Earnings Call Transcript - ARE Q4 2018

Operator, Operator

Good day, and welcome to the Alexandria Real Estate Equities Fourth Quarter Year-End 2018 Conference Call. Please note, this event is being recorded. I would now like to turn the conference over to Paula Schwartz, Investor Relations. Please go ahead.

Paula Schwartz, Investor Relations

Thank you, and good afternoon. 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 the fourth quarter and year-end 2018 conference call, and happy new year and healthy new year to everybody. With me today are Steve Richardson, Peter Moglia and Dean Shigenaga. As I always do, I want to thank the entire Alexandria family for an operationally outstanding fourth quarter and year ended 2018. A quick look at Page 4 of our press release highlights our amazing collective accomplishments as of year-end, including our all-time high revenues. Each of the speakers will discuss the quality of our tenants, the quality of our cash flows, our leasing stats, our margins, our credit rating, our exposure to variable rate debt and importantly, our leverage, which is the lowest we've ever had in the history of the company. Since our founding, we've always been blessed to operate in an idea-based meritocracy culture. As a mission-driven company, we operate at the highest standards and levels of integrity and ethical behavior. We have among the best disclosure and transparency hard-earned over our 22 years as a public company and are recognized by NAREIT. When we speak about corporate social responsibility, which is a major focus in the industry today, we at Alexandria try to embody it every day. In 2018, among many notable accomplishments, our team volunteered over 2,600 collective hours to important nonprofit causes, and 49 of our team members ran the New York City Marathon, raising nearly $250,000 for Memorial Sloan-Kettering's cancer research fund. At Investor Day on November 28, in addition to providing what we felt was solid guidance for 2019, we also shared our framework for our five-year growth plan, where Alexandria has the potential to double rental revenues from 2018 to 2022 based on what we own on the balance sheet today, assuming a positive macro and industry environment. It's essential to understand why we can articulate such a bold and optimistic framework. It is based on three key strategies. First is our business strategy. In the 2004, '05, and '06 timeframe, we shifted from a single-asset strategy to a core cluster campus strategy and began building major campuses in Mission Bay, New York City, Cambridge, and beyond, which now yield substantial cash flow results. Secondly, our financial strategy was crucial coming out of the financial crisis of '08 and '09. From 2010 through 2013, we significantly improved our position as an investment-grade company with access to investment-grade debt, selling key land parcels, including a large site that is now home to the Warriors Stadium and two towers for Uber's headquarters at Mission Bay. This was critical in substantially lowering our leverage, leading to our strong performance from 2014 through 2018. Lastly, we have a management and personnel strategy that has been vital. Since 2008, we did not lay off our construction development team during or after the market crash. Led by our talented Vince Ciruzzi, we retained our exceptional team and continued to build after the crash. Our operational excellence in delivery and cost management remains high. The strong leadership from Dean in our financial team, in addition to our long-tenured regional operating teams, has contributed to our success. One of the most crucial steps we took was appointing Peter Moglia as Chief Investment Officer during the crash, which greatly enhanced our investment philosophy and operational approach. Page 33 of the supplemental details our development pipeline, showcasing our growth after navigating the crash. To summarize the life sciences industry briefly, 2018 marked another historic year, with life sciences receiving over $27 billion in funding, San Francisco Bay claiming 32% of that, Greater Boston at 21%, and San Diego at 9%. The FDA had a record year, with 59 novel medicines approved, and we are proud of both our real estate fundamentals and the life sciences industry's robust foundation. Let me pass it to Steve for further details on the quarter and the year.

