Life Sciences: Despite ‘growing pains,’ fundamentals remain strong

IMN panel discusses ‘flight to quality,’ ‘sad labs,’ changing office-lab ratios and more

By Murray W. Wolf

About one year ago, a group of life sciences real estate (LSRE) experts gathered in San Diego noted that, due to the economic climate – which, at the time, included high inflation, rising interest rates and other factors – the LSRE space, as well as the life sciences industry itself, could be in for a period of adjustment and slower growth.

Although inflation has eased somewhat, interest rates have continued to rise – and recent signals from the Federal Reserve suggest that the rate hikes will continue. Consequently, the life sciences and LSRE markets have indeed slowed during the past year, and we do seem to be in a period of adjustment.

But a recent gathering of LSRE professionals seemed to agree that the real estate fundamentals remain strong and that life sciences is still an attractive sector.

Those comments were made during a panel session at the IMN (Information Management Network) LSRE Forum, held July 28 in New York. The session was titled, “State of the Market: Macroeconomic Factors Impacting Life Sciences.” It was moderated by Adam Spagnolo, CEO and partner with the architecture firm SGA Group Inc.

The panelists comprised:
■ Lauren Gilchrist, executive VP and Philadelphia market leader for Newmark Group Inc. (NYSE: NMRK), a commercial real estate (CRE) advisory and services firm headquartered in New York;
■ Hilda Flower Martin, a co-founder and principal with Revista, an Arnold, Md.-based CRE data service specializing in the healthcare and life sciences sectors;
■ Suzet McKinney, principal and director of Life Sciences for Sterling Bay, a Chicago-based real estate development firm; and
■ 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), headquartered in Dallas.

“We all have a positive picture of the market moving forward,” Mr. Spagnola said during his introduction, before asking the panelists for their insights.

Ms. Gilchrist of Newmark said, “Well, I don’t think it’s any surprise to anybody who’s been involved in this space that the leasing activity thus far this year has been a little bit slower really than anybody may have hoped for. And this is really a function of a couple of different things. If we’re thinking about what spurs tenant demand within the life science space, it really comes down to the funding.”

She noted that the primary sources of funding for startups and early stage companies are the National Institutes of Health (NIH), which is federal funding for basic scientific research, and venture capital (VC), “which is really provided to companies as they are trying to scale, and they’re prepared to take on investors, and really is when you start to see companies typically accelerate up the curve, not only in terms of hiring, but also in terms of real estate growth.”

For more established life sciences firms, funding can be obtained from initial public offerings (IPOs), enabling firms to become publicly traded, as well as mergers and acquisitions (M&As), often with large pharmaceutical companies investing in or acquiring smaller firms.

“That spectrum (of funding sources) is what drives demand for life sciences overall,” Ms. Gilchrist said.

“NIH funding still relatively strong in most markets,” she continued, “(but) the venture capital funding really is where we have seen a very – not precipitous, but a significant – drop-off… just as the general financial conditions in the current state of the economy have influenced the companies that are able to successfully raise venture capital.”

She added, “The venture capital is really where we see kind of that uptick in leasing demand. At one point, I believe I had measured it was you get about 150 square feet of leasing demand per $1 million raised. So that is really … one of the challenges that we’ve seen in this moment in time…”

She continued, “The IPO market has really been suffering for quite some time for basic scientific research and I think that is maybe a good thing in some ways, in terms of the sustainability of the sector. You know, to have a company that’s pre-clinical going into a public offering is really challenging from a risk perspective. And in fact, I think a lot of companies may have gotten some pretty substantially unfounded valuations in the public markets due to overexuberance coming out of COVID.

“And then, finally, looking at the M&A piece of the funding, this is really I think where some of the pent-up demand may or may not be. It’s going to be really interesting to watch over the next, call it 12 to 24 months, because we have a lot of big pharmaceutical companies who are about to fall off the patent cliff who have a lot of cash that they’re sitting on, who have the opportunity to acquire smart science.

“The question from a leasing perspective is: Does that actually retrench leasing demand or does that expand demand? And I think we might talk about some of the nuances there. But, overall, we have seen a pretty precipitous slowdown in the space.

“But the scientists will tell you that the science continues,” Ms. Gilchrist pointed out, “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.”

