Alexandria Real Estate (ARE) - Get Report continues to post solid growth in an otherwise soft office market. This specialty player in the biotechnology and medical office-building arena has been seeing rent and occupancy growth and offering a steady income stream to investors.

Earlier this week, Alexandria announced funds from operations, or FFO, a REIT's measure of earnings, of $1.05 a share for the second quarter vs. the year-ago 97 cents, and slightly better than expectations.

Moreover, while many office REITs are struggling just to keep same-store net operating income -- a measure of a REIT's rental strength -- from slipping fast, Alexandria actually saw NOI increase by about 2% in the second quarter. Although that's far from the nearly double-digit rent growth of the late 1990s, it stands out among office REITs as one of the few bright spots in a very challenging market.

Healthy

As noted when I first

profiled Alexandria, this is not your ordinary office REIT. Rather, the company focuses on the medical specialty space, largely for biotechnology companies. Its space is highly concentrated in areas with a number of biotech companies, especially along the Baltimore-Washington corridor.

That makes the company somewhat susceptible to the health of the health care business, but that hasn't been a problem in recent quarters. While traditional office-building landlords have struggled to keep tenants from walking and rents from slumping, Alexandria has seen demand and lease rates grow modestly.

In fact, the average office REIT has seen occupancy decline by at least 2% and rents decline by about 10%. Alexandria's rent and occupancy have remained relatively stable. In the second quarter, Alexandria saw occupancy growth of about one-half of a percent, as well as modest rent increases.

The outlook in the coming quarters is relatively buoyant, as well, when compared to the rest of the REIT market. The company has seen very little tenant loss in the economic malaise and expects to see same-store NOI growth in the 2% range in the coming year.

Check-Up

The company continues to have good traction with existing clients. In the second quarter, Alexandria closed nearly 80,000 square feet of leases, with about a third consisting of lease renewals. To one analyst, the re-leasing activity was generally positive.

"These deals had rent increases of 12% on a cash basis, which is quite strong, but it was a small sample," said Anthony Paolone, a real estate analyst at J.P. Morgan. "The company leased about 48,000 square feet of space relating to developments and redevelopments. These deals were done with average lease terms of 5.6 years, which is good."

He did note that in the renewal category, the lease term was a short 1.4 years, although the company said that was a specific situation and should not be considered a trend. Paolone rates the stock overweight, and his firm expects to receive investment banking compensation from Alexandria.

Going forward, the second half of the year will be critical for Alexandria. Nearly 425,000 square feet of space is up for lease renewal, which represents just less than 10% of the total portfolio. A sizable chunk of that space -- about 30% -- will go into Alexandria's redevelopment portfolio, while nearly 100,000 square feet represents traditional office space.

"Given the weakness in the office market,

the traditional office space could drag down the company's occupancy levels." Paolone said. "Thus, watching leasing activity for the balance of the year should be key."

Paolone also said that in 2004, the company will have about 11% of its property portfolio rolling over, about normal for Alexandria. The company noted that about 35% of that space already has commitments, which is a good sign this early in the renewal process.

Dividend Booster

When I first profiled Alexandria, I noted the power of its cash flow and its ability to boost its dividend consistently. Although growth hasn't been as robust as in past years, this year should be no different for those looking for a payout increase.

Alexandria has traditionally adjusted its dividend in the first quarter, but management has hinted that its board is likely to approve a dividend boost at its September meeting. That's largely because a lack of acquisitions has left the company sitting on a pile of cash and not as much need for capital. That possible special dividend increase isn't likely to preclude the traditional hike that could come in the first quarter of next year.

Experimental Tenants

The most significant risk to Alexandria's story is its tenant base. A number of big-name biotech firms adorn its client list, but so too do a number of smaller, upstart biotech companies. A turn in the biotech business leading to financial hardships for tenants would pressure occupancy, rents and the stock price.

Merrill Lynch analyst Steve Sakwa isn't terribly concerned about tenant quality. "Within the company's life-science niche, Alexandria is fairly well diversified across tenant types," he noted. "Its top three tenants, which represent 14% of rental revenues, are

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Pfizer

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." Sakwa rates the stock buy, and his firm has provided banking services for Alexandria.

He added that problem tenants are not a big concern. "Currently, we would label two of ARE's top 30 tenants as 'watch list' candidates," Sakwa said. "The two tenants

Lion Bioscience

and

Paradigm

on our 'watch list' represent just 3.8% of the company's rental revenues. The remaining tenants have at least two years of cash to fund their business plans, and as a result, we do not expect these tenants to default on their leases in the intermediate future."

Healthy Value

Since Alexandria was highlighted in February 2002, its shares have gained about 15%, not including the dividend, which at current prices provides a 4.5% yield.

Even with those gains, the stock doesn't look terribly expensive. It now trades at just 10 times 2004 FFO estimates, which looks inexpensive compared to some office REITs. Moreover, Alexandria should be able to grow its FFO by 7% to 8% in the next year, while most office REITs will be lucky to post any growth at all.

It's tough to make a direct comparison between Alexandria and the typical office REIT. But, Alexandria's fundamentals and performance also suggest it isn't your everyday office REIT. The stock isn't likely to provide the same impressive returns as it has in the past 18 months, but it remains a healthy addition to a small-cap, income-oriented portfolio. You can expect to get the dividend and about 7% growth in the coming year, which should provide a nice double-digit return in the coming months.

Christopher S. Edmonds is vice president and director of research at Pritchard Capital Partners, a New Orleans energy investment firm. He is based in Atlanta. At time of publication, neither Edmonds nor his firm held positions in any securities mentioned in this column, although holdings can change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. While Edmonds cannot provide investment advice or recommendations, he welcomes your feedback and invites you to send it to

Chris Edmonds.