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Calif. REIT’s Plan to Sell Most of Its Holdings Puts Sole Biotech Incubator in Lurch

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A California real estate investment trust’s plan to sell a chunk of its holdings to a private investor has left its sole biotech tenant, a public-private incubator, wondering how the deal will affect its plans to nearly double its space by early next year, and add new manufacturing space some time after.
 
The REIT, Mission West Properties, contains the 36,594-square-foot San Jose BioCenter, one of 110 properties that comprise the REIT’s 7.7-million-square-foot portfolio. Mission West announced July 14 that it is in talks to sell 93 of the properties totaling 6.9 million square feet to an undisclosed private equity firm for  $1.8 billion in cash.
 
“That should be some time in early August, and then the deal should close, if it closes, some time by the end of September or early October,” Carl Berg, chairman and CEO of Mission West Properties, told BioRegion News last week.
 
Asked if talks were far along, he replied: “We hope so.”
 
Melinda Richter, executive director of the BioCenter, told BioRegion News last week the facility plans to at least double its space by moving into the vacant 33,750-square-foot first floor of 5941 Optical Court while retaining its existing 36,594 square feet on the second floor of the two-story building.
 
“We’re hoping we can get something up and running by the beginning of next year,” Richter said in an interview.
 
Expansion Plans
 
Richter said the BioCenter, which changed its name last February from the San Jose Bioscience Incubator and Innovation Center, has also begun planning a new biomanufacturing center expected to be located near its facility. As part of that planning, she said, the BioCenter will consider when to proceed with the project as well as whether it can create the biomanufacturing facility within an existing building nearby, or whether it must build new space.
 
“We’re still working out what exact size we’ll be looking at. We’ll probably start out with a 20,000-square-foot facility, but potentially doing it with the eye for expansion to a larger space. But we’re still in planning mode for that,” she said.
 
Short-term the incubator needs more space, Richter said, because several of its 25 tenant startups or “clients” and their affiliates are poised to grow dramatically over the next few years.
 
“We have five clients that have grown incredibly fast, gotten lots of funding, so they need to expand their facilities,” Richter said in an interview.
 
Those companies are:
  • Aridis Pharmaceuticals, a developer of room-temperature oral vaccines that can be incorporated into quick dissolving wafers or films;
  • BioMarker Pharmaceuticals, a maker of nutraceuticals intended to slow aging and maintain health. Long-term the company is designing risk assessment and diagnostic tools for personalized health maintenance solutions;
  • BrighTex Bio-Photonics, a developer of imaging technology for early detection of skin conditions.
  • Edison Pharmaceuticals, a developer of drugs targeting the energy centers of cells or mitochondria; and
  • StrataGent Life Sciences, a developer of therapies that do not require injection.
Two of the companies announced collaborations this month. On July 11, Aridis and EnWave, a Vancouver company, highlighted an 18-month agreement to test EnWave’s technology for stabilizing and dehydrating vaccines and antibodies. The collaboration aims to develop a technology for producing room-temperature stable, oral vaccines that can be incorporated into quick dissolving wafers or films.
 
The companies said that vaccine and antibody formulation, dehydration and shelf-life studies will occur at the Aridis facility at the BioCenter, and were expected to start by year’s end. Project costs will be shared equally by EnWave and Aridis, the companies said.
 
“We recently doubled our laboratory space in anticipation of this collaboration as well as other projects that have either already initiated or will begin in the next several months (including EnWave),” adding 1,000 square feet of new space, Aridis President Eric Patzer told BioRegion News.
 
“We currently have seven people in the laboratory and expect to add one to two more” in the next several months, Patzer said.
 
On July 17, Edison and Penwest Pharmaceuticals announced a $7.5 million, 18-month agreement allowing Penwest to commercialize an Edison drug candidate targeting the mitochondrial respiratory chain, as well as at least one other drug candidate yet to be selected. And this week, Edison closed on $4.25 million in Series B preferred financing.
 
The cash and collaboration, plus anticipated growth, will help Edison expand its work force from the current 14 to about 30 employees over the next 18 months, Edison Chairman and CEO Guy Miller told BioRegion News. The company also plans to grow its space at BioCenter by one-third, to roughly 5,000 square feet, and possibly move out after that.
 
“We’ll be [growing] out of there in roughly 12 to 18 months. We’re talking with them and the city of San Jose about what that next stage might look like. I would say it’s a work in progress right now. We’re not quite sure yet what that will look like.”
 
Asked how Mission West’s planned sale would affect the BioCenter’s expansion plans, Richter said: “I have absolutely no idea. I’m unclear as to what that would mean.”
 
