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No. of Recommendations: 24
Preferred shares
10-year treasury 2.14%
Cap rates 5-6%
Spread 2.86-3.86%

REITs and Rates

The spread between interest rates and cap rates is narrow. Should interest rates normalize at 4.5%-5%, the spread nearly vanishes. Bonds have been in 30-year bull market and it may be time for that to end. What about long-term yields? After a three-decade long decline in interest rates of more than 1400 basis points, the U.S. is trending up from the bottom. Over the next several years, real GDP growth rate in the absence of another recession could be estimated to approach historical averages GDP of 3% plus inflation of 2%, for a total nominal GDP growth rate of close to 5%. I expect 10-years to increase to historical norms around 4.5% as the bond bull begins to fade. These moves affect REITs—growth is good and higher bond rates are a negative. Cap rates are key and as the rates rise, cap rates will increase from the multi-year lows we see today.

In order for a particular REIT to maintain its value in a rising interest rate environment, the rise in cap rates will need to be offset by a rising NOI. The value is NOI/cap rate

For example:

ARE’s NOI is $440.5, cap rate is 6% and the market value is $7,341.7 million. If the cap rate moves to 7%, the value decreases to $6,292.9 and that requires a $1,048.8 increase in NOI to offset the 1% increase in cap rate. NOI must increase to $8,390.5 or 14%. That’s either going to have to come from rent increases and new rental space. Not counting acquisitions, ARE guides to same store sales increases of 5%-7% on a cash basis. The rest will have to come from new rentals. The company has not guided an NOI for 2015 yet. The pipeline is strong in 2015 at over 630,000 SF. The pipeline to 2018 is $4 million. Assuming the 4 million SF can be rented at 97% that gives them 13% growth over the next 2.5 years added to 5%-7% NOI same store sales. In a rising rate world, they could potentially not lose ground but appreciation will be difficult. They would need to be much cheaper for an investor to count on capital appreciation.

It’s likely that the cap rates would rise as interest rates move up and REITs as an asset class will decrease in price. That would be the best time to buy. At present with narrow spreads and high prices, it’s not he ideal place to move a lot of cash to REITs.


Alexandria is the largest REIT renting collaborative Class A science campuses in urban innovation clusters. ARE has campuses and buildings in tech and biopharmaceutical hotspots—Boston and San Francisco are two of its best markets. They concentrate on AAA locations:

• Greater Boston
• San Francisco Bay Area
• New York City
• San Diego
• Seattle
• Maryland
• Research Triangle Park

The client base is 52% investment grade and reads like a who’s who of top pharmaceutical companies, universities and techs.

Tenant Remaining Lease
Novartis AG 2.70
Illumina, Inc. 15.30
New York University 15.80
Roche 5.70
United States Government 9.40
Eli Lilly and Company 8.90
Amgen Inc. 8.70
FibroGen, Inc. 8.90
Biogen Idec Inc. 13.40
Dana-Farber Cancer Institute 15.50
The Regents of the University of California 8.50
Bristol-Myers Squibb Company 4.00
Celgene Corporation 6.70
The Scripps Research Institute 3.10
GlaxoSmithKline plc 4.60
Massachusetts Institute of Technology 2.90
AstraZeneca PLC 1.70
Alnylam Pharmaceuticals, Inc. 6.80
Pfizer Inc. 4.90
Gilead Sciences, Inc. 5.50

Total/weighted average 8.30

Alexandria’s market cap is $6.75 billion with an asset base of 30.7 million square feet, including 18.5 million RSF of operating and current value-creation projects, an additional 2.2 million square feet of near-term pipeline projects and 10.0 million square feet of future ground-up development projects. The pipeline is robust and will provide the growth investors need beyond rent increases/same store sales.

ARE’s same store sales on a cash basis are reasonably good and tend to be higher than office REITS. On a cash basis same store NOI for! 2015 was 7.8%. That adds back the straight-line lease adjustment that is non-cash. Same property NOI is estimated to be between 5%-7% for 2015 and Q1 puts them at the top of the range.

The lease expirations will be offset with projected rental rate growth of 14%-17% cash basis. There are 50 leases expiring representing 616,528 rentable square footage at $28.29 per SF. This is some of their lowest rents and they have the opportunity to either renew or rent to new tenants at higher rates. Many of these seem to be leases signed during the recession when rentals were difficult and rates took a hit. It would lose them 5% of RSF if they fail to find occupants. Since some the properties are in AAA locations and the market for rental space is tight, ARE shouldn’t need to keep these empty on the books for long.


