Alexandra Real Estate Equities is in talks with prospective tenants interested in filling several of its buildings in the San Francisco Bay Area, including the one Pfizer recently opted not to occupy despite signing a 15-year lease, top executives of the publicly traded real estate investment trust told analysts on Thursday.
Speaking at the company's quarterly conference call, Chairman and CEO Joel Marcus said lease talks are underway for space at several Bay Area properties. They include the 210,000-square-foot 455 Mission Bay Blvd. South at the REIT's Mission Bay campus, where Pfizer planned to move into a 105,000-square-foot chunk with an option for 50,000 more square feet. This deal died last month when the pharma giant backed out, citing the ongoing economic downturn and a rethinking of real-estate needs due to its $68 billion acquisition of Wyeth [BRN, July 10].
Marcus said tenants leasing space at 455 Mission Bay Blvd. South are more than likely to sublease it from Pfizer, since the pharma cannot walk away from its lease for at least 10 years — a fact Marcus disclosed last month. Another reason: The lease "yields us a very handsome return on our shell cost, very, very strong," he said, giving the REIT no incentive to end the lease sooner.
Pfizer has spent recent weeks marketing the Mission Bay space to would-be tenants through the commercial real estate firm GVA Kidder Matthews. Pfizer CEO Jeff Kindler "is personally involved in that effort," Marcus said.
"They are looking to sublease, and we understand they may be very close to achieving their goal there," Marcus told analysts on the conference call. "I think that will probably be off the market fairly soon as far as any sublease competition for us."
Added Steve Richardson, a senior vice president with Alexandria who heads the REIT's San Francisco Bay Area region: "They've taken the steps in very short order, right after their announcement about not occupying the space, to try to backfill that. So our expectation, with the real-live activity out there, is that they'll be successful in the near term."
A multi-tenant subleasing of the space Pfizer was to occupy would not bother Alexandria, Richardson said, given the dearth of smaller-sized spaces for life-sci companies. "It's going to be beneficial to us to have some smaller spaces available to accommodate tenants,” he said. “There really is virtually no other laboratory space available in that kind of medium sized increment."
That need is likely to intensify if startups outgrow their spaces at two incubator sites run in and near the Mission Bay biocampus near the California Institute for Quantitative Biosciences, or QB3, which includes the University of California's San Francisco, Santa Cruz, and Berkeley campuses. One is the 2,500-square-foot "Garage" at UCSF's campus in Mission Bay, the other a 10,000-square-foot suite of labs opened recently by QB3 and partners at FibroGen's new headquarters a quarter-mile away at 409 Illinois St.
Also at Mission Bay, Marcus said, Alexandria is having "one significant dialogue, or lease proposal going on, with a credit tenant" interested in the remaining available space at Mission Bay's other building under construction: the 158,000-square-foot 1500 Owens St. UCSF — which has a campus at Mission Bay — already leases 41,000 square feet for its orthopedic surgery clinic in the building, whose construction cost Alexandria estimates at $350 per square foot, or $55.3 million.
And in South San Francisco, Calif., Alexandria said it was finalizing a lease with a single prospective tenant interested in occupying the two-building, 162,000-square-foot Alexandria Technology Center campus on East Jamie Court. The property has been at just 16 percent, or about 25,292 square feet, occupied in recent months, as Alexandria has carried out a redevelopment it estimates as costing $350 per square foot, or $56.7 million.
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"We think that is essentially done," Marcus said.
The potential deals could help reduce the vacancy rate in the Bay Area's core life-sci corridor, from San Francisco south to South San Francisco and Stanford Research Park in Palo Alto, from "a reasonably healthy vacancy rate” of 12.8 percent down to single digits by year end, Richardson said.
"We are now tracking demand in this corridor that should drive this vacancy rate down to approximately 8.8 percent by the end of 2009," Richardson said. That should stabilize rents and help them bounce back up during 2010 and into 2011, he said.
"You do have capital continuing to flow to promising companies from a variety of sources, as well as institutions and big pharma increasing their presence in both Mission Bay and in South San Francisco," Richardson said.
Alexandria expects to pick up much of that activity, he added, since a potential rival developer, a venture of Shorenstein Properties and SKS Development, is likely to require years of review for its plan to transform 375-389 Oyster Point Blvd. in South San Francisco from the current 400,000 square feet of industrial buildings and a 235-berth marina into 1 million square feet of waterfront biotech R&D space. Last year the venture entered into a contract to acquire the site for $85 million.
Richardson acknowledged that additional competitive pressure will come from the roughly 251,000 square feet of subleasable space now available in South San Francisco, in two buildings Amgen initially planned to occupy, then held off following a wave of company cutbacks two years ago: "It's most definitely competitive space," Richardson said. "I think we'll be capturing our fair share, if not more, and ultimately they'll capture a piece of the market as well. Once that happens, we'll end up being in a very tight market, probably approaching 5 percent [vacancy] or so."