Wet and dry labs comprise just over half of BioCenter’s space; the remainder consists of “common” space for amenities usable by multiple tenants, such as specialized biology and chemistry rooms, tissue culture rooms, cold rooms and equipment rooms. “We basically provide that big-company infrastructure for smaller companies. Our goal is to help take the risk and the capital expense out of the equation for high-potential startups,” Richter said.
 
The BioCenter was established in 2003 as a public-private venture by the city of San Jose, the San Jose State University Foundation and Mission West. The foundation manages and operates the center for the agency, while the San Jose Redevelopment Agency in 2004 signed a nine-year lease for its space with Mission West.
 
The redevelopment agency spent $5.5 million to build the facility, which opened in 2004; then last year approved $1.2 million for equipment and another $1 million for facility improvements.
 
Responding to tenant demand, the BioCenter last year created eight new wet labs by converting some of its dry lab space and office space; converted part of its office space to a chemistry analytics laboratory; expanded an existing tissue culture room; and installed modular laboratory furniture in the new wet lab spaces. The center also paid for HVAC, plumbing, mechanical, and electrical improvements associated with those projects. In addition, MedImmune donated $150,000 worth of equipment, which included centrifuges, a -80 C. degree freezer, a bacterial shaking incubator, microscopes, incubators, bio safety hoods, dairy cases, and freeze dryers.
 
Last October the agency approved $40,000 for security upgrades, the painting of a wall and installation of an interior sign with the center’s logo. “The entry and lobby currently have no corporate presence and need to be made more presentable to visitors, including investors and sponsors of the BioCenter, and its tenant companies,” the redevelopment agency’s executive director, Harry Mavrogenes, wrote in an Oct. 3, 2006, memo to board members.
 
Two months later, it approved a $16,000 payment to Mission West for an exterior sign it designed, made, and installed at the BioCenter’s entrance.
 
Berg told BioRegion News his firm did not zero in on biotech portfolio-wide given the need to back-fill large amounts of space
 
“We would have liked to have done that, but there really isn’t much down here right now. And so if you were going to do it, you’d have to [have companies] come out of this area,” Berg said.
 
Going forward, he continued, “we certainly are very interested in that, and the guys that [will] take over for us, I’m sure they’re going to be very interested in that because there are going to be some companies that come out of [the BioCenter and the rest of the Silicon Valley area] that are going to be very interesting.
 
Weakened Financials Hint at Need to Divest
 
Headquartered in Cupertino, Calif., Mission West took on its present form in 1998 when Berg merged most of the assets then held by Berg & Berg, which he launched in 1969, into a publicly traded shell company.
 
During the second quarter, Mission West net income dipped 5.5 percent to $2 million from $2.1 million in the second three months of 2006, while funds from operations fell from almost $17 million to almost $16 million. Total revenues were all but flat at $25.7 million, while rental revenue from real estate dipped 1.4 percent, from $21.6 million to $21.3 million.
 
For the first half of 2007, Mission West has seen its net income drop 26 percent, from $7.3 million to $5.4 million. Funds from operations fell almost 23 percent, from $51.5 million to $38.9 million, while total revenues at $59.3 million were 14 percent short of last year’s $69.2 million. Rental revenue decreased about 7.6 percent, from $46.1 million to $42.6 million.
 
The planned sell-off would continue the wave of real estate acquisitions that is reshaping California’s commercial real estate market. Just over the past month, Arden Realty, the west coast arm of GE Real Estate, has closed on or agreed to buy a total 5.9 million square feet of office space, including 1 million square feet of biotech space, through four separate deals. [BioRegion News, July 16]
 
Berg said a real estate market favorable to snapping up REITs was just one factor in Mission West’s decision to sell its holdings. Another reason was the decision earlier this year by San Jose officials to reject an unrelated rezoning request Berg pursued through another entity he owns.
 
The entity, Berg & Berg Enterprises, spent $10 million over four years to try to rezone a commercial site into residential as a favor to San Jose’s mayor, but when he was not re-elected to another term the new mayor nixed the request.
 

“I do think that with the new mayor we have in San Jose, we have a very unfriendly development environment. I just felt it was going to be a difficult environment to deal with.”

“It was certainly a factor [in the decision to sell] because I do think that with the new mayor we have in San Jose, we have a very unfriendly development environment,” Berg said. “I just felt it was going to be a difficult environment to deal with.”
 
A supporter of the new mayor disagreed, writing in an acerbic blog posting that the city was right to reject Berg’s request because the residential project would have generated less in tax revenue for San Jose than if the site remained industrial.
 
