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Big Life-Sci REITs Predict Rough US Rental Market in '09 as Financial Downturn Takes Toll

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The nation's largest publicly traded real estate investment trusts specializing in the life sciences offered chillier forecasts this year in the US for signing tenants to new leases, renewing existing ones, or breaking ground on new projects as landlords and tenants continue to feel the effects of the ongoing financial downturn.

In separate conference calls last week, top executives from Alexandria Real Estate Equities, BioMed Realty Trust, and HCP cautioned that life-science companies are increasingly skittish about leasing new space for the long term.

As a result, BioMed and the other REITs said, they will work this year to reduce operating costs as well as capital spending on construction and renovation projects.

"Despite the size of the pipeline, the deals we've seen recently have been shorter in term with protracted negotiations as decision makers remain reluctant to enter into new long-term commitments," Paul Gallagher, HCP's executive vice president and chief investment officer, said Feb. 10 during the company's fourth-quarter and year-end 2008 earnings call.

A BioMed executive said the resultant slowdown in demand for space and leasing activity should result in fewer deals for less space this year compared with 2008.

"We expect to see a very marked slowdown in leasing activity in 2009. And while we've already surpassed the halfway mark for our gross leasing goals, we expect the second half of the leasing objective to be much harder than the first," said Matt McDevitt, executive vice president, acquisitions and leasing for BioMed.

Alexandria Chairman and CEO Joel Marcus told analysts last week that his company now requires either he or Chief Financial Officer Dean Shigenaga to sign off on any expense greater than $250.

"Kind of unprecedented," Marcus acknowledged during his company's Feb. 9 quarterly conference call. "I think it's fair to say this is an historic, unprecedented, fundamental, and permanent structural change in the financial, banking, and credits systems, and future implications now are only somewhat becoming better understood."

All three REITs reported year-to-year declines in their net income available to common stockholders despite posting an increase in funds from operations and total revenues:

BioMed: Down 37.3 percent to $8.3 million in the fourth quarter of '08 from $13.2 million in the final three months of '07.

HCP: Down 22 percent to $35.1 million in the final three months of 2008 from $45 million in the final three months of 2007.

Alexandria: Down 5.4 percent to almost $21.1 million in Q4 '08 from nearly $22.3 million in Q4 '07.

Yet all three REITs also said they expect to benefit from the $787 billion American Recovery and Reinvestment Act expected to be signed into law this week by President Obama. The measure, billed as an economic-stimulus package, includes $10 billion in additional funding for research grants to be awarded by the National Institutes of Health.

"It's hard to say exactly how that will translate into [greater leasing activity,] but it's clear it will because [NIH funding] always has and I think that's good," Marcus said. "And what that does also then is create new opportunities for the public sector — I should say the commercial sector — to access new technologies being developed. … So we think it's a real big plus" for life-sci REITs.

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Alexandria

Marcus said one example of how the company has altered its operations in response to the economic turmoil is its decision to shift 389,000 square feet of space from its current-development pipeline to its embedded future-development square footage. The move nearly doubled the size of future-development space from the 516,000 square feet recorded during the third quarter to 905,000 square feet as of Dec. 31, 2008 [BRN, Feb. 11].

The shift reflects Alexandria's decision to delay groundbreaking for the 389,000-square-foot second tower of its Alexandria Center for Science and Technology at East River Science Park laboratory campus in New York City, Marcus told analysts. The project's 16-story, almost 320,000-square-foot East Tower remains under construction and is slated to be completed in 2010 or 2011.

At East River Science Park, Marcus said Alexandria is "negotiating a letter of intent with a very high-quality anchor tenant to lease approximately one-third of the space," or a little more than 100,000 square feet, at the East Tower. He did not elaborate.

East River Science Park is one of a handful of projects Alexandria continues to pursue despite the health of global financial systems. For instance, in San Francisco the REIT has "fully leased and committed to two credit tenants," both undisclosed, the 158,000-square-foot the third building of its Mission Bay campus.

Groundbreaking and pre-construction work has begun there, and the building is set to begin rising this year, Marcus said.

In neighboring South San Francisco, Marcus said, a prospective tenant in lease talks at the two-building, 162,000-square-foot Alexandria Technology Center has held off on a decision, keeping 16 percent of the building leased.

Also in South San Francisco, Exelixis has extended through Dec. 31 its option to lease the remaining space of Alexandria's East Grand Technology Campus, moving from the 65,000 square feet it now leases at the 135,000-square-foot facility. The space is the first of four buildings Alexandria plans to build that together will total 540,000 square feet.

"This is [Exelixis'] corporate headquarters [and] core research facility, and I think it's fair to say we reasonably expect them to exercise the option," Marcus said.