As of December 2014 ARE had two single tenant properties with expirations in the second quarter of '15, one lease for about a 128,000 rentable square feet in Woburn, Massachusetts expiring on May 31st of 2015 at a rental rate of $25 per square foot triple net. Another lease for about 82,000 square feet in Durham, North Carolina expired on April 24th at a rate of $13 per square foot triple net and they are marketing both spaces for lease. This will result in a temporary decline in occupancy by about one half of 1% in the second quarter as these expirations are offset by lease up of some vacancy in the asset base. ARE remains on track to hit the target range of occupancy from 96.9% to 97.4% by year’s end. At the end of 2014, ARE was at 97% occupied.

The following is from the conference call. The English is twisted and gibberish. The gist of the question is how much of an opportunity the loss of lower rent tenants is and whether ABR might improve if these space can be rented at higher rates.

Jim Sullivan - Cowen Group

Is it kind of fair to conclude Dean and Steve based on all of those comments that as we look over the expiration schedule looking out not just for '15 but for '16 and '17 given that the average base rent on expiring and I’m talking in total here is fairly low either in the high $20s or low $30s, that very strong spread to your --not just to 2015 event or likelihood, but I'm sure you would have a good deal of confidence in succeed in '17 as well at this point, admitting that this is very dynamic market.

Dean Shigenaga – CFO

Yeah I would say first of Jim, it is very dynamic market. I'd say it's hard to incorporate the speed of change in rental rates in a summary that we just -- Steve just rattles out. But if you look out this type of environment, very strong market should provide ongoing very solid leasing statistics going into '16 and '17.

Sales to outpace acquisitions

The top tier, med/tech space market in the best campus areas that are conveniently clustered is a tight market and favors landlords at present. Some of the properties that will be vacant are not in the most desirable areas and may not find tenants. In the event these can’t be rented, sale is at present an attractive option. Cap rates are heading to lows not seen in years. Cap rates are hovering between 5%-6% depending on locations of properties and quality of tenants among other things. The average rate is 6.11%. It’s a good time to be a seller and a less opportune time to be buying properties.

ARE is taking advantage of the low cap rates to increase it sales portfolio.

Jamie Feldman - Bank of America Merrill Lynch

And then my final question is more strategic, so it sounds like you pulled back on your disposition guidance. You increased your acquisition, but you spent a lot of time talking about how great the pricing is for sales. How do we think about that? How did you think about that rather than maybe you think you'd want to do the opposite, which is sell more and buy less, given where we're at cycle.

Joel Marcus – CEO

Actually Jamie -- sorry to point that out, but that’s actually what we are doing. We're selling, we increased our disposition program this quarter, so we have 200 million of incremental dispositions on a cash basis.

Jamie Feldman - Bank of America Merrill Lynch

I thought you took down your sale guidance. No?

Joel Marcus – CEO

No, dispositions increased. Net 200 on a cash basis over just the acquisitions. So we have about a net $65 million of cash increase on an outlay for acquisitions and about $265 million at the mid-point increase in dispositions, which nets about it.

Property characteristics

The near term development opportunities are approximately 3.2 million square feet: Seattle with about 452,000 square feet, San Francisco 1.1 million square feet, San Diego about 1 million square feet, Greater Boston about 150,000 square feet and New York City about 420,000 square feet. These are their best and highest value campus locations. They are projecting 1 million square feet demand from five big users and the rents are estimated to be in the $50-$60 per SF range for a triple net lease. Boston is also seeing tight markets and rents are going to be in the same range.

The exteriors of these properties look like traditional office properties, but the interior infrastructures are designed to accommodate the needs of science and technology client tenants. These improvements typically are generic rather than being specific to a particular client tenant and have long-term value and utility usable by a wide range of client tenants.

Improvements include:

• Reinforced concrete floors
• Upgraded roof loading capacity
• Increased floor-to-ceiling heights
• Heavy-duty HVAC systems
• Enhanced environmental control technology
• Significantly upgraded electrical, gas, and plumbing infrastructure
• Laboratory benches

At the end of 2014 ARE had 562 leases and 441 client tenants, and 87, or 45%, of the 193 properties were single-tenant properties. Leases in multi-tenant buildings have initial terms of five to 10 years, while the single-tenant building leases typically have initial terms of 10 to 20 years. Approximately 95% of ARE leases (on an RSF basis) are triple net, requiring tenants to pay real estate taxes, insurance, utilities, and common area expense. In a rising rate environment, long-term leases can be detrimental as they are locked into leases that have minimal raises.
Re-leasing can be more profitable.

