Alexandria Real Estate Equities, Inc. — Q3 2018 Form 10-Q
Reporting period: Three and nine months ended September 30, 2018. Unaudited results. Alexandria is an urban office REIT focused on life science and technology properties in major innovation markets.
Financial and operating performance
- Revenue: Q3 revenue was $341.8 million, up 19.8% year over year; nine-month revenue was $987.0 million, up 19.0%. Growth primarily reflected acquisitions and development projects placed in service.
- Profit and EPS: Q3 net income was $219.4 million versus $59.5 million; diluted common-stockholder EPS was $1.99 versus $0.55. Nine-month net income was $421.4 million versus $148.6 million; diluted EPS was $3.85 versus $1.20. Comparability is materially affected by investment gains: Q3 investment income included $117.2 million of unrealized gains; nine-month investment income included $194.5 million of unrealized gains.
- REIT operating measures: Adjusted FFO per diluted share was $1.66 in Q3 versus $1.51 and $4.92 for nine months versus $4.49. Q3 net operating income (NOI) was $242.1 million, up 19.9%; same-property NOI grew 3.4% (8.9% cash basis). Nine-month same-property NOI grew 3.8% (9.9% cash basis).
- Margins and occupancy: Q3 operating margin was 71% and adjusted EBITDA margin was 69%. North American operating-property occupancy was 97.3%; 52% of annual rental revenue came from investment-grade or publicly traded large-cap tenants.
- Leasing: Q3 renewals and re-leasing produced rental-rate increases of 35.4% (16.9% cash basis); nine-month increases were 26.9% (15.0% cash basis). These figures cover renewed or re-leased space, not the entire portfolio.
- Cash flow: Nine-month operating cash flow was $414.1 million, up from $357.2 million. Investing cash use was $1.764 billion, primarily for property acquisitions, construction and investments; financing cash provided was $1.308 billion. Cash, cash equivalents and restricted cash totaled $233.9 million at quarter-end.
- Debt and liquidity: Debt carrying value was $5.684 billion. Net debt was $5.483 billion; net debt/adjusted EBITDA was 5.7x annualized for Q3 and 6.1x trailing 12 months. Fixed-charge coverage was 4.1x annualized and 4.3x trailing 12 months. Approximately 94% of debt was fixed-rate or hedged. Reported liquidity was $2.883 billion, including revolver availability, cash, publicly traded investments and anticipated proceeds under forward equity agreements.
- Dividends: Q3 common dividend declared was $0.93 per share, up 8.1% year over year; nine-month declared dividends were $2.76 per share.
Material changes and notable items
- Real estate investments increased to $11.587 billion from $10.298 billion at year-end 2017. The company acquired real estate assets for approximately $1.077 billion during the nine months and invested $663.7 million in real estate additions.
- Alexandria sold its remaining 27.5% interest in the 360 Longwood Avenue joint venture, receiving approximately $68.6 million net of closing costs and recognizing a $35.7 million gain.
- Debt increased from $4.765 billion at December 31, 2017, to $5.684 billion. The company issued $900 million of senior notes in June and amended its $2.2 billion credit line and term loan, extending maturities to January 2024 and reducing applicable margins. Moody’s upgraded its issuer rating to Baa1/Stable.
- A new accounting standard moved equity-investment fair-value changes into earnings. The company recorded $194.5 million of nine-month unrealized investment gains; this makes reported earnings more sensitive to investment valuations and less representative of property operations.
- Q3 included $1.1 million of losses on early debt extinguishment. The nine-month period also included a $6.3 million real estate impairment on a Northern Virginia land parcel, subsequently sold for $6.0 million without an additional gain or loss.
Guidance, outlook and risks
- For full-year 2018, management updated diluted EPS guidance to $4.34–$4.36 and adjusted FFO per share to $6.59–$6.61, with the adjusted FFO midpoint unchanged at $6.60. Guidance excludes future unrealized investment gains or losses.
- Management forecast 2018 year-end operating occupancy of 97.1%–97.7%, same-property NOI growth of 2.5%–4.5% (9.0%–11.0% cash basis), and rental-rate increases of 22.5%–25.5% (11.5%–14.5% cash basis). It also projected 2018 construction spending of $1.05–$1.15 billion.
- Management expected to sell a partial joint-venture interest in a Cambridge property for approximately $400 million or more over the following one to two quarters, but stated there was no assurance of completion. The 2018 capital plan also relied on property dispositions and common equity issuance.
- The development and redevelopment pipeline totaled 2.6 million RSF targeting delivery in 2018–2019 and was 86% leased. Execution, construction costs, schedules, tenant commitments and financing remain relevant risks. Remaining construction costs under contract were approximately $613.2 million.
- Risks highlighted include LIBOR’s expected phaseout by the end of 2021 and uncertainty around replacement rates; potential operating-cost increases; and adoption of new lease accounting standards in 2019. The company estimated a $200–$230 million present value for remaining ground and office lease payments, subject to final adoption assumptions.
- A San Francisco commercial rent tax was being challenged in court. If effective as scheduled, management estimated 2019 incremental rental operating expense of $3.7–$4.6 million, approximately 90% expected to be recoverable from tenants. Other disclosed risks include development delays or cost overruns, tenant and industry conditions, tax and regulatory changes, and cybersecurity threats.
Important facts for investors to verify
- How much reported earnings and EPS growth depends on unrealized investment gains, versus recurring property operations and adjusted FFO.
- Whether the proposed Cambridge joint-venture sale closes, and whether forward equity agreements are physically settled for the projected $606.3 million proceeds; cash or net-share settlement could yield no additional cash proceeds.
- Whether development projects meet delivery, leasing and cost targets, and whether the forecast $29 million of annual cash-rent growth from recently delivered projects materializes.
- How leverage and liquidity evolve as acquisitions, construction spending, dividends and planned equity or asset sales are funded.
- The outcome and tenant recoverability of the San Francisco commercial rent tax, and the effects of LIBOR transition and 2019 lease-accounting adoption.