Among space Alexandria is looking to fill is the remainder of the 130,000-square-foot East Grand Technology Campus in South San Francisco. Exelixis now leases 72,000 square feet there, but it holds an option for the building's remaining 58,000 square feet that expires at year's end. Alexandria is completing redevelopment of the property at an estimated construction cost of $350 per square foot, or about $45.5 million.
"We'll have to wait another couple of quarters to see what will come out of that," Marcus said.
That's a change from six months ago, when Marcus, during a conference call, expressed more confidence in Exelixis exercising that option: "This is [Exelixis'] corporate headquarters [and] core research facility, and I think it's fair to say we reasonably expect them to exercise the option."
Throughout the Bay Area, where Alexandria maintains nearly 1.5 million square feet of both operating and redevelopment life-sci space, Richardson said Alexandria was in lease talks for "75 percent" of the 24,000 square feet of vacant space in the region.
"There's quite a bit of activity in both the Mission Bay market and the South San Francisco market," Richardson said.
Less so, he added, in the East Bay section, which Alexandria exited early last year when it sold off five Alameda, Calif., properties totaling 272,730 rentable square feet for about $170 per square foot, or about $46.4 million. The deal yielded a $20 million gain for Alexandria.
"High-quality tenants from our core corridor rarely consider a relocation to the East Bay markets, except for a few in manufacturing," Richardson told analysts.
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As with two rival life-sci real estate REITs, BioMed Realty Trust and HCP, Alexandria has anchored its tenant base to life-sci giants rather than financially weaker biotech startups. Besides Pfizer, the REIT's Bay Area tenant roster also includes Roche, Merck, and Celgene.
Alexandria offered updates of its Bay Area activity during the Aug. 6 conference call, during which Marcus, Richardson, and Chief Financial Officer Dean Shigenaga described leasing and other activity in a variety of markets — notably New York City, where Alexandria disclosed more details of its anchor lease with Eli Lilly/ImClone Systems at its East River Science Park.
The call followed Alexandria's release of its second-quarter earnings. The REIT saw its net income climb about 59 percent over the year-ago period to $44.1 million from $27.8 million in the second three months of last year on revenues that climbed 11.6 percent to $121.4 million from $108.8 million in Q2 '08.
However, Alexandria's bottom line was boosted by a roughly $11.3 million gain from extinguishing a debt early on related to its repurchase in April of about $75 million in unsecured convertible notes at 3.7 percent interest; and a $7.2 million cash payment related to real estate acquired in 2007, "and effectively was a purchase price adjustment on the original price accounting," Shigenaga said.
Alexandria also recorded a 49-percent year-to-year quarterly gain in funds from operation — a common measure of REIT financial performance that excludes the effect of depreciation, and is thus outside of generally accepted accounting principles. FFO rose to $68.4 million in the second quarter, or $1.59 per diluted share, from $45.8 million, or $1.44 per diluted share, a year earlier.
The company raised its FFO guidance for 2009 to $5.60 per share, up from $5.43 per share after the first quarter, when it cut its guidance from the initial $6.26 per share; and increased its earnings per share guidance to $2.58, from $2.50 after Q1, but down from the original $2.73.
During the second quarter, Alexandria said it completed 49 leases for a combined 473,000 square feet — compared with 530,000 square feet in 37 lease deals a year earlier.
For the second half of 2009, Marcus said, Alexandria has tenants under lease talks for two thirds of the 557,000 square feet of space now being marketed, with the remainder "too early to call." He said Alexandria expects rents across its properties to rise 5 percent this year and next, due to renewals of leases originally signed at low rents.
East Side Story
The largest and most significant of the Q2 deals was Eli Lilly's 15-year anchor lease for 91,000 square feet, plus 9,000 square feet of core services space, at the Alexandria Science and Technology Center at East River Science Park in New York City. Eli Lilly will move the oncology research group of its wholly owned subsidiary ImClone Systems uptown, to the East River campus on Manhattan's 1st Avenue, between 28th and 30th Streets, from the company's current lower Manhattan space at 180 Varick St., its headquarters of 25 years.
Addressing analysts, Marcus said Eli Lilly will consolidate at East River the ImClone oncology unit with oncology staffers being shifted to the Big Apple from Lilly's headquarters city of Indianapolis. In addition, Lilly will base a new venture financing arm at the New York space. Lilly is expected to base at least 125 staffers at East River.
"It may be a combination of both office and labs for a large investment, in the tune of north of $100 million, that will be putting together pre- … just very pre-IND clinical and clinical-stage candidates to basically take through the clinic," Marcus said. "That's a big win, also, for New York."
East River is a key component of New York City's emerging strategy of weaning the city away from Wall Street and the financial services as anchors of its economy by boosting life sciences, new media, and other tech-based industries. Mayor Michael Bloomberg, who is seeking a third term in November, joined Marcus and Lilly CEO John Lechleiter in announcing the lease at a July 22 press event.
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Marcus rejected the argument advanced by some observers that the Lilly/ImClone lease was not as significant a deal for New York's biotech sector as trumpeted by Bloomberg since most of the employees will be shifted from lower Manhattan. Bloomberg bristled at the argument when asked about it by the first reporter who asked him a question at the press event, the Alexandria chairman recalled.
