High demand, low vacancies and rising rents are fueling investment, development, repurposing and other trends in this sizzling sector
By Erin E. Porter
Editor’s note: At HREI™, we’ve always believed that the best way to succeed in any business is to listen to the marketplace. So after taking note of the growing chorus of voices expressing keen interest in life sciences real estate – including several members of our own Editorial Advisory Board, we recently made a strategic decision to expand our coverage of that sector in our print magazine, weekly e-newsletter and website. In addition, later this spring, we will be launching Bioscience Real Estate Insights™ (BREI™), a dedicated, monthly e-newsletter. Meanwhile, here’s an overview of what’s happening in this sizzling sector.
What does it take to be “hot”? We hear the word tossed about in popular culture, referencing the latest trendy individual, couple, restaurant, destination, company, technology – and yes, real estate sector – whereby whoever, wherever or whatever is deemed “hot” is infused with such desirable and attractive qualities to deserve the distinction, even for just a short while.
But when it comes to life sciences real estate (LSRE), also known as bioscience real estate, the sector’s hotness quotient seems to have staying power for more than just a quarter or two. When it comes to bio, it seems as if everybody’s talking about it, investing in it, developing it, repurposing it, seeking it, following it, desiring it, doing it and reading about it. (Yes, I am talking to you.)
Several venerable healthcare real estate (HRE) firms have added LSRE real estate experts to their teams in the past two to three years, and quietly (or not so quietly) added the term “life sciences” to the name of their company or business unit.
Ardent HREI readers know this well, as we have been compelled to report on the LSRE space with increasing frequency, especially in the past few months. And one doesn’t need to dig too deeply into one’s stack of HREI print magazines or scroll very far through our digital archives to see the evidence: LSRE is indeed “smoking hot.”
Before we delve into the reasons for the sector’s popularity, it would be a good idea to start with some definitions. But that’s not necessarily easy, according to the “2022 Q1 U.S. Life Sciences Market Report” from Colliers (Nasdaq/TSX: CIGI).
“The definition of life science as an industry and its spaces is still relatively loose,” the Colliers report states in its opening comments. “In the well-established market clusters that definition is clear, but in emerging markets, definitions of life science, healthcare and health tech are somewhat ambiguous.”
But that can be a good thing, the report continues. “This allows for industry specialization, and eventually these nuances could lead to competitive advantages in certain types of science and discovery.”
So there are different ways to define life sciences and LSRE. But here are HREI’s working definitions.
“Life sciences” are the sciences concerned with the study of living organisms, including biology, botany, zoology, microbiology, physiology, biochemistry and related subjects. More specifically, for our purposes, we focus on fields related to human healthcare, such as biotechnology, pharmaceuticals, medical devices and therapeutics. So it follows that LSRE consists of any types of facilities that house those activities. So far so good.
However, just as HRE has many subsectors, so does LSRE. Life sciences space includes offices, research & development (R&D) and laboratory (lab) space, manufacturing facilities, and warehouses and distribution centers. But just as HRE developers and investors tend to key on certain key product types, particularly medical office buildings (MOBs), most LSRE firms tend to focus on office, R&D and lab space, which usually go hand in hand.
Of course, it should be stated that the definitions of each of those product types can also be a little imprecise, but it’s probably fair to say that R&D is more of an umbrella term which can include lab space, space to house technology, individual workstations for researchers, meeting spaces where researchers can collaborate, space to store records, and more.
There are also different kinds of lab space: “wet labs” are for manipulating liquids, biological matter and chemicals; “dry labs” are focused on computation, physics and engineering.
But, in an effort to keep things relatively simple, we at HREI generally concentrate of the broad (if somewhat ambiguous) LSRE product types of office, lab and R&D space – because that’s also what our readers seem to be most interested in. And, as it relates to those product types we focus on “the deal” – development, financing and investment – just as we do with HRE.
Having said that, another possible trend to watch could be an increase in the development of life sciences R&D and manufacturing facilities in the United States. Historically, much of that work has been done overseas. However, frustrated by supply chain issues, industry sources say that some bio and pharma companies are either adding to their domestic manufacturing capacity or at least looking into it.
Is life science real estate really all that “hot?” Yes!
Now that we have gotten the housekeeping out of the way, let’s find out if LSRE really is all that hot, and if so why, who the major players are and why HRE firms seem to be flocking to LSRE. To do that, we turn to the steady stream of research reports all the major commercial real estate brokerages are churning out on the topic of LSRE. The reports, originating from the likes of CBRE, Newmark, Cushman & Wakefield, Colliers, JLL, Strategic Alliance and others, provide hard data that explains why the LSRE business has burst upon the scene.
