Alexandria Real Estate Equities Inc (ARE) 2016 Q2 法說會逐字稿

Good day and welcome to the Alexandria Real Estate Equities Inc second quarter 2016 earnings conference call. My name is Lisa and I'll be your operator for today's call.

(Operator Instructions)

And please note that today's conference is being recorded. I would now like to turn the call over to Paula Schwartz. Please go ahead, ma'am.

Good morning. This conference call contains forward-looking statements within the meaning of the Federal Securities Laws. The Company's actual results might differ materially from those projected in the forward-looking statements.

Additional information concerning factors that could cause actual results to differ materially from those in the forward-looking statements, is contained in the Company's periodic reports filed with the Securities and Exchange Commission. And now I would like to turn the call over to Joel Marcus. Please go ahead.

Thank you, Paula, and welcome, everybody, to our second quarter earnings call. And with me today actually here in New York is Dean Shigenaga, Tom Andrews, Steve Richardson, Peter Moglia, Dan Ryan, and John Cunningham. And I want to extend a congratulations to the entire Alexandria family for a very strong second quarter performance really in all respects.

I think the key themes for the second quarter revolve around a strong core internal growth performance, successful early deliveries of our development pipeline with strong yields, continuing strong health of our tenant base, and really and truly superb execution of our capital plan. So let me move to a couple macro themes if I can.

It's hard to imagine, but today there are approximately 10,000 diseases that we've identified that afflict humanity and we've only addressed about 500. So we're still literately in the very early innings on our quest for prevention, treatment and cure of dreaded diseases. And this battle is mission critical for humanity.

Really in answer to that challenge, there's very significant R&D investment that continues to drive innovation and demand on a global basis, $145 billion of global Biopharma R&D, $38 billion of US Government funding, heavily at the NIH, $11 billion of US venture capital, and $30 billion philanthropic money.

So the total now exceeds $200 billion for R&D. Quite a stellar dedication of resources, which in all respects end up really helping our business in a material manner. Our high barrier to entry urban cluster markets remain rock solid. If you look at the continuing strong demand, we see that in virtually every market today, with a highly constrained supply, which is obviously a very good thing. Rents are up on average about 15% over the past year and we're continuing to see and maintain high occupancy.

If you look at the Cambridge cluster market, and Tom will be available during Q&A, current supply is about 429,000 square feet of vacancy for lab. Today's demand is something around north of 2 million square feet with about 40 tenants focused on Cambridge. And based on recent forecasts of brokers in the market for laboratory, they're forecasting rents in 2018 for lab to be $80 to $85 triple net.

Alexandria is blessed with a unique business model. Our strong internal growth and core is, I think well-known and driven heavily by 96% of our leases have annual steps and many of those are 3%. Our performance this quarter on rental rate increase is 27.1% on a GAAP and 9.3% on a cash. Certainly were, I think, very important to the Company, and key drivers included Cambridge, San Francisco and Research Triangle Park.

And as I said last quarter, and Dean may comment further, in 2016 we're continuing to see tenants aggressively seek us out to extend their lease terms which roll in future years where they have no options. And that's something that clearly is to our benefit for internal growth purposes.

We're seeing slight occupancy gains since we're at pretty high occupancy today at 97%. And we're seeing very solid same property performance, Dean will comment further, 4.9% and then 6.4% on a cash basis.

One of the most important attributes every investor should note is that areas great tenant strength, 53% of our annual base rent is from investment grade tenants. Here in 2Q of 2016, 82% of our top 20 are investment grade with lease durations of approximately 8.4 years, so we've got a great runway for solid, consistent and safe cash flows.

Turning to external growth, Alexandria's business model, unique business model has been exemplified by strong external growth. We have, as you know, a strong highly leased development pipeline driving that growth. And as set forth in the Sup and in the press release, our CIP for the second half will deliver approximately one million square feet which is today 90% leased, targeting NOI of somewhere between $51 million and $56 million. And in 2017 and the early part of 2018, two million more square feet, approximately 74% pre-leased with NOI onboarding at that point of about $130 million to $140 million. So a total of well north of three million square feet.

We had three successful deliveries in the second quarter and Dean will comment on that. New York, Illumina and Longwood with very strong yields and we've hit a 7% yield on our New York development, so great kudos to the New York team. Leasing has stayed strong and we did indicate new starts for Vertex in San Diego and a parking garage for Illumina.

With respect to our major acquisition during the quarter, and Tom will be around to answer questions here during Q&A, we did sign a purchase and sale agreement to acquire One Kendall Square. And we believe that the location of that campus and the attributes of that campus present exactly what we would want when looking for external growth through acquisitions, which we typically don't make many of. Seven buildings aggregating almost 645,000 square feet, 98.5% occupancy.

