Revista panelists reflect on the data and discuss the state of the market
By Murray W. Wolf
Two weeks ago, Bioscience Real Estate Insights (BREI) reported on the data shared by Revista during the firm’s inaugural RevistaLab Life Science Real Estate (LSRE) Investment Forum, summarizing the findings by saying that life sciences is “here to stay” as a viable commercial real estate asset class. The educational and networking event was held Oct. 13-14 at the Encore Boston Harbor hotel.
This week, we taker a deeper dive into that premise, reporting on a panel discussion from the RevistaLab event and sharing the insights of a trio of seasoned executives representing three of the largest firms investing in the LSRE space:
■ Harrison Street Capital LLC, a Chicago-based private investment management firm specializing in “non-traditional” real estate – including student, senior and build-to-rent housing, as well as medical office, self-storage, data centers and life sciences – with a total of $53 billion in assets under management (AUM) across all product types;
■ Longfellow Real Estate Partners LLC, a Boston-based real estate firm that say it is “the largest privately held investor and developer of life science buildings in the world,” which has a U.S. portfolio of about 15 million square feet valued at more than $10 billion, according to recent news release; and
■ Ventas Inc. (NYSE: VTR), a Chicago-based, publicly traded real estate investment trust (REIT), which has grown in recent years to become a top five owner of U.S. LSRE– including projects under development – with a portfolio of about 10 million square feet of life sciences and “research and innovation” properties with a value of $3.3 billion, along with healthcare and senior living portfolios.
The panel discussion, titled “The State of the Life Science Markets Part 2: Expert Macro Overview,” included:
■ Tom Errath, the moderator and managing director, head of research, for Harrison Street;
■ Lauren Gilchrist, managing director, research, for Longfellow; and
■ Allison Rath, a director with Ventas.
If you’d like to read our complete article from two weeks ago, which summarized Revista’s data-filled opening session titled “The State of the Life Science Markets Part 1: Bioscience Real Estate by the Numbers,” presented by Revista Founders and Principals Elisa Hilda Flower Martin and Mike Hargrave, please click here. https://wolfmediausa.com/2022/10/19/life-sciences-encouraging-data-for-the-lsre-sector/
But, to briefly summarize the key points of that presentation:
■ Due to recent economic uncertainty, venture capital (VC) funding for life sciences declined 18.5 percent year-over-year in the first half of 2022, but the total investment of $20.8 billion was still near an all-time high.
■ Although VC funding declined, the life sciences industry continues to attract billions of dollars in government funding – $32.3 billion in 2021 – from the National Institutes of Health (NIH), the primary U.S. government agency responsible for biomedical and public health research.
■ With this year’s decline in VC funding, as well as falling valuations for publicly traded companies, a number of life sciences firms – especially startups – have shelved expansion plans or even begun laying off employees. But industry employment has increased rapidly for the past 20 years, and has spiked upward since 2017.
■ The increases in funding and employment, particularly during the past few years, have driven up demand for LSRE space. As a result, rents are high (an average of $55.32 per square foot) and rising, absorption is strong, and vacancies are miniscule in the three largest U.S. life sciences clusters: the Boston, San Francisco and San Diego Core-Based Statistical Areas (CBSAs).
■ Given the extreme tightness of the market in those three clusters, LSRE developers have responded to the soaring demand with a “robust” construction pipeline, Revista says, with a total of 372 projects totaling 113.2 million square feet planned or in progress, with a total value of $96.7 billion.
■ Total LSRE inventory in those three clusters totaled 948 properties and 119.1 million square feet through the end of Q3, so what’s in the construction pipeline would nearly double the inventory of LSRE space.
■ However, as for whether all those projects will be completed as planned in light of the current state of the economy, Revista projects that 46.4 million square feet on life sciences space will be completed through the end of 2024 – which would be less than half of what’s in the pipeline, but still a 42 percent increase in total inventory.
So with that data as a backdrop, the panelists for the “Expert Macro Overview” took the stage to share their reactions and insights.
The state of the LSRE market
“What a nice session with Hilda and Mike. I think it really sets the stage for the day and will help set the stage for the macro things we’re going to talk about,” Mr. Errath of Harrison Street, the moderator, said. After a round of introductions, he asked the panelists for their general overview of the LSRE market.