Stephen Richardson, Executive Director

Thank you, Joel. Alexandria, as an innovator and leader in creating first-in-class life science clusters, is very pleased to report healthy lab real estate fundamentals, featuring strong demand against the backdrop of constrained supply, particularly in key submarkets that I'll detail. In 2018, we experienced a remarkable year, highlighted by a cash rent increase of 14.1%, the highest in the past decade. We achieved 4.7 million square feet of leasing, the second highest in Alexandria's nearly 25-year history. Notably, the percentage of early renewals and re-leasing this past year was 71%, indicating a strong sense of urgency among our clients. For the quarter, we reported rental rate increases of 11.4% cash and an increase of $41 million in rental revenue, primarily due to the delivery of 300,000 square feet leased on a long-term basis to Merck in South San Francisco and Takeda in San Diego, both high-quality, investment-grade pharmaceutical companies. Other key leases included Dendreon, which leased 76,000 square feet in Seattle, representing a 44% GAAP increase, underscoring the value and durability of Alexandria-designed lab improvements. On the East Coast, Gates Medical leased 52,000 square feet in Cambridge, while an important GSA lab tenant leased 64,000 square feet at five Research in Maryland. Regenxbio also leased 132,000 square feet at a new project in Maryland. In addition, we have an investment-grade pharmaceutical company that leased 66,000 square feet at a redevelopment project in South San Francisco. A very exciting early-stage company, insitro, also leased 35,000 square feet in South San Francisco. Our leadership role in the leading life science markets allows us to capitalize on the strong lab real estate fundamentals. The supply dynamic is severely constrained; for example, the Cambridge market has a 1.1% vacancy rate with lab demand at 2.1 million square feet, along with another 1.9 million square feet of technology-related demand. Mission Bay and San Francisco have a 0% vacancy rate, while Greater Stanford has a 1.6% vacancy rate. The overall life science demand in the San Francisco region remains strong at 2.5 million square feet. In Seattle's South Lake Union, the life science cluster's vacancy rate is less than 1%, with lab demand increasing to 611,000 square feet. Meanwhile, the southern West Coast in San Diego shows a direct vacancy of 6.8%, with lab demand reaching 1.6 million square feet. Maryland also reports nearly 500,000 square feet of demand and a vacancy rate of 4.6%. The clear takeaway is that solid lab real estate fundamentals persist, driven by the success of the life science industry. Alexandria collaborates closely with our clients for many months or even years on new projects. Page 33 of the supplemental shows the accomplishments of our fully integrated underwriting, leasing, and construction teams over the last ten years, where we have 4.1 million square feet fully leased and 3 million square feet, 36% leased at the beginning of these Class A projects. As we consider new starts in our core markets, we will closely monitor lab real estate fundamentals and continue leveraging our strategic insights. Peter, please go ahead.

