August 22, 2019
Technology, once a wholly separate and niche group of companies, now bleeds into every market division and vertical. In particular, the life sciences and biotech sector is experiencing an evolution made possible by technology. It has not only taken advantage of an increase in computer power and precision automation, but it has also undergone a transformation of the way in which companies are created, funded, and managed.
Today’s biotech companies look entirely different from the stogy research institutions of the past. They are bred from ideas from graduate students and staffed by young, well-educated millennials. And those employees want the environment and perks of any retail technology company – cool office space, flexible hours, food options, ridesharing, gyms, and more. With $17 billion invested in biotech in 2018, there are more biotech companies fighting for the same resources and talent than ever before, and that includes real estate.
The real estate challenges that biotech companies face might be one of the most interesting facets to the industry’s continued growth. Northern California and Boston represent 60% of all venture capital investments in biotech, leading to a vacancy rate below 2% in both markets. In South San Francisco alone, there is approximately 5 million square feet of new development slated for the next two years, almost all of which has been preleased. With such strong fundamentals, one would think we would see more investment and infrastructure. However, there are two primary reasons there isn’t more life sciences space: Construction restrictions and governmental restrictions.
Compared to a typical office building, biotech real estate is built to a 50:50 laboratory to office ratio. In addition, the buildings need 20-foot deck heights and enough cooling, power and drainage to supply a working science laboratory 24 hours a day. The cost to build out biotech real estate from shell is twice the cost of standard open office, and the cost to manage, supply, and run the space is approximately three times a traditional office. Each scientist likely needs both office and laboratory workspace, making headcount density about half that of an office user. Additionally, the difficulty in venting laboratory spaces makes buildings of a lower height preferable, further hampering overall efficiency by not exploiting a vertical scale.
Taking all of that into consideration, developers are looking at a building that costs more to construct, more to build out, and more to run, with fewer employees per square foot. The metrics are more expensive in every direction and hard to justify.
The construction challenges notwithstanding, laboratory and life sciences use are not allowed in all locations. Occasionally antiquated government zoning restricts what buildings can be constructed and how they are used. Life sciences and biotech can be a tough fit compared to a rather benign office building. Laboratories can use chemicals, vent particulates and smells, and run animal testing that may require specialized buildings for specific zoning. Zoning codes never conceived of the types of life sciences companies that exist today, and simply understanding the correct zoning and use codes can be a challenge in and of itself.
There is still upside for real estate developers and investors, though. The low vacancy rates and high demand for the space have caused rents to rise, making the speculative build process less risky. Monthly rents are easily pushing $6 to $7 per square foot for a triple-net lease, with more growth imminent.
Almost every incubator is at effective capacity with new companies and ideas. Nearly every rentable square foot of biotech real estate is spoken for by current companies with ambitious growth plans. Venture capital is waiting to invest in the next wave of big ideas. With all of that, how can this impacted market save itself? Through creativity and innovation.
Biotech companies are already forming collectives to share resources and push for relaxed governmental control and expanding zoning codes. Sharing laboratory space is almost a rite of passage for young companies rather than a black eye, and many successful businesses have been generous with surplus space. Biotech companies are also addressing infrastructure issues through transit-oriented commuting, multiple specialized site locations, and outsourced manufacturing of base materials.
Regardless, those innovative solutions are still a temporary fix to a growing problem. The creation of more laboratory space is key. A shortage of suitable biotech real estate should not be the barrier to a company’s growth. Developers and real estate investors must recognize the value that the surging biotech and life sciences market is creating. With their support, the initial cost of the space creation will be tempered by the overwhelming prospect of success.
Peter Conte is the Bay Area head of Transwestern's BioTech Advisory Group, leading the company's efforts in life science and biotech office and laboratory disposition.
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