We think we can move those, the yield on this project to potentially the mid 6s over the next couple of years. We think that allocating capital to the world's leading life science cluster sub market in East Cambridge is the smart thing to do. And it gives us an excellent opportunity to expand our current campuses in close proximity at the MIT Technology Square, and the Alexandria center at Kendall Square.

We think we can significantly increase NOI and cash flows. We think in place rents are substantially below market, more than 50% of the leases expire over the next three years. And we've got a great opportunity to convert significant office space, the lab space is significantly higher rents. And we've got a great land parcel for development, about 172,000 square feet, which we will aggressively pursue and closing will be dependent upon loan assumption.

And I guess finally before I turn it over to Dean here, when we look at key future projects we're currently evaluating for future development, the two projects in Cambridge once we close on Tech Square -- I'm sorry the on One Kendall Square, the 172,000 square feet, we will aggressively move that forward. And we're looking carefully at the additional 100,000 square feet of development we have at Tech Square.

We're also looking carefully at Grand Avenue in south San Francisco and the Illumina campus. So these opportunities in each of these locations represent where we have in hand or very strong tenant demand. So without further delay, let me turn it over to Dean for more color on the quarter.

All right. Thanks, Joel. Dean Shigenaga here. Good afternoon, everybody. As Joel mentioned, we're taking this call from New York today. Just want to cover three important topics.

First, our consistent execution and delivery of very strong internal and external growth. Second, the disciplined management of our balance sheet. And then lastly, key highlights on our updated guidance for 2016, accelerated timing of improvement of leverage goals and closing remarks.

I just wanted to make a quick but very important note, we wanted to take a moment to congratulate our entire team on their consecutive Gold NAREIT CARE award. We're very pleased to be recognized as a best in class REIT that delivers transparency, quality and efficient communications and reporting to the investment community.

Moving onto our consistent execution and delivery of strong internal and external growth. Our team continued to execute on our differentiated business strategy focused on unique collaborative campuses and urban innovation cluster sub markets. Limited to no supply of Class A space continues to drive rental rate growth on re-leasing the space and lease renewals, including significant benefit from early lease of renewals.

Solid leasing activity in the second quarter of 817,000 rentable square feet, rental rates were up 27.1% and 9.3% on a cash basis. We delivered consistent and solid same property NOI growth for the second quarter, up 4.9% and 6.4% on a cash basis. One quick note on straight line rent during the second quarter, we did receive a $9 million contractual cash payment that drove a significant reduction in straight line rent for the quarter.

Looking forward into the third quarter, straight line rents are expected to be consistent with prior quarters. Occupancy was solid at 97%.

Moving onto external growth, our team continued our discipline allocation of capital. 96% of our capital for 2016 is targeted for investment into high quality facilities in urban innovation clusters including Greater Boston, San Francisco, New York City, San Diego, and Seattle.

We completed and delivered earlier than expected the third built to suit on campus in University Town Center in San Diego for Illumina, a global leader in genomics. We also completed and placed into service the remaining 63,000 rentable square feet, including about 34,000 square feet of vacancy at our second World Class Center of Innovation in New York City. The key take away from this project is that we exceeded our initial forecast cash yields by 40 basis points for a very strong final cash yield of 7%.

Moving onto the disciplined management of our balance sheet, I just think given the volume of events that we've executed on during the quarter, I want to quickly highlight the key items. We re-purchased $53 million of par value of our series D, about half of that was in the second quarter and the other half occurred in July. We issued about $348 million at $95.31 per share under our ATM program. And expect to file a new program.

We announced $256 million in proceeds to be received primarily in 2016 from two separate joint ventures at 10290 and 10300 Campus Point at a 5.7% cash cap rate. We issued $350 million, 3.95% 10-year unsecured bonds, completed $304 million in commitments under a secured construction loan for 100 Benny Street.

Raised $165 billion in commitments under our recently amended unsecured senior line of credit, aggregate commitments available for borrowings increased by $150 million, we extended the maturity date to October 2021 and reduced pricing 10 basis points to LIBOR plus 1%. We executed $200 million in interest rate swaps and interest rate cap at 2% for up to $150 million of notional.

We also executed $724 million for future proceeding from the issuance of common equity and the forward sale agreements. The goal of the forward was to lock in the cost of capital to fully fund the acquisition of One Kendall Square, while we obtain approval from the lender for the assumption of $203 million secured loan.

We expect to complete the approval for the loan assumption over the next two to three months, then complete the acquisition of One Kendall Square and settle the forward sale agreements from the common stock offering. Second quarter net debt to adjusted EBITDA was 6.8 times and I'll cover our leverage goals in a moment. Liquidity as of the quarter end was $2.4 billion.

In summary, our team completed the majority of our key items for our 2016 capital plan, accelerated the timing of improvement of our leverage goals, and extended our weighted average remaining term of outstanding debt. Lastly turning to guidance, the accelerated timing of our leverage goal and closing remarks. The detailed assumptions of underlying our guidance for 2016 are included in page 10 of our supplemental package.