Peter Moglia, Chief Investment Officer

Thanks, Steve. I'm going to spend the next few minutes updating everyone on our fourth quarter deliveries, our near-term pipeline, and our asset sales efforts. In the fourth quarter, we fully delivered 213 East Grand in South San Francisco to investment-grade tenant Merck. The initial stabilized cash yield is 6.5%, which is a healthy spread over what we believe would be a sub-5% cap rate if it was sold today. At 9625 Towne Centre Drive in the prime University Town Center submarket of San Diego, we also delivered fully to investment-grade tenant Takeda with an initial cash yield of 7.3%, which exceeded our initial projections and is 160 basis points above Green Street's cap rate for the submarket—another great example of value creation. In Maryland, we delivered two assets: 9900 Medical Center Drive in the Shady Grove submarket of Rockville and 704 Quince Orchard Road in Gaithersburg—both partial deliveries in the fourth quarter with pro forma yields approaching or exceeding 8.5%. The Maryland market is gaining momentum, evidenced by two recent announcements made by Steve for build-to-suit projects for public gene therapy companies, Regenxbio and Autolus. These projects will diversify the region's tenant base and will collectively provide over 250,000 square feet of leased space to be delivered in 2020. We also partially delivered five Laboratory Drive in the fourth quarter, with nearly a third of that project now operational. There’s been great leasing progress there, with 100% of the space either leased or under negotiation, prompting the need to expand that unique campus by beginning the development of the adjacent 9 Laboratory Drive property, also one of our 2020 deliveries. Lastly, one of our partial 2018 deliveries, 399 Binney, faced delays into January due to city-imposed pipe work that interfered with our installation timelines and delays with the power company. Both issues were beyond our control. Nevertheless, our team managed to mitigate these impacts down to a one-month delay. With achieving economic terms above our initial underwriting, the associated costs will not lead our returns to dip below our projected yield of 6.7%. In fact, it might very well be higher upon completing delivery of the remaining 40,000 square feet. This asset resides in the sub-4.5% cap rate Cambridge market, showcasing our capability to create significant value for shareholders. Despite this, 2019 brings more opportunities. With a 2.2 million square foot pipeline, including unconsolidated joint ventures, it is already 88% leased, with another 2% under negotiation. We have construction loans in place for the joint ventures, limiting our total equity needs to approximately $450 million. 188 East Blaine Street is seeing steady absorption, having moved from 33% leased in Q3 to 49% at the end of Q4. We're on track to achieve an initial stabilized cash yield of 6.7%, in a market where institutional assets are trading in the low to mid-4s. The 275 Second Avenue project in Waltham, Greater Boston, is 90% leased, with a proposal out for the remaining 10%. It is on course to achieve a 7.1% yield. The 279 East Grand project, part of our South San Francisco campus and anchored by Alphabet subsidiary Verily, is 67% leased to Verily and 33% leased to the newly mentioned insitro, which is a promising startup developing new drugs. This project is expected to deliver with an initial stabilized cash yield of a remarkable 8.1%, likely surpassing the market cap rate by 300 basis points. Our Bay Area team is also redeveloping the building at 681 East Grand, which is also anchored by an investment-grade tenant and expected to stabilize at a 7.9% cash yield before exceeding the market cap rate. Along with this, we anticipate delivering the remaining 49,000 square feet at Alexandria Park in Palo Alto by the end of Q2, fully leased to an investment-grade tenant and projected to stabilize at a 6.7% yield. Additionally, we are excited to add the redevelopment of 140,000 square feet of the Alexandria Life Science Factory in Long Island City to our 2019 pipeline. This property will support the growth of our expanding base of early-stage companies in New York City. Turning to asset sales, we are pleased to announce we have signed documents for the partial interest sale of 60% of the 388,000 square foot 75/125 Binney project in Cambridge to a respected U.S.-based institutional investor. The agreed-upon value of $1,880 per square foot represents a 4.3% cap rate based on fourth-quarter annualized net income, reaffirming the significant value present in our urban innovation campuses and our brand. Additionally, we have identified several assets that can be recycled into higher returns or joint ventured to foster a cost of capital advantage relative to common equity. We are working with consultants to finalize valuations and will adjust our disposition strategy based on these efforts and market conditions in the coming year. To summarize, our value creation engine continues to operate effectively. When it is time to monetize, we have been capable of executing flawlessly. Now, let me pass it to Dean.

