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US Credit Market Seizure Forces Two Large REITs to Halt Construction of New Projects

With the credit and debt crisis crimping financing options for new construction, two of the nation’s largest publicly traded real estate investment trusts said last week they would temporarily suspend all new life-sciences lab projects not already being built.
Top executives at Alexandria Real Estate Equities and BioMed Realty Trust told analysts last week they had elected not to build several projects in their development pipelines, opting instead to wait out the credit freeze, which they projected would run well into next year.
“We are substantially reducing our construction spending, and will not add any new commitments for significant ground-up developments or significant redevelopments until there is a confirmed proof that liquidity has returned to the marketplace,” Dean Shigenaga, Alexandria’s treasurer, told analysts during Alexandria’s Oct. 30 conference call to discuss third-quarter results.
Among the most prominent projects affected is the Alexandria Center for Science and Technology at Mission Bay in San Francisco, where the REIT had earlier planned to break ground on two new buildings that would have been built to suit for tenants it had already lined up.
Alexandria expects the move to lower Alexandria’s quarterly construction spending “by more than 40 percent, on average,” from the $100 million originally projected for 2009, he said.
“Our assumption in the current unprecedented environment is that there will be no equity or debt capital available for the next year, or possibly longer,” Shigenaga said, adding that the REIT instead expects to draw capital primarily from its $1.9 billion credit facility — on which $1.27 billion was outstanding as of Sept. 30 — as well as from proceeds of sales of some properties. The credit facility matures in 2010, though Alexandria has a one-year option to push back the date to October 2011.
“It is imperative that we plan for this set of assumptions to provide us with the best path to successfully navigate through this worldwide crisis,” Shigenaga said.
Echoed Joel Marcus, Alexandria’s chairman and CEO: “The market is tough and is going to get tougher for this industry and all industries, by and large.”
Discussing the Alexandria Center for Science and Technology, Marcus would not identify its prospective tenants except to say they are “credit[-worthy] institutional tenants that need to be at Mission Bay.” One of the tenants “has a major collaboration with UCSF and has a strong desire to be there.”
“They were flexible in their need, but would have liked us to pull the trigger. And we decided that we would defer, and revisit this come next year, and we’ll see what the markets are like,” Marcus said. “We’re going to be cautious about making any new commitments.”
The reason: Based on discussions with construction lenders, he said, “Very little if anything is moving through the current [construction] pipeline.” He cited “a top tier bank, a name you would instantly recognize,” that told Alexandria it was not funding any of four major construction projects it had recently considered despite being fully leased to well-financed tenants.
Marcus did not identify the Mission Bay buildings where construction has been deferred, or disclose the building’s combined space.
Alexandria’s Mission Bay pipeline includes: 1600 Owens St., a 229,000-square-foot building; 1515 Third St., a 204,000-square-foot building; and 1450 Owens St., a 62,000-square-foot building. Also within the pipeline is the remaining 155,000 square feet of space within a 365,000-square-foot section of the campus originally approved with the address of 1455 Third St., and envisioned as a single building. Alexandria redesigned that section when it agreed to break ground Aug. 5 on its third Mission Bay site, a 210,000-square-foot building called 455 Mission Bay Blvd. South.
The groundbreaking occurred after Pfizer signed a 100,000-square-foot lease for its Biotherapeutics and Bioinnovation Center, to where the pharma giant would relocate from South San Francisco with an option for another 50,000 square feet. At the time, Alexandria said it would construct a completely separate building that would use the 1455 Third St. address. [BRN, Aug. 11].
Marcus said that interest from existing tenants in the deferred Mission Bay buildings is part of an ongoing demand that helped fill Alexandria’s second building at Mission Bay during the third quarter. All space in the 158,000 square-foot 1500 Owens St. “is fully leased or committed to” the University of California, San Francisco, and an undisclosed “multi-billion-dollar equity-market-cap biotech company.”
During the second quarter, Alexandria announced that UCSF’s orthopedic surgery clinic would lease two floors totaling about 41,000 square feet. When completed in 2020, the clinic would expand a UCSF presence at Mission Bay, which consists of a 57.5-acre biomedical research campus set to accommodate about 9,000 students, faculty, and staff. Also, plans for a 289-bed UCSF hospital complex are under review by city officials.