Ms. Martin of Revista said, “I’d like to add to that. I feel like we’re reading and hearing and talking about the big drop-off (in funding) since the 2021-22 period. But in terms of VC fundraising, the run rate right now is still over $20 billion, which is more than we ever saw prior to that, 2021-22 period.

“So there is still funding, “ she said. “It’s definitely down. But I think, overall, it’s a growth story in the sector. It’s just some growing pains.”

Ms. Wenger of CBRE 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,” she said, “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.”

Mr. Spagnolo of SGA then asked Ms. McKinney of Sterling Bay how market conditions have affected facility programming, the collaborative process of identifying needs and objectives.

“I think it’s really interesting what we are seeing now in terms of really sophisticated developers and the things that they’re doing,” she replied, “and what they’re willing to do to get tenants through their buildings, not only to see those buildings, but hopefully for those tenants to lease those buildings. And I think some of this activity really is very broad and spans across the board.

“Obviously, tenants are very cost-conscious right now. So I’m seeing a lot more concessions being offered – greater TIs (tenant improvement allowances), greater abatement of rent. So that’s one thing,” Ms. McKinney said.

“I’m seeing developers hosting more and more events at their lab spaces, again, just to get tenants through. I’m also seeing developers allowing potential tenants to host events in these lab buildings, free of charge.

“I think we may hopefully, at some point in the conversation today, talk a little bit about flight to quality. But I think there’s also this recognition that long gone are the days … where scientists had to work in the basements of these buildings. Tenants have a lot more choice now. So we’re seeing more and more amenities and different types of amenities being placed into lab buildings or, if it’s a larger sort of innovation district that the developer is building, more and more amenities.”

Ms. McKinney continued, “I also think we’re just seeing a lot of developers go after larger type collaborative tenancies, if you will, that will bring greater attention to the property. And what do I mean by that? Think about things like these large bio hubs, where multiple universities are collaborating, but placing the bio hub in a location that’s neutral to their university… And so what the hope for those types of collaborations is that more and more companies will spin out of the bio hub, and because those scientists have already been in the property that they will spin their company out and stay within that same property.

“So lots of activity from a developer standpoint. Again, just trying to bring as much attention to these lab buildings as possible.”

She added, “But I’m even also seeing things like divvying up space – you know, if you have a large building with a large floor plate where you hope you’re going to have single tenants per floor, I think developers are getting more and more willing now to split up those floor plates and have two and three tenants on a single floor.

“So lots of different things that I think the more sophisticated developers are doing just to get tenants through and hopefully get more leases signed in what we all know is a very tenuous economy right now.”

Mr. Spagnolo asked if, given “the abundance of real estate coming online within the market,” whether tenants will gravitate toward “Class A” buildings.

Ms. Gilchrist replied, “I think one of the notable things about the construction pipeline is that, in a lot of ways, the pipeline as it exists today had been responding to extremely low vacancy rates across all of the core markets, and even maybe more tight vacancy rates across some of the secondary and tertiary markets.

“And to Suzet’s point about scientists being in the basement, I would often refer to these kinds of properties as ‘sad lab’ … properties that really weren’t meant for truly some of the top talent, the top intellectual capacity of all of civilized society” to be “forced to essentially hang out in the basement…

“We’ve kind of evolved past that point because we, I think, as a development community, have realized that scientists are people, too. Scientists like to drink beer, too. Scientists deserve natural light as well.”

Ms. Gilchrist said this evolution from “sad lab” to “modern lab” was largely driven by the new space being added to the LSRE market by third-party developers. However, she noted, the roughly 160 to 170 million square feet of third-party-owned lab space across the United States is still “a drop in the bucket” compared to the amount of lab space owned by owner-occupiers like universities and pharmaceutical firms.

Smaller spaces and changing office-lab ratios

Ms. McKinney noted, “I think the one other thing that I would add – another phenomenon that I’m starting to see, and I started seeing this originally in the office asset class, but now I’m starting to see it in the life sciences asset class as well. When you’re talking and thinking about flight to quality, I’m seeing a lot of tenants decrease the amount of square footage that they are leasing and then going to a higher quality facility.

“So they’re leasing a smaller amount of space, but a facility or an area that has more amenities and more things that the talent is going to want. And so they may actually be paying the same amount of rent, if you will, but in a much nicer space.”