We narrowed the range of our guidance for FFO per share diluted from $0.10 to $0.06 with no change to the midpoint of $5.51. Key considerations for the midpoint of our FFO per share guidance of $5.51, after execution of significant debt and equity capital market activities to date in 2016 include.

In recent years we've been able to meaningfully increase FFO per share guidance above our initial guidance at the beginning of each year. In 2016 we have held our FFO per share guidance at $5.51 since first announcing guidance at our investor day at 2015. We've had very strong internal, external growth from strong demand for our Class A facilities.

I'll touch on increases for guidance for rental rate growth and same property NOI growth in a moment. Early are lease renewals continue to drive core operating performance and mitigate leasing down time. Our value creation pipeline we're ahead of our initial projections on completion and delivery of several spaces including building six for Illumina.

The space at Longwood and the execution and lease up and delivery of space as is versus redevelopment at Barns Canyon in San Diego. We also achieved on better pricing on capital market activity in the first quarter or actually in June I should say, as we completed our unsecured bond offering at 3.95%. And this was inside of the interest rate that we had assumed in our initial guidance.

In turn, growth has been solid and continues to drive operating performance. We increased the midpoint of our guidance for rental rate growth on lease renewals and re-leasing the space by 5% and 1% on cash basis. Our ranges for guidance for rental rate growth are now up 19% to 22% and up 7% to 10% on a cash basis.

We also increased the midpoint of our guidance for same property NOI growth by half -- half of 1% on both a GAAP and cash basis. Our updated ranges for same property NOI growth is up 2.5% to 4.5%. And up 4% to 6% on a cash basis.

We accelerated the timing of our leverage goals and are now targeting fourth quarter annualized net debt to adjusted EBITDA in a range from 6.2 times to 6.6 times for a midpoint of 6.4 times. Our goal by the end of 2017 remains focused on improvement of net debt to adjusted EBITDA to less than 6 times.

We have about $162 million of par value of our series D convertible preferred stock outstanding as of today and we'll continue to look for opportunities to repurchase shares. We continue with the discipline management of our value creation pipeline and are on track to further reduce our pipeline as a percentage of gross real estate to the 10% range by year-end.

Our differentiated business strategy focuses on Class A assets and triple A locations in urban innovation clusters. And continues to attract some of the most highly innovative and successful companies.

With our best in class team, we look forward to consistently executing and delivering growth in FFO per share and net asset value quarter to quarter and year to year while we also improve our credit profile and long-term cost to capital. With that I'll turn it back over to Joel.

Operator, if we could go to Q&A?

Yes, sir, thank you.

(Operator Instructions)

And we will take our first question from Manny Korchman with Citi.

Hey, guys, thanks. Maybe if we just think about your -- the tenant environment, has there been any change in either the VC funding environment or changes in the IPO landscape and how your tenants are thinking about growth?

So, Manny, I guess two items, one would be with respect to venture capital funding in the first quarter. Venture firms raised virtually an all-time record amount of funding for investment into life science entities, which we feel will be invested over the next year, two or three depending on the length of the fund. So that's a very, very strong sign. The venture capital market remains robust.

The IPO side has been a little tougher this year than last year. There have been, I think, 12 or more IPOs on the life science industry side. They haven't perform nearly as well as last year, but the market still is open for innovative companies that have unique products, so there is funding.

And then the M&A environment continues to be fairly robust. I think we mentioned last time -- or if we didn't, just an update -- one of our tenants, Stemcentrx, that was in our south San Francisco portfolio got sold -- it's a fairly early-stage cancer stem cell company -- to AbbVie for almost $12 billion. We see that, as you look out on the landscape, things look pretty healthy.

And thanks, Joel. And a couple questions on One Kendall. The first, just what's your development timing there and what are you thinking about doing? The second, the other part of the project, the non-development piece, is pretty well leased and seemingly stabilized. Are you thinking about holding on to that in its entirety or is there a chance you'd partner that out to somebody?

Okay. So let me give you a top-side view and then I'll ask Tom to be specific. So with respect to the timing of development, I think we're going to be pretty aggressive once we close. And then Tom can give you more color, and then I think with respect to the asset itself we don't have any current intent to joint venture that asset.

Thanks, Joel. So the development side is about a 172,000-square-foot development site that is permitted with the city, has a special permit. It needs design completion, which we will begin promptly here after we select a design team and a group to go forward on the design. That will probably take about six months, which will coincide with some pre-construction activity that needs to be done on the site -- work around the parking garage and the movie theater to make, to reposition some driveways and things like that so we can do development on the site. And then, we expect the development to take about 18 months to construct.

Thanks, guys.

Thanks, Manny.

And we'll now take a question from Nick Yulico from UBS.

