Life Sciences: Some LSRE fundamentals improved in Q4 2023

Occupancies kept declining, but construction has slowed, RevistaLab data shows

By Murray W. Wolf

NATIONWIDE – Although occupancy rates in most life sciences real estate (LSRE) markets continued to decline during the fourth quarter (Q4) of 2023, construction activity moderated and space demand remained steady, which bodes well for better market conditions this year.

That was one of the key takeaways from Revista’s recent Q4 LSRE update webcast. Arnold, Md.-based Revista, with its RevistaLab and RevistaMed services, provides industry and real estate data for the healthcare and life sciences sectors.

Revista Co-Founder and Principal Hilda Martin kicked things off with an overview of life sciences industry funding, employment, construction and inventory.

“So 2023 certainly presented some challenges in the life science sector – not only for the companies themselves, but as well as the real estate that supports them,” she began. “But how did 2023 end up? What are we looking at going into ‘24? We’ve got some data to share with you today.”

Funding for life sciences companies remains strong

Ms. Martin began by discussing the level of funding coming into the life sciences industry. She noted that 2023 venture capital (VC) funding totaled about $22 billion, which is “down just under 5 percent from 2022 and down 37 percent from 2021, which she described as a “historic year” that was “off the charts.”

She added, “But, generally speaking, if you look back more historically, before the pandemic, you were seeing in 2018, 2019 this increase in funding levels that, although it skyrocketed after the pandemic, it’s sort of coming back to that natural trajectory now, with our total for 2022.

“Investors now, though, are certainly being a little more cautious,” she acknowledged. “They’re a little more risk-averse. They’re tending to invest in companies that are maybe a little further along in their process; maybe they’re in clinical trials or they have a clear roadmap. So certainly there’s been a shift in the types of investments that are happening and, in some ways, maybe this is a little bit … of a rightsizing.”

As for another key source of funding for life sciences research, the National Institutes of Health (NIH), Martin added, “NIH funding is not going to be as influenced with what’s going on in the overall market (and) ended the year at $38.1 billion. That’s up 23 percent from the pre-pandemic numbers.

“Now a lot of this funding is going to go to universities and hospitals and research institutions, but that really does fuel growth and it builds the ecosystem and can overall put some air in the tires wherever that funding is getting deployed,” she said. She added that the new Advanced Research Projects Agency for Health (ARPA-H) program, which “is very focused on high-impact, high-potential innovations,” provided another $1.5 billion in research funding last year.

“This program is cool,” she said of ARPA-H. “It’s addressing what particularly now might be a little bit of an underserved market because it’s wanting to put these funds towards some of the best ideas where the risk could be too high, the cost too large, the runway too long for other means of financing.

“So ARPA-H is exciting. They’ve already designated three hubs,” including Cambridge, Mass.; the Washington, D.C., area; and the Dallas area.

“So that’ll be very good for the Dallas metro for life science moving forward,” she said.

“All of this funding translates into employment” in the life sciences industry,” Ms. Martin continued. “There’s been a lot about this in the news of late. There have been lots of layoffs, especially in some of the mid-sized to smaller companies, bankruptcies. Certainly, that’s going to impact the growth for 2023 into 2024.”

Despite those well-publicized woes, she noted that the pace of growth for scientific research and development (R&D) jobs far surpasses that of total non-farm job growth.

“It’s definitely slowing for sure, but still growing,” she said.

LSRE growth is continuing despite headwinds

Ms. Martin noted that LSRE activity began to increase rapidly in 2018 and 2019, “when you saw that funding start to really tick up.” That prompted Revista, which has been tracking healthcare real estate, to also begin tracking LSRE.

She said the firm started by collecting data regarding the three largest clusters – Boston/Cambridge, the San Francisco Bay Area and the San Diego area – but has subsequently grown its database to include LSRE properties nationwide. Revista now tracks more than 440 million square feet of open and under construction life sciences properties across the United States, including investor-owned and user-owned facilities, and pure life sciences buildings as well as mixed-use developments with a life sciences component.

