Despite the “macro headlines,” the REIT’s execs say this is the “Golden Age of Biology”
By Murray W. Wolf
During Q4, Alexandria started two new development projects totaling 467,567 square feet. One was 1450 Owens St., a seven-story, 212,796 square foot lab and office project in San Francisco’s Mission Bay area. (Rendering courtesy of Alexandria)
“Despite the macro headlines, we remain optimistic and excited for our business as we are in the early innings of the Golden Age of Biology.”
That was just one of the bullish comments shared Tuesday (Jan. 31) by executives of Alexandria Real Estate Equities Inc. (NYSE: ARE), during the firm’s fourth quarter (Q4) 2022 earnings call with securities analysts.
And why not? According to Pasadena, Calif.-based Alexandria’s earning report released the previous day (Jan. 30), the nation’s oldest and largest life sciences real estate investment trust (REIT) finished the year with record revenues of about $2.6 billion and near-record net income of about $513.3 million. It also achieved record-level operating metrics, including attaining the lowest leverage ratio in company history. The firm also recorded its fourth consecutive year of more than 30 percent spreads on lease renewals, as it racked up 8.4 million in total annual leasing volume, only about 1 million less than during the previous record year.
“We had a truly exceptional fourth quarter and 2022 year-end results and, by any and all metrics, we’re very proud, thankful and humbled, while many public recording companies ever really struggled mightily during this past year,” Alexandria Executive Chairman and Founder Joel S. Marcus said as the earnings call began.
Mr. Marcus said the REIT delivered “truly amazing” results “against the backdrop of a very deleterious macro-market” in 2022, including roughly 8.5 percent fund from operations (FFO) per share earnings growth “while continuing to strengthen our fortress balance sheet, the strongest in our history.
“With our highly leased development pipeline and continued strong leasing … Alexandria is well positioned to deliver strong earnings growth again in 2023,” he added.
Much of Alexandria’s optimism is based on the strength of the life sciences industry itself, noted Hallie Kuhn, senior VP of science, technology and capital markets.
“As we often talk about, 90 percent of the 10,000 diseases remains an incredible opportunity and unmet need,” Ms. Kuhn said. “And the fact is, many of these that do have treatments are far from solved…
“Now, looking back at 2022, the stats truly speak for themselves regarding the enduring strength of the life science industry, of which I’ll highlight three.
Looking back at 2022
“First, despite widespread commentary that VC (venture capital) funding hit the pause button in 2022, life science venture deals totaled nearly $58 billion. Other than 2021’s record year, it was the second-highest amount of capital ever deployed. Of note, over 70 percent of VC dollars deployed went into an Alexandria cluster, and with VC funds across tech and life science raising nearly $160 billion in 2022, a record eclipsing 2021 is $150 billion, significant dry powder is on hand to deploy over a multi-year time horizon.
“Second, large pharma continues to be one of the best-performing sectors in the market. In a year where total returns for market indices such as the Nasdaq and Dow ended the year down 10 percent, the top 20 biopharma (firms) ended the year up an average 12 percent, with 8 of the top 20 pharma ending the year with total returns over 20. With historic levels of cash on hand, over $300 billion to deploy into R&D (research and development) and M&A (mergers and acquisitions), biopharma has the firepower to continue to innovate and grow.
“And last, the pipeline of early innovation to commercialization continues to deliver to patients, with 37 novel FDA (U.S. Food and Drug Administration) small molecule and biologic approvals, three gene therapy approvals, and a novel cell therapy approval, of which nearly half were developed by Alexandria tenants.”
Peter M. Moglia, Alexandria’s CEO and co-chief investment officer, also commented on the broader economic conditions last year.
“Twenty-twenty-two was quite a volatile year in the macro markets, a reminder that all businesses are subject to cycles, some more than others,” Mr. Moglia noted. “The pruning we see in the tech industry today is not a surprise to anyone who’s been around since the turn of the century. However, much like a broken bone, it will come back stronger after it heals.