Oh, thanks. Hello, everyone. I was hoping you could just talk a little bit about the demand in the market for the San Francisco area for life science. And then, how you're thinking about -- what your conversations are like with tenants because you don't -- prospective tenants, because I guess your operating portfolio is full, your development portfolio is fully occupied. And you really only, I guess, have that tennis club project that still needs Prop M. So maybe if you just talk about the demand in the market and then how are you thinking about how you might be able to accommodate from that demand?

Yes, so I'll just make a comment or so, and then I'll give, let Steve give you the detailed color. Contrary to popular belief, San Francisco has not fallen into the ocean. It's actually remained extremely healthy, both on the lab and the tech side. And demand has been robust and Steve will give you details.

Nick, hello, it's Steve Richardson. Yes, as Joel just mentioned, we're tracking over 2.5 million square feet of lab demand only. And that's in addition to 5.9 million square feet of tech demand in San Francisco only. So, you're right, it has remained very healthy. We are 100% leased.

Year to date, we've actually done 158,000 square feet of early renewals, and we have another 200,000 plus square feet in negotiations. So, big companies like Celgene, who renewed earlier -- a few months ago -- are identifying Mission Bay as a long-term destination. And the discussions we're having with them are, how do they secure and lock up their space?

So we continue to see a very healthy broad market out into the future in San Francisco. And on the development side, again, we're 100% leased with three ground up projects coming out of the ground, with Pinterest, Stripe, and Uber, so, healthy on that side as well.

And on the East Grand site, getting good activity there in south San Francisco. The vacancy rate in south San Francisco has now dropped to 4.8%, so that's about 440 bps lower than just last year. So very continued strong demand with upward pressure on lease rates there, too.

And then, do you have any update on how -- on when you think you might get Prop M approval for that tennis court project in the city itself?

We're monitoring that very closely. We have what we think is a very, very robust package of community benefits, which is going to be high on the list of city requirements. So we're very bullish on that. You may have read, we came to an agreement with the tennis club members so we have an absolute clear path now for entitlements there. And everybody's moving in the same direction. So stay tuned over the next several quarters for an update on entitlements.

All right. Thanks, everyone.

Thank you.

And we'll go next to Jamie Feldman from Bank of America, Merrill Lynch.

Great. Thank you. Joel, you outlined potential projects where you're seeing good demand where you may start over the relatively near future. Can you talk to us about the cost of some of these projects and how you guys are thinking about financing, especially after a large amount of financing you did that kind of took care of your needs through 2016 and, technically, 2017 and 2018 based on you're ability to raise debt? But just maybe help us think about the capital plan going forward if you do new starts here?

Yes. I'll ask Dean to comment on that. I think when it comes to the three areas that I mentioned -- the two projects in Cambridge, one is the One Kendall Square which Tom just spoke to; potentially adding onto Tech Square where we've got 100,000 square feet of entitlements; The Grand Avenue project, which Steve talked about, which that market has really become so tight and, as you know, Verily has taken over the Amgen sub lease at the former Onyx space -- it's pretty clear that there's pretty robust demand in that market. And then Illumina, on that campus, we've literately got a built-in tenant who's clamoring for more space and, almost, we have to hold them off.

But as far as the capital side of it, I think we probably wouldn't begin any starts over the next quarter or two. I think we'll evaluate where we are, but we clearly would look at where we are on a pre-lease basis, where we are on a construction cost basis, on a yield basis. And, potentially, we start something -- again, a lot depends on the macro environment, potentially next year, but I'll leave it to Dean to comment on funding strategy.

Hey, Jamie, it's Dean here. I would say that it's good to think about what we've done over the last few years in funding our growth, primarily construction and development projects. The key difference, I think, in 2017 as an example versus 2016, Jamie, is that we've got probably, clearly, as you look at our disclosures, a larger EBITDA growth in 2017 over 2016 as compared to 2016 over 2015.

And the key behind that is that it will allow us to debt fund more of our growth in 2017 as compared to 2016 through debt. So, in aggregate, as you recall over the last number of years, we've had free cash flows of $125 million. You add on EBITDA growth and we've been funding anywhere from $400 million to $500 million of growth from these two components, meaning debt funding through EBITDA growth and then consumption of retained cash flows after dividends.

Beyond that, we'll continue to utilize recycling of capital, Jamie, through asset sales. And I think it's just important to acknowledge that we'll continue to be very disciplined in our approach in looking at capital sources to fund growth and navigate through the markets as they unfold over the next few years.

Yes. And anything we do, our focus is to maintain the lowering of leverage to 6 or less than 6, that is one of the highest priorities. So nothing we do would alter that goal.

Okay. That's helpful. And then, I guess, as we think about the TIAA-CREF JV maybe can you talk to us about that as a potential source of capital going forward and then maybe additional JVs you might be thinking about?