Around 94% of the leases allow annual rent escalations fixed at 3% to 3.5% or indexed to the CPI.

Approximately 93% of the leases allow recapture of some capital expenditures including HVAC systems maintenance and/or replacement, roof replacement, and parking lot resurfacing typically paid by the landlord in traditional office leases. This is important because it will reduce some of the maintenance capex that decrease NAV.

Capital spending, balance sheet cash flow

As with most REITs cash flow from operations rarely covers capital spending and debt and equity play a big part in acquisitions/construction for growth. ARE has same store NOI increases in the mid-single digits making growth through capital spending a necessity. The past three years show CFFO is far short of covering capex needs. In 2013, the deficit was made up largely through share offerings that diluted shareholder around 5%. In 2012 and 2014, ARE assumed increases in net debt.

2014 2013 2012
CFFO 334,325 312,727 305,533
Real estate increases (497,773) (593,389) (549,030)
Purchase of real estate (127,887) (122,069) (42,171)
Total capex (625,660) (715,458) (591,201)
Shortfall (291,335) (402,731) (285,668)

When there aren’t sufficient funds from cash flow to cover capex, other financing is key. Debt and equity are the usual suspects for raising the required capital.

2014 2013 2012
Net debt $569,072 ($121,169) $482,093
CFFO 334,325 312,727 305,533
Total $903,397 $191,558 $787,626
Stock sales 0 534,469 97,890

Distributions are important in the world of REITs and at the end of the quarter/year it’s a good idea for the company to have enough cash to either meet or raise the previous quarter’s/year’s distribution. Since we see that there is no free cash flow, distributions rely on debt and equity to sustain them. This is a constant tug of war in the world of REITs MPLPs and LLCs. Distributions for all of these are not calculated from free cash flow – REITs use funds from operations. In addition to the standard payout ratio using distribution/FFO, it’s never a bad idea to see just how those get paid from cash.

The other important source of cash in 2014-2015 for ARE will be selling properties. With cap rates at multi-year lows, they anticipate selling will outpace acquisitions.

2014 2013 2012
Cash available from CFFO, debt equity $903,397 $726,027 $885,516
Additions to real estate (497,773) (593,389) (549,030)
Purchase of real estate (127,887) (122,069) (42,171)
Free cash flow $277,737 $10,569 $294,315
Dividends paid on common stock (202,386) (169,076) (126,498)
Dividends paid on preferred stock (25,885) (25,885) (27,819)
FCF-dividends $49,466 ($184,392) $139,998
Cash burn $28,315 ($83,275) $62,432

It was necessary for ARE to use debt, equity and real estate sales in 2013 and 2012 to pay the distributions. In 2013 they also burned through a fair amount of cash. During that time the payout ratio was relatively low compared to other REITs I have looked at. It shows that even a low payout ration can necessitate raising capital from diverse sources.

2014 2013 2012
Payout FFO 65.16% 60.28% 48.49%
Payout AFFO 68.57% 64.13% 50.36%

The ratio has been increasing over the past three years but the trend reversed over the past 5 quarters. Ratios below 70% are relatively low. Ins spite of that, ARE had to use CFFO, debt, equity and real estate sales to cover the distributions.


Debt to capital is moderate. The company is looking to improve it.

2014 2013 2012 2011
Total debt $3,678,579 $3,061,061 $2,466,521 $2,779,264
Debt/capital 48.6% 43.6% 41.4% 44.9%

Half of the debt principle is due over the next 5 years. The biggest year is 2019 with $908 million maturing. In 2016, ARE will be looking to either repay of roll $636 million –the second biggest year for maturities. In recent years, they have rolled forward for net positive increase in debt. As we saw in the cash flow and distribution discussion, this will be necessary to sustain payouts. If they fail to roll, equity will be used. Since they have some headroom before hitting overleveraged territory, rolling forward isn’t a terrible idea. Term loans will be downsized—now around $1 billion. It appears they will be moving the debt to bonds. The ARE term loans are variable rate with a specific repayment schedule. Bonds could offer lower rates and there would be no quarterly/yearly repayment schedule consuming cash

From the CC:

Briefly on debt transactions for the rest of the year really consist of the following partial repayment and extension of the maturity of our 375 million 2016 unsecured term loan.

We expect to expand the maturity date to 2021. Our goal remains the same we will continue to reduce our outstanding term loan balances over the next few years. This partial repayment and extension of the maturity date provides flexibility for our capital structure while extending our weighted average maturity.