Ms. Gilchrist, who works out of Longfellow ’s Philadelphia office, replied: “I think our primary thesis on what’s going on in life sciences, regardless of the current state of the capital markets environment, really stems from the long-term structural change that we are seeing in the sector – the shift to personalized medicine, the shift from small-molecule biologics to large-molecule biologics, and the ongoing desire to expand the quality of life for all human beings through the use of medicine and various therapies.”
Ms. Gilchrist noted that the urgency to create a COVID-19 vaccine in 2020 helped to spur an intense focus on not only the vaccine but all life sciences research, which created a lot of additional “runway” for the LSRE business. That well-funded ramp-up of research also made it clear that life sciences work – particularly research and development (R&D) and biomanufacuring – generally can’t be conducted via telework.
Although she noted that Longfellow was already well aware of this, she said the general marketplace came to a broader “realization that you can’t light a Bunsen burner on your kitchen stove and do real science.” She noted that telework has affected the associated office space to some degree, with the ratio of lab to office space shifting to perhaps 60-40 from the previous 50-50. But she also noted that the more computer-based field of computational biology – which requires a more traditional office space – is growing, which might swing the pendulum back to as much as a 30:70 ratio of lab to office space. But whether that will come to pass, she said, “That’s a question mark.”
Ms. Rath of Ventas followed up: “The only thing I might add to what Lauren said is going on in the space, and what’s making it really exciting fundamentally – just slipping over to the institutional investor side – I think it has really driven a flight to quality, a flight to cluster markets…”
Those markets, she continued, “are really concentrated around university systems, education systems, those hospital systems and things that just bring additional, more concentration of knowledge, of jobs, of the right degrees and things to the marketplace… For us, that kind of flight to the concentrational cluster markets we’re seeing more and more.”
Mr. Errath said: “I think for us, our investment thesis around life sciences has a lot to do with value. Not dissimilarly from our medical office strategy, which is kind of consistent with this. The value that we see in the medical office world, we see translating into life sciences, specifically in these companies that are solving chronic disease issues.” That will create value for the entire U.S. healthcare system, he said, “which absolutely has to reduce costs,” and will rely on life sciences research and new treatments to accomplish that.
“So that’s why we like this as a long-term player, too,” he said, “because we think for investors who are in it for the long term, there’s some great value propositions here.”
Construction and absorption
Reflecting on the construction data shared by Revista in the opening presentation, Mr. Errath asked the panelists: “With all this planned (development), what do you actually think gets done in this environment now?”
Noting that her data is based on a “pure-play wet lab perspective,” Ms. Gilchrist of Longfellow noted that she is tracking about 10 million square feet of new pure-play wet lab product under development in the San Francisco Bay Area market, with a total construction pipeline of more than 50 million square feet. That’s on top of an existing inventory of about 21 million square feet.
“The pre-leasing on what is currently under construction … is about 24 percent today,” she said. If that 10 million square feet of wet lab space delivers as planned, she continued, it would represent and almost 50 percent increase in inventory.
However, Ms. Gilchrist noted that based on historical Bay Area wet lab space absorption trends, “we believe that the absorption will take care of the existing construction pipeline…”
The question is when and if “some of the second-tier projects that have yet to kick off” will actually come to market, she said. That will be determined by the quality of the locations, sponsorship and user demand – pre-leasing – for those projects.
Speculating about spec space
In light of the high tenant demand, an audience member, noting that developing speculative ground-up and converted space has often been a successful strategy during the past couple of years, asked the panelists if they expect that to change.
Mr. Errath replied: “Yeah, and I think anecdotally, where we saw, maybe five, six, seven tenants going after a space, maybe there’s three now… And instead of taking 30,000 square feet and maybe 10,000 for growth, they’re taking 25,000, and they’re also willing to take (the space) as is.
“So effectively what’s happening is they’re saying, ‘Okay, we got all this VC funding or whatever we’ve got. We’re going to make that go further and be more diligent as it relates to that.’
“And then I think… for these (projects) that are in planning. I think you’ll probably see less people going spec,” he said. “If you use an auto analogy, instead of having cars on the lot ready to go, you’re going to order them from the factory with whatever you want… Or maybe it will be more like MOB (medical office buildings), where you won’t start building until you’re 50, 60, 70 percent pre-leased.