So we certainly have enjoyed a high-quality relationship. Peter and Dan led the joint venture on the cam -- joint ventures on the Campus Point assets. We view them as a long-term partner. And I'm not able to comment on anything in the future, but I think we both will look for opportunities to continue to work together. We think they represent a AAA partner of ours.

Would you look at additional JVs or do you have a --?

You mean other partners or additional --?

Additional partners.

I don't think we have that on our radar screen so much.

Okay. And then, finally, thinking about 2017 expiration, your expiring rents are $27.99 a foot. Can you talk to us maybe current mark to market on some of those -- on that group of leases and what we might be looking at?

Hey, Jamie, it's Peter Moglia. I could run through the North American regions for you, kind of give you a sense of where the AVR is and the market rents are to date. Keep in mind that AVR, I believe, includes straight-line rent. Market rents I'll give you will be the initial rents.

So, Greater Boston, we've got a $37.81 expiration AVR. Rental rates range there from $40 in the suburbs to $76 in Cambridge. Obviously our portfolio is heavily weighted towards Cambridge, so there should be a significant opportunity there. San Francisco, in 2017, we have a $32.78 rent expiring in 2017. Market rent there ranges from $48 in the south San Francisco area to $65 triple net in Mission Bay. So, again, a pretty big opportunity in mark to market there.

New York, we have market rents in the area of $80 to $85 per lab here. So anything that comes up, I'm sure will be a nice roll-up. San Diego we have a $30.25 expiration. Market rent there ranges from about $33 in the Sorrento Valley -- Sorrento Mesa area, up to $49 in Torrey Pines in the UTC. So another significant mark-to-market opportunity.

Seattle, we're at $45.10. That's fairly close to market today, but I'd say market is really $48 to $54, so I think there's still an incremental opportunity there. In Maryland, the expiration is $19.11, in 2017, and there's literally 2% vacancy in Maryland right now, which for a long time was a weak market and it started to push rents. And so, we're going out with proposals today in the $28 to $32 range, so possibly Maryland could contribute significant growth next year.

And then, at Research Triangle Park, at $13.61. Again, we're at about $18 for the older product, up to $30 for our newer product at Kit Creek. So that should answer your question.

That's very helpful. Thank you.

Thanks, Jamie.

And we'll go now to Kevin Tyler from Green Street Advisors.

Yes. Thanks. Dean, I might have missed it earlier but on the guidance for common equity and available for sale securities, it looks like after you backed out some of the ATM issuances and then the forward sale, I couldn't tell for sure, but did you up the guidance for either the equity sale piece or the additional equity issuances? Or how do these pieces kind of play out going forward?

Kevin, it's Dean here. You're correct, our guidance was updated to reflect the capital market activities that we've announced to date. So, on that front, everything that we've planned in our guidance has been completed on the debt and equity front. Big picture, I think, from the first quarter to the second quarter guidance, equity-related needs increased by about $950 million.

About 50% of that increase was attributed to the capital required to fund -- fully fund One Kendall Square on a leverage-neutral basis. Yet about another 20% very roughly of the capital to reduce leverage by 3/10 of a turn. You had about 10% of the capital to cover Series D re-purchases that have been completed to date. And then roughly 20% of the remainder -- or the remaining 20% was really related to timing differences on both acquisitions and disposition, and how the EBITDA interplays with your leverage metrics at the end of the day. So hopefully that color helps Kevin.

Yes. Thanks. But just the equity security sales, is that still on track for the 125?

I'd say, broadly speaking, we are monetizing a decent number of equity securities while at the same time some of the proceeds are being offset currently by other investment opportunities. So, the gross proceeds are on track. Our net reinvestment has increased a little bit, offsetting the ability to retain some of that capital for 2016.

Okay. And, Joel, when the Wexford deal came to market the first time around, I think back in 2013, you'd said that you hesitated to pursue a similar strategy. In part, I think some of the challenges that you mentioned were government budgets and university credit profiles. I just wonder, today, if we talk about a more broadly university-linked strategy outside of the key clusters, does that investment model make any more sense for you or Alexandria if you could actually go out and build it organically?

Yes. So when the Wexford opportunity came to us, I think they were represented by Goldman Sachs back in 2013, we actually knew almost every site because we had looked at it broadly, whether it be Miami, Winston-Salem, Baltimore, St. Louis, Illinois, a variety of places. And we took a very hard look at their platform and what they were doing. And it certainly impacted us in the sense that it really convinced us, once again, that the urban innovation cluster model is really the one that we think is the best to pursue for us.