New York Chill
Marcus said the current market has all but precluded Alexandria from signing on a joint-venture partner for the next development phase at the $700 million East River Science Park in New York, despite “lots of discussions with two partners that we have term sheets with.”
“We would love to try at some point to get a construction loan on that project. But given the current environment with construction lenders, virtually no construction financing is going forward that’s new,” Marcus said.
“As soon as the credit markets either loosen or unseize in a more dramatic fashion, we have a number of discussions we’ve had with a variety of lenders, one in particular who has expressed a very substantial interest in putting together a syndicate, a facility for this project,” he added. “Being a realist, my view is that that’s not going to happen until the banks have a comfort level that interbank lending and overall liquidity has come back to the market, to the point where the banks are not worried.”

“Nobody’s willing to put out much money in today’s market.”

Alexandria is now constructing the first 310,000-square-foot phase of East River Science Park. While the REIT has yet to ink a lease there, it does have out for signature a lease for “somewhere between 16,000 and 35,000 square feet” with an undisclosed prospective tenant that has deferred action pending its board’s appointment of a new CEO, according to Marcus.
“We have active discussions with biotech, pharma, product, and service companies and a variety of institutional users for more than the 310,000 square feet. And we’re actively working very closely with the city, including Mayor [Michael] Bloomberg himself, regarding a significant life sciences anchor tenant,” Marcus told analysts.
Alexandria shared more definitive news about China, where a two-building 280,000-square-foot campus planned near Macau, in South China, is being repositioned for lease to one or more technology manufacturers unable to lease space at a nearby high-tech park that is full. Marcus said the project will likely cost less than the $40 per square foot, or about $11.2 million, formally projected by Alexandria — down from a projection earlier this year of $45 per square foot, or $12.6 million [BRN, Feb. 19].
“It appears that we’ll have a good opportunity to capture a pretty significant, either one or a set of tenants,” Marcus said. “Our partner there has decided that it would prefer to not take the time and spend the money to build out what was going to be a pretty expensive interior fit out in 18 percent of that space. As a consequence, we decided jointly to reposition the property rather than [plan] for partial owner-occupancy.”
During the conference call, Alexandria reported that net profits increased 6.4 percent to $21.5 million in Q3 ’08 from $20.2 million in the third quarter of 2007. It also reported that funds from operations, before depreciation and amortization, jumped 14 percent to $48.8 million from $42.7 million; and total revenues rose nearly 13 percent in the quarter to $115.3 million from $102.1 million in Q3 ’07.
A potential source of future income for Alexandria, Marcus said, could emerge if the REIT acts on the requests of some tenants that have asked the company to sell to them for purchase portions of their facilities deemed mission-critical. “We have nothing to report, but clearly, if we make a decision at any point, that would be a great source of available cash to us,” Marcus said.
So too would be a deal at any of two underperforming South San Francisco properties under redevelopment.
Answering a question from JP Morgan analyst Anthony Paolone, Marcus said Alexandria “is in discussions with a number of companies” interested in leasing space at the two-building, 162,000-square-foot Alexandria Technology Center on East Jamie Court, which sits almost adjacent to property owned by Genentech. The tenant prospects could fill more than half the space that remains beyond the 16 percent, or about 25,920 square feet, now leased there, Marcus said.
At the 135,000-square foot building called 249 East Grand Ave., the building’s sole current tenant, drug discoverer Exelixis, occupies 55 percent of the space, or 74,250 square feet, and recently exercised an option to extend that lease through the end of 2009.
“We’re cautiously optimistic that with some favorable partnering opportunities, that hopefully they’ll end up taking the rest of the building,” Marcus said.
“We do know that South San Francisco has been a soft, slow market,” he added.
Paolone has questioned Alexandria’s ability to weather the downturn next year. Last week, he downgraded the firm’s rating to “neutral” from “overweight,” citing a variety of potential hurdles to earnings in 2009, including "rising interest rates and deteriorating fundamentals in the lab-space business."
Lower FFO Forecasts
Both REITs also lowered their funds from operations guidance. Alexandria lowered by one cent its FFO guidance, from $5.86 per share to $5.85 per share, reflecting the impact of higher interest rates the lab space developer expects in the fourth quarter.
