Paced by the presence of the nation's largest regional life sciences cluster, the San Francisco Bay Area's market for laboratory space had expanded for much of the past decade. But the economic upheaval that has halted much of the nation's economy has also taken its toll on the Bay Area's life-sci real estate market, as tenants ranging from startups to biotech giants back away from renting new lab space, or renewing existing leases, within the region.
In the San Francisco Peninsula sub-region, for example, a large space giveback by medical device maker Beckman Coulter — the return to market of a five-building, 260,000-square-foot R&D/office-warehouse "flex" complex in Palo Alto, Calif. — helped more than double the sub-region's vacancy rate over the past year, to 6.8 percent in the fourth quarter of 2008, from 3 percent in Q4 '07, according to a regional MarketView report by CB Richard Ellis.
San Francisco's office market vacancy rate rose more than three percentage points year to year, from 9.5 percent to 12.6 percent in Q4 '08, despite the completion in 2008 of a key life-sci project in the city's Mission Bay section, the 449,307-square-foot 409-499 Illinois Ave., anchored by a new headquarters space for Fibrogen, according to a MarketView report for the city sub-market.
The report also noted that life-sci also accounts for nearly all of the 400,000 square feet of new commercial space construction projected to be completed in the city of San Francisco in 2009, with another 210,000 square feet slated for 2010 completion, according to CB Richard Ellis.
Both reports are available here with e-mail registration.
Another brokerage, Grubb & Ellis, recorded a similar office vacancy increase for San Francisco — to 12.6 percent in Q4 '08 from just under 10 percent in the year-ago quarter — but said the jump was driven more by the collapse of several financial service providers and two downtown law firms, Thelen and Heller Ehrman.
BioRegion News recently spoke with Robert Schwartz, a senior vice president and northern California representative in the national life science practice group of the commercial real estate firm Colliers International, about the Bay Area life sciences real estate market, and its prospects in 2009. Following is an edited transcript of that interview:
What is the current state of the San Francisco Bay Area's market for life sciences space?
In general, the market is slower. Rents are not going up. The market is flattening, to softening a bit on the life science side. There's not a dramatic increase, but a relative increase in available space that's re-let space, previously improved.
It's extremely difficult because of the funding levels, and the current economic conditions, for a young company, a newly-funded company to get an owner to front the cost of high-quality lab build-out. Venture capitalists do not provide the funding to pay for the lab build-out. And [on] the flip side, the owners are having the problem of the risk of the cost, the heavy-duty expense of build-out because of what happens if a tenant doesn't make it. There's a lot of volatility in the market right now.
A few weeks back, Alexandria Real Estate Equities announced it would not break ground on new lab projects, including an expansion of the Mission Bay campus in San Francisco for which it had found tenants for two planned buildings. How much has that affected decisions by other landlords?
It's a good barometer, because Alexandria knows what it's doing. They're one of a handful of real pros in the biotech facility field. The cost of construction is very high, and it's a difficult climate in which to get financing, because who knows where credit really is right now. The math for somebody who does a very expensive build-out is that the rent they need to get to cover the expense of build-out is not a rent they can assume they will get if the client doesn't make it. It's very different from a [research and development] build-out, where you've got a large R&D marketplace, and you get a certain kind of rent, and you figure that if something happens to the tenant, you could probably release it somewhere in that order of magnitude. When you do a specialized custom lab build-out, the discount will be significant if you have to release the space prematurely.
If Alexandria is a bellwether, is it fair to say that new construction of lab space has all but stopped at this point?
Yes. It's an interesting question: What Alexandria was talking about doing in downtown San Francisco was a very expensive, class A-plus type product. Right now, new construction has slowed to a crawl in all of the Bay Area, as it has in most places in the country right now. I'm trying to think offhand if anything has happened in a while on spec in the life sciences area, and the answer is no.
I can count on one hand the number of people who would even consider doing a spec facility designed specifically for biotech, because there[ are] special extra costs to design that product. I don't anticipate much of anything happening in the next year or two, anyway.
What, in the meantime, are landlords doing? How generous or stingy are they with concessions to tenants?
[The amount of concessions] will start accelerating. And the concessions take different forms. They may take the form of [reduced] rental rent, free rent, or [higher] tenant improvement allowances. You will probably see more concessions focused on previously-improved lab space, in the form of rental rate or perhaps free or phased rent being favored by landlords over putting in significant amounts of money for tenant improvements.
The math on that is that if you've got a slowing market, and you have a previously improved space, you say, 'How long is it going to take me to rent it, anyway?' The math favors giving rent concessions rather than trying to have a much higher rent and take the risk of specialty improvements that are expensive. You'll err on the side of trying to shift the cost of the build-out to the tenant.
The flipside of that will be the tenants, as in any industry — this is not unique to the life science industry — all tenants in all businesses, including life sciences, are extremely conscious of cash flow, and capital cost. So there's a lot of pressure, especially on the small, younger companies to find facility solutions that use the least amount of capital.
What range in tenant allowances can tenants now expect, either in percent increases or in dollars?
It could be anywhere from $40 to $150 a square foot, but that's going to depend dramatically on the credit [of a tenant]. If you're Genentech, you're going to be able to get real numbers. If Genentech went to Alexandria and needed a healthy tenant improvement allowance, that would not be a problem. The thing to remember is that a lot of the companies on the biotech side are still in R&D stages. And in this climate, anybody who doesn't have a solid, established sales and profitability base, it's a real credit risk. It would be perceived to be a much higher credit risk than it would have been two or three years ago.
