After this year’s slowdown, LSRE professionals have high hopes for 2024
By Murray W. Wolf
NATIONAL – In looking back on the year in life sciences real estate (LSRE), 2023 was obviously The Year of the Slowdown.
We have not yet closed the books on 2023, so we don’t have final data. But it looks like total investment sales this year will end up as only a fraction of the annual levels achieved from 2020-22. Likewise, construction starts declined steadily this year, dropping to early 2022 levels.
LSRE sales volume during the third quarter (Q3) was about $300 million, according to RevistaLab data, versus about $3.4 billion in Q3 2022. For the trailing 12 months (TTM) that ended Sept. 30, there were 61 deals with a total value of about $4.8 billion, versus 263 deals for a total of nearly $18.4 billion – both record highs – for the TTM that ended a year earlier.
Through it all, however, LSRE professionals steadfastly continued to insist that the fundamentals of this sector remain strong, and 2024 might even usher in the start of a rebound.
Let’s take a closer look at some of the events and trends that defined this year with BREI’s somewhat subjective thoughts on the biggest LSRE stories and trends of 2023.
Nothing ventured, nothing gained. In a September market report, Jones Lang LaSalle Inc. (NYSE: JLL) noted the critical link between venture capital (VC) investment in life sciences and the prospects for LSRE.
“One of the purest relationships in the biotech sub-sector is between venture funding rounds and how the recipient start-ups use those funds to expand their footprints,” the JLL report noted. In other words, the volume of VC investment in life sciences companies tends to be highly correlated with LSRE demand, and that level of investment was down sharply in 2023.
JLL’s report showed that after a peak of 2,771 VC deals accounting for about $46 billion in life sciences investment in 2021, and a fairly modest reduction to 2,038 deals totaling about $36 billion in 2022, VC funding had sunk to 742 deals totaling about $11.6 billion by the time of the report.
And while the 2023 dip in VC funding was felt, that was mostly because investment reached unprecedented levels in 2022.
During the IMN (Information Management Network) Life Sciences Real Estate Forum in New York in July, it was noted that funding for life sciences was relatively flat at about $100 billion per year from 2006-16 before rising to about $200 billion per year from 2016-2021.
“So while we have declined slightly from 2021, we are still at – if you look at it over the past 20 years – we are still at an extremely high rate in terms of funding,” noted Sondra Wenger, senior managing director and head of CRE, Americas, for CBRE Investment Management, a unit of the CRE services and investment firm CBRE Group Inc. (NYSE: CBRE).
Debt dilemma. In addition to the relative drop-off in VC investing, the LSRE market was also challenged this year by high inflation, rising interest rates and other factors, ushering “a period of adjustment,” according to the IMN conference panelists. Consequently, investors and developers across all asset classes, including LSRE, found debt to be more expensive and more difficult to obtain. Many lenders and investors, who had enthusiastically climbed aboard the LSRE bandwagon in 2021-22, “put down their pencils” in 2023.
Even so, some financing deals still got done. For example, JLL’s Capital Markets group announced in June that it had arranged a $750 million construction loan for the first phase of the Enterprise Research Campus (ERC), a 900,000 square foot, master-planned mixed-use development in Boston, near Harvard University.
In another example, Breakthrough Properties announced in May that it had secured a $130 construction loan from Corebridge Financial and has started construction for 2300 Market by Breakthrough, an eight-story, 223,000 square foot office and research and development (R&D) project in Philadelphia. And, in June, Boylston Properties and J.P. Morgan Global Alternatives announced that they had closed on a $150 million loan from Northwestern Mutual for 100 Forge, a nine-story, 165,600 square foot life sciences building in Watertown, Mass.
More recently, CBRE announced that it arranged $136 million in financing for the previously disclosed 164,747 square foot expansion of the Ionis Pharmaceuticals Inc. (Nasdaq: IONS) 18.4-acre campus in Carlsbad, Calif. As BREI reported Dec. 9, Oxford Properties Group, a Toronto-based real estate investor, developer and manager, recently broke ground for the project.
‘Value harvesting and capital recycling.’ Alexandria Real Estate Equities Inc. (NYSE: ARE) is believed to be the largest owner and developer of LSRE, which means its actions always attract outsized attention from those who follow this sector. This year was no different. But what changed were the types of actions. Rather than acquisitions and new developments, Alexandria concentrated on “value harvesting and capital recycling strategies.” The Pasadena, Calif.-based real estate investment trust (REIT) recapitalized, sold or sold interests in several properties this year, sometimes at loss.
Some of those deals included: the April sale of a partial interest in the under-construction 15 Necco Street project in Boston to Mori Trust Co. Ltd.; the $86 million sale to DivcoWest in May of a two-story, 72,506 square foot facility at 11119 N. Torrey Pines Road in San Diego; the $365 million sale in June of a five-building, roughly 425,000 square foot LSRE portfolio in Cambridge and Waltham, Mass., to Alloy Properties and joint venture (JV) partner Anchor Line Partners; the $160.5 million recapitalization in June of an existing JV for 9625 Towne Centre Drive in San Diego; and the June sale to Boston Children’s Hospital of 41 percent of the square footage in the 660,034 square foot 421 Park Drive development in Boston.
It was also reported in June that a MassMutual subsidiary and Boston-based developer Greatland Realty Partners had acquired the three-building, 510,000 square foot Riverside Center in Newton, Mass., from Alexandria for $117.5 million. The REIT acquired the complex for $235 million in January 2020 with plans for a lab conversion, but a softening of the life sciences market prompted the firm to drop those plans.
