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ARE > SEC Filings for ARE > Form 10-K on 3-Mar-2014All Recent SEC Filings

Show all filings for ALEXANDRIA REAL ESTATE EQUITIES INC

Form 10-K for ALEXANDRIA REAL ESTATE EQUITIES INC


3-Mar-2014

Annual Report


ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion should be read in conjunction with our consolidated financial statements and notes thereto appearing elsewhere in this annual report on Form 10-K. Forward-looking statements involve inherent risks and uncertainties regarding events, conditions, and financial trends that may affect our future plans of operation, business strategy, results of operations, and financial position. A number of important factors could cause actual results to differ materially from those included within or contemplated by such forward-looking statements, including, but not limited to, those described under "Item 1A. Risk Factors" in this annual report on Form 10-K. We do not undertake any responsibility to update any of these factors or to announce publicly any revisions to any of the forward-looking statements contained in this or any other document, whether as a result of new information, future events, or otherwise.

As used in this report, references to the "Company," "we," "our," and "us" refer to Alexandria Real Estate Equities, Inc. and its subsidiaries.

Overview

We are a Maryland corporation formed in October 1994 that has elected to be taxed as a REIT for federal income tax purposes. We are a self-administered and self-managed REIT, and the largest and leading REIT focused principally on owning, operating, developing, redeveloping, and acquiring high-quality, sustainable real estate for the broad and diverse life science industry. As of December 31, 2013, our asset base consisted of 30.9 million square feet, including 17.5 million RSF of operating and current value-creation development/redevelopment assets, as well as land supporting an additional 13.4 million square feet of ground-up development projects. We were founded by Jerry M. Sudarsky and Joel S. Marcus in 1994. We pioneered the laboratory/office niche and have become the leading life science real estate brand and dominant market presence in the top life science clusters, including Greater Boston, the San Francisco Bay Area, San Diego, Greater New York City, Maryland, Seattle, and Research Triangle Park. We manage our properties through fully integrated regional and life science teams with unparalleled real estate and life science expertise. As the Landlord of Choice to the Life Science Industry®, we are known for our high-quality and diverse client tenant base, which includes renowned academic and medical institutions, multinational pharmaceutical companies, public and private biotechnology entities, United States government research agencies, medical device companies, industrial biotech companies, venture capital firms, and life science product and service companies. We have a proven and superior track record developing Class A laboratory/office assets focused primarily in key urban science center campus locations in AAA cluster locations adjacent to leading academic medical research centers, offering highly creative amenities that drive client tenant productivity and foster innovation, and cultivating our longstanding and expansive network in the life science community. We believe these advantages result in higher occupancy levels, longer lease terms, higher rental income, higher returns, and greater long-term asset value.

Our average occupancy rate of operating properties as of December 31 of each year from 2000 to 2013 was approximately 94.9%. Our average occupancy rate of operating and redevelopment properties as of December 31 of each year from 2000 to 2013 was approximately 89.1%. Investment-grade client tenants represented 51% of our total ABR as of December 31, 2013.

Executive Summary

Our per share results for the year ended December 31, 2013, reflected (i) the strength of our core operations, (ii) completion of significant high-value Class A development projects in AAA locations in urban science and technology cluster markets, and (iii) the completion of many significant and important improvements in our long-term capital structure. Monetization of significant non-income-producing land parcels (Alexandria Center™ for Science and Technology, located in Mission Bay, Alexandria Center™ at Kendall Square, located in Cambridge, and Alexandria Center™ for Life Science - New York City) through lease-up and development, and through selective sales, has generated significant long-term asset value. In 2012 and 2013, we sold certain non-strategic income-producing assets and land for approximately $275 million. Proceeds from these sales, including $55 million from the sale of a land parcel in late 2013, were invested into high-value Class A development projects with an estimated projected value of approximately $450 million, representing a projected increase of almost $175 million above the value of the properties sold. We are also pleased with the successful execution of our second 10-year unsecured bond offering in early 2013 at a rate of 3.90%. The capital generated from the sales of properties and issuance of long-term debt and common stock improved our long-term capital structure, and funded our Class A developments, among others, at Alexandria Center™ at Kendall Square located in Cambridge, but resulted in short-term per share dilution. We are optimistic about our ability to deliver solid and stable per share earnings growth and continue to increase long-term asset value in 2014 and beyond.