For any real estate sector, of course, a key factor is always the health of the underlying industry, which is the source of the development clients, building tenants and potential property sellers. And the life sciences industry is healthy indeed.
“The life sciences sector has been on an upward trajectory over the past decade, with billions of dollars of investment accelerating activity and employment growth. COVID-related research has further catalyzed activity and demand for new lab and R&D space.” That’s according to a 2021 article in Development, the magazine of NAIOP, the commercial real estate development association.
The “Q4 2021 U.S. Life Sciences” report from CBRE Group Inc. (NYSE: CBRE) gets more specific: “Venture capital funding in U.S. life sciences has grown 328 percent during the last five years,” including a record $32.5 billion in 2021.
The billions flowing into life sciences companies are, not surprisingly, stoking their demand for space. The CBRE report notes that, at 172.5 million square feet, the inventory of U.S. life sciences real estate has never been greater. But the same goes for demand, which on a national basis has driven the average vacancy rate down to 4.8 percent, driven up the average rental rate to $67.05 per square foot (PSF) and spurred 31.6 million square feet on new projects under construction, as of the third quarter (Q3) of 2021..
Those fundamentals have captured the attention of commercial real estate investors. The recent “Investor and Developer Survey Results” report from CBRE’s Healthcare & Life Sciences Capital Markets team found that “investment in life sciences real estate, comprised of lab and research and development properties, reached $21.4 billion in 2021, a 62 percent increase over 2020. Investment in the sector has grown by 111 percent since 2018.”
The “2021 Life Sciences Lab Real Estate Outlook” from Jones Lang LaSalle Inc. (NYSE: JLL) tells us: “Life sciences industry momentum has been building for decades, but it’s recently become one of the most highly sought-after sectors within commercial real estate… New modalities and technologies will fuel ever evolving infrastructure and real estate requirements.”
What’s the healthcare real estate connection?
Interestingly, if you talk with industry professionals who are knowledgeable about both HRE and LSRE, they will insist that the two sectors are “very different,” with different kinds of facilities and largely different players. The design of an MOB versus an office/lab facility are quite dissimilar, for example.
So, to be sure, the LSRE market is highly attractive. But what makes HRE professionals think they can get into the business?
As it turns out, there are quite a few similarities and synergies between the two sectors, and there are some HRE firms with many years of high-level LSRE experience, most notably the big publicly traded healthcare real estate investment trusts (REITs). The big three healthcare REITs – Healthpeak Properties Inc. (NYSE: PEAK), Ventas Inc. (NYSE: VTR) and Welltower Inc. (NYSE: WELL) – have all been investing in life sciences facilities for more than a decade and have millions of square feet in their LSRE portfolios.
The fact that those REITs have long, strong working relationships with many HRE developers, brokers and property managers undoubtedly helped to put life sciences on the radar screens of those HRE professionals. As a result, some of them have gone on to develop their own expertise in LSRE, both to better serve their REIT clients and to pursue other opportunities on their own.
Another link between HRE and LSRE is the fact that many HRE professionals have worked for decades with academic medical centers, developing, financing and investing in their hospitals and outpatient facilities. But, in addition to clinical space and education buildings, those institutions also have research facilities, making it almost inevitable that HRE professionals would be drawn into those kinds of opportunities.
And if an HRE firm doesn’t have much life sciences expertise, it can always hire it or buy it. Several brokerages and property management firms have added experienced LSRE professionals to their teams in recent years, as well as a few HRE firms that have partnered with or acquired LSRE firms.
Power players, compelling clusters and more
Unlike the HRE space, which remains highly fragmented in terms of ownership, LSRE is dominated by a few big players. According to the “2021 Year-End: Life Science National Overview & Top Market Clusters” report from Newmark Group (Nasdaq: NWMK), the top 10 owners of LSRE accounted for a total of about 107 million square feet, as of the end of last year. If the total inventory is 172.5 million square feet, as CBRE reported, that means those top 10 firms own more than 60 percent of the total inventory of LSRE space.
So who are these LSRE heavyweights? Far and away the largest owner of LSRE is South San Francisco, Calif.-based Alexandria Real Estate Equities (NYSE: ARE), a pure play bioscience REIT that owned 407 facilities with a total of 43 million square feet of space, as of the end of 2021. Alexandria added acquisitions totaling $900 million in January and has 8 million square feet of space planned or under development.
The other firms among the five largest owners of LSRE area:
■ BioMed Realty, San Diego, a division of The Blackstone Group (NYSE: BX) of New York, which owns 14.4 million square feet;
■ Healthpeak Properties, Denver, 11.7 million square feet;
■ Ventas Inc., Chicago, 9 million square feet; and
■ Longfellow Real Estate Partners, Boston, 7.3 million square feet.
