Life Sciences: How and when will LSRE development rebound?

There’s no ‘silver bullet,’ RevistaLab panelists say, but there are hints of progress

Editor’s note: This article is part one of our coverage of a recent panel discussion on life sciences real estate (LSRE) development. Part two will appear next week.

PASADENA, Calif. – Life sciences real estate (LSRE) construction starts have been declining steadily since the fourth quarter (Q4) of 2022. Starts totaled about 28.4 million square feet during Q4 2023 on a trailing 12-month (TTM) basis, down 43.8 percent from the 50.5 million peak recorded one year prior, according to RevistaLab data.

The decline in construction starts is even more stark on a quarterly basis. Starts during Q4 2023 totaled about 5.4 million square feet versus a peak of about 14.3 million square feet during the Q2 2022 heyday – a decline of 62.2 percent.

At the same time, there is another 83.1 million square feet of life sciences space under construction and in the pipeline, according to RevistaLab data – plus another 64 million square feet of approved projects and 80.8 million square feet of proposed projects waiting in the wings.

Meanwhile, the very market conditions that led to the decline in construction starts persist, namely higher interest rates, skittish lenders, reduced space demand from life sciences companies and reduced funding from investors.

With tens of millions of square feet of additional life sciences space already under construction and getting ready to deliver amid a tough market, the reasons for the decline in construction starts seem obvious. However, there are still millions of square feet of life sciences projects breaking ground every quarter. So the market dynamics are a bit more nuanced.

To better understand what is happening in the market, BREI took the opportunity to sit in on a panel discussion of LSRE development during the RevistaLab Life Science Real Estate Investment Forum in Pasadena, Calif., Feb. 29.

The session, titled “A Deep Dive into Life Science Development,” was moderated by BREI Publisher and Founder Murray W. Wolf and featured:
■ Will Germain, CEO and managing partner, MCB Science + Health;
■ Eric Johnson, executive managing director, Transwestern Real Estate Services;
■ Nancy Moses, principal, Trammell Crow Company; and
■ Liz Sillay, senior counsel, HCA Healthcare (NYSE: HCA).

After the panelists introduced themselves, Mr. Wolf, who for more than 21 years has also been publisher of Healthcare Real Estate Insights (HREI), began the discussion by comparing the current state of the LSRE market with that of the healthcare real estate (HRE) space.

“Just one thing I have to say before we get started is that the people in healthcare real estate like to talk about how 20, 25 years ago, they used to go to conferences and there’d be maybe 18, 20 people at those events,” Mr. Wolf began. Then, looking out over the noticeably larger audience for the Revista event, he continued, “We’re doing a lot better than that already.”

Although life sciences as a specialized real estate market – separate from office and industrial space – has existed since at least the 1990s, he noted that the most rapid period of market growth by far has been the past decade or so, particularly in the past three years.

“I think what’s so exciting… is that we’re really still just at the beginning,” he continued. “If you look at the long-term demographics and all of the indicators, this is going to be a tremendous industry to be a part of for a long, long time to come and you should all be proud of yourselves for being kind of on the cutting edge and getting there first.”

Mr. Wolf then shared the construction data detailed above – the “bad news” regarding the downward trends in LSRE starts and the massive amount of additional space under construction, approved and proposed.

“Construction starts for life sciences real estate just soared over the past few years and there are many, many projects in the pipeline,” he said. “Construction starts now have tapered off for reasons that I think we all understand…

“But there’s still a pretty high pipeline coming down the pike,” he continued. “If you’re a developer – not such good news.”

However, he noted that although venture capital (VC) investment in life sciences is down from its peak of about $6 billion in 2021, “it is still very high by historic levels” and National Institutes of Health (NIH) funding is at an all-time high.

Interest rates, geopolitics and labor

Mr. Wolf then asked the panelists for their insights into the LSRE development market.

Mr. Germain explained that MCB Science + Health “is a full-service real estate development and investment firm. We’re in Chicago, but we are part of a company called MCB Real Estate, which is based in Baltimore. So it’s a $3 billion real estate investment company focused on multiple asset classes.”

With respect to the outlook for LSRE, he said, “I guess maybe taking a quick step back and talking about just the economy as a whole, and I think there are probably three things that I think about (in terms of) where things are going,” he said.

“One is obviously inflation and just the rising cost of capital, which I think is impacting us all… Obviously, that impacted the real estate industry, but also the Big Pharma players as well, which is causing them to slow down their activity from an M&A (mergers and acquisitions) standpoint.

