairman and Founder

Yes, we didn't have 150 failures. But Dean, could you highlight that for a moment?

Dean Shigenaga, CFO

Yes. So Steve, the huge majority of the change was really due to a simple future mega campus development project that we acquired. It's a retail project known as The Shops at 10 Fran. That accounted for nearly all of the tenancy reduction from roughly 1,000 to 850. You're correct that we also have some normal lease expirations occurring where tenants opt not to extend, which is typical activity.

Joel Marcus, Executive Chairman and Founder

Yes. And let me add to that, the nature of underwriting. I think kind of Hallie summarized it well; we are much more focused now on private companies or preclinical public companies or even companies in clinic that are public. We’re looking for much nearer-term value inflection milestones, solid data, and importantly, large unmet medical needs. We've always been vigilant, but with the shift toward ‘haves’ versus ‘have-nots,’ the mindset is much more pronounced now.

Steve Sakwa, Analyst

Great. And just one last question, Dean, do you have an overall mark-to-market estimate on what you think the portfolio has lost on leases overall today?

Dean Shigenaga, CFO

Yes, it's around 27%. Last quarter, it was closer to 22% overall in the entire portfolio.

Operator, Operator

The next question comes from Anthony Paolone with JPMorgan. Please go ahead.

Anthony Paolone, Analyst

You discussed driving much of your leasing from internal relationships within your existing tenant base. If there's an Alexandria dashboard of sorts, could you give us a sense of what leasing traffic, rates, or aggregate demand from your portfolio today looks like compared to two, three, or four quarters ago?

Joel Marcus, Executive Chairman and Founder

That’s a tough one to generalize, as it’s so market- and building-specific. Overall, demand is down from the peak of 2020 and 2021 as evidenced by a normalization of leasing metrics. However, we notice that active companies are primarily pharma and larger biotech product and service companies not heavily focused on manufacturing or supply. Additionally, biotechs that have good data are more active.

Anthony Paolone, Analyst

With that in mind, do you believe there's enough demand to absorb the new space coming online in the next couple of years, or should we expect some moderation in occupancy levels?

Joel Marcus, Executive Chairman and Founder

Yes, I think our pipeline, which is highly leased, gives us a level of confidence that we can fully lease those projects. There is demand that may not even be apparent yet for projects that are on the drawing board. We do not foresee demand dropping off a cliff.

Peter Moglia, Chief Operating Officer

There has been a slowdown in activity due to boards and companies figuring out the economy. However, there are definitely expansion needs, just some are on hold due to uncertainty. We believe there’s pent-up demand that will surface in a couple of years.

Rich Anderson, Analyst

On the $7.6 million square foot pipeline, how much does that imply in terms of development spend in 2024? And how much can you potentially pause like you did this quarter due to the current market?

Dean Shigenaga, CFO

The projects under construction, 5.5 million square feet plus another 1.2 million near-term, are mostly 100% pre-leased, contributing to the $610 million incremental net operating income. The spend will distribute over the project span, and we will monitor for site work and entitlements closely, being cautious in the current capital environment.

Joel Marcus, Executive Chairman and Founder

Exactly. The focus is right-sizing our approach given recent conditions while working on our pipeline.

Dylan Burzinski, Analyst

Can you provide more insight on how the leasing activity is shaping up in different regions? Are certain submarkets showing a more significant slowdown?

Joel Marcus, Executive Chairman and Founder

I think South San Francisco may be an example of where we’re trying to minimize exposure. We’ve made moves toward pruning assets in that area. Changes in transportation and shifts in tenant demand have also impacted our strategy in that market.

Anthony Paolone, Analyst

Are you seeing similar trends in other non-cluster markets, like RTP or suburban Maryland?

Joel Marcus, Executive Chairman and Founder

RTP has certainly slowed a bit more than anticipated, but not our tenants specifically. Maryland still shows decent activity, slower than prior peak years but consistent with historical numbers.

Georgi Dinkov, Analyst

Can you provide insight into the current credit watch list? What does it look like today versus six months ago?

Joel Marcus, Executive Chairman and Founder

We don’t have a formal watch list. Instead, we have a systematic approach to monitoring all tenants, ensuring timely payments and strong relationships. Our collections reflect our efficacy, with rates approaching 100% in various segments.

Dean Shigenaga, CFO

We’re doing well and have managed collections from tenants effectively across the board, maintaining a high level of scrutiny as tenant situations change.

Jamie Feldman, Analyst

Could you talk about venture investment realized gains?

Dean Shigenaga, CFO

Certainly. We've averaged about $25.8 million in realized gains over the last eight quarters. Recently, it's been more like $20.7 million in the first quarter of 2023 with expectations for slight increases moving forward.

Joel Marcus, Executive Chairman and Founder

I think our historical data shows we have the capacity to again achieve strong returns through our investment strategy.

Operator, Operator

This concludes our question-and-answer session. I would like to turn the conference back over to Joel Marcus for any closing remarks.

Joel Marcus, Executive Chairman and Founder

Thank you very much, and we look forward to speaking with you on the second quarter call.

Operator, Operator

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.