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Calif. REIT HCP Will Start New Buildings, Renovations Only for ‘Significant’ Spaces

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Life-science real estate-investment trust Health Care Property Investors said it will start new life-sciences space construction or renovation projects in coming months only after securing commitments from tenants to lease “significant” amounts of space.
 
Though company officials did not define “significant,” HCP’s direction, expressed by executives earlier this month in its quarterly conference call with analysts, differs from the approach taken by two other REITs with substantial portfolios of life-science space. Alexandria Real Estate Equities and BioMed Realty Trust, citing the all-but-frozen capital market, have both said they will hold off breaking ground on all construction projects beyond those already in progress [BRN, Nov. 3].
 
HCP, based in Long Beach, Calif., said it would stay busy over the next several months on two Bay Area projects: one it is wrapping up in South San Francisco and one it has started in the San Francisco suburb of Redwood City.
 
In South San Francisco, HCP will complete buildings A and B at its Oyster Point II life-sci campus, consisting of a combined 251,000 square feet of space entirely leased to Amgen, Mark Wallace, the company’s CFO and treasurer, told analysts. The REIT will begin recording rent collected on building A in the fourth quarter and on building B in the first quarter of 2009, when tenant improvements are completed.
 
While Amgen has signed a 15-year lease for both A and B, it backtracked on plans to move into the space last year as part of a company-wide cost-cutting plan [BRN, Aug. 20, 2007], and sought to sublease the properties, without success.
 
Also at Oyster Point II, Wallace and HCP Chairman and CEO James Flaherty III said HCP plans to complete the core and shell of Building C this quarter. HCP is marketing the 87,586-square-foot building through the real estate firm CB Richard Ellis. said HCP plans to complete the core and shell of Building C this quarter. HCP is marketing the 87,586-square-foot building through the real estate firm CB Richard Ellis.
 
“We're actively talking to tenants, but as of now there's zero pre-leasing on that particular building,” Flaherty said.
 
Flaherty and Wallace discussed Oyster Point II during a conference call with analysts held to discuss the REIT’s third-quarter results. HCP finished Q3 ’08 with diluted funds from operations, or FFOs, applicable to common shares of $179.1 million, more than 60 percent over $111.6 million in the third quarter of 2007.
 
While listed companies report earnings as a measure of their financial health, REITs use FFOs.
 
HCP expects Oyster Point II to account for $6.5 million to FFO in the last half of 2008, or about $14 million annually, Wallace said.
 
During Q3, HCP racked up $269.9 million in revenues, up 10.8 percent from almost $243.6 million during the third quarter of 2007.
 
Efforts to sign tenants are tougher now than in recent months as the ongoing upheaval in the credit and equities markets has slowed activity in the life-sciences real-estate space for even the vaulted sub-region that includes South San Francisco, let alone the broader Bay Area, one brokerage concluded.
 
“The lack of credit within the banking system is going to dramatically stall the development of new life-science space that is built in anticipation of demand from this industry sector,” GVA Kidder Matthews cautioned in its quarterly Life Science & Cleantech SF Bay Area Real Estate Market Review for the third quarter, available here.
 

“[O]nly those companies that are able to accurately forecast their demand for space will be able to enter into pre-lease and build-to-suit transactions … “

“Given the fact that life-science buildings can take at least 18 months to build and deliver, only those companies that are able to accurately forecast their demand for space will be able to enter into pre-lease and build-to-suit transactions with the development community,” GVA Kidder Matthews added.
 
Just how much the market has deteriorated since last year can be seen from the real estate firm NAI BT’s third-quarter report, available here, on the R&D market for San Mateo County.
 
In the sub-market consisting of South San Francisco, Burlingame, and Brisbane, the vacancy rate has more than doubled year-to-year to 11.2 percent from 4.7 percent. Redwood City’s vacancy rate nearly doubled to 22.4 percent from 13.5 percent.
 
Overall R&D vacancy in San Mateo County rose 19 percent to 12.4 percent from nearly 10.5 percent.
 
Also in South San Francisco, HCP said it completed work in August on the final two buildings totaling 147,000 square feet at its East Grand campus. Buildings Seven and Nine are entirely leased to Genentech, the biotechnology giant headquartered in the San Francisco suburb that Roche seeks to acquire for $43.7 billion.
 
Genentech also leases the rest of East Grand, an eight-building, 794,000-square-foot campus, including the 82,000-square-foot Building Eight, completed during the second quarter.
 
“With our Genentech campus being placed in service in the third quarter, and the Amgen campus being placed into service in the next two quarters, HCP has minimal 2009 development risk. Furthermore, any new construction starts would require significant pre-leasing commitments,” Flaherty said.
 
In Redwood City, HCP has begun 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, for which the REIT won approval from the city’s Architectural Review Committee in August.
 
“We anticipate our redevelopment efforts for these two buildings to be completed in the fourth quarter of 2009,” Paul Gallagher, HCP’s chief investment officer, said on the Nov. 4 conference call.
 
Seaport Centre was developed in the 1980s and acquired in 2005 with life sciences activity in mind by Slough Estates Group, the UK-owned developer that, two years later, sold its US life-science properties to HCP for $2.9 billion [BRN, June 11, 2007]. Seaport Centre consists of 15 buildings totaling 622,000 square feet of life-sci, R&D, and office space.
 
Gallagher said life-sci tenants are not foreseen as being a drag on HCP’s earnings because its properties are filled mostly with larger and more mature companies.
 
“With respects to our life-science portfolio, the composition of our tenant base is strong with almost 90 percent of our rents coming from public companies or well-established private entities,” he said. “The number of early-stage life-science companies is very small at approximately 2 percent of the entire life-science portfolio.”
 
Gallagher said HCP continues to pursue a pipeline of potential future lease deals with tenants seeking a total 500,000 square feet of existing space.
 
“The deals we’ve seen recently have been shorter in term and are taking longer to execute as decision makers remain reluctant to enter new, longer-term commitments given the economy,” he said.

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