"If you were there, [Bloomberg] would have jumped down your throat," Marcus told Citigroup Senior REIT analyst Michael Bilerman after he asked the Alexandria chairman about the topic. Marcus added that the mayor's verbal joust with the reporter made an impression on Lechleiter: "He grabbed my arm and said, 'Gee, we don't see this in Indianapolis.'"
Answering an analyst's question, Marcus said the undisclosed rent Eli Lilly will pay did not decrease in recent months as the economy continued to struggle: "It was one of the least combative and most pleasant leases to negotiate, but it's a very, very complicated lease in a very complicated building in a market that has never had real life science users."
New York, and the East River biocampus, emerged as ImClone's new home after Lilly completed its $6.5 billion acquisition of the company last November. Until then, Marcus told analysts, ImClone had planned to move its employees from lower Manhattan to Branchburg, NJ, where it was to occupy a suburban manufacturing campus. The planned move to the Garden State also ran into opposition from ImClone employees who live in New York City and were balking at the extra commute required, since Branchburg is about 50 miles southwest of Times Square.
"In a sense, if East River did not exist, New York would have lost virtually all of these [ImClone] jobs," Marcus said.
"[ImClone] could have built traditional suburban office-lab buildings at a fraction of the cost of East River. That was the game plan before Carl Icahn got involved on the takeover side, Marcus added, alluding to the financier's ImClone takeover attempt last year that ended with the Lilly acquisition.
Lilly will move into floors 10 through 14 of the 16-story East Tower within the East River biocampus in June 2010, when Alexandria completes its construction, now in progress, of the 310,000-square-foot building. Plans for the $700 million biocampus also call for a West Tower of 389,000 square feet, but Alexandria has held off breaking ground on that and all other new projects, citing the difficulty of obtaining financing due to the ongoing economic upheaval.
In its 8-K filing with the US Securities and Exchange Commission, Alexandria disclosed the cost of constructing East River's East Tower at $155 million, based on a $500 per-square-foot construction cost.
Within the East Tower, Alexandria is "in lease negotiations right now on significant space with a world-class, brand-name food group" for food service, as well as with prospective providers of conference and other core services to tenants, Marcus said. Those uses will occupy three of the East Tower's 16 stories, Alexandria said in the 8-K filing.
"We're also working on a number of pretty important additional requirements for office/lab space, so we feel very good about where we are on the East Tower," Marcus said.
East Coast Success
New York was one of two East Coast successes trumpeted by Alexandria in the filing and conference call.
In Rockville, Md., at the four-building Life Science and Translational Research Center Shady Grove, Marcus disclosed that a 50,633-square-foot space within a 123,501-square-foot building is in the process of being leased to a federal agency, but did not offer specifics about the agency involved or its planned use.
"We've essentially signed a deal, and it's working through the government on their end. Essentially it's leased," Marcus said.
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Shady Grove is part of a 31-property, nearly 2.4-million-square-foot portfolio of properties Alexandria owns in the suburban Washington, DC, market. That market's overall occupancy jumped during the quarter to 92.2 percent, up from 89.8 percent in Q1, and 91 percent in Q2 '08. Marcus attributed the jump to new tenants receiving increased research funding made available through the National Institutes of Health and the $787 billion federal stimulus measure, the American Recovery and Reinvestment Act.
"I think you'll see more of that in the coming quarters, virtually directly related to these two aspects," Marcus predicted.
But in San Diego, Alexandria said it had found more sluggish leasing activity than the Bay Area or the East Coast. Marcus cited in part decisions by several of San Diego's anchor life-sci research institutions based in the Torrey Pines and University Towne Center submarkets to open new facilities in Florida, after the Sunshine State and local communities showered them with a combined billion dollars in economic incentives a few years back, under then-governor Jeb Bush.
Other reasons cited by Marcus: Dearth of expanding biopharma tenants, and the venture capital needed for startups to expand.
"Big pharma really is not growing or focused on San Diego. For the past number of years, Pfizer has slimmed down. Merck has exited that market. And a numbers of others who are there — [Johnson & Johnson], Novartis, and so forth — have maintained a presence, but [are] clearly not expanding. That's substantially different than you've seen in the Bay Area or the Massachusetts area," Marcus said.
"The biotech side has been pretty tepid, or, I should say pretty quiet, in the San Diego area, partially due to, I think, the lack of robust venture capital that you see more traditionally in the Bay Area and in the Massachusetts area," Marcus added.
Alexandria is faring better further north along the Pacific in Seattle, where the REIT said it anticipated delivering all but 5,000 square feet of the 111,000-square-foot 199 E. Blaine St. to Gilead Sciences in the first quarter of 2010. The remaining space consists of ground-floor retail.
Alexandria also said it was proceeding as planned with construction of its first overseas life-sci campus. The REIT said in its 8-K filing that it "is nearing shell completion" of a two-building, 275,000-square-foot campus its is developing in South China, near Macau, with a joint venture partner, and also has plans to build a second China project, a two-building, 272,000-square-foot campus on a site it would only identify as being in "North China."