Dean Shigenaga, CFO

Thanks, Peter. Dean Shigenaga here. Good afternoon, everyone. Let me touch on an important topic before diving into key highlights for the quarter and the full year. As highlighted, we have executed a P&S for the sale of a 60% interest in the Class A property developed at 75/125 Binney Street in Cambridge for $1,880 per rentable square foot, representing a 4.3% cap rate on fourth quarter annualized cash NOI. Looking back over five years, including this transaction, our aggregate dispositions total $1.5 billion at an average cap rate in the mid-4% range. The key takeaway is that our team has built a high-quality asset base of Class A properties in premier real estate submarkets across the country, translating into one of the best portfolios of high-quality cash flows in today's REIT sector. We possess a highly attractive high-value asset base, and this P&S validates our accomplishments. Our office lab properties should command a premium over Class A office properties due to their quality, high-tenancy roster, lower long-term CapEx requirements, and the unique differentiated business strategy we operate under, complemented by our established brand and experienced team. Shifting gears to cover our fourth quarter and 2018 results, balance sheet, and improving credit metrics, growth and cash flows from operating activities and dividends, as well as a brief comment on sustainability efforts and updated guidance for 2019. From a real estate perspective, 2018 was an outstanding year with our team executing our strategic goals effectively. Real estate and life science fundamentals remained robust throughout the year, and 2019 will benefit from continuing strength. 2018 recorded our highest leasing pace so far, reflecting 4.7 million rentable square feet executed along with the highest cash rental growth rate of 14.1% in a decade. Our 2019 leasing outlook is equally strong, with manageable contractual expirations at only 5.2% of total annual rental revenue, and projections indicate cash rental increases in the 11% to 14% range for 2019. Occupancy levels climbed to 97.3% at year-end, up 50 basis points since January 1. We expect to reach around 98% occupancy at the midpoint of our guidance, reflecting ongoing demand from some of the most innovative companies globally. Our unique strategy centers on high-quality cash flows from collaborative life science and technology hubs in urban innovation clusters. Class A properties situated in AAA locations contribute 77% of our annual rental revenue. Moreover, we have a high-quality tenant portfolio, with 52% of our annual rental revenue sourced from investment-grade rated or publicly traded large-cap companies. Collectively, our strong fundamentals, record leasing, elevated occupancy, collaborative campuses, Class A properties, beneficial lease structures with annual escalations, and operating expense recoveries contribute to our consistently robust same-property performance. Our same-property NOI growth has shown an impressive 3.7% increase, with a cash basis growth of 9.2% in 2018, both surpassing our strong 10-year average. Our outlook for 2019 anticipates continued strength, projecting cash same-property NOI growth between 6% and 8%. Our adjusted EBITDA margins remained strong at 69%, ranking among the best in the REIT industry. Operating expenses surged 17% during 2018, alongside a 7.5% rise within the same property portfolio, primarily driven by increases in property taxes resulting from recent projects and annual reassessments in selected markets. It's crucial to note that our favorable lease structure includes a triple net provision in 97% of our leases, allowing for the recovery of operating expenses from tenants. Due to our solid leasing philosophy in 2018, we also achieved remarkable success in leasing value creation projects, executing 1.7 million rentable square feet of leases tied to the development and redevelopment of Class A properties, with 90% of these leases scheduled to commence in 2019. These leases will provide substantial initial annual rents aggregating $96 million and entail annual escalations, ensuring ongoing cash rental growth. Our venture investment and support company is devoted to transforming lives around the globe. With the implementation of new GAAP rules since early 2018, we now recognize changes in the fair value of specific investments in earnings. As of December 31, our cost basis equates to $652 million, or 4.5% of our total assets, with unrealized gains reaching $240 million. Our net loss for Q4 was $0.30 per share, with an annual earnings per share of $3.52 for 2018, reflecting unrealized losses of $83.5 million and unrealized gains of $136.8 million due to fair value changes of non-real estate investments. Now, regarding our balance sheet and credit metrics, we completed 2018 with the strongest balance sheet in company history. In 2018, Moody’s and S&P acknowledged improvements in our credit profile, with Moody's elevating our rating to Baa1 stable and S&P adjusting their outlook to BBB positive, placing us near the top tier of the office sector today. Our leverage ratios stand solid at 5.4x based on net debt-to-adjusted EBITDA, and we remain dedicated to maintaining strong and improving credit metrics. Briefly discussing cash flows and dividends, our cash flow from operating activities post-dividends reached an all-time high in 2018, exceeding $150 million, largely owing to internal and external growth initiatives. We saw the Board of Directors approving two increases in our quarterly common stock dividends during the year, resulting in an 8.1% rise for full-year 2018 dividends compared to 2017. Our Board's policy continues to reflect our approach of sharing cash flow growth with stockholders while retaining significant capital for reinvestment into new Class A properties. Touching on sustainability and philanthropic efforts, our dedication remains focused on cultivating sustainable environments that facilitate breakthroughs in therapies and technologies aimed at curing diseases, enhancing nutrition, and improving quality of life. We are proud of our Green Star designation from GRESB and are committed to our 2025 goals aimed at reducing our environmental impact. 2018 also turned out to be a successful year for our philanthropy and volunteerism initiatives, with our team dedicating over 2,600 hours to more than 250 nonprofit organizations, providing essential support to organizations engaged in medical research, STEM education, military support services, and local community initiatives. To conclude, our updated guidance for 2019 reflects revisions made following our usual reviews of construction projects throughout the last 60 days, identifying areas for cost reduction. We anticipate a $100 million decrease in construction expenses, amounting to a 7% cut in overall spending. Half of this reduction stems from common conservative estimates, while the other half relates to a project element no longer included in the finalized design. It is crucial to note that these cost reductions will not alter the timing of project deliveries for 2019. The decrease in spending has also led to a reduction in forecasted common equity needs by $100 million, alongside a decrease in capitalized interest, which is a consequence of reduced construction expenditure for the year. I should mention that capitalized interest in Q4 of '18 peaked at $19.9 million, up $2.5 million from the third quarter attributed to a buildup of construction in progress for nearly 650,000 rentable square feet of new Class A properties delivered in Q4 and January 2019. These deliveries will lead to a reduction in capitalized interest in Q1 of '19 compared to Q4 of 2018. Our guidance for EPS in 2019 is set within a range of $1.95 to $2.15, with no change to the positive outlook for our 2019 FFO per share as adjusted, pegged at a midpoint of $6.95. In closing, 2018 has proven to be an exceptional year, and our team is off to a great start in 2019. Let me turn it back over to Joel.