“I think the second thing that makes me a little bit nervous sometimes is just some of the geopolitical tensions,” he continued. “I think Big Pharma companies are global, they work in a global supply chain, and those disruptions cause them to slow down their decision-making and how they think about where they spend their dollars and how fast they spend their dollars.

“And I think the last thing is really around just the labor market in general. I think unemployment is relatively low, but I think there are some concerns around just the quality of employees for specific industries. So the healthcare and life science industries being the two that we are in, (those) really have their own kind of headwinds and challenges.”

Even so, Mr. Germain said, “There are some real positive things happening in our space, in our industry, and some opportunities.” Noting that the record NIH funding “primarily goes to not-for-profits like universities and research institutions,” he said, “I think that bodes well for projects that are centered or adjacent to universities and research parks… I think that those types of investments in life sciences are faring a little bit better than the traditional life science activity that you’re seeing in some of the core markets like Boston and San Diego.”

He added that there are numerous other federal, state and local funding programs intended to support the life sciences industry that bolster development efforts.

He noted that although VC funding of life sciences has slowed because they take their cue from what’s happening with the Big Pharma companies, some of which have also pulled back. But, he added, “I think, over time, as things start to normalize, that activity should start to increase again.”

He also observed that “healthcare spending continues to rise, right across the country, so that drives the need for continued innovation to try to curtail that spend or the rate of growth of that spend.”

Other strong industry fundamentals, he said, include the growth of personalized medicine and the potential for artificial intelligence (AI) to accelerate the pace of research.

What’s happening on the real estate side?

When asked about what is happening on the real estate development side, particularly the impact of softer leasing activity, Mr. Germain replied, “I think it really is market-specific and project-specific… Generally speaking, because of the slowdown in the VC funding that our tenants typically rely on, they are taking a lot more time to make a decision about their space needs. So that obviously impacts us on the development side in terms of delivering new buildings. If there’s not the demand… that hurts what we can do.

“But I think (there are still opportunities) in certain markets and certain projects,” he said, especially “around some of the things that the universities are doing. I think there is a little bit more demand there. But they still have their own challenges that they’re facing as well. But I think we’ll probably see that rise over time.

“But, right now, it’s a little bit challenging for everybody.”

Asked what it will take to reverse the downward trends in LSRE development, Mr. Germain said it will require several occurrences, including a reduction and stabilization of interest rates and an easing of geopolitical tensions.

“I don’t think there’s a silver bullet that’s going to” make the LSRE industry “just take off,” he replied.

Noting the billions of dollars of VC and government funding that continues to pour into the life sciences industry, he said, “There’s still a lot of capital there, it’s just not being deployed. I think eventually they’ll start to come back into the market; they already have.

“So I think all of these things… will start to finally culminate to create more demand, which will… allow us to deliver on the supply.

“And I also think there was a lot of overbuilding, right? So we have to work through some of that supply… We have no choice, right? If you look at markets like Boston and San Diego where there was just a lot of heavy supply, it’s going to take some time to fill, backfill those spaces…

“So I think some of these other macro things will happen, and we’ll be hopefully back on pace… hopefully soon.”

How soon is ‘soon?’

Ms. Moses said, “I’m your local friendly neighborhood developer out of the Greater Los Angeles for Trammell Crow Company… We have 16, 17 offices nationwide. We’ve also moved over into Europe focusing on industrial, multifamily and commercial; commercial includes office. It’s still there, people. It’s still coming back.

“Healthcare and life sciences? I’m out of our Greater Los Angeles office, but excited to be talking about some of our other projects. We actually have a project in Georgia that I’m happy to talk about, and San Diego and then Los Angeles.”

With respect to the state of the LSRE market, she shared, “Last night I had dinner with a few of my friendly capital partners. And Will, I think you hit upon a lot of good points. Like, there’s a lot of capital out there waiting to deploy. Everyone’s sitting on the sidelines.”

Ms. Moses said that the current investor sentiment is positive and “we all want to say (activity will begin to rebound) mid this year, second quarter 2024.”

However, she added, “There is some kind of hesitation of who’s the first person to jump in, and whether or not it’s going to take the Feds (the U.S. Federal Reserve) to actually lower the rates one time, just to prove that we’re done with this whole 2023 fun-time.