She noted that the top three markets “only represent about 36 percent of total inventory existing across the U.S., so there’s a significant amount outside of those markets.”

Ms. Martin acknowledged that the three largest clusters account for about half of the 82.8 million square feet of LSRE space that is currently in the pipeline.

“However, the flip side to that … 50 percent of construction is outside those major metros,” she pointed out. “So there’s a lot of growth and expansion happening throughout the U.S. and in some new and up-and-coming clusters.”

Ms. Martin then shared a slide showing the types of organizations that own LSRE. According to RevistaLab data, 57 percent of LSRE is owned by third parties, including 35 percent owned by private investors and 22 percent by real estate investment trusts (REITs). The other 43 percent is owned by life sciences companies (31 percent) and hospitals, universities and government organizations (12 percent).

When it comes to construction, she noted, the mix is quite different. Of the aforementioned 82.8 million square feet of LSRE in the pipeline, third parties account for 74 percent, including 48 percent private investors and 26 percent REITs. The other 26 percent is being developed by life sciences companies (16 percent) and hospitals, universities and government organizations (10 percent).

“So we’re going to continue to see a shift towards (a higher percentage of investor-owned properties) as these projects open,” she noted.

According to RevistaLab data, the top 10 developers based on square footage now under construction are:
■ Alexandria Real Estate Equities Inc. (NYSE: ARE), 6.6 million square feet;
■ BioMed Realty, a unit of Blackstone Inc. (NYSE: BX), 4.6 million square feet;
■ Lane Partners LLC, 3.5 square feet;
■ IQHQ Inc., 3.5 million square feet;
■ Wexford Science & Technology, 2.4 million square feet;
■ Trammell Crow Company, a unit of CBRE Group Inc. (NYSE: CBRE), 2.4 million square feet;
■ King Street Properties, 2 million square feet;
■ Longfellow Real Estate Partners, 1.8 million square feet;
■ Boston Properties Inc. (NYSE: BXP), 1.8 million square feet; and
■ WS Development,1.5 million square feet.

“These 10 developers represent 36 percent of … everything that’s under construction,” she noted. “So you’ve got a very concentrated group of companies that are basically driving a lot of the construction that’s currently underway.”

Concerns about overbuilding

The recent surge in new development in the LSRE space has raised concerns about overbuilding. Ms. Martin noted, “That 82.8 million square feet (currently under construction) is almost a quarter of existing inventories. So what’s currently underway will drive up inventory 24 percent when it opens.

“So, there’s still a very large pipeline; there’s still a lot being delivered. When we look at all of 2023, 17.8 million square feet opened, which is a tick down from the third quarter. But it’s still four times what we were seeing on an annual basis prior to the pandemic.”

However, she noted, construction starts have been declining steadily since Q4 2022 on a trailing 12 months (TTM) basis, and have dropped to pre-pandemic levels.

“Construction starts have come down quite a bit,” she said. “We were at an annual run rate of over 50 million square feet starting (in Q4 2022). In the most current quarter, for all of last year, it was 26.7 million square feet. So it literally cut in half on an annual basis how much we’re starting, which is good.”

She said that soaring demand and the relatively easy availability of project financing spurred the record level of construction starts in 2022.

“And now we’ve had developers catch up with that, and now there’s been a pullback in funding,” she said. “So it’s sort of finding that balance moving forward between demand and new inventory.”

As for the nature of the projects now proceeding, Ms. Martin said, ”It’s definitely a slightly different picture…” She noted that more than half of the projects started last year “are either 100 percent pre-leased or driven by the user. So you don’t see nearly as much as that pure speculative development projects breaking ground.

As for the future, she said Revista is tracking a “monstrous” planned pipeline of more than 200 million square feet. However, she said, “We imagine that a lot of that is either going to shift directions or it’s not going to move forward.”