The six through 10th largest owners, all with between 3 million and 5 million square feet of space, are:
■ King Street Properties, Boston;
■ Boston Properties (NYSE: BXP), Boston;
■ Diversified Healthcare Trust (Nasdaq: DHC), Newton, Mass.;
■ IQHQ Inc., San Diego; and
■ Alloy Properties (TPG Real Estate Partners), Fort Worth, Texas.
CBRE tells us that these and other rising LSRE owners will continue to look for development opportunities in 2022 and that there aren’t enough existing properties on the market to meet demand.
Unlike the highly fragmented HRE space, LSRE is dominated by a few big owners. According to the “2021 Year-End: Life Science National Overview & Top Market Clusters” report from Newmark Group (Nasdaq: NWMK), the top 10 owners of LSRE accounted for a total of about 107 million square feet, as of the end of last year. If the total inventory is 172.5 million square feet, as CBRE calculates, that means those top 10 firms own more than 60 percent of the total inventory of LSRE space.
Keen on clusters
As for where all this activity is happening, the answer is: a lot of different places. Also referred to in the industry as “clusters,” these hotbeds of activity are well-known.
“Life sciences companies thrive in strong ecosystems that include academic institutions, capital sources and dense clusters of scientific talent,” noted Lauren Gilchrist, managing director, research, at Longfellow Real Estate Partners, in a recent Forbes article.
Cushman & Wakefield’s (NYSE: CWK) 2022 Q1 Life Sciences Update spells out where cluster activity is happening in several different ways, including talent, increased demand for lab space and funding from the National Institutes of Health (NIH), which is a federal agency, part of the U.S. Department of Health and Human Services (HSS), which pours billions of tax dollars into public funding for medical research. After what biopharma companies invest on their own, NIH funding is the biggest source of life sciences R&D capital investment.
The Cushman & Wakefield report lists the top 15 markets in order of NIH funding as: Boston; New York; San Francisco Bay Area; Raleigh-Durham, N.C.; Seattle; Los Angeles; Philadelphia; Chicago; Houston; Pittsburgh; Ann Arbor, Mich.; St. Louis and Atlanta. The report also notes that these top 10 markets account for half of all U.S. funding.
The JLL report lists some key components that “define the industry and predict its growth” and ranks the clusters accordingly. Using the benchmarks of talent, industry depth, innovation and lab real estate dynamics “to provide a more robust market comparison,” JLL’s top 10 are Greater Boston (149.81); San Francisco Bay Area (132.54); San Diego (119.81); Raleigh-Durham, N.C. (119.71); New York-New Jersey (109.61); Greater D.C.-Mid-Atlantic (107.58); Los Angeles (104.41); Denver-Boulder, Colo. (104.36); Philadelphia (104.29); and Seattle-Bellevue, Wash. (102.14).
The Newmark Group report pays homage to “Potential Future Clusters” including Phoenix; Providence, R.I.; Dallas; Miami and New Haven, Conn.
CBRE’s report also notes the emergence of new markets and new entities entering the life sciences facility sector. “A number of new life sciences markets are emerging to meet robust demand and many new developers have been drawn to the sector,” CBRE writes. “Between Q2 2020 and Q4 2021, the number of life sciences developers in the top 12 life sciences markets rose to 64 from 45, with construction rising to 29.5 million square feet from 16.2 million square feet over the same period.”
Markets with the kind of academic medical centers we mentioned earlier are seen to have the greatest potential.
During a panel discussion at the BOMA MOB + HRE Conference in Dallas in November, Ryan Stewart, a director and the head of HRE lending with Chicago-based BMO Harris Bank reiterated that life science lending has typically been a “cluster market-driven product. And, you know, we’re starting to see more transactions in like those secondary markets as well, like, Houston, Raleigh (N.C.), and Boulder (Colo.). And I think moving to the non-cluster markets makes a lot of sense, because there are only so many places to build in those cluster markets, and office conversions can be difficult because the specs of the life science buildings are so specific in terms of needs.
“So, this is something that once there is enough scale in those markets, I think there’s a lot of opportunity there, even though the sector is still typically still focused around academic research institutions.”
‘Strong demand drivers’
As to why LSRE is so hot, JLL’s report has some great and obvious insight. It’s not just all about the money, honey. Despite some of the gloom and doom of the past couple of years, a lot of us are concluding that life is worth living, and LSRE is responding to that innate instinct.
“Our basic human desire to live long and healthy lives will forever drive demand for the industry’s main product: therapeutics aiming to do just that,” the report explains. “The focus on personalized medicine will be a tailwind for the industry, enabled by tech-enabled productivity gains related to drug discovery and delivery. Biologics are gaining market share over conventional medicines and that will increase as new modalities are discovered through advances in technology.”