BioMed lowered its forecast of funds from operations for 2008 to between $1.84 and $1.87 per share — from the previous per-share projection of between $1.85 and $1.91. The lower guidance came despite a 15.5-percent year-to-year increase in FFO, which rose to $35.6 million.
BioMed’s net income available to common stockholders inched up to $13.0 million in Q3 ’08, compared with $12.2 million in the year-ago quarter. And total revenues, at $80.8 million, were 24.7 percent above the $64.8 million recorded in Q3 ’07.
Like Alexandria, BioMed plans no new groundbreakings.
“We do not currently anticipate any new construction starts for the foreseeable future” beyond three developments that are all at least 50-percent leased and set to be completed in the first half of 2009, Alan Gold, BioMed’s chairman, president, and CEO, told analysts Oct. 30.
During that call, held an hour before Alexandria’s, the company described those three developments as:
  • The Center for Life Sciences Boston, the 18-story, 703,000-square-foot lab building in the city’s pricy Longwood Medical Area. During the third quarter, Beth Israel Deaconess Medical Center nearly completed its move into its more than 300,000 square feet there, Gold said.
  • The Landmark at Eastview in the New York City suburb of Tarrytown, NY, where BioMed is building three interconnected buildings totaling 360,000 square feet, adding to the biocampus’ existing 751,648 square feet.
  • 530 Fairview Ave. (Fairview Research Center), a five-story, 94,000-square-foot lab building set to rise on the southeast corner of Fairview Avenue North and Mercer Street, in Seattle’s South Lake Union area. On Oct. 14, BioMed acquired the minority interest in the property for $2.6 million, giving the REIT full ownership.
“We expect to invest approximately $100 million to complete our three development projects in 2009,” said Kent Griffin, BioMed’s chief financial officer.
Also under development — but through a joint venture with Prudential Real Estate Investors — is 650 East Kendall St. (Kendall B) in Cambridge, Mass., a six-story, 280,000-square-foot lab building set to be completed in late 2009 or early 2010.
At Center for Life Sciences, BioMed has a KeyBank-led secured acquisition and construction loan allowing up to $550 million in borrowings, and set to mature in 2009. BioMed is weighing whether to seek a one-year extension, or instead secure new long-term financing. While that financing “is likely to be at a higher cost than our current financing, we believe that obtaining long-term fixed rate financing will be prudent despite potential impact on our 2009 financial results,” Griffin said.
“It’s appropriate to go ahead with long-term capital in place to match the long-term nature of the asset,” as opposed to trying to refinance the company’s $266 million credit line, which matures in 2011, Gold said.
Answering a question from Jordan Sadler, a director and equity research analyst with KeyBanc Capital Markets, Gold said the plan to pursue new financing was not a reflection of pessimism about future leasing activity in Center for Life Sciences. The project is 80 percent leased to Beth Israel Deaconess and three other tenants: Children's Hospital Boston, Dana-Farber Cancer Institute, and the Immune Disease Institute.
“On the CFLS loan, could you extend it today with the current lease rate?” Sadler asked.
“I don’t know. We've — certainly there would be no reason to extend it early, but we could,” Griffin replied.
Also during the call, Gold told Chris Haley, a managing director with Wachovia Securities, that BioMed would not lower its rent at Center for Life Science to spur leases for the remaining vacant space. He said prospective tenants there are research institutions waiting for the overall economy to return to normal and the results of this week’s Presidential election before deciding whether to sign leases there.
“We don’t believe that if we were to drop the rent by 50 percent that we would lease the space up immediately,” Gold said, “We still believe we have the premiere asset in that location. We still believe that the vacancy factor in that market is very low.”
One sign that this was a tougher year than anticipated, even before the market upheaval of the past two months: BioMed had only leased about 700,000 square feet of lab and office space to tenants year-to-date, compared with a projection of 1.2 million square feet.
“We had some leases that we projected [would] happen in ’08 that may happen in ’09, and vice versa,” Gold said.
Another sign: For the five quarters stretching from Oct. 1 through the end of 2009, BioMed anticipates completing 1 million square feet of leases, compared with 1.2 million square feet a year earlier. “A large portion” of the million square feet will be leased in new and redeveloped properties, said Gold, who also noted that BioMed completed 1.3 million square feet of leases during the four quarters that ended Sept. 30.