Ms. Wenger of CBRE added, “There is a flight to quality. They’re looking for the best locations, and they’re looking for the right user experience. So, again, coming back to: What is the right location? It’s really where the neighborhood is that is the number one amenity.

“So, if you take a cluster like Kendall Square in Cambridge, if you look at that, they’ve got the medical office users, they’ve got the smart institutions like MIT and Harvard, they have high-tech companies, they have biotech companies. And they’re all kind of working together and trying to share talent. And that is really important for the energy that comes out of these clusters.”

She added, “And then you also look at Kendall Square and it’s got the walkability, it’s got retail amenities that are right by it, and it has restaurants and yoga studios. And so I think that tenants are getting more sophisticated in their requirements, and they’re looking for those amenities to bring their people to work.”

Ms. Martin of Revista then cited a recent report from the investment firm Land & Buildings that used cell phone data to estimate how many workers were going to the office. The study looked specifically at Alexandria Real Estate Equities Inc. (NYSE: ARE), the largest owner of LSRE.

“They were analyzing Alexandria’s portfolio and looking at foot traffic before COVID to now,” she explained, “and they had Placer.ai data and they’re showing a 50 percent drop – still, now – into Alexandria’s portfolio, which begs the question: Is the (LSRE) sector exposed the way regular office is? Is this going to affect … the makeup of these properties moving forward? I mean, right now you hear 50-50, the office supporting the wet lab space. Is that sort of makeup going to change over time? Is it affected by size or the work-from-home (trend) we’ve been seeing?”

Ms. Wenger replied, “I would say we’re looking at future-proofing life science, not only for an increase in lab space but also for AI. And in order to future-proof it, what does that mean? It basically means that you have to bring more power and ventilation to your buildings.

“So, on the more power side, what does that mean? You have to be able to have the service that provides for more lab space. So, if you look at just the ratio of watts per square foot for office, it’s 5 to 10 watts per square foot; for lab space, it’s about 20 to 30 watts per square foot. So, what does that mean? It’s not just a matter of, can I increase my lab space, but also a matter of, do I have the utility capacity to do that? And if you don’t have it, you’ve got to go to either your utility provider or else additional tenants that are within the building.

She continued, “So we are starting to think about that in terms of service capacity and then also the build-out for that. So, if you need more ventilation, you’ve got to be considering the ceiling heights, and you may need more equipment that is up on your roof to support the (additional) utilities. So does your roof have that capacity?

“But … it’s not going to jump overnight from (the) standard right now,” which she said is typically about 40-60 office-to-lab space. “It’s not going to jump overnight to 10-90, but I do think that with both AI and an increase in lab (space), you’re going to see that gradually climb. And so, you want to make sure that you’re constantly thinking about that in future-proofing your lab buildings.”

Ms. McKinney of Sterling Bay said, “And I would say … I think that we will see the program changing in some places. I can’t necessarily say that will see it in all.

“But back to the point that Hilda was making… the programming was always 50 percent lab, 50 percent office. But I have to imagine that, to some degree, the more administrative type personnel that were just heavily using the office aspect of the product may still be working remotely or working hybridly. So there’s less of a need for 50 percent office space…

“I’m also seeing a lot of changes with regards to programming,” she continued, “because, when you think about it now, in life sciences, it’s really a race. There is a race to refine your product, your discovery, whatever it is, and try to move to that unicorn status to the point where you can be acquired.

“I’m seeing some tenants coming in and requesting a footprint that’s 75 percent lab and 25 percent office. So I do think that we’re seeing shifts in the programming, but the reasons behind that shift is differing from one market to another, one tenant to another. I think the point that Hilda makes about foot traffic, definitely is a signal, but I think that there are other signals as well.”

Market performance varies

Mr. Spagnolo then asked Ms. Martin which LSRE submarkets are performing well.

She explained that Revista, through its RevistaLab service, is tracking more than 300 million square feet of life sciences space nationwide. Owner-users like universities and pharmaceutical companies account for much of that.

“But what we’ve seen over the last year is that 16 million square feet was delivered and only 8.7 million square feet was absorbed. So we are seeing about a 200 basis point overall drop in occupancy, 94.8 to 92.8 (percent) over the last year, and it’s very different market to market.”