I think, coupled with the fact that we're always worried, probably the biggest issue that we see in that model is the re-leasing downstream. Because if you're in a place like Winston-Salem or in Baltimore -- we were in Baltimore at one point -- the depth of the market is such that -- or the lack of the depth of the market is such that you're really reliant on the institutional tenant base. Now, it's a good tenant base for sure, high quality in general, but it isn't a deep one. So if they decide to leave, you've got a problem. And in a lot of cases they want to own. So there's sometimes a requirement that you have to either sell it back or they want to purchase.

And I guess the other thing, which has been exemplified by our struggle with Longwood, government budgets have been under pressure over the last couple of years with underfunding from the NIH. Now that will seems to be turning around a bit, which is a good news situation. But, a lot of times, institutions prefer to own rather than lease, and we've certainly seen that in the Longwood area.

So I think for anybody this go around in bidding and the ultimate buyer, I think this represents a platform that works for their business, but certainly doesn't really fit our business.

Okay. Thank you, appreciate it.

Yes.

(Operator Instructions)

And we'll go now to Richard Schiller from Baird.

Hey, good morning, guys. First question on New York City, the vacancy rate drop there, the footnote shows that 62,000 square feet came online, could you describe the activity you're seeing on the remaining 34,000 feet that's vacant?

Sure. I'm going to ask John Cunningham who runs our New York City region to do that.

Hey, Rich, how are you? The activity we have on the remaining floor in the west tower, which is the 14th floor, which represents the majority of that vacancy is actually really strong. We have a lease out for half the floor right now. We recently put out a press release, about a month and a half ago, for the Alexander Launch Labs that we will be doing on the other half of that floor. That will pretty much use up all of the vacancy. We have one small suite associated with the accelerator that still remains on the eighth floor. Aside from that, we'll be 100% full.

Awesome. Thank you. And just a high-level macro question, in some of your prepared remarks you guys were talking about how tenants are aggressively looking to renew leases. With 2 million square feet of demand and 400,000 square foot of vacancy, like in the Cambridge area, how do you balance tenant renewals versus trying to get higher rents later on in the future?

Yes, that's a good question. I'll ask Tom to reflect upon that.

Yes. It's certainly challenging, I mean, we have lots of great tenant relationships in our portfolio in Cambridge and we'd like to have a balance between really maintaining and promoting those relationships, but also knowing that there may be others who are prepared to pay higher dollar.

So we kind of walk that tight rope and it is challenging in this market right now. In the long run, we think we make good decisions on that and are able to, as you've seen, with the type of rent increases we've been able to achieve, we feel we've got a good balance on that.

Yes. And I think, in the remarks, if broker estimates are correct, if rents in 2018 are in the $80 to $85 triple net range, then that does give us pause to think about how we think about delivering space over the next year or two and how we charge for that space. So that analysis is certainly ongoing and something that is top of mind. And certainly one of the motivations that we had for moving on the One Kendall Square acquisition.

Certainly one of the things we've done -- this is Tom again -- it's certainly one of the things we've tried to do in this part of the business cycle is really extend term and gain, try to gain longer rents -- higher rents for longer durations. And also certainly reduce the TI allowances and really try to make sure we're spending as little of our own capital as possible in the spaces and get tenants to extend terms as much as possible.

Sure.

Hey, Joel, it's Dave Rodgers, just to follow up on that comment and questions as well. I guess I wanted to talk a little bit about it. The last year or so, or six months, it sounded like, on a lot of the calls, you had become a little more caution about starting development. And I don't want to call it a change in tone, so I'll let you address it how you want. But it seems like now you're talking about multiple development opportunities on multiple sites. Has there been a change in tone among your tenants? Do you feel better? Maybe reconcile those two if I'm thinking about it correctly.

Yes. That's a good question, Dave. I think that, again, we have, as you know, a very robust pipeline set of deliveries 2016, 2017, into early 2018. So there's no reason for us in the past to have double downed on that. We've got huge NOI coming on board over the coming quarters. And we wouldn't get any additional credit for adding on to that, plus it complicates the capital raise.

But because we've, I think, had great success in advancing our capital plan, our leverage goals, and we're well into the second half of deliveries in 2016, I think we can afford to take a re-look at where we are with future potential developments. So it's really a matter of not so much change in tone or demand -- because I think things haven't changed on either side, we feel positive on both sides -- but I think it's just a maturation of the plan and a look at what's going on in 2018 and 2019. So I think it's just a natural evolution.

I missed some of your earlier comments, so I can go back and read if I have to, but, with the joint venture in San Diego, was that wildly marketed or not? And I guess if it was, can you talk about maybe the contrast in interest from potential joint venture partners between what you've done in Cambridge and what you just did in San Diego

Yes. So we always talk to a number of folks when it comes to a joint venture, but I think it's fair to say that we've developed an extraordinarily good and mutually respectful relationship with TIAA. We think they're very high quality. I think they feel like we are the franchise they would like to invest with in the life science industry and the core urban cluster markets. So ultimately we would talk to them and give them the best shot at things.