Joel Marcus, Executive Chairman and Founder

So operator, if we could move to the Q&A session, please?

Operator, Operator

The first question comes from Jamie Feldman of Bank of America Merrill Lynch.

James Feldman, Analyst

I was hoping you could talk more about the pre-lease percentage of the 2020 development delivery pipeline? Can you provide more color on that?

Stephen Richardson, Executive Director

Jamie, it's Steve here. Yes, sure. As we look at the 2020 deliveries, we've got five different buildings that total about 560,000 square feet. Currently, those projects are 81% leased, with another 2% under negotiation, so we are substantially resolved in the 83% range there. Additionally, we have a number of other projects totaling about 1.3 million square feet slated for deliveries later in 2020. We're actively in discussions with several of those project groups and look forward to updating everyone as the year progresses.

Dean Shigenaga, CFO

And Jamie, if I could add, I would just remind you of my prepared comments stating that in 2018, we executed 1.7 million rentable square feet tied to the value creation pipeline, with 90% related to deliveries occurring in 2019. Our team is hitting on all cylinders when it comes to leasing up the value creation pipeline, and we are diligently working to address the remainder of it, but we remain excited about our progress.

James Feldman, Analyst

Okay. Did I miss it somewhere that you actually say, which five are leased?

Stephen Richardson, Executive Director

We haven't broken those out yet, Jamie. We'll be doing that in the future.

James Feldman, Analyst

Can you say which ones are leased?

Stephen Richardson, Executive Director

Yes. We've got a couple down in San Diego and then two projects at Medical Center Drive in Maryland.

James Feldman, Analyst

Those are leased?

Stephen Richardson, Executive Director

Yes.

James Feldman, Analyst

Okay. All right. And then, Dean, regarding your comment on the $100 million of reduced spend, does that get pushed out into 2020, or how do we consider that? Or does it just shrink the overall pipeline?

Dean Shigenaga, CFO

It is not pushing out much of the spend into '20. Most of it related to conservative assumptions we were able to address over the last two months, which is pretty typical in a given year. We often identify 3%, 4%, or 5% that can be taken out of the budget, and we also have a unique project that had an element we could not include in the final design, leading to a cost reduction.

James Feldman, Analyst

Okay. And then, finally, as you consider the potential for more joint venture sales due to the attractive pricing in Cambridge, can you envision a scenario where you don’t require any more common equity this year?

Dean Shigenaga, CFO

We have a modest amount that remains, Jamie. Dispositions are always a key component of our capital plan. We also have unique opportunities to invest capital at attractive returns. While I'll say it may not fully eliminate the need, it is a significant component.

Operator, Operator

The next question comes from Manny Korchman of Citi.

Emmanuel Korchman, Analyst

Your markets have certainly witnessed substantial rent growth, which stems from those very low vacancy rates you mentioned. Is there an elasticity curve to rent? Or could you potentially increase rents more? If so, why aren't we observing even larger mark-to-market or rental adjustments on rollovers?

Stephen Richardson, Executive Director

Manny, it's Steve here. There’s always a balance, and I think we've been quite consistent on that. These are repeat clients, multi-market clients, and we’ve been proactive in pushing rents. The figures speak for themselves, with our highest cash increase this past year. I believe we continue to engage long-term with these tenants, and we are indeed capturing full value. As we move forward, stay tuned as our development pipeline progresses.