Other reasons for the sector’s hotness are its extreme pandemic-proof resiliency, as evidenced in Newmark’s report, which says venture capital firms’ investments in life science and healthcare flourished during the pandemic, topping a pre-existing funding level record of $33.1 billion in 2020 with a new, whopping $43.3 billion in 2021.
The all-encompassing sector also has “has strong demand drivers” that aren’t going to fade anytime soon, according to the Strategic Alliance HRE & Life Sciences 2021 Year End Report, published by The TICI Group of Companies, in collaboration with Texas International Consultants Inc. and Stealth Realty Advisors LLC.
Those drivers include “the continued commercialization and development of pharmaceuticals and devices… World drug sales compound growth rate (3.5 percent) has outpaced the national GDP growth rate (1.5 percent) over equal time periods. Other drivers include advances $15 billion in technology, such as genome sequencing used in mRNA vaccines, as well as America’s aging population continuing to grow.”
But climbing onto the bio bandwagon isn’t easy. JLL’s report gives us a daunting list of beefy barriers to entry: “Some of the hurdles and barriers of getting from early stage translational research to commercialization of a product are real estate related issues, and they can be sources of significant cost, lack of efficiency and lack of coordination,” they say. “In the end, for life sciences, location continues to matter most. Now, more than ever, firms are seeking deep insight into geographies to weigh cost, rental price, access to venture capital, access to skilled labor, intellectual capital, support services and political predictability in making location and growth decisions.”
Repurposing: All the rage
Simply put, there aren’t nearly enough life sciences facilities available to meet tenant or investor demand. With an average of a sub-5 percent vacancy rate nationwide – and even lower vacancies is some of the top clusters – competition for space is fierce.
But life sciences firms don’t only nee space, they need it fast. For most, getting up and running quickly with new facilities is crucial.
Adding to the pressure, some markets simply have no available land for development and, even if they did, new facilities are expensive.
As a result, one of the hottest strategies being implemented, or at least considered, by owners and developers is the repurposing and redevelopment of other types of commercial real estate for life sciences use. This trend is huge right now, especially in the “big three” clusters of Boston/Cambridge, Greater San Francisco and San Diego, where repurposing and conversion are the name of the game.
Examples abound, but to name just a few recent ones:
■ In the San Francisco Bay Area, hometown developer Presidio Bay Ventures, in a joint venture (JV) with private investment firm, Kinship Capital, announced in November 2020 that it had acquired a 45,000 square foot car dealership and parking lot 777 Industrial Road in San Carlos with an eye toward redeveloping the property into a 123,000 square foot, Class A, life sciences building.
■ Also in the Bay Area, Boston-based Longfellow Real Estate Partners in October 2021 acquired an 85,000 square foot self-storage facility on a 2.07-acre plot in Millbrae, near San Francisco International Airport, for $80 million, with plans to repurpose it for a 260,000 square foot, Class A, life sciences development.
■ San Francisco-based DivcoWest acquired a vacant, 143,000 square foot office and research building and an adjacent strip of land from Johnson & Johnson (NYSE: JNJ) in South San Francisco in January 2022 for $164.5 million. The company plans to revamp the three-story facility for life sciences.
■ In San Francsico itself, Boston-based Lighthouse Real Estate Investment LLC bought a 14,000 square foot property for $31 million in December 2021 and plans to redevelop it into a 185,000 square foot life science lab facility.
Repurposing, also known as adaptive re-use, is also being pursued in other tight urban markets. In the Colliers report, Philadelphia is used as an example where this trend is taking hold.
“The strong market demand for lab space in Philadelphia has caused many office building owners to evaluate the feasibility and costs of conversions to lab, manufacturing, or incubator space,” the report states. “Owners of buildings with adequate clear heights, floor loading, and shaft space capacity to accommodate the fresh air and exhaust requirements of lab space have moved quickly to respond to lack of supply. Some CBD buildings have already successfully converted vacant floors and have signed tenants that couldn’t wait for new product.”
At the BOMA MOB + HRE Conference in Dallas in November, Sabrina Solomiany, a first VP with CBRE’s U.S. Healthcare and Life Science Capital Markets Team, noted, “Life science has been all the rage the last two, three years, and obviously it’s a very high-performing space, with occupancies tending to be 95 percent plus in cluster markets, and even in non-cluster markets.”
“We typically haven’t seen a ton of transactions in that space, but recently they’re really starting to crop up a lot more and specifically we’re seeing a lot of office to life science conversion projects.”
It should be noted that although repurposing and redevelopment also happen in tight HRE markets, there is a big difference in the LSRE space. Most of the revamped space being proposed – as well as a lot of the new, ground-up development, for that matter – is speculative. The LSRE market is so hot that developers and even their underwriters consider spec space a risk worth taking. ❏
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