As an example of the type of projects that are moving forward, Ms. Martin mentioned “Project Black Bear,” a $170 million, 400,000 square foot R&D with supporting office space that broke ground in November in the Minneapolis suburb of Maple Grove, Minn. Developed by Ryan Companies US Inc., the project is being purpose-built for medical device maker Boston Scientific Corp. (NYSE: BSX).

In addition to being an example of a non-speculative project, the new space for Marlborough, Mass.-based Boston Scientific is an example of LSRE development beyond the three largest clusters.

The push for manufacturing has moderated

Ms. Martin also noted that, as a percentage of total square footage, the 2021 and 2022 uptick in construction starts for manufacturing facilities has moderated a bit. In 2020, a little more than 20 percent of construction starts included some manufacturing component. That grew to about 40 percent in 2022, but declined to about 30 percent last year.

“We’ll see if there’s just some mix of developers holding off on certain types of projects or whether that’s a trend that we’ll see continue,” she said.

In terms of LSRE sales transactions, Ms. Martin noted, “All of commercial real estate has been seeing a pullback in transaction activity; life science is certainly in that bucket. It’s the rising interest rates, it’s the difference between buyers and sellers and their viewpoints on valuation.

“Very likely we’ll see maybe things start to thaw this year. There’s a little bit more clarity on what’s happening with interest rates in the market. But, as we ended 2023, the total for the year for life science in terms of (sales) volume was $6.4 billion. So that’s certainly down from the $13 billion in ‘22 and the $18 billion in ‘21,” although she noted that 2023 sales surpassed pre-pandemic levels.

“In the fourth quarter, $3.2 billion traded,” she noted, “which is half of everything that traded throughout the year. So there was a little bit of an uptick starting.” She also noted that, on a TTM basis, the average capitalization rate on an LSRE sale has been on the rise since Q4 2021, when it bottomed out at 4.1 percent; it was 5.6 percent as of Q4 2023, an increase of 150 basis points.

Who’s buying and selling LSRE?

Ms. Martin then discussed the mix of LSRE buyers and sellers and how that has changed during the past five years, most notably how REITs have become net sellers. In 2020, REITs accounted for more than half (52 percent) of all LSRE acquisitions; last year, REITs accounted for 6 percent. Conversely, REITs sold almost no LSRE assets in 2019, but accounted for nearly half (47 percent) of sales last year.

The big seller has been Alexandria Real Estate Equities Inc., the largest owner of LSRE, which has been pursuing a “value harvesting and asset recycling program” it says will continue in 2024.

RevistaLab data also suggests that private investors have been more willing to buy and less willing to sell during the past five years, at least in terms of the percentage of total acquisitions. Private investors were responsible for 44 percent of acquisitions in 2020, which increased to 54 percent in 2021, 76 percent in 2022 and 70 percent last year. Private investors made 80 percent of sales in 2020, gradually declining to 39 percent last year.

“So it’s interesting to see that interplay there,” Ms. Martin said, “and there’ll be a lot of opportunities as we move forward for acquisitions, not only distressed opportunities with their slow lease-up, but also in the next couple of years when things sort of right-size, there’s going to be all this new inventory and opportunities there as well.”

At that point, Ms. Martin handed off the presentation to another Revista Co-Founder and Principal, Mike Hargrave.

“It’s no secret … that inventory has been Increasing lately in many … life science markets,” Mr. Hargrave began. “Developers obviously have been responding to increasing demand for new space, really, during the past few years, and especially coming out of the COVID-19 pandemic that we saw back in 2020.”

To illustrate those market trends, he then shared data from the three largest markets about occupancy and absorption rates, sub-leasing, space availability, rental rates, pre-leasing, construction starts and project completions.

What’s happening in the Boston area?

