An Interview With A REIT That's Looking To Take Advantage Of The Growing Healthcare Industry
Banking On Profit's Tim Melvin recently had the chance to talk with Peter Moglia, the CIO of Alexandria Real Estate Equities Inc (NASDAQ: ARE), to talk about the company's strong earnings report and future. The following is a transcript, edited lightly for length.
Tim Melvin: Okay, we’re on today with Peter Moglia. The Chief Investment Officer of Alexandria Real Estate, a REIT that has had some very strong results and great performance in the market in the last year with the stock up over 24%. Peter, thanks for taking some time to talk with us today.
Peter Moglia: No problem. Great to be here.
Melvin: Now, you guys operate in kind of a niche of the real estate market and it’s one that never really occurred to me until I started reading through your presentations and results and everything. Can you talk a little bit about this sector of the real estate market that you guys operate in?
Moglia: Well, I guess we consider ourselves a world class collaborative science and technology campus developer. The main part of that is that we’re a pure life science real estate company, and we kind of invented that sector many years ago when Joel Marcus and Jerry Sudarsky founded the company. They noticed that there was a lot of demand for facilities to do life science research and development, but there was no avenue to lease. That was about 1994.
The company went public in 1997 at about a $200 million market cap, and today we sit at about $12.5 billion market cap. We serve the pharmaceutical and biotech industries, government, personal care product companies, the whole gamut of companies that need research and development space.
Melvin: I would imagine that life sciences, that’s going to be biotechnology, pharmaceuticals, so you kind of cover the industries. Do you provide just research and development space or also warehouse and production space or is it primarily research?
Moglia: We want to put our capital into space that generates revenue for our clients, so we really focus on the R&D, the space where the drugs are being developed, discovered, and that’s our sweet spot. We let others handle things like warehouse. From time to time our clients need office space and we do provide that as well, either as part of a lab solution or sometimes on a stand alone basis, but we really focus on the R&D space.
Melvin: Now, the market itself for life science properties, I would assume that you see that as a market that’s going to continue to grow with increased demand going forward?
Moglia: We are going to grow along with the life science industry and there have been a lot of great trends in that industry. The R&D budgets for top 20 R&D spenders has increased 78% over the past 10 years and 450% since 1994 when we started. The FDA review period has become 61% shorter than 8 years ago. The FDA is approving 64% more drugs per year than they did 10 years ago.
These trends, these R&D budgets going up, venture capital increasing quarter to quarter, government funding increasing quarter to quarter, pharma biotechs coming into our markets, we only see growth at this point on.
Melvin: The cluster model, actually that makes a lot of sense to me. You’re in all the major ones at this point. Do you see any new markets developing that might be an area of growth potential as a new science cluster forms somewhere around the country?
Moglia: I get a number of phone calls every year from municipalities that are interested in having Alexandria come and invest because they really would like to have these high paying jobs in their markets, but it’s more just saying, hey, here’s some land. We’d love for you to build a building.
It takes a lot of things. I takes talent, great science, access to capital, a lot of people need to be dedicated to creating a cluster. Our most recent cluster that we kind of helped create and developed has been New York City, and that’s been a labor of love, but it’s taken a decade to get where we are today. Somewhere down the road there’s going to be another municipality or 2 that will be able to showcase its wares, its great science, it is great academic institutions.
They’ll draw upon entrepreneurs to start companies and it’ll get noticed for sure and could develop into our next market. I’d rather not speculate on where that’s going to be right now because we just don’t know, but I can tell it’s on the mind of almost every major municipality in the United States to get a piece of this pie.
Melvin: Now you guys recently reported a fantastic quarter. Can you talk a little bit about recent results and occupancy levels and all that fun stuff?
Moglia: What I can say is that we’ve been highly occupied for quite a long time. I think one of the reasons that our stock is being driven to the levels it is today is that we delivered $14 million in incremental NOI in the first half of 2016.
From the second half of 2016 through 2018 we’re going to deliver another $181 to $196 million in incremental NOI to a base of about $635 million today. That’s over a 30% increase just from delivering our developments.
We’ve had very strong internal growth in the second quarter. We reported rental rate increases of 9.3% on a cash basis and 27.1% on a GAAP basis. It even caused us to increase our guidance to 8.5% on a cash basis and 20.5% on a GAAP basis at the midpoint. That’s 1% for cash and 5% for GAAP from our prior guidance.
So those reasons right there, strong external, strong internal growth, and I think 95% occupancy throughout the portfolio are a number of the reasons for our outstanding results that we’re very proud of.
Melvin: On the recent conference call there was some discussion of deleveraging the balance sheet now. A lot of the REITs I’m talking to you right now are really reaching. They’re levering up because rates are low. What’s driving your decision to control leverage a little bit?
Moglia: Well, about three, maybe four years ago, we became investment grade rated, so that has been a very important source of low cost capital, being able to go to the bond markets and raise long-term money at very attractive rates.
Currently, we are rated by Moodys at Baa2 with a stable outlook and by S&P at BBB- with a positive outlook. That’s investment grade, but we would like to do better and lower our cost of capital even more.
In order to do that, we’ve stated a goal to decrease leverage from a current 6.8 times down to below 6. Our guidance for 2016 is to get leveraged down to a midpoint of about 6.4, which actually was recently lowered. Again, it’s going to translate to a lower cost to capital and that will just mean more accretive investments in the future.
Melvin: What’s in the future for Alexandria Real Estate? You guys have a niche. It sounds to me like it’s protected from some of the market fluctuations. You’ve got your clusters. What’s going to happen for you with you guys over the next few years?
Moglia: I think that you’re going to see that the life science industry is going to continue to grow. The cost of healthcare is a big problem in the United States. The number one solution is really development of drugs that can keep people out of the hospital and out of homecare situations—which are really almost 90% of the healthcare budget. Drugs are really only 10%. It’s not really well known.
Drugs are usually the No. 1 thing that people target in the press as far as pricing, but as more drugs are available to cure or manage disease it’ll keep people out of the hospital.
So there’s going to be an enormous investment by both biotech pharmaceutical industries and the government to continue to develop drugs to help solve that problem. And as they need more R&D to develop those drugs, Alexandria will be there to supply the lab space for them to do it in.
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