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CBRE’s Jacobs on How the Bay Area’s Rising Rents Impact Biotech Migration

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The Bay Area is the nation’s largest life sciences cluster, so it’s no surprise that demand for its lab, research, and office space is high enough to keep the region’s vacancy rates among the lowest in the nation.
 
One recent example of what high demand has wrought came earlier this fall, when the region’s life sciences industry group BayBio teamed up with Hitech Construction Management and Design to release their third annual survey of life sciences companies. Among the survey results was an increase throughout the region in the rents paid by life sciences businesses, from startups to corporate giants, in the mid-Peninsula and northern Silicon Valley sub-regions [BioRegion News, Oct. 1].
 
Within days, the region’s largest commercial real estate services firm issued its own figures showing a similar jump in rents region-wide. CB Richard Ellis recorded even higher numbers than BayBio,, reflecting in part the use of average “asking” rents sought by landlords — versus the lower, and typically undisclosed, “taking” rents agreed to by those landlords and tenant companies when they hammer out leases for space.
 
According to BayBio and Hitech, the region’s rents ranged from $1.53 per square foot for the southern East Bay section to $2.91 per square foot for the northern Peninsula, which includes South San Francisco. CBRE’s third-quarter average asking rents started lower at 79 cents per square foot in the East Bay, but generally ran higher, peaking at $3.50 per square foot in South San Francisco. Biotech and other R&D users typically pay “triple net” rents in which tenants pay for utilities, taxes, and maintenance.
 
The rise in rents took place despite a series of space returns to market that threatened to contain prices. The two most talked-about returns: Johnson & Johnson said it would vacate space in Mountain View, Calif., as part of a series of corporate cuts as it prepares for the end of patent protections for some of its products. And Amgen placed for sublease three South San Francisco buildings totaling 365,000 square feet as part of a company-wide cost-cutting plan it announced in August. [BioRegion News, Aug. 20]
 
Christopher Jacobs, a senior vice president with CB Richard Ellis, recently discussed the state of the Bay Area’s life sciences market, the factors that have kept rents rising, and the market’s prospects over the next several months with BioRegion News editor Alex Philippidis. The following is an edited transcript of the interview.
 

 
Why are companies more inclined now to look for space farther south on the Peninsula? Is there that much new construction going on in the southern Peninsula and the East Bay to draw these folks, or is there that much space on the market?
 
It’s the latter. There is very little, if any, new construction in mid-Peninsula. It’s very difficult to find sites that are of a significant enough size to put together a campus or a biotech park. It’s just a very tight market. And if you look at it, if you look at this area just from an aerial view, most of the buildings are smaller [than elsewhere in the region], so it’s very difficult to assemble everything you need. It’s a challenge to find product or to gain product in the mid-Peninsula.
 
In the East Bay market — which people tend to call Hayward to a small extent, but mostly people are talking about Fremont, then there is a market up in the Berkeley/Emeryville area, across from San Francisco, too — that’s extremely tight as well. There are not many areas for new development. But Fremont is pretty open, so to speak. There’s a master-planned project called Ardenwood, which started development 15 years ago. But there are a number of life science companies that have for varying reasons moved out of there. Protein Design Labs moved recently to Redwood City from the East Bay, so they vacated their buildings. Another company was purchased by Amgen, so they vacated their buildings. [Johnson & Johnson] has some buildings that they might be vacating. We have those market factors, along with BioMed [Realty Trust]’s acquisition of the Pacific Research Center, which used to be Sun Microsystems’ large campus of 1.4 million square feet. They’d like to convert a lot of that to life science.
 
What effect does all of that have activity have on the East Bay life sciences space market?
 
All of a sudden, you have a market in Fremont that has 40 percent vacancy, very significant vacancy if you count that space as vacant space. So there’s existing lab over there, and there’s a lot of potential rehab that BioMed can do. Because of that, the secondary market has become more depressed. So in the primary market, it’s still very tight and rents have been very strong. In the secondary market — ‘B’ locations, not ‘A’ locations — rents are a little depressed and landlords are getting a little hungry for deals.
 
It is a very interesting dynamic when you look at an A location; South San Francisco is probably the A+ location. It’s kind of the epicenter, so to speak. Then you look at the market in San Francisco today and people would say that’s probably an A. And then you move down to Redwood City, that’s probably an A. But the further you get away from that, tenants tend to be reluctant, because the intellectual capital has to commute further. There is a stigma about going across a bridge from a traffic standpoint, and maybe it’s just a psychological standpoint, too. Executives and employees tend to — it’s not universal — tend to be on this side of the bay. So for them to commute over there is a little bit of a reach. It doesn’t mean nobody is doing it. There are people who have done it. There are people who are doing it. But if you look at the volume related to the Peninsula and then the Fremont-Heyward area, it’s a pretty significant difference.
 
What’s going to happen if rents keep going up on the Peninsula and rents stay depressed on the East Bay? Do you see a migration of companies west and south within the region?
 