He said Alexandria is optimistic about the drug developer's future due to the global collaboration on two cancer-fighting efforts that it and Bristol-Myers Squibb announced last December. As part of that alliance, BMS agreed to pay Exelixis $195 million in upfront cash for development and commercialization rights to both programs, and plans to shell out $45 million in additional license payments this year.

And earlier this month, the South San Francisco City Council approved Alexandria's plan to build a nine-story, 292,000-square-foot research-and-development center to replace a pair of 40-year-old buildings at 213 East Grand Ave. However, the REIT will not begin construction until it signs a tenant [BRN, Feb. 9].

In Cambridge, Mass., Alexandria won a key approval last week when the City Council voted 8-1 to rezone 15.7 acres in the city's East Cambridge section for the REIT's planned $1 billion, 1.8 million-square-foot laboratory-residential campus [See feature in this issue].

The East Cambridge project, which will include street-level retail space, would nearly double Alexandria's current 2-million-square-foot portfolio in Cambridge, anchored by the seven-building, more than 1-million-square-foot Technology Square complex. In December 2008, the REIT announced that Pfizer took a long-term lease for an undisclosed amount of space in the building for its Capsugel division.

According to Marcus, Alexandria may see additional activity in Cambridge if pharma giant GlaxoSmithKline follows through on plans to add space there. "A bunch of us met with some of the Glaxo team up in Cambridge, and they're very focused on creating a new set of pipeline opportunities for Glaxo there and doing some expansion," he said, without elaborating.

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He said his company's efforts in Cambridge in general and its contact with Glaxo in particular reflects the strength of Alexandria's portfolio strategy of maintaining properties located near the research institutions and universities that anchor large bioclusters.

"I think when we look at big pharma, we're in the sweet spot of where they want to be at the heart of the clusters adjacent to the great institutions," Marcus said. "If you're out in the suburbs or you're in a secondary location within a market, those aren't going to be the places they want to be."

Alexandria said fourth-quarter funds from operations rose 6 percent to $49.5 million from $46.3 million in Q4 '07. Total fourth-quarter revenues increased 17.6 percent to $126.6 million from $107.6 million in the year-ago period.

During the quarter, Alexandria's 513,000 square feet of leased space represented an 18.75-percent increase from the 432,000 square feet of space leased in the year-ago quarter, though the number of deals fell to 34 from 43.

"It's pretty remarkable and unbelievable, in a sense, given, again, the worst quarter in the financial history of certainly our reporting quarters," Marcus said.

Shigenaga said Alexandria will look to generate $100 million in cash in 2009 by selling some properties, a little more than the $86 million it secured that way in 2008. Last October, Alexandria completed its sale of a $1.9 million, 24,867-square-foot building in Eastern Massachusetts. The REIT did not elaborate.

"While the current environment is challenging to execute asset sales to the traditional investor, we will continue to focus on opportunistic sales of properties to users," Shigenaga said.

To help it raise capital, the company said it will also dip into its $475 million unused, unsecured line of credit, use some of its $120 million cash on hand, and take advantage of loan extensions, refinancings, new loans, joint ventures, and other new sources of equity. Quarterly construction spending will be lowered to $60 million, from $100 million a year ago, Shigenaga said.

Alexandria said most of its buildings are unencumbered by debt.

In addition, Marcus said, Alexandria will work to stabilize some of its earlier-stage tenants by establishing consulting relationships with them.

"We've had a number of strategic meetings with a number of major companies who've asked us to come in and actually consult with us, much like a McKinsey would do, although we're not charging like McKinsey, but to come in and help them rationalize what they're doing on the innovation side," he said.

With its focus on filling existing bioclusters and on cost-cutting, Marcus added, Alexandria will not likely break ground on overseas projects in 2009. Over the past two years, the REIT had sought to build a variety of developments in China, India, Scotland, and another, undisclosed, country in Europe [BRN, Feb. 19, 2008].

"Given the structural change in the capital markets, it's very difficult to imagine [doing it] now," Marcus said last week of the international projects.

In addition, Alexandria "is nearing shell completion" of a two-building, 280,000-square-foot project it is developing near Macau with a joint venture partner, the REIT said in its quarterly filing. The project last year was estimated at costing $12.6 million; as of Dec. 31, 2008, its cost to complete the remaining shell construction stood at $7 million, Alexandria said.

"We are working with the local government on a substantial modification of our land-use right to expand it to a broader range of uses," Alexandria stated in its filing.

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HCP

Like Alexandria, HCP is also looking to big pharma for new activity in 2009. Mark Wallace, HCP's executive vice president-chief financial officer and treasurer, said his REIT was well-positioned to ride out the financial crisis from a life-science perspective because much of its life-sci tenant base consists of biotechnology and pharmaceutical giants, which he suggested are better shielded than other industries from the ongoing cash and credit crises.