The equity capital market for the year ended December 31, 2013, was extremely strong for biotech and pharmaceutical companies, with 46 U.S. biotech companies pricing initial public offerings, the most in over 13 years. More important to us, these companies have continued the strong focus of performing mission-critical research in key intellectual centers where we own laboratory/office facilities, and we benefited greatly by that trend.

Our same property NOI growth for the year ended December 31, 2013, was solid, up $17.3 million, or 5.4%, on a cash basis, and up $6.0 million, or 1.8%, on a GAAP basis compared to the year ended December 31, 2012. Our cash basis performance for 2013 was driven primarily by our favorable lease structure. As of December 31, 2013, 95% of our existing leases contained annual contractual steps in rent, and 94% of our leases were triple net, wherein tenants reimburse us for all or a majority of the operating expenses of the property. Our same property performance also benefited from strong leasing performance in 2013, with increases on average in rental rates upon renewal or re-leasing of space and an increase in overall occupancy percentage.

Our non-same property NOI growth for the year ended December 31, 2013, was also very strong, up $34.4 million, or 55.8%, compared to the year ended December 31, 2012. Our non-same property performance for 2013 was driven primarily by our key value-creation project deliveries and lease-up of temporary vacant space. We delivered a significant portion of our value-creation pipeline during the year with a major milestone in December, including, among others, the initial delivery of 45% of our second Class A laboratory/office building in New York City to Roche and New York University, among others, and the delivery in September 2013 of our 305,212 RSF development project at 225 Binney Street in the Cambridge submarket of Greater Boston that was 100% leased to Biogen Idec.

Our leasing activity reached a new record level with a total of 212 leases aggregating 3.6 million RSF executed in 2013. Our rental rates increased 4.0% and 16.2% on a cash and GAAP basis, respectively, on renewed/re-leased space during 2013. The occupancy percentage for our operating and redevelopment properties in North America increased by 390 basis points to 95.5% at December 31, 2013, compared to 91.6% at December 31, 2012.

In December 2013, we completed the sale of our final land parcel in the Mission Bay submarket of the San Francisco Bay Area at 1600 Owens Street, along with certain parking spaces, for an aggregate sales price of $55.2 million. The delivery of completed development and redevelopment projects, combined with the sale of land parcels in 2013, allowed us to decrease our non-income-producing assets (CIP and land) as a percentage of gross investments in real estate by 600 basis points during the year ended December 31, 2013.

We achieved many of the long-term components of our capital strategy in 2013, including a net debt to adjusted EBITDA ratio of 6.6 times and a fixed charge coverage ratio of 3.2 times for the fourth quarter of 2013 on an annualized basis; completed the successful offering of $500 million of 10-year unsecured senior notes at 3.90% ("3.90% Unsecured Senior Notes"); reduced our non-income-producing assets as a percentage of gross investments in real estate to 17% as of December 31, 2013, compared to 23% as of December 31, 2012, due to the deliveries of value-creation development and redevelopment projects and land sales. For additional information, see "Execution of Capital Strategy in 2013" below.

Results

Core operations

•         Total revenues were $631.2 million for the year ended December 31,
          2013, up 9.9%, compared to $574.5 million for the year ended December
          31, 2012;

• 51% of total ABR from investment-grade client tenants;

•         NOI was $442.1 million for the year ended December 31, 2013, up 10.0%,
          compared to $401.7 million for the year ended December 31, 2012, driven
          by our value-creation project deliveries, same property NOI growth, and
          leasing activity described below;

• Operating margins were 70% for the year ended December 31, 2013;

•         Cash and GAAP same property NOI increased 5.4% and 1.8%, respectively,
          for the year ended December 31, 2013, compared to the year ended
          December 31, 2012; and


•         Our same property performance and operating margins remained solid,
          primarily due to the strong occupancy percentage of our asset base,
          record leasing activity, and our favorable lease structure, as detailed
          below.