After extending the 2016 maturity date we will focus on reducing the outstanding balance under our 2019 unsecured term loan. As noted in prior calls we do expect to issue unsecured bonds this year before any meaningful increases in all in pricing settles in. We believe all in pricing today for 10-year bond to be in the range of 3.5% to 3.7%.

Q1 2015 highlights

• FFO was $1.28 per share for 1Q15, up 9.4%, compared to
$1.17 per share for 1Q14. The dividend was $0.74 and the payout ratio was 58%.

• Net operating income was $136.4 million for 1Q15, up $12.7 million, or 10.3%, compared to $123.7 million for 1Q14

• Same property NOI increase of 2.3% and 7.8% (cash basis) for 1Q15, compared to 1Q14

• 30.8% and 18.5% (cash basis) rental rate increase on lease renewals and re-leasing of space aggregating 489,286 RSF (2% of total SF). Even with substantial increases since it’s 2% of total SF, it doesn’t move the overall growth by rate increase.
• 96.8% occupancy for operating properties, up 20 basis points (“bps”) from 1Q14

• 95.9% occupancy for operating and redevelopment properties, up 80 bps from 1Q14

• Operating margins steady at 69% for 1Q15

A few numbers per share to look at

Payout ratio is dividend/FFO

1Q15 4Q14 3Q14 2Q14 1Q14
Stock price $98.04 $88.74 $73.75 $77.64 $72.56
Dividend $0.74/2.96 $0.74/2.96 $0.72/2.88 $0.72/2.88 $0.70/2.80
Payout ratio 58% 60% 60% 61% 60%
Yield 3.0% 3.3% 3.9% 3.7% 3.9%
Shares 71,545 71,464 71,372 71,318 71,246
Op. margins 69% 70% 69% 70% 70%
SG&A percentage
of assets 0.7% 0.7% 0.7% 0.7% 0.6%
SG&A percentage of
Revenues 7.3% 7.4% 7.4% 7.6% 7.6%
EPS $0.25 $(0.23) $0.39 $0.39 $0.46
FFO/share $1.28 $0.86 $1.20 $1.19 $1.17
AFFO/share $1.10 $1.09 $1.08 $1.02 $1.00
Rental rate
Increases 30.8% 10.1% 18.6% 9.9% 18.2%
Rental rate
(cash basis) 18.5% 2.4% 5.6% 3.0% 10.4%

NOI increase 2.3% 3.6% 5.0% 5.3% 3.8%
NOI increase
(cash basis) 7.8% 6.7% 5.9% 5.7% 4.3%

Some trends to note:

There is a pattern of increasing FFO and AFFO that supports a rising dividend without increasing the payout ratio over the last 5 quarters.

Speaking of payout ratios, Alexandria’s is below average and gives them room to increase the dividend to a bigger percentage of FFO should they choose. I doubt they will want to increase the ratio significantly and will choose to retain cash for investments. The capital spending budget for 2015 is intense at $1.2 billion.


ARE narrowed the range for FFO per share in 2015 from $0.20 to $0.10 and increased the midpoint by $0.02 to $5.22, due to strong rental rate increases on lease renewals and re-leasing of space.

Capital raises will continue to be a priority and ARE will use diverse sources

86% of capital in 2015 will be focused on their best and highest yielding campuses including Cambridge, Mission Bay, Manhattan and Torrey Pines.

They will need $1.15 billion

$490 million or 43% will come from net cash provided by operating activities after dividends, incremental debt and a non-cash acquisition in the form of a tax deferred structure.

The remaining $655 million or 57% will come from $475 million in property sales. The final $180 million may need debt or equity financing.

Alexandria is a good investment at the right price. They have a nice niche in specialized high priced technical/medical/pharmaceutical businesses. Their biggest competitor for clients is Biomed realty. Biomed has more lease terminations recently and a less robust pipeline. ARE is a better company but priced accordingly. The NAV/share was ridiculous at $151/share without convertibles and $125/share with convertibles. This would seem to indicate they are undervalued but looking through all the numbers, I would prefer to pay quite a bit less based on the research, ignoring the NAV/share.
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No. of Recommendations: 7
It's not necessarily true that cap rates rise when market interest rates rise. Remember, cap rates depend on both (a) investors' requirement for prospective IRR, which generally does increase with market interest rates, AND (b) investors' expectation for the growth rate of NOI. If the hypothetical rise in market interest rates is due to an improved GDP growth rate and increased inflation, then it is likely the expected growth rate of NOI is increased as well. The effect on cap rates of increased required IRR and increased expected NOI growth is ambiguous -- could be up, down or flat, depending on the magnitudes.