"We like our position very much and we think it's a great space, particularly the way we've elected to play it with the bigger-cap companies and the companies that have commercially viable drugs that are actually making money," Wallace told analysts during his firm's fourth-quarter call.

Wallace said HCP anticipates securing capital this year not by divesting its properties but by issuing more debt secured by those assets. He said HCP reasons that it can benefit from plans by pharma and biotech giants to continue to dominate the market for unsecured debt. He cited as an example Novartis' success earlier this month in issuing a $5 billion, two-tranche bond which the pharma plans to use for general corporate purposes.

"Fortunately, with life science now representing 25 percent of [HCP] … with a majority of that with names like Genentech, Amgen, Pfizer, Takeda Pharmaceuticals, and all of that real estate totally unencumbered, that becomes a very interesting opportunity for us," Wallace said.

During the three months ended Dec. 31, 2008, HCP said funds from operations available to common stockholders rose almost 4 percent to $121.5 million from $117.2 million year over year. Meantime, total revenues rose 3.5 percent to $263.3 million in the current fourth quarter from $254.3 million one year earlier.

The 25 percent of HCP's portfolio that comprises life-sci businesses includes senor housing, medical office buildings, hospitals, and skilled nursing properties nationwide. While the amount of space it leased in its life-sci portfolio remained at 91 percent year-to-year, HCP said it anticipates net operating income to increase during 2009 by between 12 percent and 12.5 percent. According to Wallace, the REIT reasons that leasing activity has been strong since the company acquired the former US life-sci holdings of UK-based Slough Estates Group nearly two years ago [BRN, Aug. 20, 2007].

By comparison, HCP's net operating income in the life-science segment rose 19 percent in 2008 over 2007. Gallagher, the firm's HCP's executive vice president and chief investment officer, said during the call the higher increase was "primarily driven by the repositioning at our Sorrento Summit buildings" in San Diego — which paid off early last year when Veralliance Properties agreed to lease all 143,614 square feet at the campus' two existing buildings.

NuVasive also has options to lease additional space in a third building in Sorrento Summit scheduled to start construction this year, and HCP has said it plans eventually to add another roughly 125,000 square feet to the campus.

During the fourth quarter, HCP completed about 392,000 square feet of leases in its life-sci properties, of which about 71 percent, or 278,000 square feet, consisted of 15-year renewals of leases by ARUP Laboratories at the University of Utah Research Park in Salt Lake City. ARUP is owned by the university.

In the year-ago quarter, HCP completed 423,000 square feet of leases in its life-sci portfolio.

HCP's properties also include three South San Francisco buildings totaling 370,000 square feet that are leased to Amgen but not occupied by the biotech giant, which in 2007 backtracked on expansion plans as part of a company-wide series of cost-cutting measures [BRN, Aug. 20, 2007].

During last week's call, Gallagher told analysts that Amgen has opted to occupy one of the buildings after all — namely the 95,000-square-foot space located at 1130 Veterans Blvd. The other two buildings — 331 and 333 Oyster Point Blvd., within the three-building Oyster Point II campus — are still available for sublease. HCP completed the core and shell of all three Oyster Point buildings during the fourth quarter.

Also in South San Francisco, HCP expects during the third quarter to finish redeveloping three buildings from office/industrial use into a life-science building to be called Britannia Modular Laboratories. The 97,000-square-foot project, begun during the fourth quarter of '08, "will provide HCP with additional space targeting small-to-medium life-science users," Gallagher said during the call.

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And by the fourth quarter, Gallagher said HCP continues to expect to finish redeveloping two buildings totaling 89,000 square feet within its Seaport Centre campus. The REIT is repositioning the buildings from office to life-science use in a project that includes a $6 million central lobby designed to connect the two buildings.

BioMed

BioMed last week said funds from operations rose 10.8 percent to $35 million in Q4 '08 from $31.6 million in the year-ago period. Total revenues during the quarter jumped nearly 30 percent to just over $83 million from just over $64 million one year earlier.

During the fourth quarter, the REIT raised more than $212 million through a stock sale; racked up $28.8 million by selling a portion of its parking spaces at the Center for Life Sciences; and gained $17 million by repurchasing almost $47 million of exchangeable senior notes for $28.8 million. The company also recorded a $19.2 million loss on derivatives.

During Q4 2008, BioMed lowered its debt-to-asset ratio to 41.8 percent, its lowest leverage level since Q3 2006 — a feat that CEO Alan Gold trumpeted as "the real highlight for the quarter."

Also during the period, BioMed completed 10 leases totaling 195,000 square feet compared with 18 transactions totaling about 681,000 square feet in Q4 '07. For all of 2008, the REIT completed 46 lease deals totaling 848,000 square feet, down from 53 deals for 1.5 million square feet.