The days of doing a really expensive, high-tech build-out for somebody who gets a $20 [million] to $30 million VC investment, those days are not here right now.
You mentioned Genentech a few minutes ago. What, if anything, is happening with their Bay Area real estate in light of Roche's offer [to merge with Genentech]?
I'm not aware of anything that they've changed. They have a very solid presence in South San Francisco. They had picked up a lot of space over the past couple of years and made plans for expansion. They're very good at their facilities planning, and they plan for expansion well in advance.
Given the sluggish life-sci space market that you described, how much are landlords considering converting lab buildings to R&D or office uses?
Good question. Each product, and each market, is different. If somebody has a building that has a good, clean-condition life science build-out, they won't pull that out and convert it back into R&D. They would be more likely to market it at an R&D rent, and say, 'Here's the premium value that you get because you've got all this value that's in there.' Eventually, what happens in a lot of the areas is, [instead of basing rents on] the biotech improvement value, which has a significant dollar value and in theory should justify much higher rent, they just drop the rents.
If I owned a building with good lab space, I would not go ahead and convert it back to R&D, because R&D is slowing significantly. And having a life-science build-out at least gives you some marketing differentiation.
By not converting lab buildings to R&D, is it because landlords think the downturn will end in about a year?
It's because the R&D market is slowing post-September and October . The general R&D market is slowing very rapidly, except in certain very primo areas, and even then it's slowing, and the rents are dropping. And everybody knows that 2009 is going to be a very difficult year. To take out lab improvements and just have another R&D building would not be the prudent way to go.
There are life sciences companies that will continue to be funded. Some of those will be biotechs. There will continue to be funding of medical device companies. And if there's some good usable lab or medical-device clean environments that somebody can go into without having to front the cost, that's a plus in the market. I'd rather own that kind of a building than a generic R&D building in some of the larger R&D areas.
What is the current range of rents for life-sci space across the Bay Area?
If I had to throw out a number — and I would caution that life science includes medical device[s], electronics, and biotech — it would be anywhere from $18 [per square foot] triple net, to maybe $40 [per square foot], which is a huge range. It's got to do with the fact that a medical device company could go into an R&D space that could be $18 [per square foot] or less. If you go farther down the Peninsula, a medical electronics company could be in a spot that's more like $15 [per square foot], because they're going into a R&D-ish kind of space. And there's some sublease space out there, where landlords may be quoting $28 [per square foot]. But if it's sitting there vacant in today's market, what can you really get? Quite a bit less.
Given the change in the market the last few months, how has that changed who's going to be involved as landlords? Are there any changes in terms of the kinds of landlords in the market?
No. There still are a very small people who really know and understand biotech. About two or three years ago, when biotech was sort of hotter, everybody was saying their buildings were biotech-convertible, even though many of those owners really didn't have any expertise in biotech.
I was at a meeting where I was talking to a fairly substantial Bay Area property owner — I won't say who — who [has?]office[s] with some R&D, and they happened to buy a project that had a prior medical user, though they bought it as a land play. Its location and features make it convertible for higher-quality biotech. So even though it's not within their core competence, [the property owner is] going to be doing some upgrades and marketing that it's focused on life science use, biotech use, as an alternative that they can provide; versus if somebody just wanted to use it for general R&D. That's the first one I've seen in the last year or two, and certainly in the last few months. It has to do with the site's unique location, and the infrastructure and entitlements of the building.
For example, [electric] power is going to increasingly become an issue. It's very expensive now, very complicated, and much more time consuming than in the past to bring in additional power to a building. If you have a lot of existing power, maybe because of a prior semiconductor or heavy manufacturing use, that's a useful entitled capacity in the building that makes one think, 'Hey this building has some real plus for biotech.' You don't just go in, over the counter, saying, 'I need a few hundred or thousand more amps' and have [local officials] saying, 'sure.' Now it's a very rigorous process to justify the need, fill out forms, and go through an assessment of allocation by the power companies as they look at their short- and longer-term allocation of power. It gets done, but it doesn't happen in 30 days.
Going forward, how much influence will the life sciences sector hold in shaping the Bay Area's commercial real estate market?
Biotech and life science has had a very high degree of public consciousness in recent years, particularly in the Bay Area, post the dot-com era. A lot of people were looking at life science as the major new shaker and mover that would hopefully pick up big amounts of the slack from [the 2000 collapse of the Internet-based high tech investment bubble].
But as big as the life science market is in the Bay Area, it doesn't have the capability to do that. If you compare the number of people employed in the life sciences area in the Bay Area [about 90,000 employees, to industry group BayBio's Impact 2008 report, available here], and you compare that to how many people are employed throughout the region [more than 1 million people, according to California's Employment Development Department], you can see that even if the biotech industry were to grow by five or 10 percent per year, it still gets dwarfed by a Google or a Yahoo that is doing well, or an HP that is doing well. It's not an industry that employs hundreds of thousands of people in the area.
So everybody is very conscious of [life sciences] as an industry. It gets a lot of press. It's very important. It does terrific work, and so forth. But it's not by itself going to be a mega-driver of the whole Bay Area economic condition.