But we're always looking at the market. I think, as a public company our fiduciary duty is always to test the market, but when you have a great relationship you always feel that's your first choice if at all possible. And they've been extremely diligent, flexible -- time frame-wise and so forth. So.

Yes, this is Peter, I'd say that we've actually used UBS to help us with some of these relationships and made some meetings with a couple of sovereigns and others just to talk about potential projects just to get a gauge in what their interest would be so we have an idea of the market. But, at the end of the day, the TIAA partnership was one that we felt was the right choice for these projects.

Thank you.

And we'll now take a question from Sheila McGrath from Evercore ISI.

Yes, good afternoon. Joel, you mentioned in your remarks 3% annual increases across many of the leases. This appears to have trended higher, I was just wondering if this is across all your markets and this is the norm now. And is it both for lab space and tech, if tech tenants took the space?

Yes, on the lab side it is certainly our standard that we try to achieve, given where we are in macro economics. I mean, if inflation ever came roaring back. At one point in the Company's history we went to a min 3, max 6 on annual increases. But we think that this represents a stable market and acceptable market annual rental escalation. There are sometimes some changes to that, especially on the development side where you might get a 0.25 point lower or something like that, but by in large we try to maintain that across the portfolio in each of the markets.

Okay. And then on -- just with the tightness in the markets, I was wondering if there's been improvement in trends on TI allowances that you would be giving tenants?

Hey, Sheila, this is Peter. I -- one of the things I do is I review all of the major proposals that are going out in total -- rents, free rent, TIs especially, given our sensitivity to capital. I have been counseling our regional leaders to lower TIs and I think we've done a really good job of doing that. Tom, probably, the best out of all, because of the leverage he has in the market. But, yes, at the end of the day, if we can lower TIs significantly -- even if we have to take a little bit less rent -- that's the way we prefer to do it.

Okay. And last question. Just maybe, Joel, you could give us an update on the Volpe process -- like where is that in the timeline and does that still remain of interest to Alexandria?

Yes, so I'll ask Tom to comment on that.

Yes. We have a team putting together a response to the RFP which was issued a couple months ago. And we understand -- well, we are planning to submit a response for the -- it's a deadline of September 8 that the government is requesting proposals be submitted. We believe they intend to try to get a developer selected by year end approximately. We'll update on that once we learn more, but we're planning to submit a proposal by September 8.

Okay. Great. Thank you.

Thanks, Sheila.

And we'll now take a question from Karin Ford from MUFG Securities.

Hello, good afternoon. Can you please give us your latest thoughts on the potential impact of the upcoming election on your business and the business of your tenants?

Yes. Hey, Karin. So we think that the election -- if you have read the cover story of Barron's a couple of weeks ago, that probably is the best prognostication that I've read. I'm not a political person, but I think that really is the one that I think we adopt and we believe is true, that the real race is in the House and Senate.

They predicted that the Republicans would retain the majority in the House, and that the Senate was pretty close but Republicans might retain it. But if they don't, you'd have a split House and Senate. As you know, the President doesn't have legislative authority, although I guess our current President maybe believes he does a bit. But I think it's fair to say that split government is a balanced government and I think we continue to see that moving forward.

I think where it is important to us, we think there's been very strong support -- and we've seen it, in fact -- of supporting the NIH for basic biomedical research -- really critical. And this bipartisan Congress has supported that and we've seen a over $2 billion increase over the past few months for the coming year and looks like that may go higher.

We'd like to see more funding for the Food and Drug Administration -- because they're clearly underfunded and have hundreds and hundreds of slots unavailable to fill without further funding -- because that tends to be an important area, although they've approved a large number of drugs in the past couple of years and they're on a pretty strong pace this year.

And then a good business, pro-business, or good-quality business environment that we can see positive growth so that we get continued employment hiring. So that's kind of the view that I think is the majority view on the Street, and I think we adopt that view.

Great. Thanks for the color.

Yes.

And we will now take a follow-up question from Manny Korchman from Citi.

Hey, guys, if we go back to One Kendall for a second. How much of the cost basis did you attribute to the land site for development and how much to the income-producing property? Or, said differently, if you were to take the land out of it, what would be the going-in yield?

The going-in yields, Manny, are reflected in our disclosures in the supplemental.

I mean, how much value do you attribute to land when you came up to those yields? There has to be some amount of land value that's (multiple speakers) --

Yes, you're right. You're right. It is from a purchase accounting perspective, Manny. You're correct, we did allocate a portion of the investment to the development site -- 170,000 some odd square feet at roughly high $200s, approaching $300 a foot. $300 a foot, which we believe is market. We will generate a very nice return on that investment and so the initial stabilized yield is reflective of the operating asset today, with a small allocation of the purchase price over to the land site.

I think Michael has one for you guys as well.