Peter Moglia, Chief Investment Officer

Manny, it's Peter Moglia. I’d also like to point out that we excel at incorporating annual increases into our leases, often inserting a 3% escalation per year, ensuring that by the time those leases roll, we're still achieving exceptional cash and GAAP increases beyond what happened during the lease.

Emmanuel Korchman, Analyst

And regarding your discussion of those low vacancy rates, what are the re-lease-up multiples of demand in this market that cannot find space?

Peter Moglia, Chief Investment Officer

Our 2019 and 2020 deliveries support that.

Stephen Richardson, Executive Director

Yes. The early renewals were at an all-time high at 71%, marking a clear sense of urgency among clients to secure space. This is a high-class problem we are tackling in several of our markets.

Emmanuel Korchman, Analyst

I have one last question for Peter. What criteria do you utilize when considering JVs? Specifically, why did you opt for the 75/125 project for the JV instead of one of your other Cambridge assets? Furthermore, as you consider expanding JVs or sales programs, how do you decide what to include in a JV?

Peter Moglia, Chief Investment Officer

I apologize for the last part. In general, we assess whether we have maximized the value from the asset up to this point and if we can generate more value in the future. In the case of 75/125 Binney, it’s fully leased to excellent tenants, and it has a long timeline before reaching the market. We have partnered with patient capital that will thrive once the lease rolls. It's a great time for us to monetize this and allocate resources into our well-leased, high-return pipeline. Regarding JV partners, we seek those who understand our business model and collaborate well with us, as trust in our judgment and brand is crucial.

Operator, Operator

The next question comes from Sheila McGrath of Evercore.

Sheila McGrath, Analyst

I wanted to ask Peter a few more questions on the JV. Did you speak exclusively with one partner, or were multiple potential partners considered? What level of interest did you receive? Could you provide insight into where the rents for that asset stand in comparison to current market rates?

Peter Moglia, Chief Investment Officer

To address the current rents, they are in the mid-70s, while the market rent is conservatively in the low to mid-80s. Regarding marketing, we had a targeted strategy involving investors we wanted to collaborate with. This was not solely about cost or purchase price, but also about ensuring cultural alignment as we approached potential partners. We had a small audience we targeted, knowing what value we wanted, and our buyers responded quickly to finalize the deal. Some interest was expressed from others before we made our final choice, with significant interest stemming from the Cambridge property due to the demand for life science real estate.

Sheila McGrath, Analyst

Okay, that's insightful. Do you believe that the parties you're in discussions with are beginning to regard the life science lease structure and EBITDA margins more favorably than traditional office properties?

Peter Moglia, Chief Investment Officer

Certainly, I believe people are recognizing our efficient operations on the CapEx side compared to office properties. They also see our tenant roster and understand that they are not just investing in solid real estate but also backed by strong credit. The life science industry is quickly becoming a significant economic contributor in the U.S. due to its unique challenges related to intellectual property, and our tenant base consists of financially strong companies eager to expand.

Sheila McGrath, Analyst

Great, and one last thought. You’ve allocated more capital to the Stanford cluster through acquisitions. What’s your perspective on that market, and is the demand being driven equally by both tech and life sciences?

Stephen Richardson, Executive Director

Sheila, it’s Steve here. Having worked in that market for 35 years, it has traditionally maintained a balanced demand between life sciences and technology. However, we've observed that tech has become more dominant, leading to a scarcity of options for life science companies—in particular, with major players like Google, Facebook, and even Apple pushing out life sciences. While we have strong demand in that area, we see a resurgence in life sciences through significant investments and notable ventures, which suggest that the environment will shift back towards growth and sustainability.

Operator, Operator

The next question comes from Tom Catherwood of BTIG.

William Catherwood, Analyst

We are witnessing considerable M&A activity in the life sciences sector, notably impacting your tenants such as Bristol-Myers and Celgene, alongside Takeda. How do you evaluate exposure to these large companies when mergers take place? And what historical impact do such mergers have on real estate requirements, especially in distinguishing between large-cap pharma versus small-cap biotech?