Ms. Martin said that in some markets, like Boston-Cambridge, Mass., “intense amounts” of new LSRE space are being delivered. She said that the new space under construction there amounts to more than 40 percent of the existing inventory.

“The demand can’t keep up with all those deliveries, so there’s a bit of a downtick in occupancy there,” she observed. Even if developers “walk back” so of those projects, she said, “there’s still a significant amount of inventory likely to hit that market…

“But there are markets that are still positive, and Philadelphia is one of them. The Denver-Boulder market is one of them. They have not gone negative in terms of absorption at any point over the last year… San Diego’s another strong market. Out of the core ones, San Diego’s also positive and is not seeing that same occupancy deterioration over the last year…

“So it is, again, a market-to-market thing as to demand and performance, as well as how much is getting delivered.”

Spec vs. pre-leased projects

Concerning the performance of specific markets, “I think a lot of that is also a function of just how much spec space was delivered or was planned,” Ms. Gilchrist said. She noted that by the time the public hears about a project, “significant amounts of capital (have already) been sunk into the design and development of that project… So, to a certain degree, while not everything is fully capitalized by the time the world hears about it, there are significant sunk costs at that point in time.

She continued, “So a big regulator in the environment right now is truly what banks are willing to lend… We have seen in Philadelphia, for example, some pretty substantial projects that are completely speculative,” yet are drawing interest – and in some cases, financing – from lenders.

“But … we are seeing some indicators of oversupply, for example in Boston,” Ms. Gilchrist continued. “I would probably put San Francisco in that bucket as well…

“Where the markets have been much more kind of steady – and we’ve not seen that volume of spec construction kind of in the planning phases – that’s where I think we’re going to continue to see, not robust growth, but increased volumes of supply.”

She noted that there are 1.6 million square feet of LSRE space in the pipeline in downtown Philadelphia, which would double the market’s inventory.

“So, yeah, that’s a 100 percent increase, but it’s a 100 percent increase on a very small number. So I think it’s going to be interesting to see what other kind of smaller- to medium-sized markets mature a little bit more, like Boulder, as well.”

“The spec comment is right on,” Ms. Martin agreed. “Just another stat: Just projects in Boston scheduled to open this year are 66 percent pre-leased. So that’s a pretty significant amount of projects that are supposed to open in the next six months that still are yet to be leased.”

Mr. Spagnolo asked the panelists if developers are – or should be – “pre-building” lab space, suggesting that the wisdom of doing so depends on the market.

“I would also say that’s very size-dependent,” Ms. Wenger said. “So, if we can deliver small bench spaces from like 2,500 to 5,000 square feet, those will get leased up right away, or if we can deliver 5,000 to 10,000. The smaller spaces, we’re willing to put the capital in, and they do get leased up right away, and that I would say is pretty consistent across the markets that were in.”

Ms. McKinney added, “I would add, in terms of the markets that we’re in, we’re pretty much pre-building everywhere: Chicago, Boulder, Philadelphia, San Diego – particularly the Sorrento-Mesa area – and then also in the Raleigh-Durham market.

“However, one aspect of our strategy that we’ve been modifying, to your point about the smaller footprints, is we are now looking at implementing more graduation space within some of these buildings, so that we can try and capture some of those tenants that will need that smaller footprint.

“But I think, from a decision perspective, whether you go spec or do pre-leasing, I think, for us, we are looking at the markets – not so much the core markets, but those emerging markets that seemed to be having a lot of demand,” she said.

“I mean, Philadelphia – you just cannot dispute it. Philadelphia is blowing up.

“Down in North Carolina, they are making it incredibly easy for developers to come in because the local government there wants their life sciences ecosystem to grow exponentially over the next few years. I’m hearing less about markets wanting to try and be more like Boston, and instead just trying to be the best that they can be.”

Ms. McKinney added that Sterling is developing different types of facilities based on the clients and markets.

“We’re looking at what the trends are in each market and we are building to those trends,” she said. “So I’m really excited about our new product that we will start this year in Philadelphia because it’s really a unique type of product, really harnessing a lot of the CGMP (Current Good Manufacturing Practice) activity that we see in Philadelphia. So, we’re doing a project there that will include wet lab, office, CGMP and warehousing. So that’s a life sciences product that you really don’t see in a lot of other places, but we believe that there’s a market for that in Philadelphia.”