I think that there’s a market factor that will keep the rents from spiking. In South San Francisco, if they’re $48 per square foot now, we don’t see them going to $70 in six months or anything like that. I think you’re going to see … a relatively stable, reasonable growth rate on those rents. And you will see, probably, a little more, because there will be people that will say, ‘We just can’t or won’t spend that kind of money. We’re going to have to look at Fremont.’
 
But you also have to understand the mentality of the industry in two ways. One, intellectual capital is king. I don’t care how much you’re paying for real estate. If I can’t get talented people to my site, it doesn’t matter how much I pay in rent. My business isn’t going to work.
 
The second thing is what I alluded to earlier: The real estate cost, even if it’s a higher number here, compared to the overall cost isn’t the overall driver. It’s not like a low-margin business where real estate costs have to be low, where you’ve got to keep those [costs] tight. If you can’t operate for labor and for distribution here, you’ve got to go out to Sacramento or Stockton or somewhere which would be the value area that’s much cheaper. It’s different industry than that.
 
So I think those two factors keep people from just saying, ‘Gee, everyone’s going to Fremont, now.’ And then all of a sudden the Fremont rents go up, and then people go, ‘Oh, those have gone up high enough. Let’s go back to the Peninsula.’ That’s not how it’s worked, certainly historically. There’s been some trickle effect over to Fremont, and we think that will probably continue. It might increase a little bit. But I don’t think it will be a dramatic effect.
 
For the third quarter, CBRE released average asking rents for sub-regions of the Bay Area that ranged from 79 cents per square foot in the East Bay to $2.61 per square foot for the entire Peninsula, to $3.50 in South San Francisco. These figures were generally higher than those published in the 2007 Bay Area Biotechnology Real Estate Survey [released by BayBio with Hitech Construction Management and Design of South San Francisco]. How do you explain the discrepancy?
 
[O]ne of the things that happens sometimes is, life science rents don’t get pulled out separately from other rents. For example, in our quarterly reports, we report R&D rents. R&D isn’t just life science. It’s also what you consider to be electronics R&D, so there’s sort of a melding of the two. The life science [average rent is not reported separately], because it’s such a small submarket. You really have to be careful about how you’re defining what your asking rent is. Is this overall R&D market? Is this just biotech and life science space?
 
Actually there’s even a difference. We’ll call ‘biotech’ space the ones that have biology space, chemistry labs, whereas life science would include things like medical device spaces. And ‘medical device’ is significantly different than the biotech space. They have usually a lot lower percentage of what we consider to be wet-lab kind of space. And they’ll have some clean room space. But they’ll also have more storage and a machine-shop area where [companies] are building their devices. So each one of those carries a little different build-out, and a little different cost associated with it from a rent standpoint.
 
Again, I don’t know for a fact, not looking at the numbers in front of me right now, what those discrepancies are. But I would say that there certainly would be, depending what you’re talking about.
 
The BayBio numbers ranged from $1.53 per square foot, triple net, in the East Bay South, to $2.50 in East Bay North, $2.86 in mid Peninsula and $2.91 in North Peninsula.
 
I would say, again, the $2.91 in the northern Peninsula is probably OK if you look at a strict average. Let me give you the detail behind that average. There are subleases in South San Francisco that we call third-generation space: Older lab space that’s functional, but it’s old. That could sublease for as low as $2.25 a [square] foot, maybe $2.50 a [square] foot — somewhere in that range. But there [are] also build-to-suit [spaces] that might be $3.75 [per square foot], triple net, or $4 triple net. . . .On any new deal, you’re going to be $3.50 or more, depending on your [tenant improvement allowance] and term and who the company is and those kinds of things.
 
What change, if any, do you foresee in market trends over the next few months?
 
I think for the fourth quarter, I would say we’re sort of status quo. I don’t think there will be a dramatic tightening of the market, nor do I think that there will be significant additional space coming to market. You have Amgen, which put space back on the market. I think that’s kind of a unique situation in that it’s a very large building. It’s not as if a developer built a campus and can do anywhere from 20,000 to 100,000 square feet. For Amgen, you really need a big fish. So the question is, how’s that going to work? The good news is, if you are a big fish, there’s an availability. Will there be a big fish coming to the market in the next three months? It’s hard to say. There [are] a couple poking their noses around, on a preliminary basis. But it’s tough to say whether something will come together the next few months.
 
[Amgen] won’t have a dramatic effect. With the vacancy in [South San Francisco] at 3 percent, that’s not going to have a dramatic effect on the market, from a rent standpoint.
 
We can say there is, generally speaking, a supply constraint in that market. And that’s the other issue that may push people elsewhere. If you want to pay, if you’re willing to pay whatever it costs you to be in South San Francisco, but the space just doesn’t exist, then you have to go somewhere else. So Mission Bay in San Francisco is going to get some benefit from that. And possibly the Redwood City area on the Peninsula will too, if they have space, because their space is tight, too. And if they can’t find it there, then people may either go all the way down to Sunnyvale, or they may go to Fremont. They may go east.

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