“Unlike tech, developing products and services to address disease is hard and takes a lot of time, much harder and more time-consuming than creating the next app to book a reservation or share recipes. Because of that, there is more discipline in life science investment, a discipline Alexandria has mirrored in our real estate strategy, which is why through the dot-com bust to the financial crisis, to whatever you want to label today’s conditions, our business remains sound, as you can see in our results this quarter and during those historic down cycles.
“Despite the macro headlines, we remain optimistic and excited for our business as we are in the early innings of the Golden Age of Biology. We have only had the blueprint of the human genome for 20 years. And in that time, we’ve developed more new modalities to attack disease than in the previous 100. It’s going to be hard, and it’s going to take time, but the industry is going to have options for people with Alzheimer’s. It’s going to perfect technology to detect pancreatic cancer in time to save lives and much, much more.
“So let’s all remember, it’s hard, it takes time and patience, and then you will understand why life science research and development continues through the proverbial thick and thin of economic cycles, making our business resilient and essential.
What’s ahead for 2023?
Turning her attention from the industry as a whole to Alexandra specifically, Ms. Kuhn said that the firm has an “unrivaled” life science tenant roster of about 1,000 clients, many of which are “at the forefront of life science innovation.” Large pharmaceuticals companies, for example, invested about $260 billion in R&D in 2021, she said, “and analysts estimate that, including leverage, pharma has over $600 billion to deploy into M&A and partnerships.” That has set the stage for “large pharma’s continued pursuit of innovation as product patents expire and new types of medicines such as mRNA (messenger RNA) and cell therapies transition from large preclinical and clinical pipelines to commercial stage,” she said..
“Alexandria tenant Pfizer (Inc.) is a great example,” she said, with more than 110 programs spanning early to late clinical developments, and an estimated 19 products launching in the next 18 months. Pfizer (NYSE: PFE) also expects to generate an additional $25 billion in revenue from M&A activity by 2030, she said.
As for public biotechnology companies, Ms. Kuhn said, “our tenant base includes the majority commercial-stage companies, which brought in nearly $150 billion in revenue in 2021. She noted that Alexandria tenants such as Amgen Inc. (Nasdaq: AMGN) and Vertex Pharmaceuticals (Nasdaq: VRTX) “have large, diversified pipelines, driving long-term growth… While the public markets are still recovering, life science follow-on financings reached nearly $17 billion in 2022, which is right on par with the average life science follow-on financings over the past decade.”
With regard to life science products, services and devices, she said, “This segment largely consists of commercial-stage tenants. While not immune to higher interest rates and supply chain challenges, this is a big business segment that both drives and responds to the needs of researchers across academia, biotech and large pharma, which continue to grow and innovate. She added that “a notable development” in the space has been “the rapid drop in the price of genome sequencing, driven by a healthy increase in competition.” The cost to sequence a genome in 2001 was $100 million. That fell to $1,000 per genome in 2020, and “we are now looking at the $200 genome…”
“In the face of persistent economic headwinds, all industries are forced to double down on the areas of greatest value,” Ms. Kuhn continued. “As part of the reset, there are companies that won’t make it, and we’d argue that this, in the long run, is healthy as capital is deployed more efficiently. There will continue to be further separation of haves and have-nots.
“But companies like those on Alexandria’s tenant roster with differentiated technologies (and) a clear road map to key inflection points such as generating clinical data and tenured management teams, will continue to raise capital. As history has shown time and time again, some of the most successful companies are those created in the depths of a financial downturn.”
Alexandria’s development pipeline
Mr. Moglia went on to provide an update on Alexandria’s development pipeline progress, construction trends, leasing results and investor demand for life sciences real estate (LSRE).
“Our best-in-class development teams continue to deliver high-quality, purpose-built laboratory space to our tenants on time and on budget in a very challenging construction environment,” he noted. Alexandria delivered nearly 500,000 square feet of new space during Q4, and 1.77 million square feet for the year, spread over 15 development and redevelopment projects. Initial stabilized yields for recent deliveries averaged 6.8 percent and 6.3 percent on a cash basis, he said, “reflecting the healthy contractual annual increases embedded into our leases.”