Starting with the Boston Core-Based Statistical Area (CBSA), he noted, “About 8 million square feet of lab space that has been completed in the Boston market during the past six quarters. During that same time, absorption has been really strong, at a little over 6 million square feet, but it’s been underneath the level of completion. So, as a result, the occupancy rate during this time has fallen market-wide from 94.4 percent to 92.1 percent.”

Noting that Revista tracks occupancy rates on both a direct and sub-leased basis, he pointed out that Boston-area direct-leased space “has fared much better” than sub-leased space. The occupancy rates for direct-leased space have declined about 180 basis points during the past six quarters, about 50 basis points less than for sub-leased space.

“Another way to look at vacancy in the market … is to look at the availability rate,” he explained. “So the availability rate measures all of the vacant space in both open as well as in-progress construction properties each and every quarter.”

On that basis, he said, “A lot of the vacancy in Boston is as a result of properties that are currently under construction,” suggesting that existing properties aren’t necessarily to blame for the overall rise in vacancy rates.

He added that the availability rate in Boston declined to 16.2 percent in Q4 2023.

“This is likely a sign of demand beginning to soak up some of the excess inventory that has been delivered to the Boston CBSA,” he said.

As for Boston-area LSRE construction, Mr. Hargrave noted that the square footage of projects under construction has leveled out and the square footage of construction starts has declined steadily during the past year, a sign that the construction pipeline is stabilizing.

Mr. Hargrave then shared similar data for the San Diego and San Francisco CBSAs. In both markets, as in the Boston area, the occupancy rates have declined steadily since Q1 2023.

Some similarities in San Diego

In San Diego, the overall occupancy rate has fallen about 320 basis points during the past six quarters, to 88.9 percent during Q4 2023 from 92.1 percent Q2 2022. Completions totaled about 2.4 million square feet during that time, while absorption totaled about 1.2 million square feet.

“So absorption has been about half of completions during the past six quarters, and this is why the occupancy rate has fallen in the San Diego market,” he said.

The occupancy rate from Q3 2023 through Q4 2023 was stable, he noted, “So this is where you say, ‘Flat is the new up,’ I guess.”

“The one thing that is really driving the overall occupancy rate lower in San Diego is an increase in the sub-lease space available during the past six quarters,” he said, an increase of nearly 427,000 square feet during that period.

“That’s really the culprit that’s driving the occupancy rate lower in the market,” he said.

Without sub-leased space, the vacancy rate would be 90.6 percent, he said.

“That’s down in the past year, but it’s actually up sequentially from the third quarter of 2023 when it was 90.2 percent, so that’s an encouraging sign in the San Diego market,” he said.

In terms of the availability rate, he continued, “There’s about 2.7 million square feet of vacant space and open properties, and about 2.2 million square feet of vacant space in under-construction properties, in progress, in the market… The overall vacancy ticked down from about 200,000 square feet from the third quarter of 2023, so overall vacant space is lower in the market compared to last quarter. So, the overall availability rate fell from 16.7 percent in 3Q ‘23 to 15.7 percent in the fourth quarter of 2023…”

Mr. Hargrave noted that “the construction pipeline in San Diego is at a cyclical high. It’s currently at 7.1 million square feet,” up from 4.1 million square feet in Q4 2021.

“Trailing 12-month starts are currently 2.2 million square feet. While that’s down from 5 million square feet in 2022, it has ticked up from the level that we saw in just last quarter, in the third quarter of 2023.”

He noted that the pre-leasing percentage for the in-progress pipeline is “pretty strong” at about 67 percent.

“So we’ll see … where this all goes when some of this construction hits the market beginning in 2024.”

The Bay Area is seeing higher vacancies

Turning to the San Francisco-San Jose CBSA, Mr. Hargrave noted, “The occupancy rate has fallen about 290 basis points during the past six quarters. It’s currently at 89.8 percent, and I want to point your attention to really, just the past quarter or so, it’s fallen pretty significantly. We actually saw in the fourth quarter of 2023, negative absorption of about 131,000 square feet, and this was in the face of completions of about 775,000 square feet, so the occupancy rate fell from the third quarter of 2023 to the fourth quarter of 2023.

