Tech Companies Such As Salesforce.com, Google and LinkedIn Are Competing With Lab Developers For Shrinking Supply of Available Land
With occupancies and rents beginning to rise in two of the country's most prestigious biotechnology clusters, life science space is becoming one of the few niches enjoying bona fide development plays in 2011.
Nowhere in the country has the tightening of lab space supply been more evident than in the supply-constrained San Francisco Bay Area -- especially in South San Francisco and the San Francisco CBD, where leading life science owners and developers such as Alexandria Real Estate Equities Inc. (NYSE:
ARE) and HCP Inc. (NYSE:
HCP) are competing with technology and Internet companies for some of the last available land parcels.
In recent months, tech companies have scooped up land in the Bay Area that effectively eliminates millions of square feet previously earmarked for lab and biotech buildings in one of the nation's tightest land markets. In response, Alexandria and HCP have acted recently to lock up available properties and fill the demand at increasingly healthy return profiles on new development, including assets within the Mission Bay redevelopment in San Francisco's CBD, one of the most desirable biotech addresses in the country.
However, observers say they don’t expect another speculative boom like the one during the mid-2000s upcycle that fueled construction of millions of square feet of life science space in clusters like the Bay Area, Boston/Cambridge, San Diego, Raleigh and Durham, NC; New York, Seattle and suburban Maryland. Even in the tightest markets like Boston and San Francisco, companies are still mainly interested in less risky build-to-suit or solid pre-leased projects.
“Building true, specialized life science space on spec is a challenge given both the above-average cost per square foot and the unique needs of each user,” noted Chris Macke, senior real estate strategist for CoStar.
Just seven months ago, ARE sold most of its undeveloped Mission Bay land to cloud computing company Salesforce.com for construction of a global headquarters -- a loss of up to 2 million square feet of potential new lab space development. In April, ARE jumped back into the Mission Bay market, acquiring a newly developed two-building property at 409-499 Illinois St. developed by Shorenstein Properties and SKS Investments.
Alexandria paid $293 million for the two towers totaling 453,000 square feet located across the street from the $1 billion University of California, San Francisco (UCSF) research and development campus and medical center.
The first 240,000-square-foot tower is 97% leased to a biotechnology company through November 2023, while the second tower has 212,000 square feet of
rentable space in shell condition, which the company plans to build out. The acquisition gives ARE the capacity to develop nearly 300,000 square feet of additional new supply in Mission Bay, where it now has a footprint of more than 975,000 square feet of existing space at a vacancy rate that has dwindled to just 1%.
The peninsula has recently experienced a sharp increase in absorption, driving direct vacancy rates in South San Francisco to less than 5% and total vacancy to near-single digits when including subleased space, said Paul Gallagher, HCP chief investment officer, during the company’s first-quarter earnings call earlier this month. The ramp up of tenant demand from tech, life science and medical device companies has driven up rental rates by as much as 25% this year.
“This activity reiterates the importance of understanding which industries are driving the various markets and even submarkets across the country,” Macke said. “South San Francisco and the San Francisco CBD are benefitting from the confluence of tech companies and life science companies, as they have both chosen those submarkets as the place to be in the San Francisco MSA.”
ARE essentially traded development risk for leasing risk when it sold the Mission Bay land to Salesforce.com and acquired the new buildings from Shorenstein last month. But the decision whether to acquire or develop buildings is more than just a simple matter of comparing yields or initial rates of return, noted Joel Marcus, Alexandria chairman, president and CEO.
With a major presence in San Francisco, New York City and Boston/Cambridge, three of the nation’s strongest life science markets, the company is positioned to capitalize on pent-up demand as one of the few companies with the ability and resources to develop both build to suit and preleased projects.
In additional to the 300,000 square feet of remaining development capacity in Mission Bay, ARE has about 800,000 square feet left to build in New York at the Alexandria Center for Life Science, where it hopes to begin pre-marketing a 400,000-square-foot tower next month. The company also expects to announce the first build to suit at its Kendall Square project in Cambridge, where it has 1.7 million square feet in its development pipeline.
Leasing isn't as brisk at its San Diego and North Carolina properties, but on May 18, Alexandria announced plans to build a 50,000-square-foot agricultural research center with 18,000 square feet of research greenhouse space near Research Triangle Park in North Carolina. The multi-tenant project will be called Alexandria Ag-Tech Center.
About 20% of HCP's wholly owned properties are in the life science sector. Its portfolio also includes senior housing, medical office, post-acute/skilled nursing and hospitals assets.
In its life science portfolio, HCP has only about 750,000 square feet of vacancy across six buildings, with significant interest in about half of those buildings, HCP Chairman and CEO James Flaherty said.
Large tech companies such as HP, Motorola, Google and others
have been expanding within Silicon Valley in recent quarters. Firms are now pushing from Mountain View and Sunnyvale northward into San Francisco, sometimes into land and space previously earmarked for life science development.
With lab vacancy now at about 5% in the San Francisco area, development may become an attractive option, with existing
buildings for sale likely to be priced in the mid to high $600-per-square-foot range, HCP's Flaherty said. And the company has jumped right in, announcing the purchase April 15 of the largest undeveloped site in the city, a 20-acre parcel called The Cove at the former U.S. Steel site in South San Francisco.
HCP acquired the land, next to the REIT’s 900,000-square-foot Oyster Point campus anchored by Amgen, from Genentech Inc. for $65 million and began development of The Cove at Oyster Point late last month. The project will deliver up to 800,000 square feet of new lab and
office space at an estimated 8.5% return on cost, said Gallagher, the HCP CIO.
Flaherty emphasized that the bullish outlook on development is based on the heated South San Francisco area market, rather than a full-on development play across the company's life science portfolio.
HCP, holding an already significant market share with its Amgen and Genentech campuses, will "move very quickly on [The Cove] to prepare for what we expect will be an attractive supply-demand dynamic in South San Francisco," Flahery said.