Joel Marcus, Executive Chairman and Founder

Yes. So Tom, if you refer to Page 26 of the supplemental, you'll notice that we’ve built a highly diversified tenant base, with our top 20 tenants comprising nearly 45% of our revenues. We consciously avoid excessive concentration risk; our major tenants span a range from Takeda at 3.6% to FibroGen at 1.4%. In the case of the Bristol-Myers and Celgene acquisition, while we engage with our tenants, we don't have exposure to Celgene's New Jersey campus, where most of their synergy costs will likely be realized. Key locations include Juno in Seattle and Receptos in San Diego, which house critical therapies that add greater value post-acquisition.

William Catherwood, Analyst

Understood. Historically, do you observe significant reductions in space requirements as a result of mergers, or does it depend on the mission of the companies and their product pipelines?

Joel Marcus, Executive Chairman and Founder

Generally speaking, cost synergies often lead to reduced footprints, particularly when large firms merge. However, acquisitions of biotech firms tend to be driven by their talent and product pipelines rather than real estate needs. We maintain due diligence during our tenant assessments; thus, none of our top 20 tenants are anchored to single product or one-time projects.

William Catherwood, Analyst

Got it. For Peter, you mentioned that Maryland is gaining momentum alongside the lease-up in RTP, leading to further development in that area. Is this growth dependent on specific resources or funding sources, or are markets developing sustainable ecosystems as seen in your larger clusters?

Joel Marcus, Executive Chairman and Founder

In terms of Maryland, there's been notable resurgence in government funding for the National Institutes of Health, alongside rising venture capital. This influx creates sustainable opportunities as commercial firms seek proximity to government institutions for collaborative programs, resulting in stability for the emerging firms in the area. North Carolina has similarly seen growth as we've strategically relocated to sectors focused on both health care and ag tech research.

Peter Moglia, Chief Investment Officer

I’d add that RTP’s recent ag tech research focus increasingly attracts investments. Over time, it has set the stage for solid growth, and we are strategically well-positioned. In Maryland, the past reliance on government funding is dissipating as commercial entities are starting to occupy the space, further diversifying our tenant base.

Operator, Operator

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

Michael Carroll, Analyst

Can you share insight into the major near-term development projects the company is pursuing? I know the North Tower is on that list, but are there other significant projects we should monitor in the upcoming quarters?

Stephen Richardson, Executive Director

Michael, it’s Steve Richardson. Certainly! Beyond the North Tower, we have projects in South San Francisco along Haskins Way for predevelopment work and horizontal infrastructure. We’re also evaluating the 825, 835 Industrial Road project in Stanford, and there’s predevelopment work commencing at 3115 Merryfield in San Diego and 1165 Eastlake. These are all in areas where supply is limited, and we have gathered insights from our client tenant base to guide future investments.

Michael Carroll, Analyst

Regarding the initiation of these projects, do you require any pre-lease percentages before breaking ground? Or is interest alone sufficient given the lack of available space?

Stephen Richardson, Executive Director

Historically, we take a considered approach towards predevelopment and horizontal work, focusing on speed to-market. That said, before making significant capital investments, we assess the necessity of confirming an anchor tenant or leading occupant to ensure viability before going vertical. At the start of these projects, we saw 4 million square feet already fully leased, while the remaining 3.1 million square feet had approximately 33% leased.

Michael Carroll, Analyst

You mentioned heightened competition in South San Francisco. How does the market currently appear in light of this, and is it still a target for continued investment given your planned projects?

Stephen Richardson, Executive Director

Reflecting on our recent strategic planning meeting, we find ourselves very well balanced across the four key clusters: SoMa, Mission Bay, South San Francisco, and Greater Stanford. We're not excessively weighted in any single market. Our 100% leasing in the Bay Area spans years. We view South San Francisco as critically important, particularly with our Haskins project, which presents a platform that can accommodate diverse firms from various sectors. That said, we keep a close watch on competitive dynamics.

Operator, Operator

The next question comes from Daniel Ismail of Green Street Advisors.

Daniel Ismail, Analyst

Are you observing any new supply in your markets that raises concerns?