‘A lot of strong fundamentals’

As the panel discussion continued, Ms. Wenger said, “You still have a lot of strong fundamentals” in the LSRA space. “We still have an aging population that the government is putting a lot of funding towards and resolving. We have also seen massive technological advancement. So if you look at the cost to sequence the genome 20 years ago, it was $100 million. Today, it’s less than $1,000. So those technical advancements are going to allow more investors to continue to keep going.”

Ms. Gilchrist said, “One other thing I might add to that … I think one of the great legacies of the pandemic will be the fact that we increased our general societal awareness, and acceptance of new medical technology, which probably opens the door for a lot more development and utilization of those technologies.

“So, I mean, who in this room, knew what mRNA was prior to the pandemic? Probably very few people, right? …Now we’re all sort of saying, all right, whatever your political opinions are about the pandemic or the vaccines, etc., mRNA is (now) a household term and, I think, as a result of what we all observed in kind of the science race, I think we’re going to see a lot more interest funding and acceptance of new types of technologies for life-saving medicine.”

“I would agree with that,” Ms. McKinney said. “And the other thing that I will add that, at least I’m starting to see, is a lot more philanthropic dollars going into the life sciences. I think the largest and probably the one example that most people have heard of is the Chan Zuckerberg Biohub.”

The Chan Zuckerberg Biohub Network, a nonprofit research organization started by Facebook founder and Meta Platforms Inc. (Nasdaq: META) CEO Mark Zuckerberg and his wife Dr. Priscilla Chan, in March announced that they have selected Chicago as the home of their next biomedical research hub.

“So that within itself has brought a lot of attention to the life sciences ecosystem in Chicago,” Ms. McKinney noted, “and that has just combined with what was already a growing effort to advance the life sciences ecosystem. I think we are also beginning to see more and more lab space begin to come online.

“You know, Chicago has been one of those markets that’s never really taken off in the past and is finally, starting to take off now…”

Ms. Martin said, “I’d add to that, that (although) Chicago has a very high occupancy, it’s still one of the smaller clusters… It’s a growing cluster, but it’s still pretty small in terms of what’s there now. There’s not a ton of construction when you compare it to some of the other markets, and generally what is built is being absorbed, and it’s still very tight and low on space availability.”

Ms. Wenger added, “We’re invested in Chicago and, to Suzet’s point, there are a lot of owner-occupiers. We were surprised when you look at how many there are in that market, and not a lot of privately-held buildings where you’re going out and leasing. So we saw a real underserved niche there where if we can provide high quality, we can attract smaller users within that market.”

Purpose-built space vs. conversions

As the discussion drew to a close, the panelists touched on potential differences in leasing performance between LSRE space that was purpose-built vs. repositioned.

Ms. Wenger replied, “In markets like the Bay Area and San Diego, where it takes so long to get entitlements and to get through a development process, we saw in 2019, 2020, the demand for life science really increase. And because that demand jumped up so high, these tenants couldn’t wait for these buildings to get built out. So there were a lot of conversions that were done, and they were leased up and they re-leased up at strong rates.

“What’s going to be interesting is when you start studying these markets, as the purpose-built assets start coming online, and how they are going to compete against these conversions. You know, if you truly believe in the flight to quality, then you would expect those conversions to start sensing a little bit of pain now that there is that availability for tenants to go lease a purpose-built building versus a converted (one). In the past, they just didn’t have that option and, when they get that option, we believe that they’re going to lean towards the flight to quality.”

“And that’s definitely market to market as well,” Ms. Martin added. “So one of the biggest markets for conversions is Boston, which has something like 20, 25 percent of what’s currently underway is a conversion. That’s the highest of any market, certainly some in San Francisco, San Diego, but it’ll have impacts market to market, depending on how much of that is in the construction pipeline.”

“I would agree with both Hilda and Sondra,” Ms. McKinney said. “I mean, our behavior, when it comes to conversion vs. new build, we’re really looking at markets individually, and the only market that we’re in right now where we’re doing any conversion is in the San Diego market because that’s a market that where there’s demand for it. I think in our other markets it’s much more a story of flight to quality…

“So I think you really do have to evaluate it market by market.”