"Biotech and pharmaceutical buildings became one of the hottest investments in commercial property at the start of the pandemic. Now, the glut of life-sciences properties has gotten so bad that some developers are exploring the unthinkable: marketing the space for office use.
In the Boston region, for example, owners of at least 10 life-sciences locations are now offering those buildings for office space instead of lab space, according to brokers and other real-estate professionals.
The building owners are willing to lease them for office use even though they can face a 30% haircut on what they had hoped to charge for life-sciences use.
"They're no longer aspiring to get $100 [per square foot] rents," said Fred Borges, a senior managing director of Boston-based investment firm Rockpoint Group, referring to the asking rents for lab space. "They will gladly do a deal for $70 on the office side."
As the U.S. office market downsizes and works off its surplus nationwide, owners of life-sciences buildings in such regions as Boston, San Diego and the Bay Area also are facing a glut of new life-sciences properties, a function of a rapidly growing sector that was turbocharged by Covid-19.
When the pandemic hit, developers moved at warp speed to develop life-sciences workspaces with climate-controlled laboratories and specialized systems for controlling tiny vibrations that could interfere with experiments, as well as for ventilation, fire safety and power.
Newcomers to the sector included owners of office buildings, which saw demand for their own properties crater partly because of remote work. Many then converted conventional office space into space for life-sciences usage.
Since the first quarter of 2020, more than 59 million square feet of new space has been added with an additional 19.1 million square feet in the pipeline in the U.S., according to real-estate services firm JLL.
By comparison, an average of 3.7 million was added annually in the five years leading up to the pandemic. "A lot of people just threw money in stupidly," said Joel Marcus, executive chairman and founder of Alexandria Real Estate Equities, one of the largest owners of life-sciences property in the U.S.
Making matters worse, demand for life-sciences space has fallen sharply from its pandemic peaks. Many biotech, pharmaceutical and other life-sciences companies have lost their appetites for rapid expansion because of high interest rates, weak venture-capital financing and an uncertain economy.
"This is the age-old story of real-estate developers over-responding," said Travis McCready, head of life sciences, Americas markets for JLL.
Some projects that have hit the market in the past three years have seen little or no leasing.
Most traditional life-sciences core locations in places such as Cambridge, Mass., South San Francisco, Calif., and the northern suburbs of San Diego remain healthy.
But the pain from overbuilding and faltering demand is severe in new locations the industry tried to pioneer during the boom years.
In September 2020, developer IQHQ broke ground on what would be downtown San Diego's first major life-sciences campus on 10 acres of waterfront property. Four years later, the nearly $2 billion five-building project is close to opening without any life-sciences tenants announced.
A spokeswoman for IQHQ, which also has life-sciences projects in the Boston and San Francisco regions, said the company is seeing "growing leasing momentum . . . across all of our districts."
In the Boston area, with over 49 million square feet, vacancy has soared to 27.7% compared with less than 6.2% in late 2020, according to JLL. An additional 5 million square feet is under construction, which could push vacancy higher.
The outlook is so bleak that the developer of one nine-story project in Boston's Somerville suburb, a venture of Leggat McCall Properties and DLJ Real Estate Capital Partners, has halted construction. "Construction has paused until market conditions improve," the developer said.
Like the recent distress in the office market, troubled life-sciences developments are sending shock waves through the financial system. The value of even high-quality life-sciences property is down about 15% to 20% from its peak in 2022, because of supply and demand pressures as well as high interest rates, according to Dylan Burzinski, analyst at real-estate analytics firm Green Street.
In May, Citigroup downgraded Bank OZK, which provided close to $915 million in construction financing to IQHQ, partly citing weak life-sciences demand for the 1.7 million-square-foot San Diego project. The report sent the bank's shares down sharply.
Bank OZK said in a regulatory filing in July that its loan to IQHQ was performing and that its sponsors had contributed an additional $87 million which "should carry the project into 2026." The report said that the sponsor recently negotiated a two-year extension option "in anticipation of a longer than originally expected leasing cycle."
Meanwhile, IQHQ has hired PJT, an advisory firm, to help it study financing options.
The good news is that distress in life sciences doesn't pose as much peril to the broader economy as the carnage in the office market. The sector is much smaller, with less than 175 million square feet of life-sciences space in the U.S. compared with 4.8 billion square feet of office space, according to JLL.
The highest-quality, best-located life-sciences buildings, owned by companies such as Alexandria as well as Blackstone's BioMed Realty, are still registering healthy occupancy and rents. And some of the projects seeing weak leasing have little debt and are owned by developers with deep pockets.
Greystar Real Estate Partners, which has over $78 billion in commercial property assets under management, launched its first major life-sciences development in 2020: a 1.7 million-square-foot campus in Somerville, Mass. The first of the three buildings, a 465,000-square-foot project named 74M, is scheduled to open later this year.
That project has yet to announce any leases. But Greystar has paid for the $600 million development with all equity so doesn't have to worry about paying debt service or loans coming due. "It might take longer than we first envisioned," said Gary Kerr, a Greystar senior managing director. "But that's OK when you have that patient capital."
Developers are taking hope from the increase in both biotech initial public offerings and venture-capital investments in biotech and biopharmaceuticals this year compared with 2023.
But an economic slowdown would likely have the reverse effect on demand, prolonging the space glut for years. McCready, of JLL, pointed out that some markets are beginning to see slippage in asking rents, a move landlords hate to make because that can hurt the value of their property for years.
"We cannot withstand this level of supply-demand imbalance for too long," he said." [1]
1. A Once-Hot Sector Falls on Hard Times --- A glut of space for life sciences leads developers to weigh offering it as offices. Grant, Peter. Wall Street Journal, Eastern edition; New York, N.Y.. 04 Sep 2024: B.6.
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