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Boston, the Life-Sci Real-Estate Goliath, Starting to Show Symptoms of Weakness

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Strong as it may be, even the Boston region’s life-sciences real-estate market is not immune from the current economic slump.
 
After zooming along through 2006 and into the first half of last year, both leasing activity and rents in the region’s R&D market downshifted into neutral and remained stuck there into this year.
 
In Cambridge, for example, a decline in leasing by biotech, pharma, and medical device tenants came just as new space appeared on the market. The resulting real-estate glut marked the end of two straight years of rent growth.
 
Broadly, according to real-estate firm Colliers Meredith and Grew, the vacancy rate for lab space in Cambridge increased barely a full percentage point in the fourth quarter of 2007 to 13.7 percent from 12.9 percent year over year.
 
For instance, BioMed Realty Trust, a publicly traded real estate investment trust, continues to market the same 126,500 square feet it had available a year ago at its 702,940-square-foot Center for Life Sciences, within Boston’s Longwood Medical Area, home to the region’s priciest life sciences space.
 
The REIT has been unable to find tenants willing to lease space at its asking prices, which range from $95 to $105 per square foot — which is 35 to 40 percent above rents agreed to by the four research institutes that have pre-leased a combined 82 percent of the building’s space.
 
BioMed’s situation was among many examples of market activity, or inactivity, cited in the newest edition of the quarterly Biotech REview, published by Colliers Meredith & Colliers International. Last month, Colliers acquired the long-independent commercial real estate firm of Meredith and Grew.
 
Another trend noted in the winter 2007-08 edition of Biotech REview was the migration of Cambridge life sciences companies to suburban sites, led by Shire Pharmaceuticals proceeding with its long-discussed expansion into a 400,000-square-feet space at the Lexington Technology Park [BioRegion News, Feb. 19].
 
Other suburb-bound companies in recent months included Altus Pharmaceuticals, which agreed to lease 85,000 square feet in Waltham and ImmunoGen, which took 88,000 square feet in that city.
 
BioRegion News spoke with Joseph Flaherty, an executive vice president with Colliers Meredith and Grew, about many of the findings in Biotech REview, as well as the challenges faced by life-sciences companies searching for space in greater Boston, and owners of the region’s laboratory and lab-office properties:
 

 
In the Longwood Medical Area, the report cited how tenants weren’t biting at leases ranging from $95 to $105 per square foot. Have you reached the limit of how high rents can go in the region?
 
I don’t know. I really don’t know. There’s been so little vacancy at the Longwood Medical Area that rents have escalated up, and there may in fact be an institution that would be wiling to pay those kinds of numbers because they want to be right there and not be anywhere else. Again, I think an institution or a big pharma company might make the decision [that] they have to be there, and then they won’t care what they pay. But that tenant hasn’t shown up yet to pay those rents.
 
Activity at the Center for Life Sciences has not progressed beyond the institutions that pre-leased space there more than a year ago. Is that because of the economy tanking, or are there other factors unique to the life sciences market in the region?
 
I think there have been fewer requirements than there had been, and I think the high rents may have given some people cause to pause. I think that’s the reason. But clearly overall, since the middle of last year, demand really across the board has been off, I would say, for the most part. I think it’s just overall caution of the unknown.
 
In Cambridge, it really quieted in the second half of the year. I think that probably had to do with the economy. The big story was the Cambridge tenants that migrated to the suburbs. Most of those deals were in play in the early half of the year last year, and there happened to be space available in the suburbs — some big blocks of space that they were able to take advantage of. The interesting part right now is that all those big blocks of space are gone, so there really aren’t any good suburban options right now for a decent-sized tenant.
 
Meaning what size?
 
Certainly 40,000 [square feet] and up to 50,000 [square feet] and up. There’s nothing that big around any more.
 
The report cites the tightening of the suburban market resulting from the factors you cited. How does this reshape the Boston and Cambridge markets? Does this bring the REITs out to the suburbs?
 
Well, the REITs are in the suburbs. Alexandria has been very active in the suburbs. The effect I think it’s going to have is that there are fewer options in the suburbs, which means Cambridge tenants may be forced to stay in Cambridge.
 
Will that be enough to stabilize rents in Cambridge, which had spiked up for about a year through early last year?
 
That’s a good question. Most of the demand in Cambridge right now is coming from very young companies. And they’re not going to go to the best projects and pay the top dollar. They’re going to look at second- third-, [and] fourth-generation lab space. And I think with the options in the suburbs drying up for them — these are your 10,000- to 25,000-square-foot tenants — I think they’ll have to take a harder look at the existing lab space in Cambridge, and work harder to re-adapt, to make that space work for them.
 
How are landlords responding to the drop in demand? Have tenant companies drawn any breaks on tenant improvement costs, for example?
 
I think the landlords with existing lab space have become more aggressive. I think rents have held firm. There hasn’t been any demand to make the market either one way or the other.
 
Certainly for the new shell space, like [the 420,000-square-foot Cambridge lab building under construction by BioMed Realty Trust] or [a 155,250-square-foot Cambridge building owned by Alexandria Real Estate Equities], quite frankly I don’t think they’ve seen the demand or tenants where they could make a deal, and really set what the market is right now. I’m sure if there was a live tenant there and they had to cut their rent to make the deal, they’d make the deal. But I’m not sure they’ve seen too many live tenants lately.
 