“But still, a lot of this market, once they get their funding, they need to go, right? They just need to start doing whatever it is they’re doing. But we… we may see a little bit less spec going forward.”
Ms. Gilchrist added that some tenants seem to be waiting longer to add space.
“So I think there’s still healthy demand out there. I just think it’s taking a little bit longer” to sign tenants, she said.
“And, to Tom’s point, I can’t see how in this environment we don’t see pre-leasing rates increase. We saw just a lot of spec projects kicking off in the last couple of years, in this cycle… and I just think we’re going to have to see higher levels of pre-leasing at this point.”
Pitfalls for new entrants
An audience member asked what the biggest mistakes are that developers tend to make when they first enter the LSRE market.
“This brings me to the pancake theory,” Ms. Gilchrist replied. An inexperienced firm’s first LSRE project is like a cook’s first pancake, she said, “and you always burn the first one… And that’s very much like your first lab project… It’s your pancake; you’re going to make mistakes.”
Ms. Rath of Ventas added: “I wish I had an analogy as good as the pancake. But I will say when we’re looking at redevelopment or opportunities in our portfolio, we do spend a lot of time talking to brokers, talking to would-be tenants, and understanding what they need day one so we don’t overbuild. And so I think the more time you spend, to Lauren’s point, doing that work and research, understanding what your tenants need, understanding the kind of warm shell that you need to have a place on day one, the more you can protect yourself against overspecialization and overspending.”
Mr. Errath added: “I guess the only example that that I’ve heard from some of our team is that people were converting buildings or buying buildings to convert, (but) the ceilings weren’t high enough, the floor loads weren’t strong enough. So all of a sudden these new developers build out this building that couldn’t be a lab building, so they got stuck with a very expensive, single-story office building.”
That’s why it’s important to have a good engineer, he said, and there’s no substitute for experience – “In Lauren’s terms, making two or three pancakes before you serve them.”
How M&As affect the real estate
Reflecting on Revista’s data regarding NIH funding and the recent decline in VC investment, Ms. Gilchrist noted that it varies by geographic markets and the life sciences companies in them. For example, she said, some markets have seen a big drop-off, but others are still seeing strong funding.
Then she brought up another big source of life sciences investment, and a potentially huge driver of LSRE space demand: major multinational pharmaceutical companies.
“The one question I’d like to introduce into the conversation is: What’s Big Pharma going to do?” Ms. Gilchrist asked. She noted that major pharmaceuticals companies poured about $30 billion in mergers and acquisitions (M&A), R&D and other investments last year, “which is the equivalent of the entire Federal government’s investment into the lab space.
“So what’s Big Pharma going to do? You know, (this is a) great time for mergers and acquisitions, a great time for them to reload, because they’re sitting on tons of cash and re-strategizing. We’re probably going to see a lot of that activity. And so I think the question, Tom, becomes: Does that spur additional demand? Does that spur some consolidation, and what happens there?
“So I think it’s an interesting moment and I think you’ve got to read the headlines, but you’ve also got to dig underneath.”
Mr. Errath replied that some acquisitions have already taken place, with Big Pharma buying smaller start-ups and other smaller companies.
“It’s kind of a cheap way to bring science in-house,” he said. “So I guess it might create some consolidation, but in some respects they might just leave it there. If you happen to be a landlord for one of these tenants, you just upped your credit.” He said Harrison Street has experienced that in its portfolio.
However, he continued, although the stock prices of many of the newly publicly traded biotech firms have declined sharply in recent month, “I think (would-be acquirers) are still waiting a little bit… because I don’t believe the equity in the stock market has really bottomed yet.”
“I think that’s right,” Ms. Gilchrist said, adding that the number of initial public offerings (IPOs) so far in 2022 has been “abysmal,” and “they were bad last year, too.”
Evaluating life sciences tenants
Ms. Rath of Ventas said: “With everything you guys have said, I’d just add a little bit about the tenant side – what we see in our local area.
“You might’ve expected to see a little bit of a slowdown,” she said, but “We’re still signing leases at rates well above what was in place before,” with reduced tenant improvement (TI) requirements, “as people are able to move into existing space more quickly. So we haven’t seen a slowdown on the demand side from our tenants coming in.”
Another key factor is overall market demand, Ms. Gilchrist said. With life sciences vacancy rates so low – less than 2 percent in some markets – even if a landlord loses a tenant, there are “many tenants behind them to fill that space back up.”