Berg told analysts the acquisition talks marked the second time this year that Mission West heard offers. In February, he said, the company was approached by “a large REIT” and almost simultaneously by “a large equity opportunity fund” about selling its assets. Mission West turned down both proposals, hoping to fetch more from another buyer.
 
In early May, Berg said, Mission West expanded its field of potential suitors, starting with a list of 149 different companies that might be potential investors or acquirers. It narrowed the field to 30, just as the REIT’s board hired AG Edwards to serve as financial advisor; Edwards hired CPS as real estate advisor.
 
Mission West winnowed down that list to 11, and invited them to bid on the company and most of its assets. Six of the would-be buyers placed bids, three of which the company considered further before commencing talks with the highest of the bidders “on July 12 or 13,” Berg said.
 
“We’re still in that process,” Berg told analysts. “The process will take another 20 to 30 days for them to complete all the due diligence and complete all the other things necessary. We will at that time enter into a definitive agreement with them and move forward to getting all the necessary approvals.”
 
Mission West has refused to divulge the prospective buyer’s identity. The Silicon Valley/San Jose Business Journal, citing unnamed “real estate sources,” reported July 18 the REIT was negotiating a sale to Starwood Capital Group of Greenwich, Conn., citing unnamed “real estate sources,” reported July 18 the REIT was negotiating a sale to Starwood Capital Group of Greenwich, Conn.
 
Neither Berg nor Starwood Capital spokesman Tom Johnson would confirm that the firm was the potential buyer.
 
If Starwood Capital buys Mission West, it would expand what is emerging as the firm’s second wave of purchases in California. Beginning in 2000, Starwood Capital acquired 3.3 million square feet of R&D space in southern California, then fully leased it up before selling the 27-asset portfolio in June 2003.
 
Starwood Capital cited anticipated growth by both biotechs looking to move south from South San Francisco, and high-tech companies looking to move north of San Jose, when it paid Jay Paul $835 million last December for the 1.7 million-square-foot Pacific Shores Center, an 11-building office campus in Redwood City, Calif.
 
But in April, Starwood Capital sold off two five-story buildings within the center that are leased entirely to a biopharmaceutical company. The firm sold 1400 and 1500 Seaport Boulevard, totaling 447,747 square feet, to Shorenstein Properties. The buildings were leased last year to PDL Biopharma, which plans to move its headquarters there from Fremont, Calif., during the third quarter of 2007.
 
On July 11, Starwood Capital announced it bought for an undisclosed price 11 Larkspur Landing extended-stay hotels stretching from the Silicon Valley through the Pacific Northwest from an entity of Larkspur Hotels and Restaurants, which will continue to run the facilities.
 
From Dot-Com to Bio
 
As with other building owners in Silicon Valley, Mission West has struggled to fill its portfolio of manufacturing and research-and-development sites since the 2000 technology bust.
 
The company has fared better over the past year, with its occupancy rate climbing by 7.6 percent, to 67.8 percent, or a 32.2-percent vacancy rate. But those figures include the 894,000 square feet of existing R&D space in 17 developed properties that Mission West wants to convert to residential use. “On most of them, we’ve already got a contract to somebody who’s going to tear them down for residential,” Berg said.
 
He said the vacancy rate when measured by properties Mission West is keeping is “right around 20 percent,” Berg said. Throughout the Silicon Valley, the second-quarter vacancy rate for R&D space is almost 18.1 percent, according to preliminary data by CPS/CORFAC International. That amounts to 30.3 million square feet, of which 17 percent is R&D space marketed for sublease.
 
Apple is Mission West’s largest tenant, leasing 650,000 square feet within its portfolio, with Microsoft not too far behind at 515,000 square feet. While corporate giants like these and Google have taken some of the valley’s empty space in recent years, the region has yet to fully recover from the dot-com meltdown. After losing 200,000 jobs between 2000 and 2003, Silicon Valley picked up 23,000 jobs last year, according to the Center for the Continuing Study of the California Economy. .
 
But during the 12 months ending in May, the region netted only 13,100 jobs, according to California’s Employment Development Department. And over the latest six-month period ending in May, Silicon Valley’s Santa Clara County and the cities within the North Santa Clara Valley Consortium lost 15,500 jobs, going from 861,000 to 845,500 jobs.
 
San Jose is pinning its hopes for future job growth on broadening its economy beyond traditional high-tech, to alternative energy and biotech. The city is now planning an Electronic Transportation Development Center, a center where established and emerging Silicon Valley technology companies can collaborate on the development of clean-energy and hybrid commercial vehicles.
 
It would be the city’s fifth incubator. San Jose is also home to the global trade-oriented US Market Access Center, software and environmental business incubators — and the San Jose BioCenter.

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