The following table presents information regarding our asset base and value-creation projects as of December 31, 2013, 2012, and 2011:

                                                          December 31,
(Rentable square feet)                       2013             2012             2011
Operating properties                      15,534,238       15,435,147       14,065,172
Development properties                     1,826,919        1,566,774          818,020
Redevelopment properties                      99,873          547,092          919,857
RSF of total properties                   17,461,030       17,549,013       15,803,049

Number of properties                             180              179              174
Occupancy - operating                           94.4 %           93.4 %           94.9 %
Occupancy - operating and redevelopment         93.8 %           89.8 %           88.5 %
ABR per leased RSF                      $      35.90     $      34.59     $      34.39

Leasing activity

Leasing activity for the year ended December 31, 2013, represented the highest level in the Company's history:

•         Executed a total of 212 leases, with a weighted average lease term of
          7.6 years, for 3,645,056 RSF, including 1,174,306 RSF related to our
          development or redevelopment programs;


•         Achieved rental rate increases for renewed/re-leased space of 4.0% on a
          cash basis and 16.2% on a GAAP basis; and


•         Increased the occupancy rate for operating and redevelopment properties
          in North America by 390 basis points to 95.5% during the year ended
          December 31, 2013.

Approximately 57% of the 212 leases executed during the year ended December 31, 2013, did not include concessions for free rent; tenant concessions/free rent averaged approximately 2.5 months, with respect to the 3,645,056 RSF leased during the year ended December 31, 2013.

The following chart presents renewed/re-leased space and development/redevelopment/previously vacant space leased for the years ended December 31, 2011, 2012, and 2013:

[[Image Removed]]


Lease structure

Our cash same property NOI increase for the year ended December 31, 2013, of 5.4% and operating margin of 70% benefited significantly from our favorable lease structure. As of December 31, 2013, approximately 94% of our leases (on an RSF basis) were triple net leases, requiring client tenants to pay substantially all real estate taxes, insurance, utilities, common area expenses, and other operating expenses (including increases thereto) in addition to base rent. Additionally, approximately 95% of our leases (on an RSF basis) contained effective annual rent escalations that were either fixed or indexed based on a consumer price index or another index, and approximately 92% of our leases (on an RSF basis) provided for the recapture of certain capital expenditures.

Value-creation projects and external growth

Value-creation projects - deliveries of development and redevelopment projects in North America

The following table summarizes the deliveries of key development and redevelopment projects in North America during the year ended December 31, 2013 (dollars in thousands, except per RSF amounts):

                                                          RSF                                                                        Total Project
                                                                                            Project
                                                                                           Occupancy
                                               Delivered    CIP as of                          at                                           Initial Stabilized
Property/Market -     Date       Delivered     Prior to      December                       December     Investment at                                                 Average
Submarket           Delivered     in 2013        2013        31, 2013     Total Project     31, 2013      Completion        Per RSF     Cash Yield     GAAP Yield    Cash Yield
Development
projects in North
America
225 Binney
Street/Greater       End of
Boston -            September
Cambridge             2013        305,212             -            -           305,212        100%      $     174,160     $     571          7.7 %           8.2 %      8.2 %
430 East 29th
Street/Greater       End of
New York City -     December
Manhattan             2013        189,011             -      229,627           418,638         45             463,245         1,107          6.6 %           6.5 %      7.1 %
Development
projects in North
America                           494,223             -      229,627           723,850         68             637,405           881

Redevelopment
projects in North
America
400 Technology
Square/Greater
Boston -
Cambridge/Inner      January
Suburbs               2013         71,592       140,531            -           212,123         86             145,625           687          8.4 %           8.9 %      9.0 %
343 Oyster
Point/San
Francisco Bay
Area - South San     Various
Francisco             2013         53,980             -            -            53,980        100              16,632           308          9.9 %          10.0 %     10.4 %
1616 Eastlake
Avenue/Seattle -
Lake Union (1)      July 2013      66,776             -            -            66,776         61              37,906           568          8.4 %           8.8 %      9.4 %
9800 Medical
Center
Drive/Maryland -     Various
Rockville (1)         2013         75,056             -            -            75,056        100              79,165         1,055          5.5 %           5.5 %      5.5 %
285 Bear Hill
Road/Greater         End of
Boston - Route      September
128                   2013         26,270             -            -            26,270        100               9,267           353          8.4 %           8.8 %      9.2 %
4757 Nexus Center
Drive/San Diego -    End of
University Town      October
Center                2013         69,673             -            -            69,673         82              33,473           480          8.1 %           8.0 %      8.7 %
Redevelopment
projects in North
America                           363,347       140,531            -           503,878         86             322,068           639

