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HCP Acquires Slough's US Lab Portfolio to Gain Foothold in California Biotech Market

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By snapping up the US portfolio of British-owned Slough Estates USA last week, a Long Beach, Calif., real estate investment trust has positioned itself as the largest of three major owner-developers of laboratory space within the West Coast’s top two biotech regions.
 
Health Care Property Investors agreed to shell out $2.9 billion, including assumption of $1.2 billion in debt, for SEUSA’s roughly 5.2 million square feet of space in 82 properties in South San Francisco and San Diego County; as well as 3.8 million square feet the company had committed to build in both regions, and another 3.3 million square feet in as-yet-unscheduled future development phases, also in the two California regions.
 
“As a leading developer of life science real estate, we expect to develop high-quality lab-pharma facilities at 8 to 11 percent yields, which will be attractive to our institutional capital partners,” HCP chairman and CEO James Flaherty said in a conference call June 4, the day the deal was announced.
 
HCP will manage the SEUSA portfolio through a new life science group to be led by Marshall Lees. He is now SEUSA’s president and CEO, but would become executive vice president of the group after the sale closes. Other top managers at SEUSA would serve under Lees in the life science group.
 
To pay for the acquisition — set to close in the third quarter — HCP will use a $3 billion bridge loan, sell some of its properties and sell joint-venture stakes in some other properties, Flaherty said. The properties to be sold or joint-ventured have yet to be determined.
 
Over time, HCP also hopes to squeeze more revenue from SEUSA’s properties. Of SEUSA’s existing portfolio, 84 percent is 95 percent occupied, while the remainder is only 48 percent occupied. HCP projects it will fill those properties over the next 18 to 24 months.
 
Also, 17 percent of the SEUSA portfolio consists of leases at below-market rents — 20 percent in South San Francisco, the rest in San Diego County. As leases come up for renewal, “we’ll be able to [bring] the portfolio, particularly the South San Francisco market, to market over that time frame,” Flaherty said.
 
The SEUSA acquisition marks another shift for HCP. Originally focused on owning and managing healthcare facilities such as nursing homes and hospitals, the company gravitated to the senior housing market, notably purchasing CNL Retirement Properties last year for $5.2 billion, before concluding it could generate higher returns as a landlord in the life sciences market. “This is probably one of the last spaces really where the premium hasn’t totally been arbitraged yet,” Flaherty told investors.
 
HCP’s entry into the lab market comes as two other REITs move to grow their portfolios in California. Alexandria Real Estate Equities has completed a single 155,000-square-foot building at its Mission Bay campus in San Francisco, with 2.2 million total square feet planned by 2011, plus rights to build another 2.7 million square feet. In San Diego, BioMed Realty Trust has begun a more modest 84,000-square-foot addition to an existing biotech campus in its headquarters city.
 
Until now, SEUSA has amassed the largest life sciences portfolios in the two regions, owning and managing just under 4 million square feet in the Bay Area, as well as just over a million square feet in San Diego County.
 
John Minervini, a senior director and member of the Global Life Science practice group of Cushman & Wakefield based at its San Diego office, said the deal makes HCP “a serious player” in two of the nation’s largest life sciences real estate markets. He noted HCP’s decision to keep SEUSA’s life sciences team intact through a separate division.
 
“They have essentially put themselves on the map in California,” Minervini said. “They’ve got people who know what they’re doing. They have created a third major laboratory player. My assumption is that they may want to take that platform across the country. That’s a guess, but that’s what Alexandria and BioMed have done.”
 
Until those companies and HCP build more space, he added, rents will continue to rise in response to demand from growing biotechs.
 
The longer that happens, the more likely HCP is to carry out SEUSA’s timetable for new projects. As of March, SEUSA had planned to break ground in September on its latest US property, the 326,000-square-foot 494 Forbes Blvd. in South San Francisco. The company has also sought approvals to build 540,000 square feet at Sierra Point in Brisbane, Calif.
 
SEUSA had been a top life sciences landlord in South San Francisco with the biotech giants Genentech and Amgen among its two top tenants, accounting for a combined half-million square feet of space. Next year, SEUSA had planned to complete the first phase of its Britannia East Grand Business Park, consisting of two buildings totaling 223,686 square feet. Genentech has agreed to lease the business park with an option to buy its eight buildings comprising 780,000 square feet.
 
Colleen Wilson, the Genentech’s director of community and patient programs, told BioRegion News on June 8 that HCP’s acquisition of SEUSA will not affect that or other future expansion plans by Genentech [BioRegion News, April 30 and May 14].
 

“They’ve got people who know what they’re doing. They have created a third major laboratory player. My assumption is that they may want to take that platform across the country. That’s a guess, but that’s what Alexandria and BioMed have done.”

Addressing analysts, Flaherty said HCP planned to start construction of new space this year — but did not say whether the 494 Forbes Blvd. project would be among them. The company is on pace to build at least 15 percent of its development pipeline each of the next five to six years, but may proceed faster.
 
“If we’re sitting a year or two from now [and] the vast majority of that pipeline is sitting up in South San Francisco and we’re still at a 4 percent vacancy rate, we may well elect to accelerate the build-out of that,” Flaherty said, speaking at the National Association of Real Estate Investment Trust Investor Forum.
 
Vacancy rates in the Bay Area fluctuate between from 3 to 5 percent as growing biotechs find a tight supply of mostly second-generation space, Dino Perazzo, a senior vice president with CB Richard Ellis, told BioRegion News last month. That space becomes available, he said, as biotechs downsize or move outside the market.
 
According to CB Richard Ellis research, “asking” rents sought by landlords across the Bay Area rose last year 11.6 percent for office space, to $34.30 per square foot; and 5.7 percent for R&D properties, to $13.42 per square foot “triple net,” with tenants paying taxes, utility and maintenance costs.
 
But in the “peninsula” area that includes South San Francisco, office rents jumped 20.8 percent to $35.52 per square foot. Industrial space asking rents rose as much as 27 percent for industrial space, to $27.12 per square foot triple-net, and 37 percent for R&D space used by biotechs to build labs, to $2.50 per square foot triple net.
 
Office rents have continued to climb this year: “You’re probably in the low $40s” per square foot for new San Francisco space, said Alan Gold, CEO of BioMed Realty Trust, during a May 3 conference call.
 
BioMed owns and manages more than 1.5 million square feet in California — seven Bay Area properties totaling 955,593 square feet, as well as another nine properties in the San Diego region totaling 565,364 square feet.
 
Last month BioMed, which is headquartered in San Diego, broke ground on another San Diego property, an 84,000-square-foot office-lab facility for Illumina. The new facility marks an expansion of BioMed’s Towne Center Drive property, now three buildings totaling 115,870 square feet.
 
For SEUSA’s parent company, British-owned SEGRO, the shedding of its US portfolio followed a strategic decision to focus more on building office space in the United Kingdom and the rest of Europe, where it projects rents will rise even further than the US as the biotech industry grows over the next few years.
 
“Slough Estates USA, although an excellent business in its own right, is not part of our long-term strategy because of the lack of synergies with our UK and European businesses,” SEUSA CEO Ian Coull said on a June 4 conference call.

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