Stephen Richardson, Executive Director

Daniel, it's Steve again. Not specifically, no. Seattle is quite tight; Cambridge remains severely constrained. We’ve talked about the Bay Area, and outside of South San Francisco, I haven't noticed significant ground-up development activities that could impact our markets.

Daniel Ismail, Analyst

To broaden the discussion, Joel, there are expectations for prescription drug pricing to arise in the State of the Union. What do you foresee in the regulatory landscape regarding drug pricing over the next 12 to 18 months, and how might this impact your tenants' pricing power?

Joel Marcus, Executive Chairman and Founder

Well, it's hard to envision Congress reaching any consensus! However, we recently held a productive discussion with Medicare. The President's objective is to eliminate rebates and fees imposed by middlemen, which represents nearly 40% of branded product costs. When discussing this with stakeholders in D.C., we recognized that numerous vendors—hospitals and other dispensaries—mark up drugs as much as 10x the cost. This realignment of how prices are set is vital and could address unreasonable costs and the behavior of certain players within the system. It's essential to remember that while drug costs garner attention, they only comprise 10% to 15% of overall healthcare costs—90% of all prescribed drugs are generics. While significant discussions are held concerning drug pricing, the fiscal burden lies with many downstream participants. If any action is to arise from Congress, bipartisanship is crucial, and that’s a tall order!

Daniel Ismail, Analyst

That insight is appreciated. Dean, concerning your equity sources for 2019, should we anticipate that to occur via a forward equity raise or through an ATM consideration throughout the year?

Dean Shigenaga, CFO

Dan, the method of obtaining debt or equity capital will rely on market conditions, as will our disposition strategy. Presently, our equity needs are modest, facilitated by our disposition plan. Therefore, both options remain available to us when opportunities arise.

Operator, Operator

We have a follow-up from Manny Korchman of Citi.

Michael Bilerman, Analyst

This is Michael Bilerman. Following the whole capital discussion and acknowledging the advantages of trading at a premium, you previously referenced over-equitizing growth initiatives to strengthen your balance sheet. Your outstanding report demonstrates notable growth. Reflecting on the increase from 70 million to over 100 million shares, do you contemplate a more merchant-bill approach to kickstart substantial value creation from your development pipeline? This might entail pre-selling additional assets to harness market strength while committing your development capital to enhance returns.

Dean Shigenaga, CFO

Michael, your comments echo a similar sentiment. Our increase in equity issuance to bolster our balance sheet has also aimed to optimize leverage. Although we witnessed growth of 60% in FFO per share, our focus must remain balanced on executing our value creation pipeline through disciplined funding approaches. Over the years, we have indeed contemplated alternative strategies to enhance capital deployment, analyzing prudent solutions to ensure sustainable growth.

Joel Marcus, Executive Chairman and Founder

We'll certainly weigh various considerations regarding asset selection, particularly for those like our centers in New York and key Cambridge assets. The 75/125 project offered a distinct opportunity based on timing, value, and was strategically similar to previous ventures down the same street. We've encountered various transitional phases with multiple tenants, and Peter’s expertise equips us to navigate these opportunities effectively.

Michael Bilerman, Analyst

Understood. Can you share insights regarding your eldest son's litigation? I've been receiving some inquiries about the international lab venture he initiated, along with counterclaims related to logo usage and potential paths forward.

Joel Marcus, Executive Chairman and Founder

At its core, Alexandria has thrived for the past 25 years. We pioneered and established a unique market position with a well-defined business strategy. Despite any challenges, the strength of our management and dedicated team remains firm. Jennifer, our General Counsel, will share her perspective on any ongoing litigations, but fundamentally, Alexandria embodies integrity and ethical behavior, which we regard as essential.

Jennifer Banks, General Counsel

Michael, I am the General Counsel here at Alexandria. I cannot comment on ongoing litigation processes, but we will always ensure full compliance with appropriate disclosures as required. Thank you for your understanding.

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 all for attending and engaging in this call. We appreciate your input and look forward to sharing more details during our first quarter results in late April or early May. We will provide further insights into ag tech strategies during that call as well. Thank you very much, everyone.

Operator, Operator

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