“I think overall, the other concern around the corner is that we do have an election in November and, historically speaking, that usually causes a hesitancy in our… debt partners wanting to invest more money. They want to figure out what’s going to happen, what’s the outcome of that election, and then how is that going to impact any future investments. I think this year is going to be a bunch of hurry up and wait…”

However, she continued, “I think a lot of us are very excited about opportunities. I think 2023 was the year of creativity, especially as a developer. I can happily say that our company focused on land acquisitions and how do we look for great real estate in this market, trying to figure out the next investment. So when the timing is right, we’re delivering the products when our tenants are out there ready to lease the space immediately, because we recognize this is a point in time…

Ms. Moses added, “Unfortunately, I can say I worked here in 2007, so I was in that time when… back in the day, everyone said office was going to die then, too. I think we’re in a period where there’s a shift, there’s a pivot, and we’re rethinking, re-strategizing how we’re developing projects that we’re finding capital, how we’re underwriting deals.

“This year I think is probably going to be a little bit slower than we want it to be, but I do think that there’s going to be a lot of creativity in the developments that our partners are putting out there.”

Ms. Sillay, an attorney with HCA, based in Nashville, Tenn., said, “I’ve been in healthcare for 25 years. I support HCA’s Research Institute and, prior to coming to HCA seven years ago, I was in private practice and worked with lots of startups in the biotech space. So I love talking about emerging life science companies.

“I’ll touch on some of that creativity,” she said. “It will come from partnerships that look unique: academic, public, private.

“Another factor that I want to introduce is that life science companies, particularly the smaller ones that are just starting, are not necessarily funded through traditional funding sources. They really get their dollars for real estate and for other purposes from venture capital, from even seed and angel funders. So that looks different and it makes the conversations around financing for development and for leasing slightly different as well.”

Mr. Germain added, “Yeah. I think that’s a good point. Just along those lines… I think these startup companies. some of them are coming out of the universities, and spending on the universities, and so they’re being supported by the universities and they’re able to obtain other types of government funding and support to help sustain them, from an operational standpoint. So I think that’s why I mean I kind of like the university or that that kind of research institution-adjacent strategy because I think you just have a little bit more stability when the market looks like it does right now.”

Mr. Johnson explained that he serves as “executive managing director for Houston-based Transwestern’s healthcare and life science platform nationally. We have three companies within Transwestern; we do investments, we do development and we do services – leasing services, asset services – to properties and life science and healthcare.”

He said, “I have one more positive lever that we’re seeing in some of the biotech companies that are coming to Houston is the FDA (U.S. Food and Drug Administration) is approving more drugs. And so their advisory boards are more optimistic about their prospects because of that.”

So why aren’t investors jumping in?

An audience member, Mike Hargrave of Revista, said, “I found the comment that there are a lot of investors on the sidelines waiting to come in pretty interesting because I feel like at the underlying asset level, this is a growth sector. I mean you have you still have funding levels that are higher than they were five or six years ago. You have a lot of IPO Initial public offering) volume starting to come up now, and the underlying investments that investors make in the properties, they can get above-average rent growth compared to some other sectors that you’re seeing…

“You’re seeing absorption increase even in the top four markets… You might be seeing occupancy rates go down, but aren’t investors looking at that and saying… it’s a high growth-profile investment and… they can get in right now probably for attractive pricing relative to what you saw a couple of years ago?”

Mr. Germain responded, “I think is more geared toward – I guess it could be development, too – acquisition activity, and from an acquisition standpoint, yes, I think there are a lot of good things happening. But there’s still a lot of uncertainty in underwriting and modeling some of these things…

“Like the cap (capitalization) rates right now have expanded on the life sciences side, for sure. Modeling what exit caps are going to be on deals is kind of tough right now because you don’t know where your interest rate is going to be, and you don’t know where your future cap rates are going to be. There’s a little bit of like disconnect… We have this argument with our LPs (limited partners) all the time. ‘Okay, what should the underwriting look like, and what should we model on exit cap?’ A 50 basis point difference on an exit cap can kill a deal, right?

“So, I agree with you, I think there are some unique things happening. But I think when you peel back the onion and you start to work your model and you start underwriting what that market growth rate is… Historically, Boston has (had) very strong rental rate growth, but there’s the fact of the matter of there’s still a lot of supply, right? So can you actually model 5, 6 percent rent growth? Probably your LP’s not going to let you do that, right?

“So I think that kind of creates a little bit of tension in that capital being released into actual deals and slows down the decision-making. So these are all things that we have to work through. When the crystal ball gets a little bit clearer, I think there’ll be more consensus on the modeling, and I think that will kind of allow the capital to get off the sidelines and say, ‘All right, yeah, we feel comfortable over there.’”

