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Developers, Investors Snap Up Life Science Properties as Market Tightens in Leading Biotech Clusters

Limited Availability, Strong Tenant Demand Driving Acquisitions and Development in High-End Hubs
February 28, 2018
Kilroy Realty Corp. recently bought Oyster Point Tech Center, a three-building,146,000-square-foot lab and office project in the burgeoning South San Francisco, for $111 million, or $726 per square foot.

Competition remains fierce among investors competing for a dwindling supply of land and available space in South San Francisco, San Diego and the Boston suburb of Cambridge where clusters of specialized office and lab space devoted to supporting 'life science' companies have emerged.

While total investment sales of the major properties have decelerated after hitting record levels in 2016, sales of specialized R&D and lab properties have remained steady, according to CoStar COMPs data. Developers of this type of space have also been very active, with deliveries reaching a post-recession high of 97.5 million square feet in 2017, while both starts and inventory under construction hovered at cyclical highs last year.

Most of the development and sales activity is concentrated in few urban clusters of lab and R&D space in upscale locations that share several similarities. They tend to be located near major research hospital and universities, they cater to well-funded biopharmaceutical and other life science tenants, and the specialized, and expensive, space requirements tend to create high barriers to entry for competition.

The national vacancy rate for R&D office and flex buildings 25,000 square feet and larger has fallen steadily over the last five years, from 12% in 2013 to 10.4% in the fourth quarter of 2017, according to CoStar data.

Due to differences in the caliber of nearby scientific talent and varying degrees of access to capital, however, some life science clusters are faring better than others, according to CBRE's 2018 Life Science Outlook.

For example, the vacancy rate in leading biotech cluster South San Francisco and surrounding San Mateo County communities has plunged from 14.3% to as low as 7.4% during the same period as absorption and rental rate have surged, triggering plans for large speculative development projects such as the $2 billion Landing at Oyster Point, a mammoth project in South San Francisco controlled by Greenland USA.

The Chinese investor is divesting its U.S. real estate assets and is said to be shopping half of the site to Kilroy Realty Corp. (NYSE: KRC), and Alexandria Real Estate Equities Inc. (NYSE: ARE) is also believed to be planning speculative construction nearby.

Most recently, San Diego-based developer Phase 3 Real Estate Partners signed a contract to purchase a development site at Sierra Point in Brisbane near South San Francisco. The 8.9-acre site at 3000-3500 Marina Blvd. has capacity for 438,104 square feet of new office, R&D and lab space, according to Cushman & Wakefield, which listed the property.

Conversely, clusters in New Jersey, Philadelphia and Chicago, while still seeing exceptionally strong momentum in certain submarkets, are more affected by the ongoing consolidation wave among pharmaceutical and medical manufacturing companies, CBRE said.

CBRE said despite current strong demand, investors should closely monitor the sheer levels of often-speculative new supply under way in Boston and San Francisco,

Despite some supply concerns, capital remains plentiful for the highest-quality markets and lab space, Citigroup, Deutsche Bank, Goldman Sachs and Société Générale this week agreed to provide $1.9 billion in first-mortgage and mezzanine loans to a Blackstone Group affiliate to refinance a 27-property portfolio of properties in California, Massachusetts and Washington, according to a pre-sale report issued by Kroll Bond Rating Agency.

Blackstone acquired the 3.9 million-square-foot portfolio from BioMed Realty Trust in 2016 in a deal valued at about $8 billion, the largest portfolio sale of life science property on record.

In January, Alexandria Real Estate Equities, Inc. (NYSE: ARE), the nation's largest owner of high-end lab and R&D space, added to its already large portfolio by acquiring a four-building complex of flex properties in San Diego's Sorrento Valley totaling just under 250,000 square feet for $148.7 million as part of a sale-leaseback deal with biotech firm Quidel Corp.

Also in January, Kilroy Realty paid $111 million, or $726 per square foot, to buy the Oyster Point Tech Center, a three-building, 146,000-square-foot lab and office project in the burgeoning South San Francisco submarket.

Given the limited availability (and steep prices) more investors have begun to look in non-core locations in search of value. After acquiring the Illinois Science + Technology Park in Skokie, IL last year, Chicago-based American Landmark Properties signed two lease extensions and expansions by long-time tenants Vetter Pharma International USA and Charles River Laboratories International, plus a new lease with Northwestern University, to bring the complex to full occupancy.

American Landmark is now focused on development, including immediate plans to redevelop a three-story 130,000-square-foot building at the tech park. Five other sites totaling 1.3 million square feet of potential build-to-suit development are also available, said John Roeser, American Landmark Properties executive vice president.

Roeser said the ability to expand in the same location is an important consideration for life science tenants.

"The ability to provide significantly more space is very important to our profile tenants who want expansion space potential, as relocating these types of facilities is very expensive and disruptive to their research activities," Roeser said.

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