ALEXANDRIA REAL ESTATE EQUITIES, INC. quarterly report, Q3 FY2015

Business context and reporting period

Alexandria Real Estate Equities, Inc. (NYSE: ARE) is a REIT focused on science and technology properties in major U.S. innovation markets. This unaudited Form 10-Q covers the quarter and nine months ended September 30, 2015; comparisons are with the corresponding 2014 periods unless noted.

At quarter-end, the portfolio included 19.9 million rentable square feet of operating properties and development or redevelopment projects under construction, plus 11.5 million square feet in near-term and future development projects. North American operating-property occupancy was 96.2%. Investment-grade tenants accounted for approximately 53% of annualized base rent (ABR).

Financial and operating performance

Metric	Q3 2015	Q3 2014	Nine months 2015	Nine months 2014
Total revenue	$218.6 million	$185.6 million	$619.5 million	$538.2 million
Income from continuing operations	$39.7 million	$36.1 million	$103.2 million	$112.5 million
Net income attributable to common stockholders	$32.7 million	$27.6 million	$81.7 million	$88.3 million
Diluted EPS	$0.46	$0.39	$1.14	$1.24
Operating cash flow	Not separately reported for quarter	Not separately reported for quarter	$246.4 million	$255.1 million

Q3 revenue increased 17.8%; common-stockholder net income rose 18.2%. Nine-month revenue rose 15.1%, while common-stockholder net income fell 7.4% and diluted EPS declined from $1.24 to $1.14.
Q3 NOI, including the company’s share of unconsolidated joint ventures, was $151.2 million, up 17.9%. Nine-month NOI was $430.4 million, up 14.5%. Same-property NOI grew 1.1% in Q3 and 1.2% for nine months; cash-basis growth was 4.8% and 5.6%, respectively.
Management reported a 69% Q3 operating margin and a 65% adjusted EBITDA margin. Adjusted FFO per diluted share was $1.33 in Q3, up 9.9%, and $3.92 for nine months, up 9.8%. AFFO per diluted share was $1.10 and $3.28, respectively. These are non-GAAP measures and may not be comparable across REITs.
Q3 common dividend declared was $0.77 per share, versus $0.72 a year earlier. Nine-month common dividends declared were $2.28 per share, versus $2.14.
Nine-month operating cash flow was down $8.7 million year over year, but operating cash flow before changes in operating assets and liabilities increased 7.1% to $276.0 million. Investing cash use was $557.5 million, primarily reflecting property purchases and construction; financing cash provided was $301.6 million.

Balance sheet, debt and liquidity

Total assets were $8.74 billion at September 30, 2015, up from $8.14 billion at December 31, 2014. Cash and cash equivalents were $76.4 million; restricted cash was $37.0 million.
Consolidated debt was $4.31 billion, up from $3.68 billion at year-end. Weighted-average debt interest rate was 2.97%, and weighted-average remaining term was 5.1 years. About 76% of debt was fixed-rate or hedged; 24% was unhedged variable-rate debt.
Net debt to adjusted EBITDA was 7.4x on a quarter-annualized basis and 8.1x on a trailing-12-month basis. Fixed-charge coverage was 3.5x annualized for Q3. Management targeted net debt to adjusted EBITDA below 7.0x by Q4 2015 and unhedged variable-rate debt below 15% by year-end.
Reported liquidity at quarter-end was approximately $855 million, comprising cash and available borrowing capacity. Pro forma liquidity including a $350 million construction loan closed in October was approximately $1.2 billion.
Approximately $1.44 billion of principal maturities fall in 2019, largely reflecting the credit line and term loan; the filing describes maturities as limited through 2018 and well laddered overall. The company reported compliance with debt covenants.

Material changes and management outlook

Growth in revenue and NOI was driven principally by development and redevelopment projects placed into service after the comparable periods and by acquisitions. Q3 same-property rental revenue declined 0.7%, with management attributing the decrease mainly to lower average occupancy; same-property average occupancy was 93.3% versus 94.4% a year earlier.
Interest expense increased 34.7% in Q3 and 35.8% for nine months, reflecting higher debt and less interest capitalized as projects entered service. Nine-month depreciation and amortization increased 13.8%.
Nine-month GAAP income from continuing operations included a $14.5 million impairment charge on a Hyderabad, India property classified as held for sale and sold in March. The sale also involved foreign-currency translation losses. Q3 comprehensive income attributable to common stockholders was a loss of $9.2 million, mainly reflecting unrealized losses on marketable securities, swaps and currency translation; these effects did not represent the quarter’s GAAP net income.
Management updated 2015 guidance to diluted EPS of $1.46–$1.48 and adjusted diluted FFO per share of $5.24–$5.26. The adjusted FFO range excludes $0.08 per share of Q3 investment income; reported FFO guidance before that adjustment was $5.32–$5.34. Assumptions include year-end North American operating occupancy of 96.9%–97.4%, same-property NOI growth of 0.5%–2.5% (cash basis 5%–7%), and 2015 construction spending of $535–$585 million.
Management cited 1.5 million square feet of projects targeted for completion by Q4 2016, 89% leased, expected to add $75–$80 million in annual NOI upon stabilization; another 1.8 million square feet targeted for 2017–2018 was 71% leased and expected to add $105–$110 million in annual NOI upon stabilization. These are forecasts, not guaranteed outcomes.
Nine-month leasing volume reached 3.96 million square feet, the company’s highest nine-month total to date. Rent increases on renewed or re-leased space were 19.6% including straight-line rent and 10.6% cash basis for nine months.
Subsequent to quarter-end, ARE repaid a $76 million secured note, closed the $350 million construction loan for 50/60 Binney Street, and entered agreements to sell interests in 1500 Owens Street and 75/125 Shoreway Road. Agreements for partial interests in 225 Binney Street were also outstanding; expected sales proceeds form part of the capital plan.

Risks, contingencies and unusual items

Key risks include tenant and science-sector credit conditions, leasing and occupancy, development costs and timing, access to capital and refinancing, interest-rate movements, REIT qualification, foreign currency exposure, and economic or regulatory changes. A 1% increase in rates was estimated to reduce annualized future earnings by $7.9 million after swaps.
Commitments included approximately $656.8 million of remaining contracted development, redevelopment and improvement costs, about $84.9 million of investment funding commitments, and $28.4 million of letters of credit and performance obligations. The company also disclosed minimum development obligations in India; failure to meet, extend or eliminate them could result in default under agreements.
Unconsolidated joint ventures carry project-level risk. The 360 Longwood Avenue venture had $175.3 million of secured construction debt outstanding; the Uber joint venture project remained in design and budget development, with total completion cost and yields not yet clear.
Management stated that disclosure controls were effective as of September 30, 2015 and that no material change in internal control over financial reporting occurred during the quarter. The filing reports no new material risk-factor changes, but refers investors to the 2014 Form 10-K for the full risk discussion.

Important facts for investors to verify

Whether the updated 2015 EPS and adjusted FFO guidance, occupancy assumptions, and leverage targets were achieved, and how the company defines its non-GAAP adjustments.
Actual completion, leasing, costs and stabilization of the development pipeline, including whether projected incremental NOI is realized.
Closing and proceeds from the announced property and partial-interest sales, and the resulting impact on liquidity, debt and future NOI.
Debt refinancing and interest-rate exposure, especially unhedged variable-rate borrowings, maturities and covenant headroom.
Tenant retention, leasing spreads, same-property occupancy and operating costs, including whether recent utility, tax and snow-removal expense increases persist.
Potential further impairment, foreign-exchange effects and investment-value volatility; Q3 marketable-security losses were largely reflected in comprehensive income rather than net income.