Same point said a little differently: Cap rates are just the ratio of noi to asset price. To predict their movement you have to break them down into their component parts. If I'm a rational buyer of income property, I want to pay no more than the present discounted value of future NOI (adjusted for CAPEX). So the ingredients of my valuation of the asset are my discount rate and my notion of future adjusted NOI. Cap rate does not enter in. The cap rate RESULTS from the price I pay. It does not determine the price I pay.

It's also not necessarily true that the next move for medium and long-term interest rates is up. Approximately flat for a long time, or down, are also possibilities.
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No. of Recommendations: 9
maybe not the price you pay, but it has a significant effect on the price paid for assets and indirectly will effect the value of the stock/REIT

With cap rates at almost historic lows, I don't see any direction but up when the interest rates rise. Flat might be the best we can expect, but it seems likely as interest rates rise, property values may decline.

The following is a discussion of record low cap rates and record high prices per SF that Alexandria uses as comps to value their own properties. It's of course more than cap rates. Location is a key component as are quality of tenants and terms of the lease

Peter Moglia - CIO

Okay, good afternoon. I think I will make some comments on the investment market and cap rates. The national investment market has continued to be health through the first quarter of 2015 illustrated by a further compression in cap rate of 5 basis points in the fourth quarter of 2014 for a national average of 6.11% according to the PWC Korpacz Investor Survey.

Alexandria's strategy to focus our allocation of capital into the innovation gateway coastal cities of Boston, Cambridge, New York City, San Diego, San Francisco and Seattle continues to drive our NAV higher as the year-over-year cap rate compression in those markets was two times that the year-over-year national average at 34 basis points. According to the PWC survey the office sector in particular is expected to lead the industry in terms of value growth followed by warehouse, lodging, apartments and retail which is mostly attributed to a continuation of improving fundamentals and the focus on office investment from foreign capital and pension funds.

There was one notable lifetime stay to report in the first quarter which occurred in the Seattle region where 307 Westlake and South Lake Union traded for a 5.6% cap rate and a record price per square foot of $859. This acted very similar to another lab office asset at South Lake Union 401 Terry which traded in the first quarter of 2014 at a 6% cap rate and $755 per square foot. Given that the assets are within a couple of blocks from each other and occupied by similar non-credit tenant research institutions on long-term leases these trades are a good barometer for the cap rate compression that lab office assets have experienced over the past year.

Because the real estate market is almost bubbly, ARE is looking to be a net seller of properties

I'm not front running the Fed but I think we can agree that the entire tenor of this board and REITs in general is it's a bad time to buy. Interest rates are going to go up, properties are expensive and so are REITs. I'm searching for good companies I want to own doing the work now, and anticipating I may have to wait on a buy.
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No. of Recommendations: 30
I'm not front running the Fed but I think we can agree that the entire tenor of this board and REITs in general is it's a bad time to buy. Interest rates are going to go up, properties are expensive and so are REITs. I'm searching for good companies I want to own doing the work now, and anticipating I may have to wait on a buy.

MonsterFluff, with all due respect, I don't think I can agree (I don't know what others may think). I don't think it's a bad time at all to buy comm'l real estate or REIT stocks, and I don't think either asset class is bubbly or even overvalued. CRE is being priced today for unlevered IRRS of about 6%. Yes, that's a lower IRR than has been the case historically. However, bond yields are very low today and, compared with such bond yields, neither CRE nor REITs are expensive (especially as REIT stocks are trading at NAV discounts now). Spreads are within the historically "normal" range.

Now, we can argue forever about when and by how much bond yields will rise, which could put pressure on CRE prices especially if they rise a lot and NOI prospects don't rise enough to offset. However, I very much agree with Jim Luckett in his belief that yields might or might not rise. We just don't know. Pundits have been claiming for quite some time that yields "must" go up - but, so far, they have not. How long will inflation remain muted? How long will we remain mired in a 2% GDP growth economy? I don't know, and I'm not sure it's worth spending a lot of time trying to answer these questions.

I think the best approach to this conundrum is to assess one's risk tolerance. Personally, I am willing to accept capital losses on stocks I buy today, as long as the companies (including REITs) I invest in are doing fine and increasing their dividends and cash flows over time. But others, who cannot accept capital depreciation risk, might want to wait for some kind of major market decline - whether caused by a spike in interest rates, bond yields, recession, or major global hostilities.

We know that we cannot predict the future, and that almost anything can happen. Investing is a dangerous game, and it's always been so. Those who invest only because they are earning nothing on cash are not thinking clearly.

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No. of Recommendations: 0
The next major market decline might be from today's levels, or it might be to today's levels (or higher). We don't know.
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