Ms. Rath added: “When it comes to evaluating tenants, we take a similar portfolio approach when looking at assets.” She said Ventas starts with market fundamentals, preferring geographic areas supported by research universities and hospital systems. Then the firm looks at the specific characteristics of the prospective tenants. Particularly for start-up life sciences companies, that means taking a close look at their management teams and their financials, including sources of financing, cash flow, balance sheets and so forth.
“And when it comes to evaluating the science,” she added, Ventas sometimes brings in consultants to help because “you really need to better understand the science.”
Harrison Street approaches tenant underwriting similarly, Mr. Errath said, “and what’s been interesting for me is we’re actually … on the phone with the (tenant) management team, which we don’t typically do in any of our other segments.” He said the company executives are “in some respects trying to sell us as much on their strategy and their viability, because we’re going to make a fairly significant investment.”
In terms of new construction and increasing inventory, Ms. Gilchrist asked, “I think the question is: How much is too much? How much supply is too much?”
The RevistaLab data is reassuring, she said, but Longfellow and its partners are keeping a close eye on vacancy and absorption rates.
“If all of this client space gets built, then yes,” it would be too much, Mr. Errath said. “But other side of life sciences, and I think this is why we’ve always liked it,” is how much money is being invested in the space – including money invested by the tenants.
“So if the tenant’s putting so much money into the space, are they going to move for five or $10 a foot or even $20 a foot, in some respects? And then you take that back even further, and you look at rent as a percentage of their operating budget, and usually it’s in the single digits or low teens, not like any other business…
“This isn’t a segment – again, why we like it – where people move just to get the cheapest next space,” he said. Life sciences tenants move because they’ve either outgrown the space or gone out of business. Either way, he said, you make sure you’ve built a space flexible enough to meet the needs of subsequent users.
Ms. Rath of Ventas added that, in addition to job growth, “when you look at some of the university statistics and people majoring in the sciences or majoring in degrees to go into the life sciences, those have been on the rise as well. So you have a bigger than ever job pool going into the life sciences and so, as that continues to grow, it will continue to help demand.”
‘Where’s the next best market?’
In the coming months, Revista plans to compile a nationwide database of LSRE data. So far, it has compiled data for the three largest U.S. life science clusters: Boston-Cambridge, Mass.; the San Francisco Bay Area; and the San Diego area.
With that data as backdrop, the panelists again touched the importance – and future prospects – for those clusters, as well as others.
The panelists expressed some mild concerns about the potential for overbuilding in the Boston and San Francisco clusters, but seemed to agree that those markets are so strong that even a modest uptick in vacancy rates would do little to dent their long-term attractiveness for life sciences and LSRE investment.
Ms. Rath of Ventas noted that the demand for life sciences space in some secondary markets “picked up in the last couple of years. We started seeing some of the Seattles, the Denvers in the top 20 or top 10.”
“I think it’s an interesting question, right?” Ms. Gilchrist said. “Because I get this a lot: ‘Where’s the next best market? Where should we be looking next?’
“And, a lot of times, it feels as though it’s real estate-driven because that’s what we do, when the reality is it … should be a little bit more macro driven, right?”
She noted that although two geographic markets have roughly the same LSRE space inventory, they can be worlds apart in terms of their attractiveness to investors and real estate firms.
That’s also something that can change over time, she said. Taking her home market of Philadelphia as any example, she observed: “Everybody’s interested in Philly right now. We have lots of new investors. We have lots of activity.”
The Philadelphia suburbs have long had a heavy concentration of Big Pharma firms that own their own real estate, she said. “But for decades, they didn’t do anything to sort of help capitalize on or kind of create new companies. That really took the universities to do that.
“So I almost think of it as like an ecosystem equation. It’s like: Do you have certain ingredients? Do you have certain amounts of capital? Do you have certain, you know, novel technology? And then the real estate follows.”
“We think about it a little bit the same way,” Mr. Errath said. “We think about it a lot from standpoint: Where’s the talent? And clearly the talent’s here (in Boston) and it’s in San Francisco and it’s San Diego. But more and more, we’re seeing some of that talent want to move to other places. So we’ve recently made some secondary market investments in Durham (N.C.) and Boulder, Colo., driven by a lot of those things Lauren talks about.