“Overall, about 4 million square feet has been completed in the market in the past six quarters, and absorption has been about 2.5 million square feet during that time, so a little bit less than 50 percent absorption level during the past six quarters.”

He went on to show that sub-leased space available in the Bay Area has increased to almost 1 million square feet as of Q4 2023.

Although the overall occupancy rate in the market has fallen “precipitously” during the past year, Mr. Hargrave noted, the direct occupancy rate has “fared much better.” Although the direct occupancy rate has also declined, it was about 92 percent as of Q4 2023.

“The availability rate in San Francisco/San Jose fourth quarter 2023 was 22.2 percent. That’s the highest of the three markets that I’ve gone over so far,” he continued. “There’s almost 8 million square feet of available space in under-construction properties, and about 4.5 million square feet available in open properties…

“There’s more vacancy in the under-construction group than there is in the open group. And the availability rate, unlike the other two markets, has actually been slowly increasing over the past year or so… a little bit different trend that you’re seeing in the fundamentals in San Francisco/San Jose than you’re seeing in Boston or San Diego.

On the other hand, the Bay Area is similar to the Boston and San Diego markets in that the construction pipeline is “relatively stable,” Mr. Hargrave said.

“You can see it’s showing signs of starting to come down a little bit, and that’s being driven by TTM starts,” he said, which were 3.2 million square feet during Q4 2023. “That’s decidedly down from almost 11 million square feet that we saw just three quarters ago in the first quarter of 2023.

“It looks like in San Francisco there’s a little bit more speculative construction than you see in the other two markets. We count pre-lease space for in-progress at about 40 percent of the current in-progress pipeline.”

Other markets are also active

Next, Mr. Hargrave shared information about all 14 top markets across the United States.

He noted that, in terms of existing LSRE square footage, the New York-Newark-Jesey City metro area is actually the largest, with 38.1 million square feet, “but it stretches into three different states. It’s a big, big metro area.

He also noted that all of the 14 top markets saw at least some new construction begin last year.

“Every single market has had construction activity over the past year,” he said,” and really all the markets but Los Angeles have current construction in progress…

“When we look at the occupancy rates in these markets, you can see they range from a high of 99.8 percent in the Minneapolis market to a low of 79 percent in the Princeton/Trenton, New Jersey, market. And just like (the three largest markets), most of these markets are seeing some measure of occupancy loss over the past year – some greater than others.

Finally, Mr. Hargrave shared some data regarding rents.

“In-place rents peaked back in 2022,” he said. “We also saw that landlords really had the upper hand in terms of writing leases. We saw many leases with big Year 1 escalators. That may not necessarily translate over the life of the lease, but we saw a lot of demand-side power in terms of the terms of the landlords.

“That’s come down a little bit into 2023. We’ve seen some fall-off on the in-place leases that are being written… (They) are a little bit lower, although we’re not seeing anywhere in our data any mention of or any evidence that there’s a stripping of demand in terms of landlords providing more concessions or lowering escalations. We still see 3 percent-plus escalators in leases that were written even in the late part of 2023…”

Ms. Martin said, with at least some LSRE construction underway in almost every market, it is interesting to see how much exposure the different metro areas will have when those project open. Some markets, like San Diego, with 67 percent pre-leasing for its under-construction space, have strong pre-leasing, but others don’t.

“So even when you’re looking at some of the differences in absorption currently, and the direction of occupancy, it really varies area to area how things are going to look down the line when this stuff opens,” she said.

“I agree, it’s amazing,” Mr. Hargrave said. “You have a lot of development going on. But, also at the same time, you have a lot of demand going on for space. And so there might be more options on the tenant side and looking for space.”

But he said the ongoing demand demonstrates “a pro-growth agenda for the life science sector, which is encouraging for a lot of participants in the sector and what’s moving forward.” ❏