Life Sciences Developers Enjoy Expansion In Q3 As Uncertainty, Overcrowding Cloud Next Year
While it might appear strange for the co-founder of the country's largest life sciences developer to quote and fawn over legendary Duke University men's basketball coach Mike Krzyzewski, it was an apt reference for Alexandria Real Estate Equities Chairman Joel Marcus, considering that the incredible winning streak life sciences real estate is having mirrors Coach K's championship résumé.
"Imagination has a great deal to do with winning," Marcus said, quoting Krzyzewski, who started his final year on coaching the Durham school's program this week.
Covid-19 has brought opportunities perhaps beyond the imagination of the companies developing highly coveted life sciences space, as a review of Q3 earnings calls and statements showed the continued growth and expansion of the industry, both because of, and in spite of, the pandemic. But supply chain and construction labor shortages are bedeviling lab developers, as they have developers and construction firms in every real estate sector.
The overall message was success. Marcus boasted about his firm’s largest lease ever, the new 462K SF Boston headquarters for mRNA vaccine giant Moderna, and Alexandria had another banner quarter, with total revenues and net operating income up 20% and 21% over the same time period last year. Healthpeak Properties has signed 2.2M SF of leases year-to-date, twice its annual yearly average, across the three core markets of Boston, San Diego and the Bay Area. Diversified HealthCare Trust CEO Jennifer Francis said the REIT has seen “large, double-digit roll-ups in rent” for lab space and a strong market, with 2.4M SF in the pipeline.
But amid these sales figures, there are signals that this momentum will be very challenging to maintain. With hints of ever-rising demand in core clusters, there are signs that next year may be especially difficult for life sciences firms looking for space that hasn’t already made a deal. New supply in 2022 and 2023 may be limited, as existing product in the pipeline is quickly being leased.
Alexandria said it has 7.7M SF either under construction or primed to begin over the next six quarters, 80% of which is already leased or under negotiation. Boston Properties notes that it has 800K SF of signed leases that haven’t commenced, and 25% of leases commencing in 2022 are already in some stage of renewal negotiations. Healthpeak said its $1.2B active development pipeline is 87% pre-leased, including all of its San Diego development and 88% of its Cambridge Park Drive project in Cambridge's Alewife neighborhood, delivering at the end of 2022.
Considering the substantial rises in venture capital funding haven’t shown any signs of slowing, hitting a record $26B in the first half of 2021, it seems demand will only increase at a time when immediately available space in the next 12 months especially is increasingly spoken for, leaving many new startups scrambling for lab space.
Healthpeak Chief Investment Officer Scott Brinker estimated that every $1M of venture capital and money raised in initial public offerings translates into about 400 SF of needed space. By that calculation, the first half of the year's fundraising could equate to 10.4M SF of new lab demand.
There is even doubt about the industry’s ability to deliver what it has promised in the next 24 months. Alexandria co-CEO Stephen Richardson, one of the firm’s executives who claimed to have done an extensive inventory of its key markets, said much of the potential product being discussed as deliverable by competitors in 2022 and 2023 isn’t as guaranteed as it seems.
“A lot of what is being talked about still needs to be entitled, still needs to be permitted, still needs to actually have the horizontal work done before someone is going to make the decision to go vertical and potentially go vertical without an anchor tenant,” he said.
Another potential drag on the sector’s earnings potential is delivery delays, a constant subject during questioning by analysts. Boston Properties President Doug Linde said “there’s no single answer” to cost overruns caused by supply chain issues in the industry, and Boston Properties expects 5% to 6% escalation in upcoming projects while taking precautions due to shipping and trucking issues. The use of overseas items is being minimized, Linde said, while air freight has been tapped to rush materials to construction sites.
Alexandria executives have seen record escalation in prices for concrete, steel, wood, aluminum and glass as well as disruptions in skilled labor, which they predict will get worse if a vaccine mandate comes to the construction industry. Industrywide, the status quo seems to be that material delays haven’t altered delivery times yet, but everyone is taking extreme measures, and further deterioration in the supply chain might quickly change those calculations.
Despite these challenges, executives of these firms also hinted at and suggested ways to increase density and deliver new space in key markets, especially around Boston.
Healthpeak announced a series of eight transactions totaling $625M in the West Cambridge submarket, with plans to create a campus within walking distance of a nearby train station — although local officials in the area have proposed a lab development moratorium aimed squarely at the REIT.
Boston Properties is converting Bay Colony in Massachusetts and Alexandria reps talked about further densification in Cambridge after being asked about their plans for recent acquisitions such as One Rodgers and One Charles Park.
In addition, Ventas announced the development of a new $500M, 1M SF life sciences project in Davis, California, 60% pre-leased to University of California Davis, which could tap into both the university’s potential as well as spillover from the Bay Area. While these projects will add much-needed square footage, they seem unlikely to alter the immediate space crunch facing the industry in the next 24 months.