Total/weighted
average                           857,570       140,531      229,627         1,227,728        76%       $     959,473     $     782

(1) Project represents a partial-building redevelopment project. The RSF, occupancy, total investment, yield, and NOI information is related to the redevelopment portion of the property and does not represent information for the entire property.


Value-creation projects - commencement of development and redevelopment projects in North America

The following table summarizes the commencement of key development and redevelopment projects in North America for the year ended December 31, 2013 (dollars in thousands):

                                                                                              Initial
                                                                                          Stabilized Yield
                                                                                            (Unlevered)
   Property/Market -                                                   Investment at                           Average Cash
       Submarket          Commencement Date      RSF      Leased %      Completion        Cash         GAAP       Yield       Key Client Tenant
Development
75/125 Binney                                                                                                                       ARIAD
Street/Greater Boston -                                                                                                        Pharmaceuticals,
Cambridge                       1Q13          388,270         99 %    $     351,439      8.0 %         8.2 %      9.1 %              Inc.
269 East Grand/San
Francisco Bay Area -
So. San Francisco               1Q13          107,250        100 %    $      51,300      8.1 %         9.3 %      9.3 %           Amgen Inc.

Redevelopment
11055, 11065, and 11075
Roselle Street/San
Diego - Sorrento                                                                                                               Tandem Diabetes
Valley (1)                      4Q13           55,213         75 %    $      18,350      7.8 %         7.9 %      8.0 %           Care, Inc.

(1) On November 12, 2013, we acquired three adjacent buildings for a total purchase price of $8.3 million. Subsequent to the purchase, we pre-leased 75% of the space to Tandem Diabetes Care, Inc.

External growth - acquisitions

The following table presents acquisitions for the year ended December 31, 2013 (dollars in thousands):

                                                                                                Initial Stabilized Yield
                                                                                                      (Unlevered)
  Property/Market -                        Number of       Purchase                                                          Average      Key Client
      Submarket          Date Acquired     Properties       Price          RSF      Leased %      Cash           GAAP       Cash Yield      Tenants
10121/10151 Barnes
Canyon Road/San Diego
- Sorrento Mesa (1)        July 2013               2     $   13,100     115,895        100 %     N/A            N/A             N/A           N/A
407 Davis Drive/
Research Triangle Park
- Research Triangle
Park                     September 2013            1         19,445      81,956        100 %     7.8 %          8.7 %           8.7 %      Bayer AG
11055, 11065, and
11075 Roselle                                                                                                                               Tandem
Street/San Diego -                                                                                                                         Diabetes
Sorrento Valley (2)      November 2013             3          8,250      55,213         75 %     7.8 %          7.9 %           8.0 %     Care, Inc.
                                                                                                                                              Two
                                                                                                                                           publicly
150 Second                                                                                                                                traded life
Street/Greater Boston                                                                                                                       science
- Cambridge              November 2013             1         94,500     123,210         85 %     7.3 %          7.5 %           8.2 %      companies
                                                   7     $  135,295     376,274

(1) The property was 100% occupied as of December 31, 2013, with leases that expire in 2014 and 2015. We intend to convert the existing space through redevelopment when the spaces become available. Initial stabilized yields and average cash yield will be provided upon commencement of the redevelopment.

(2) The buildings are currently undergoing redevelopment, see development and redevelopment table above.

On January 30, 2014, we acquired 3545 Cray Court, a 116,556 RSF laboratory/office property located in the Torrey Pines submarket of San Diego, for a total purchase price of $64.0 million. The property is currently 100% occupied by The Scripps Research Institute. The estimated initial stabilized yields for this property are 7.0% and 7.2%, on a cash and GAAP basis, respectively. In connection with the acquisition, we assumed a $40.7 million non-recourse secured note payable with a contractual interest rate of 4.66% and a maturity date of January 2023.