Next year, Gold said, “we are assuming an aggregate gross leasing volume of 1 million square feet,” divided almost equally between new leases and renewals, based on activity over the past four quarters.
“We do believe that the deterioration of financial markets will continue to make the leasing environment a challenge, lengthening the lease cycle even further. We expect this to be more so for new leases than for extensions,” said Matt McDevitt, BioMed’s executive vice president for acquisitions and leasing.
Gold said that despite the market upheaval, BioMed’s “watch list” of tenants most likely to give up 10,000 square feet or more of space before the end of their leases has not changed much. It includes:
  • Artes Medical, the developer of an injectable dermal filler designed to remove "smile line" wrinkles. The company leases all 66,745 square feet at the two-building Pacific Center Boulevard campus, in San Diego’s Sorrento Mesa area.
  • MDRNA, a developer of RNA interference-based therapeutics that leases all 51,000 square feet at BioMed’s Monte Villa Parkway campus, in the Seattle suburb of Bothell, Wash. “They are looking to sublease space, and we’re working with them on that,” Gold said.
Alexandria has a single tenant on its watch list – cancer therapy developer Cell Genesys, which occupies about 155,000 square feet at 500 Forbes Blvd. in South San Francisco. The company on Oct. 16 announced it was restructuring its business operations following the failure of its GVAX immunotherapy for prostate cancer during two phase 3 clinical trials.
“I’m very confident that the situation will resolve itself in a satisfactory manner,” Marcus said.
That watch list is not likely to grow much, Marcus said, since only “12 to 13” percent of Alexandria’s portfolio is leased to private smaller biotech companies; most of the space is leased to multinational pharma giants and research institutions, Marcus said.
Despite the near-halt to construction activity, both REITs trumpeted the signing of new leases during the third quarter.
Alexandria said it executed a total 41 leases for about 618,000 square feet, not counting month-to-month deals, at 26 different properties. Approximately 211,000 square feet of that total related to new or renewal leases of previously leased space, while about 310,000 rentable square feet were taken in newly built or newly redeveloped properties, and another roughly 97,000 square feet was taken in previously vacant space.
The REIT has previously announced its largest three leases of the quarter —Pfizer’s deal at Mission Bay; Novartis’ deal for 47,185 square feet of office/lab space at the 177,101-square-foot 200 Technology Square in Cambridge, Mass.; and the 106,000-square-foot lease, with option for another 4,000 square feet, inked by Gilead Sciences at 199 East Blaine St., in Seattle’s South Lake Union section [BRN, Oct. 27].
Rental rates for these new or renewal leases were on average about 8.2 percent higher than rental rates for expiring leases. Alexandria expects rent revenue growth of between 5 to 10 percent next year, based on the expectation that it can replace most of its current below-market leases in recently acquired properties with leases closer to market rental rates, even if those rates rise slower or fall next year, Marcus and Shigenaga said.
BioMed’s McDevitt said his REIT leased roughly 200,000 square feet of space in the third quarter. In the largest lease, Regeneron Pharmaceuticals agreed to extend its occupancy of 91,000 square feet it had earlier planned to vacate at The Landmark at Eastview. The deal expands Regeneron’s presence at the campus to just over 348,000 square feet — and resolves what would have been BioMed’s largest lease expiring in 2009.
That deal paced a total 147,000 square feet of early lease renewals and extensions, with another 52,000 square feet consisting of new deals, highlighted by Nteryx, a developer of gastrointestinal tract therapeutics, taking 28,000 square feet at BioMed’s Ardenwood Boulevard property in the San Francisco suburb of Fremont, Calif. — a deal McDevitt called “yet another validation of the demand for Life Science tenants in this submarket.”
With far fewer new projects to market than in past years, executives at both BioMed and Alexandria agreed that their companies’ ability to lease more existing space will hinge in no small measure on a recovery of the financial markets — something they did not anticipate would happen until the second half of 2009 at the earliest.
“It used to be that banks used to monitor borrowers for default. Now, borrowers monitor banks for default. It’s an odd kind of juxtaposition here. And until that remedies itself, we’ll not be able to get a construction loan,” Marcus said. “Nobody’s willing to put out much money in today’s market.”

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