Were REITs overly optimistic, especially in the Cambridge area?
 
Yes, I think they were over-optimistic. They bought into a strong market, and the first half of 2007 saw very strong tenant demand. And then when [the core and shell of the 420,000-square-foot Cambridge lab] finished in the second half of the year, demand dropped off. And I think their high rents have scared some tenants away — certainly on the new biotech-ready stuff, rents in the $65 to $75 [per square foot] range, those would be the highest rents ever in the Cambridge market. And again, what you saw last year is, a number of the young to middle-aged companies said, ‘Heck, this is nuts. We could go to the suburbs and get basically brand-new space in the mid-$30s to the low $40s [per square foot].’ So that was a big part of the migration.
 
Most of the attention in the suburbs has focused on a handful of deals by giant pharma and biotechs. Bristol-Myers Squibb is constructing a new $750 million lab building in Devens, and Shire plans to conduct a $394 million facility expansion in Lexington. How typical are these kinds of companies going to the suburbs?
 
It has been a mix. Historically, you’d have Cambridge-grown companies going to the suburbs, like Cubist [Pharmaceuticals] and Immulogics. You’ve had big pharma doing that too. AstraZeneca used to be in Cambridge, and they moved out to Waltham. You had BASF Biosciences. They were in Cambridge and they moved out to Worcester. So I think it’s a natural progression that certain companies go through. I think what happened this time is, with the spike in rent in Cambridge, at the same time there happened to be some big blocks of space available right along Route 128, in the preferred markets of Waltham and Lexington. So those companies saw those opportunities and took advantage of them.
 
How much has Cambridge’s life science market been hurt by non-industry factors like traffic, high housing costs and other quality of life concerns?
 
That’s part of it. But again, Kendall Square is Kendall Square, and I think most life sciences people, if they can find the right situation, still want to be in Kendall Square. But again, as some companies will never leave Kendall Square, or the area around [Massachusetts Institute of Technology], other companies, as they mature, and as [their top executives] live in the suburbs, and as they have kids, they do migrate to the suburbs. That is a natural process.
 
Will there be more projects in the near suburbs like the 130,000-square-foot space being built by Boylston Properties, or Beth Israel’s plan to market 225,000 square feet later this year [following its move to the Center for Life Sciences]? Will they have any effect in terms of bringing more companies closer to Boston and Cambridge?
 
No. I think the space Beth Israel is vacating, and Boylston Properties, those will probably be leased by the institutions that are right over in that market right now. Or it might be a big pharma parachuting in because they want to be right in the Longwood Medical Area. But you will not see companies moving to that market from Cambridge or from the suburbs, in my opinion.
 
This past year, as the report noted, Harvard University broke ground on a 589,000-square-foot building of what is to be the four-building, 1 million-square-foot Harvard Allston Science Complex. The building will house Harvard’s stem-cell initiative. What effect will that project have on the region’s R&D space market?
 
I think the impact of that is, you have this $40 billion institution with its efforts in the sciences reinvigorated. It just adds to the whole life sciences cluster — which I call a super-cluster — that we have up here. More science begets more science begets more companies begets more science. It just keeps building. That’s the impact of what Harvard is doing. It’s another major engine, which will ultimately be a demand engine for the life sciences in this region. That’s why it’s so important. Think of the scientists that institute is going to draw. It adds to the brainpower that’s coming into the area or that is being educated here and staying here.
 
What sort of a spinout engine will the project be?
 
That hasn’t been talked about that much. But when you have that much science going on, clearly that will have a big impact.
 
Boston University has been working to develop its own science space through the BioSquare campus, which includes the National Emerging Infectious Diseases Laboratories biocontainment project that has been the subject of a lawsuit for several years. How has that uncertainty affected the ability to draw tenants to BioSquare?
 
I don’t think the NEIDL has any impact at all on drawing tenants to BioSquare. I think the issue with BioSquare is, you have a mixed[-use] neighborhood over there with research space, residential space. It’s sort of an island unto itself, and most of the companies that I’ve dealt with would much rather be in Kendall Square, where there’s many more life sciences companies, they’re right next to the main engine, which is MIT. I think BioSquare’s success has been in getting affiliated institutes or affiliated entities into those buildings. They have not had any success really getting, call it third-party companies, into those buildings. That’s the nature of the overall environment that surrounds BioSquare.
 
The reports discussed the challenges of companies that recently completed or are contemplating an initial public offering. What effect has that had on the market? Has it helped by generating larger companies capable of paying more rent? Or hindered the market by consolidating the number of potential tenants?
 
That has hurt the market. Tenants have less money to spend to expand, to build their companies. I’m sure part of the drop-off in tenant demand that we’ve seen since last year was partially the result of the difficulties in the IPO market.
 
Overall, how would you sum up the state of the research and development and lab markets in the greater Boston region?
 
Overall, I think demand is off. The suburbs had a real strong year last year, coming into this year. In Cambridge and Longwood, the demand has slowed significantly since the middle of last year. That’s where we are now. Medium- and long-term, because of all the demand drivers that we have here, it’s all going to happen. It’s just a matter of when.

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