“It’s talent. Where’s the science going? We’re do young people want to live? And those are very popular places,” he continued. “So, for us, creating some of those places where all these things can occur in the secondary market, as long as all the other stuff works, provides some interesting opportunities going forward.”
“I’m excited about Philadelphia,” Ms. Gilchrist said, “but I feel like Raleigh-Durham is still a little bit of a sleeper and has really gained a lot of traction in the biomanufacturing space, and has really begun to accelerate some of those venture capital dollars. It’s still not a great venture investment market, and I feel like it is it’s got a long way to go, (but) the real estate is still fairly affordable. The venture environment is picking up. So if I’m kind of betting on momentum among the big markets, I think I’d bet on Raleigh-Durham.”
Ms. Rath of Ventas added: “Where I’m excited, I think it’s where you’re seeing population growth… and that certainly is in the North Carolina market. But it’s also in parts of Colorado, Seattle, parts of Texas. So, really, I follow that kind of broader macro trend, where you’re seeing some of the population and job growth.”
The panelists also noted that there are “very secure” agricultural technology – ag-tech – opportunities in St. Louis and other markets.
Mr. Errath added: “This is a market, a segment, investors are really excited about and we spend a lot of time with them. They’re excited about it around the world. We do this in the U.K., in Europe, too. That’s probably like five years-ish, maybe 10, behind the United States. And so we really see this whole life science real estate phenomenon happening in a lot of different places.”
Onshoring and nearshoring
Speaking of overseas markets, another tot topic in life sciences, as well as other industries, particularly semiconductor manufacturing, is “onshoring.” After being burned by supply issues and with concerns over our dependence on manufacturing taking place in foreign countries, particularly China, there has been a growing interest in onshoring, which refers to the establishment or relocation of manufacturing facilities back to the United States.
“I do wonder about ‘nearshoring’ if not actual onshoring,” Ms. Gilchrist said, citing as an example the discussion at a recent conference of the possibility of manufacturing in Puerto Rico.
“And I think if we saw anything in COVID, it was just how fragile the supply chain is,” she noted, adding that if those issues have been affecting the kind of basic consumer products Amazon sells, imagine the impact on highly specialized pharmaceutical manufacturing.
Also, if mass-produced drugs give way to personalized medicine and gene and cell therapy, which require in-person contact with the patient, that could lead to more localized, small-scale manufacturing. There can also sometimes be a need for manufacturing near where R&D is taking place.
“I’m not sure that it necessarily has to be right next door to the actual research and development,” Ms. Gilchrist said, “but the process is the product, right? And so, I think we will see an element of nearshoring as a result of these drugs being produced in these high-cost-talent markets in these dense clusters of research and development activity that… previously for regular pharmaceuticals, would have been sent overseas.
“I think it’s going to become much more critical to keep them nearshore. Maybe that means Mexico, maybe that means Canada. Maybe Puerto Rico’s coming back. But I really do think that there is an element to that because the scientists need to be close by when the process is the product.”
“The one challenging thing that you find with a place like Puerto Rico is infrastructure,” Mr. Errath said. “And I know they were recently impacted by a hurricane… and the island was down for a couple of days. So in this business you really can’t be down for a couple of days. So I mean that’s certainly a challenge with anybody valuing that. However, there was stuff manufactured there for years so they must have certainly figured that out.”
He added that nearshoring could also apply to domestic locations beyond the established life sciences clusters.
“I mean, could you put a facility and Wyoming or Colorado or a lower-cost state (where labor costs are lower?),” he asked, noting that areas like those have a much lower cost basis than the major clusters.
“And we’ve looked at a number of different … GMP opportunities around the country that have some of those characteristics, and I can see people starting to lean that way just to get out of these higher-cost markets. So clearly that might be an opportunity.”
‘Still a pretty bright future’
“I hope we’re not sounding doom and gloom here about what’s going to happen, because you know, these life science markets are as highly occupied as anything we do, in the mid- to high 90s,” Mr. Errath told the audience. “We like a lot of things about life sciences and it’s very consistent with the rest of the things we do across the alternative real estate sectors.
“So I think there’s still a pretty a pretty bright future here. It might be a little bumpy in the next year or so, but this segment has absolutely plans to grow.” ❏
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