Life Sciences Funding Drop Means Risk-Averse Tenants, Advantage For Incumbents

A 28.2% year-over-year drop in life sciences venture capital funding will reverberate through the lab real estate world, according to a new report from Savills on the funding for the subsector in 2022.

The combination of a standstill in initial public offerings, which is causing VCs to pause investment, as well as general market chaos has led to a rightsizing of the investment market, the report says. It is a situation where established real estate players, possessing the capital and clients to withstand uncertainty, will benefit. 

“Remember in 2020 and 2021 when there was this sentiment that we were running out of lab space?” said Austin Barrett, Savills executive vice president and North America life sciences practice lead. “Now, I think tenants will gravitate to those partners that have a track record of performing, and you're also going see this flight to quality.”

While 2022 saw the second-most VC money dedicated to life sciences at $58.3B, there was a sharp decline in the second half of the year, including a significant drop in funding for Series A and crossover rounds. Investors want to see more proof and potential before providing additional funding, forcing smaller firms and younger startups to rely on small runways longer and making it more difficult for smaller firms to thrive. 

At the same time, those firms with funding are finding more real estate options. A tenant looking for 30K SF to 50K SF of lab space in markets like Cambridge, Massachusetts, a few years may have had few options. Today, they have five to seven, said Barrett, whose team mostly focuses on representing tenants.

This means startups aren't “going out over their skis” and taking up too much space, instead better aligning the business and real estate strategies. But that is likely to mean rents won’t be rising, especially at the rates they did just 18-24 months ago. Barrett said he thinks they may even fall as demand softens.

“You're certainly going to see a lull in landlord activity, certainly on a speculative basis,” he said. “People are going to sit tight, wait until they've got tenants in tow. And tenants are going to be more risk-averse.” 

In addition, office owners looking to convert Class-B space to labs are going to be disappointed when demand doesn’t materialize. This shift toward quality is why Alexandria Real Estate Equities engaged in a handful of high-profile sales last year to get conversion projects off its balance sheet, Barrett said. 

Barrett has also seen more firms moving from top markets to second-tier cities, such as Nashville, Tennessee, Houston and Chicago, which saw a rare year-over-year bump in VC funding in 2022, growing from $2.4B to $6.6B.

Savills data also points to a tremendous amount of dry powder sitting on the sidelines. Between 2021 and 2022, the number of deals declined dramatically from 1,193 to 714. But the gap in the amount raised was much smaller: $163.6B to $152.7B. This speaks to a significant amount of money waiting for investment and acquisition opportunities. 

“Once we get valuations corrected, and a lot of the banking turmoil is going to allow for that, I think you’re going to start seeing more deals get done,” Barrett said. “They’re just going to take longer and be slower.”