Although Mr. Moglia noted, “At a high level, it appears the construction industry is on the cusp of slowing down,” based on leading economic indicators, as of year-end, Alexandria had 7.6 million square feet of additional development under construction or expected to start construction this year. That space is 72 percent pre-leased, he said, with about 77 percent of that leasing coming from current tenants.
The new development projects Alexandria started during Q4 totaled 467,567 square feet. They were:
■ 1450 Owens St., a seven-story, 212,796 square foot project in San Francisco’s Mission Bay area, consisting primarily of lab and office space, along with ground-level retail, and
and will be 100% funded by our joint venture partner; and
■ 10075 Barnes Canyon Road, a 254,771 square foot project in San Diego’s Sorrento Mesa sub-market.
Mr. Moglia also reported some good news about construction costs, which have soared in recent years.
“For the first time since the post-pandemic restart of construction projects, which was the genesis of significant cost inflation and supply chain problems, we’re starting to see some signs of materials pricing flattening out and general contractors and subcontractors looking for work,” he said.
Having said that, he noted that are still some items – such as aluminum, rebar, copper and glass – that cost 16 percent to 21 percent more today than they did at this time last year.
“And it’s still very difficult to obtain electrical switchgear, emergency generators, building controls and smart air handling units… Laboratory buildings are heavy consumers of these hard-to-get items, so to keep a laboratory construction project on time and on budget is a difficult task,” he said.
On the leasing front, as noted earlier, Mr. Moglia reported activity was at near-record levels in both Q4 and 2022 as a whole.
“These results are certainly reflective of Hallie’s commentary on the strength of VC funding and the stellar 2022 performance of large pharma,” he said. Alexandria executives expect robust leasing again in 2023, from both established tenants and for those whose research will be moving from early innovation to commercialization, he added.
Alexandria’s investment activity
Mr. Moglia reported that Alexandria “completed $2.2 billion of value harvesting,” or asset sales, in 2022, “with the improved properties achieving a weighted average cap rate of 4.4 percent, realizing a total gain of $1.2 billion and a value creation margin of 107 percent.
“This is a tremendous achievement considering the volatile interest rate environment in 2022 with many real estate investors on the sidelines. It speaks to the desirability of our assets, which are in the best markets with high-quality tenants and managed with operational excellence.”
He continued, “High-quality life science assets are scarce, and that is reflected in the pricing. We have started working on, and are making good progress on 2023 value harvesting and asset recycling, and we’ll update you on that next quarter.”
Mr. Moglia went on to share details about “three notable non-Alexandria sales that illustrate that there is still strong demand for life science real estate product.” In each case, the acquisitions involved properties with some less desirable characteristics, yet the properties sold for between $878 and $902 per square foot (PSF) and with capitalization rates (projected first-year returns) of from 5.8 percent to 6.2 percent.
“As the Fed continues to pull levers to battle inflation, we expect we will see cap rates move up,” Mr. Moglia said, “but much less on a relative basis to other product types. And thus we remain well positioned to fund our value creation pipeline efficiently and at a relatively attractive pricing by harvesting our value creation among other sources.
Finally, Dean A. Shigenaga, president and chief financial officer, went over Alexandria’s finances in greater detail.
“Our team is very pleased to have the strongest balance sheet in the company’s history as of Dec. 31,” Mr. Shigenaga said, “and this really is a result of disciplined execution of liability management year-to-year over the past decade.
“Our key highlights include: we really have earned our corporate credit ratings that rank in the top 10 percent of the REIT industry today. We ended the year with tremendous liquidity of $5.3 billion that provides us important flexibility in this macro environment. No debt maturities until 2025, a statement only a small handful of REITs can make today, and a weighted average remaining term of debt at 13.2 years. Net debt to adjusted EBITDA was 5.1 times on a quarter annualized basis, 5.2x on a trailing 12-month basis.”
In light of its healthy balance sheet, it is perhaps unsurprising that yesterday (Feb. 2) Alexandria announced that it is commencing an underwritten public offering, subject to market conditions, of two tranches of senior notes. It plans to use the net proceeds for working capital; general corporate purposes; to pay down debt; and to fund possible acquisitions, as well as development, redevelopment or tenant improvement projects.
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