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Is Alexandria Real Estate Equities a Buy?

Motley Fool - Sat Aug 26, 4:18AM CDT

The rapid rise in interest rates has been a major headache for real estate investment trusts (REITs). Rising interest rates increase financing costs, and REITs have to compete with bonds, which are increasing attractive given their yields.

We are seeing plenty of negative sentiment in the office commercial real estate sector. That said, not all commercial real estate is equal; location, tenant base, and quality matter as well. Alexandria Real Estate Equities(NYSE: ARE) is an office REIT that focuses on life sciences companies. Is it a buy?

A laboratory

Image source: Getty Images.

Alexandria Real Estate Equities focuses on "innovation clusters"

Alexandria Real Estate Equities owns and operates life sciences, agricultural technology, and other similar tech facilities in innovation cluster locations such as Boston, San Diego, New York, San Francisco, Seattle, Maryland, and the Research Triangle in North Carolina.

As the term implies, these are notable for their concentration of companies focused on innovation. Alexandria Real Estate Equities has approximately 1,000 clients and 74.6 million square feet of space.

Its tenants include major pharmaceutical, biotech, and life sciences companies; government and academic offices, and tech companies. The REIT's biggest tenants include Bristol Myers Squibb(NYSE: BMY), Moderna(NASDAQ: MRNA), and Eli Lilly(NYSE: LLY). Alexandria's exposure is generally well diversified, with no one tenant accounting for more than 3.5% of annual revenue.

Sentiment is awful in office commercial real estate

The problems in the commercial real estate sector have been well documented this year, especially in office real estate. The pandemic proved the efficacy of the work-from-home model, and office occupancy rates are at ultra-low levels.

According to some estimates, occupancy percentages in many big cities are below 60%. This is putting pressure on the entire office-space REIT sector.

Alexandria's occupancy rates are better than its peers

Alexandria's focus on life sciences is a major differentiator compared to other office REITs like S.L. Green(NYSE: SLG). While employees of law firms, ad agencies, and tech firms are able to work remotely, companies in the life sciences space require sophisticated laboratory facilities, which makes remote work more difficult.

This difference is borne out in Alexandria's occupancy numbers, which stood at 93.6% as of June 30. In comparison, S.L. Green's June 30 occupancy rate was below 89%, and Boston Properties' (NYSE: BXP) was 88.3%.

While Alexandria Real Estate Equities' business model is probably superior to generic office REITs, the bottom line is that investor sentiment toward the space is awful, and that doesn't look set to change anytime soon. The REIT is down about 19.5% year to date, and other office REITs haven't performed that much better.

On the second-quarter earnings conference call, Alexandria guided for occupancy to increase during the second half of the year, rising to 95.1%. The company sees funds from operations (FFO) per share coming in between $8.93 and $8.96. It is important to note that FFO is different from net income as reported under generally accepted accounting principles (GAAP). The main difference is that FFO ignores depreciation and amortization, which is a big noncash expense.

The valuation is attractive, but sentiment is terrible

At current levels, Alexandria Real Estate Equities is trading at a price-to-FFO ratio of 13 times, which is an attractive multiple for a high-quality REIT. The dividend yield of 4.3% is around its highest mark over the past decade.

ARE Dividend Yield Chart

ARE dividend yield data by YCharts.

The problem for Alexandria is not its fundamentals, which remain strong. The issue is the negative sentiment in the office space overall.

The company's belief that occupancy is going to improve is a good sign, and investors who have the patience to wait out the negative sentiment in the space might find the company attractive. Otherwise, it is a great company in a lousy sector.

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Brent Nyitray, CFA has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Alexandria Real Estate Equities and Bristol Myers Squibb. The Motley Fool recommends Moderna. The Motley Fool has a disclosure policy.

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