Dispositions

During the year ended December 31, 2013, we sold seven income-producing assets for an aggregate sales price of $128.6 million, aggregating 826,824 RSF located primarily in the suburban markets of Seattle, Maryland, Greater New York City, and Greater Boston. In addition, we completed the sale of four parcels of land for an aggregate sales price of $73.3 million, which included the sale of our final land parcel in the Mission Bay submarket of the San Francisco Bay Area, at 1600 Owens Street, for an aggregate sales price of $55.2 million.


Balance sheet

Over the past several years, we successfully completed important steps in order to improve our long-term capital structure and our credit profile. We have a solid balance sheet that will allow us to deliver stable growth in per share earnings and net asset value.

We expect to continue the transition of our balance sheet debt from short-term and medium-term bank debt to long-term unsecured fixed-rate debt over the next several years. However, some bank debt will remain a component of our long-term capital structure, primarily consisting of an unsecured senior line of credit for liquidity and flexibility, and if appropriate, unsecured senior bank term loans. The transition from unhedged variable-rate bank debt to longer-term fixed-rate debt is expected to result in an increase in our interest costs. Growth in earnings from core operations and completion of Class A development projects is expected to generate growth in per share earnings and FFO, even after consideration of projected increases in interest expense related to refinancing outstanding variable-rate bank debt. Our capital structure will also continue to benefit from longer and laddered debt maturities, less LIBOR-based variable interest rate risk, and continued access to diverse sources of capital. While this transition from unhedged variable-rate bank debt is in process, we expect to utilize interest rate swap agreements to reduce our interest rate risk. We expect to keep our unhedged variable-rate debt at approximately 30% or less of our total debt over the short to medium term. The transition of unhedged variable-rate bank debt to longer-term fixed-rate unsecured bonds is not expected to impact the "highly effective" designation of the existing interest rate swap agreements as of December 31, 2013. Our forecasts assume outstanding unhedged variable-rate debt in an amount at least equal to our effective notional amount of interest rate swap agreements in effect at any point in time.

Secured mortgage notes payable will remain a small portion of our capital structure, and we may utilize secured construction loans for our value-creation development projects from time to time. We believe perpetual preferred stock should remain as a component of our long-term capital structure.

As of December 31, 2013, we had four properties held for sale with an aggregate net book value of $7.5 million. We may identify additional properties for potential sale in 2014 and thereafter.

As of December 31, 2013, approximately 17% of our gross real estate represented non-income-producing assets (CIP and land). Our current development and redevelopment projects represented 8% of our gross investments in real estate, a significant amount of which is pre-leased and expected to be delivered over the next two to eight quarters. The completion and delivery of these projects will significantly reduce our non-income-producing assets as a percentage of gross investments in real estate. Over the next few years, we may also identify certain land parcels for potential sale. Our medium-term target is to reduce non-income-producing assets (CIP and land) as a percentage of our gross investments in real estate to 10%.

The chart below shows the historical trend of non-income-producing assets as a percentage of our gross investments in real estate:

[[Image Removed]]


Execution of capital strategy in 2013

During 2013, we achieved many of the long-term components of our capital strategy intended to provide a solid and flexible capital structure that enables stable and consistent future growth, highlighted by the following key accomplishments:

•         Improved our key credit metric ratios forecasted, including net debt to
          adjusted EBITDA ratio of 6.6 times and a fixed charge coverage ratio of
          3.2 times for the fourth quarter of 2013 on an annualized basis;


•         Reduced our non-income-producing assets (CIP and land) to 17% of our
          gross investment in real estate as of December 31, 2013, compared to
          23% as of December 31, 2012, due to the deliveries of value-creation
          development and redevelopment projects and completed land sales;

• Reduced our variable-rate bank debt by approximately $612 million;

•         Completed the successful offering of $500 million of 10-year unsecured
          senior notes at 3.90%; extended average remaining term of outstanding
          debt to 5.3 years;
. . .
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