The consequences of spec development

Ms. Moses added, “I feel like we have to highlight the fact that in 2020 a bunch of investors jumped into spec development for life sciences. Anyone who has ever been a developer in healthcare was scratching their head, saying, ‘How the hell? How is this possible, when we know this is such a specialty development product that really requires a lot more thought?

“And anytime for healthcare, historically speaking… if I’m going to build an MOB (medical outpatient building) it needs to be 60 percent leased – pre-leased – before I’m going to bring on a capital partner, before I am actually going to jump forward and do something.

“And so for me to see that a bunch of investors (who) had no idea what they were doing in this space, recognized an opportunity and now we have a lot of product out there on the market because of other factors, the leasing is slowed down.

“I’m not going to say life sciences isn’t a product we should believe in 100 percent. We should. There’s a lot of innovation happening. I think there’s a lot of growth in this market. It’s just, we now need to right-size what those first investors just jumped into, right? Let that leasing kind of settle, and then I think we’re going to see a lot healthier activity.”

Mr. Germain added, “I think to add to that is, you know, some of these investors have gotten burned, right? And so they’re still kind of working through some of that, and I think that’s also whether they want to come back to market. Or other investors see that (and they say), ‘Hey, this person got burnt in this market.’ I think that’s also something that we’re going to have to work through, that’s going to be something that happens over time.”

Mr. Johnson said, “A lot of our top buyers… that have traditionally been in this space are right-sizing their risk portfolios right now, and so they’re trying to gear up, and they’re selling assets and doing things to get ready because you’re right — things are swinging a little bit, and I think there is going to be a play out there.

“The people have been in this space for a long time, this is when they go out and try to plant seeds for that next run, you know, that next cycle. But I think there’s been a lot of spec development, a lot of slowdown in leasing, and so it’s just sort of delaying some of that investment.”

Ms. Sillay added, “But it’s contributed to expanding supply, which is pushing down pricing.

“And so if we look at the profile of the standard life science investor for small to medium-sized companies, it’s still private equity and venture capital. And they’re looking at these trends, they’ve got a ton of cash to deploy, they’re buying it up, they’re ultra-compelled by the ROI (return on investment) that the product they’re developing will have at the end of the 10-year span, and they’re diversifying their Investments with the real estate.

“And we’re going to see more of that, and there’s going to be more demand for the products that they’re working to commercialize. So for these, among other reasons, I’m really strong on the pipeline for real estate development in life sciences.”

MCB takes over Viva White Oak

Before moving on to the next portion of the discussion, Mr. Wolf asked Mr. Germain about the long-delayed Viva White Oak mixed-use project in eastern Montgomery County, Md., which MCB Science + Health recently took over, as BREI reported a few days before the RevistaLab conference.

“I like the site because it sits right between Advent Health Hospital and the FDA,” Mr. Germain said. “So it’s a nice swath of land right between those two institutions. And we’ve been kind of looking at this and underwriting it for quite some time. It got kind of, I guess, leaked that were involved…

“I think, you know… this is not a like a five-year project. I mean, this is like a 20-year endeavor that we’re going be getting into on this. It’s 280 acres, zoned for up to 12 million square feet. I don’t know if we ever get to 12 million square feet and… we have to put in all kinds of new infrastructure, utilities, everything, and it’s basically an empty site right now.

“But I think what we like about it and what’s unique about it is we’ll have kind of little neighborhoods within the site, and little campuses. And so one of the components that I’m going to be in charge of there is delivering our medical office component to the site, which is going to be close to or adjacent to the Advent Health side of the site. We’ll (also) have a lot of retail, an enormous amount of residential there.

“And then adjacent to the FDA side will be our life science campus. We hope to do about 2 million square feet. There are a lot of groups that want to be close to the FDA and want to be part of the some of the partnerships the FDA can provide, so I think there are also research institutions that want to be connected to a project like this.

“So I think we’re going to hope to take advantage of all of that as we build to the life science programming. And so I like it from a life science play. Our partners like it from a residential (perspective) because they do a lot of residential and retail. So it will be a nice mixed-use community that I think we’ll build over on a lot of different industry factors.”

Editor’s note: Next week, we will also publish part two of this article, which will include specifics about the life sciences projects currently being developed by HCA Healthcare, Trammell Crow and Transwestern.