Among properties for which leasing lagged in Q4 '08 was the Pacific Research Center, which is the nearly 1.4 million-square-foot former Sun Microsystems campus in Newark, Calif. Gold said PRC drew only 336,000 square feet in lease deals, which represented two-thirds of BioMed's goal of leasing 500,000 square feet of the campus.

"That asset, more than the rest of our portfolio, is affected by the broader commercial real-estate market conditions given that a substantial portion of the project is expected to be leased to non-lab users at least initially," Gold said. "We did have a couple of larger tenant prospects pull back on their leasing plans at the end of [last] year as a result of the economic turmoil. And we just expect that the leasing is going to continue to be tougher in the broader Bay Area, and for that property over a period of time."

Gold said vacancy rates in the Bay Area have increased from between 5 percent and 7 percent before the economy slipped into recession to the current 9 percent to 11 percent range. That's identical to the range in Boston/Cambridge, and just under San Diego's 11 percent to 12 percent range, which is nearly identical to BioMed's range in the New York metro area.

"Do I think that smart management teams and boards are slowing down activity to make sure they understand what goes on in the broader market? Yes, I think that's what they're doing," Gold added.

Three notable BioMed leases during the final three months of 2008 took place in:

• Boston, at Children's Hospital Boston, which took an additional 49,286 square feet consisting of the 15th and 16th floors at the Center for Life Science, raising its occupancy to 150,215 square feet at the 18-story, 703,000-square-foot life-sci building — and catapulting Children's to one of BioMed's 10 largest tenants based on amount of space leased;

• Seattle, at a Novo Nordisk subsidiary, which took 36,900 square feet at BioMed's five-story, 94,000-square-foot 530 Fairview Ave., also called Fairview Research Center [BRN, Oct. 27, 2008]; and

• Tarrytown, NY, at the Landmark at Eastview campus to Profectus Bioscience, which leased 20,000 square feet for the Institute of Human Virology, its first commercial operation.

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"We intend to lease approximately 1 million square feet between September 2008 and December 2009. Of this, we expect about half to be new leases and half to be renewals," McDevitt said.

BioMed is already halfway to its 2009 leasing goal, following a pair of deals announced in January: the 24,400 square feet leased by Japanese-owned Kowa Company at the Center for Life Science in Boston; and the 292,000 square feet of leases renewed by Vertex Pharmaceuticals in two Cambridge buildings [BRN, Jan. 26; Jan. 19].

BioMed was able to renew the Vertex leases at a 50-percent mark-to-market rent increase despite not spending any money on tenant improvements typical of most leases. Looking at 2009, with the economy remaining weak, "that's not something we think our investors should expect," McDevitt said.

"We generally expect 2-percent to 3-percent spreads. And obviously we've been doing a lot better than that for the past, probably, year and a half or more," McDevitt added. "But from a long-term perspective we think 2 percent or 3 percent is a better assumption, particularly in this environment."

Also in Cambridge, BioMed and a fund managed by Prudential Real Estate Ventures last week refinanced to $203 million an April 2007 loan to help them afford their $507 million acquisition of two buildings totaling 604,445 square feet from Lyme Timber Co. One of the sites, a 420,000-square-foot life-science building, was completed in 2008.

During the call, BioMed said it repaid its roughly $30 million remaining balance of the $40 million it invested in the venture.

"Clearly the market for Cambridge has slowed. But we are currently tracking roughly seven transactions that are over 50,000 square feet," McDevitt said.

Also encouraging, McDevitt said, was that rents have remained steady. The Children's Hospital lease "is just shy of $70" per square foot triple net, he said, while Kowa paid "just around $80 a foot, triple net." Those rents include zero in tenant-improvement costs.

To stoke interest in its Cambridge and Boston holdings, McDevitt said, BioMed is "now … doing things a little differently to kind of meet the market." Those steps include hiring a Lyme veteran as a director of leasing and "looking at [accommodating] some smaller tenants on some different floors."

McDevitt said BioMed is also on course to complete four major developments in 2009: The Center for Life Science, slated to end construction by the end of the first quarter; and the Fairview Research Center and a $145 million, 360,000-square-foot addition to the Landmark at Eastview, both of which will be "moving into lease-up [mode] around mid-year."

Later in 2009, BioMed expects to complete the six-story, 280,000-square-foot 650 East Kendall St. in Cambridge, also called Kendall B. "The construction on Kendall B is going very well," Gold said. "It's scheduled to be delivered in the late-summer, early-fall."

BioMed said its portfolio was 90.1 percent leased as of Dec. 31, 2008, down from 93.8 percent a year earlier. More than half that portfolio — 48 of 62 consolidated properties — are unencumbered by debt, giving the REIT another avenue for raising cash, said Kent Griffin, BioMed's president, chief operating officer, and chief financial officer.

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