BXP also sold a major interest. Alexandria wasn’t the only REIT that sold a major interest in one of its LSRE developments in 2023. In fact, a November deal by Boston Properties Inc. (NYSE: BXP) might go down as the largest LSRE transaction of the year.
Under the deal, PXP said it agreed to sell a 45 percent interest in two developments in Cambridge, Mass., at a gross valuation of about $1.66 billion. On that basis, a 45 percent interest would be worth $746.4 million. The buyer is Norges Bank Investment Management (NBIM), the branch of Oslo, Norway-based Norges Bank responsible for managing the Norwegian Government Pension Fund. The properties in question, lab and office buildings now under construction in Cambridge’s Kendall Square area, total about 810,000 square feet.
The conversion craze cooled. As noted above, Alexandria backed away from conversion plans for a property in Newtown, Mass. But many other LSRE firms apparently had second thoughts about life sciences conversions this year.
To be sure, the conversion of an existing office building or other property to life sciences use can sometimes be viable, potentially providing reduced costs and increased speed to market. But during the overheated LSRE market of 2021-22, when lab demand outstripped supply in many markets, it seemed that some developers considered nearly any type of property ripe for conversion – anything from car dealerships to decommissioned nuclear power plants.
However, the conversion craze has cooled. The most recent data from LSRE and healthcare real estate research firm Revista indicates that the number of conversion projects in planning nationwide fell to 85 projects totaling about 13.1 million square feet and about $9.1 billion in construction value through the end of the Q3. That is still significant, but that represented only about 15.7 percent of all LSRE projects currently in planning. That compares with about one-quarter to one-third of all projects in 2021-22. New construction now accounts for nearly 82 percent of new projects, with a few renovations and expansions making up the balance.
In addition, some of the proposed conversions will probably never come to fruition. Part of this can probably be explained by increased selectivity on the part of both tenants and investors, at least in the short term. As part of that, there has been a “flight to quality” and a “reversion to the core,” as tenants and investors are more interested in top-quality facilities in the most desirable locations.
Development dipped. Speaking of new development, RevistaLab data indicates that LSRE construction starts declined steadily this year. Although the number and total square footage of projects completed continued to rise, development is, of course, usually a multi-year process. Consequently, the vast majority of the projects delivered this year were in the pipeline two or three years ago, when capital was flowing and tenant demand was high.
Today, with financing much more difficult to find and cooler demand, it’s no surprise that construction starts are down. As the September JLL report noted, “A supply wave of lab space is hitting markets across the U.S., with higher concentration in Boston and the Bay Area,” which is increasing vacancy rates. However, the report noted, “The pipeline for lab space has peaked, and completion of projects is expected to surpass new project starts in the coming years, thus reducing the pipeline. Downward pressure on base rents and occupancy is anticipated in top markets in the short run before supply begins to mediate at the end of 2024.”
And while speculative projects were commonplace in 2021-22, investors and lenders became much more cautious in 2023. So although at least some level of spec development always makes sense in the LSRE sector, single-tenant net-leased and substantially leased multi-tenant projects were more likely to be funded this year.
Good tidings from the Fed. One challenge that might diminish in 2024 is relatively high interest rates. The U.S. Federal Reserve announced Dec. 13 that it had finished raising interest rates for the foreseeable future, and Chairman Jerome Powell noted that the Fed might reduce rates multiple times in 2024.
The potential for lower interest rates was an early Christmas gift for the financial markets and most business sectors, including LSRE, although it would probably take until later in 2024 for much positive impact to be felt if rates are indeed cut.
Reassuring fundamentals. Despite a down year in 2023, and the probability of only a partial recovery in 2024, most LSRE professionals seem to agree that the life sciences and LSRE businesses continues to be characterized by good long-term fundamentals and strong investor demand, and that they are still very promising businesses to be in.
“The scientists will tell you that the science continues,” Lauren Gilchrist, executive VP and Philadelphia market leader for Newmark Group Inc. (NYSE: NMRK), said during the IMN conference, “and I would say that this is probably a moment in time as the sector resets a little bit and we are likely to see robust demand down the pike as a result of the structural changes that we’ve seen in the sector overall.”
An October report from Cushman and Wakefield (NYSE: CWK) expressed similar optimism. After riding a wave of “hypergrowth” during the early stages of the COVID-19 pandemic in 2020 and 2021, the life sciences industry is transitioning into a more stable environment, the report said. The long-term prospects for the life sciences industry and LSRE remain excellent, Cushman and Wakefield insisted. It’s just that what some would say were the days of easy money and rampant speculative development have now given way to a renewed focus on the fundamentals that made life sciences and LSRE compelling investments long before the pandemic.
Additional positive signs were shared in November during Revista’s first LSRE market update webcast. One of the panelists, Elizabeth Berthelette, head of National Life Science Research for Newmark Group, noted that although life sciences industry employment and funding trends are well below their 2021-22 peaks, both are comparable to their pre-pandemic levels.
On the funding side, Ms. Berthelette added, VC funding has increased every quarter this year, rising to $7.1 million in Q3 – more than before the pandemic – although there appears to be a “flight to quality” as VC investors have done fewer but bigger deals. Meanwhile, National Institutes of Health (NIH) funding is also at an all-time high, and U.S. Food and Drug Administration (FDA) clinical trials and new drug approvals are both at their highest levels ever.
So as we bid adieu to 2023, we can’t summarize the year any better than Alexandria executives did during their Q3 earnings conference call with securities analysts, when they asserted that concerns about the LSRE sector are overblown despite “a de facto recession,” a “self-inflicted inflationary and high interest rate environment” and “too much stupid supply.”
For a longer version of this article with additional information and comments regarding 2023 and the prospects for 2024, please click here.
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