Yes. Hey, Joel, just out of curiosity, you talked a little bit about -- in response I think it was to Dave's question, about ramping development and one of the things you talked about was the balance sheet being in much better position to be able to look towards funding that growth as well as a lot of the developments that you have on target being leased. I'm curious, as you think about One Kendall and does that come to market before, how much did your access and cost of equity capital play into the decision to buy One Kendall and how much of that is playing into increasing development and potentially looking at other acquisitions?

Well, I think it's fair to say that the, well, our cost of debt capital certainly has been very favorable in this environment. And our cost of equity capital, with the stock doing pretty well, was certainly an important factor. I don't think we'd want to go out and do a large offering, whether it be forward or not, with the stock price that would be in the 70s, which it was in February. So that certainly weighed heavily on our mind, and our goal has always been, how do we balance a couple of things.

One is maintain our goal on earnings, continue to increase our net asset value, and at the same time achieve our lever score ratings increase. So that's -- those are the three things we're clearly focused on as we looked at One Kendall. But, as I said, we looked at this a couple of years ago and Mr. Moglia, sitting here to my right, vetoed my desire to buy that a couple of years ago for a variety of good reasons. But I have always felt that, that asset was unique. It -- the address alone speaks to it: One Kendall.

The -- it is rare to be able to find an urban campus in the best life science cluster in the universe -- or galaxy maybe. And also, the factors that were attendant to that -- if brokerage estimates are right, and we can get $80 to $85 triple net in 2018 -- that gives us even more upside than our base-case projections would hold. We think we can do well on the development, and we also think there's a huge opportunity to convert office to lab there. So that was kind of the constellation of considerations broadly that we thought about.

And then, as you think about where your stock sits today, I guess, how many more opportunities do you have your team sort of trying to either aggressively uncover, because I assume there's other assets like One Kendall that are out there in markets that you'd like to own? I'm just trying to get a sense of whether we may see more things come through acquisition.

Yes. I don't think so. We -- if you asked us at the beginning of the year, did we plan on buying One Kendall, I would tell you that we didn't even know it was coming to market. There was another asset -- one lab and one building, that -- 245 First, I think -- that went out to bid. They're assets that somewhat older but they're adjacent to our Alexandria Center at Kendall Square. Would have loved to have probably owned those. But for a variety of reasons coupled with the One Kendall Square acquisition, we didn't see the upside in the roles. We didn't bid on that, but we clearly underwrote it and tried to follow all the assets.

So I would say that we're not, in general, aggressively pursuing things. But where we see, I guess, the one opportunity -- or the one characteristic of an opportunity we'd look at is where we see a great asset in a great location that we'd like to own for the long term, and we see short-to-medium termability to add significant value. We wouldn't buy just a fully stabilized asset for the next 10 or 12 years, just probably no interest in that. So our main focus is on our development pipeline, though. That's where our key focus is.

And just the last one just on the ATM, just so we get a perspective of how you're going to use it going forward. How much of the significant ATM issuance was almost, you sort of knew One Kendall was coming and you wanted to sort of get as much equity in the hopper as possible. I'm just trying to get a sense of when you do reissue a new program, how we should think about when you use it and the volume that you're going to use at a given moment. Because certainly the size of the ATM issuance, even pre the equity deal, was certainly sizable in the quarter.

Hey, Michael, it's Dean here. So, at some point, we'll re-file the program only because we think it's a great tool to have on balance sheet. It's a very efficient tool as we all know. As far as usage goes going forward, the only thing that is contemplated at the moment would be, to the extent we retire any amounts of our Series D convertible preferred, we'd like to time that and match fund it with some common equity. And I think, again, we've been pretty clear on that strategy.

As far as your question on the ATM usage in the second quarter and pre-funding One Kendall, One Kendall was funded through the forward equity offering and we just saw opportunities to utilize the program in connection with the changes in the overall capital plan outside of One Kendall Square. The mix of dispositions, as an example, the ability to get ahead on our leverage goals, as well, was interplaying into that thought process. So hopefully that gives you a little color, Michael.

Yes, I guess I would say, to the extent we think about using it in the future -- in addition to what Dean said -- we'd always try to think about it in a leverage-neutral fashion in the sense that we want to try to maintain our earnings trajectory, obviously, grow our NAV, and, at the same time, use it in whatever way that we might, but in an accretive fashion. So that's how we're trying to thinking about it. We've tried to be, over the past quite a number of years, as disciplined as possible in the utilization of equity.

Great, thank you.

Ladies and gentleman, with no additional questions, I'd like to turn the conference back over to Joel Marcus for additional and closing comments.

Well, thank you, everybody. We're one hour into the conference, so right on time. Thank you for your questions and we look forward to talking to you for third-quarter results. Take care.

Ladies and gentleman, this does conclude today's conference, and we do thank you for your participation. You may now disconnect and have a wonderful rest of your day.