Betting on alternative real estate assets
Value seen in research laboratories, cell towers
A decade ago, real estate financing companies had no interest in data centers.
Then along came Digital Realty Trust Inc. (DLR). The real estate investment trust, which owns, develops and manages data centers, was a pioneer in what is now a large asset class in the REIT landscape, said Richard P. Imperiale, president of Uniplan Advisors Inc., Union Grove.
Alternative REITs like Digital Realty that invest in nontraditional assets such as data centers, cellphone towers, and research and development laboratories have created a lot of value for investors over the last decade, Imperiale said.
“Often the best ways to make money in those asset categories is by being involved early relative to other, more mature real estate classes like office and industrial, and figuring out how the big trends impact demand,” he said.
Imperiale said he calls it a “second differential strategy,” where, for example, you’re not investing in the Cisco Systems switches and hardware, you’re investing in the company building out the data centers that use them.
One promising trend he and his team have been evaluating is research and development labs.
“In that world there’s a nexus between academics, large and small companies and facilitators like venture capital, private equity, business accelerators and state and local agencies that want to promote life sciences businesses,” Imperiale said.
There are a few areas around the country — Cambridge, Mass.; San Diego; San Francisco; and North Carolina’s Research Triangle, for example — where these forces have created a powerful commercialization effort that spawns droves of companies, all of which need lab space, he said. And there are a small number of REITs that help them build them.
Alexandria Real Estate Equities Inc. (ARE), Pasadena, Calif., is a REIT that owns, operates, manages, develops and acquires properties for the life sciences industry.
Alexandria is the leading owner of R&D lab space in areas of the country that are near medical centers, business accelerators and venture capitalists, Imperiale said.
The REIT has an interesting business model where it acquires land or underused buildings, then partners with a life sciences company and implements a long-term sale leaseback strategy to build what that user needs. Alexandria announced in late November, for example, a build-to-suit development lease on a nearly 300,000-squarefoot facility for pharmaceutical giant Merck in San Francisco.
“This is the kind of property that if you can develop it for them and lease it for 15 years with three more five-year extensions, it creates tremendous value for shareholders,” Imperiale said.
Alexandria has about 900,000 square feet of new developments in its pipeline, which Imperiale says he views as builtin growth in an environment where growth overall is uncertain.
While it might seem risky that some of Alexandria’s developments are for smaller life sciences companies, those companies are typically backed by big money from private equity and venture capital firms or big pharmaceutical companies, Imperiale said.
“And the truth is there’s far more demand for this type of space than supply, and there’s high demand in those life sciences hubs,” he said.
The biggest risk here is that Alexandria could suffer if an executive from its very skilled and integrated management team were lured away, Imperiale said. It is also becoming more difficult to build new projects in high-demand cities like Cambridge and the others, and the company would be hurt if an economic or political event disrupted capital markets, which it needs for financing its projects, he added.
Investors have been concerned that REITs, like other high-dividend stocks, might tumble as interest rates rise. Historically in the face of rising rates REIT prices have declined, Imperiale said. But they tend to stabilize within the next three months, and some of them can go on to perform very well, he said.
“Operations growth has been very strong over the last few years and there’s nothing that suggests REITs will slow down over the next few years,” Imperiale said.
These shares have a 52-week trading range of $70.69 to $114.67. They could reach as high as $122 in the next 12 months, he said. With a dividend yield of about 4%, that would give investors a nearly 15% return during that period, he added.