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Law360 (November 2, 2020, 5:44 PM EST) --
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| Dawn Saunders |
Investors and landlords are gravitating toward this sector of the market for many reasons.
First, life science has traditionally weathered economic challenges well, including the tech crash in the early 2000s and the Great Recession.
Secondly, life science companies tend to make significant capital investments in building out their premises and prefer longer lease terms, even when rents are higher in this segment relative to the rents typical in other product types. This combination of stable assets with high rental streams along with low turnover and high returns make life sciences an especially attractive investment opportunity in this down cycle — particularly as other commercial sectors, such as retail and office, struggle.
Indeed, life sciences is a shining light in the commercial real estate industry right now, with investors and owners eyeing the many possibilities.
Life Sciences Sector Outperforms Other Real Estate Sectors
The life sciences boom contrasts dramatically with other commercial real estate sectors, most of which have softened considerably since COVID-19 induced work-at-home mandates.
The surge in life science is not surprising. Unlike typical office employees, lab employees cannot work remotely. Moreover, consider the macroeconomic picture — we are facing an aging population that expects and demands a high quality of life, often with assistance from pharmaceuticals and medical devices. Because science and technology are the catalysts for achieving better health and longevity, it follows that our reliance on life sciences is only continuing to increase.
The COVID-19 pandemic highlights our reliance on this critical market segment as we watch funding pour into this industry from both public and private sources. The entire world is watching as life science companies race to develop a test (then a better test, then a faster test, then the ability to perform a higher volume of tests) and a treatment (then better treatments) and, of course, the vaccine that will hopefully end this pandemic.
As a result of the rapid growth of life science companies, law firms have seen their life sciences practices surge, while deal flow during the COVID-19 era for other real estate practice areas is in sharp decline.
Construction in the life sciences arena is also booming — with new buildings typically leased before construction is complete or in some cases has even began. Lab space is difficult enough to find generally, but in some of the new emerging market areas, large blocks of much-needed lab and research and development space is nearly impossible to find or simply doesn't yet exist.
With all of this in mind, it is clear that life science and technology will continue to be a growing and increasingly critical part of our economy — all signs point to the demand for innovation space staying strong — at least for the foreseeable future.
Investing in ways to supply the new demand is, therefore, a sound strategy. However, life science is not an easy product type to master, and there are significant traps for the uninformed and inexperienced. Accordingly, it's important to clearly understand some basic fundamentals of the life science market before jumping in.
Challenges of Investing and Leasing in the Life Sciences Market
Life science buildings represent a very specific product type with a highly specialized and scalable infrastructure. Consequently, it is nearly impossible to simply convert a building that was industrial or office space into life sciences without first making a large capital investment.
Companies that occupy life science spaces must be able to rely on a strong, dependable and specialized building infrastructure to support their often sensitive scientific work. Simply put, when a landlord doesn't understand that and fails to get it right, disaster is certain to ensue.
Before investing in life sciences, landlords must do the critical legwork and put an experienced team of brokers, lawyers, contractors and property managers in place. Getting the building infrastructure right is critically important — this starts with construction and carries through the entire building life cycle.
The consequences of failure are significant because, for example, in life sciences, if the HVAC in a lab facility is not working properly, the life science tenant cannot "do science," which means the space is not simply uncomfortable, it is functionally useless.
Life sciences leasing attorneys spend a lot of time on issues related to finding the appropriate balance between the owner and user so that each party is able to realize its objectives. Having a strong operational team that understands and can coordinate and work effectively with the user is critical for the building owner.
As another example, manufacturing facilities subject to the Current Good Manufacturing Practices are highly regulated by the U.S. Food and Drug Administration and require the manufacturer to show proper monitoring and control over building systems to ensure consistency and safety in their manufacturing processes.
This requires the landlord and tenant to work together to allocate responsibility for systems maintenance and control in a manner that allows the tenant to achieve and, thereafter, retain its status as a Current Good Manufacturing Practices facility.
Another important issue is that the infrastructure in these buildings is robust, and it is often used 24/7 at high intensity, requiring a level of capital investment that is often a magnitude of order greater than customary in general office transactions.
Moreover, life sciences campuses are usually highly amenitized and many also have collaboration space on site — these amenities centers are a specialized product type in and of themselves and require special treatment in terms of construction, operation and cost pass-throughs.
The Future Looks Bright
While the life sciences surge predates the pandemic, the COVID-19 outbreak has accelerated the industry's rapid growth.
In the months to come, the news will continue to be filled with reports of multibillion-dollar life sciences deals — some of which will be part of the industry's expansion into new market areas. This trend is especially likely as the supply becomes scarce in traditional life sciences hubs such as the Torrey Pines area near University of California San Diego.
The planned conversion of Horton Plaza — a former retail urban lifestyle mall in downtown San Diego — to a life sciences campus offers an example of a high-profile conversion of former retail space into life sciences use. The project is part of a broader attempt to attract life sciences companies to an urban area that is not traditionally occupied by this sector.
As another example in San Diego's urban core, life sciences real estate developer IQHQ Inc. recently purchased five city blocks of the downtown waterfront development formerly known as Manchester Pacific Gateway, paving the way for a new San Diego research development district, with future plans to build more than one million square feet of laboratory and corporate campus space aimed at attracting life science companies to downtown San Diego.
Another emerging trend is the increase in the number of technology companies leasing life science buildings. The extra infrastructure that life sciences buildings offer is attractive to tech users, particularly those with heavy research and development uses.
Investors will continue to enter and expand in the life sciences arena, and we will see a large infusion of capital looking to invest in a limited supply of assets, which will likely drive up asset values and support continued demand for new development projects. Life sciences companies themselves will remain strong and well-funded, and that will continue to drive rents.
Ideally, the hard lessons learned from the COVID-19 pandemic will translate into greater opportunities for advancement in other areas of science and spur an innovation spike — resulting in greater investment in life science companies themselves, which translates to increased demand.
Dawn Saunders is a partner at Crosbie Gliner Schiffman Southard & Swanson LLP.
The opinions expressed are those of the author(s) and do not necessarily reflect the views of the firm, its clients or Portfolio Media Inc., or any of its or their respective affiliates. This article is for general information purposes and is not intended to be and should not be taken as legal advice.
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