U.S. Life Sciences Real Estate Investors Say The Market Will Improve. Few Are Willing To Bet On When
The rapid spike in interest rates didn’t just make it harder to finance real estate deals — it ended an era of wild spending from venture capital firms, panelists said at Bisnow's International Life Sciences & Biotech Conference last week.
That VC boom inspired the wave of life sciences real estate development that began delivering late last year and is projected to continue into next year. But as the spigot of new capital shut off, those firms’ demands for space dried up.
Real estate investors say they remain confident that demand will recover eventually. But since they're flying blind on future interest rates, they aren't making bets on when the horizon will appear.
“We’re looking to take a hell of a lot less risk,” The Davis Cos. Chief Investment Officer Quentin Reynolds said. "If we are investing today, we’re lending, we’re going in as preferred equity, or we’re doing unlevered transactions.”
The life sciences sector's rising vacancy is more due to new construction delivering with empty space than to shrinking footprints and expiring leases at older buildings, Ventas Managing Director Brian Newman said.
"Within the private funds portfolio I run, two years ago it was pretty typical for venture capitalists to tell portfolio companies to 'Get ahead of the real estate demand you’re going to have because we want you to grow and meet your future needs fundamentally," he said, adding that today VCs are telling their companies to "wait and see what happens."
In other sectors, the availability of financing is one of several factors in real estate decision-making for occupiers. But in life sciences — especially in emerging fields — a high percentage of potential tenants are pre-revenue, making the availability of financing the ultimate factor in real estate strategy, Berkadia National Head of Life Sciences Sabrina Solomiany said.
Enthusiastic investors pushing their portfolio companies to prepare for explosive growth was the driving force behind those companies searching for large blocks of space, just as it was for the 2021 rash of initial public offerings from life sciences startups before their clinical trials were completed, SmartLabs Vice President of BioScience Services Dipankar Ghosh said.
Since rising interest rates began to affect the financing environment last summer, VC investors have been much more demanding of companies to show promising results before funding the next stage of growth, speakers said across several panels. As a result, companies that get funding when capital resumes flowing could be stronger potential tenants.
“This infusion of rigor in terms of screening companies and their science is a great event for the future of the [life sciences] space,” EQT Exeter Life Sciences Chief Investment Officer Thomas Wang said. “The macro trends that really drive this space are compelling. They’re undeniable.”
The inherent value of the science being pursued hasn’t changed in the way that the utility of the office has, so owner-developers with projects coming online aren’t terribly concerned about whether their buildings will ever get filled, MassBio President and CEO Kendalle Burlin O’Connell said.
The question of when conditions will improve for life sciences is impossible to answer until the market has more clarity on the future of interest rates, panelists said. Property investors who seek short-term returns, like sponsors of closed-ended funds, are flying blind.
“The recycling of capital into new vehicles is slowing and quite difficult,” Wang said. “The opacity of the next 24-36 months is very, very challenging.”
Because of that opacity, capital partners are behaving with historically high levels of caution, TPG Real Estate's Andrea De Leon said. Sponsors soliciting investment are having a hard time laying out the case for choosing real estate over safer investments when the yield on government bonds is so high.
“It’s very hard for me to tell you what the actual [initial rate of return] would be,” The Davis Cos.' Reynolds said. “I squirm a lot when people ask me to try to pinpoint IRR.”
If IPOs can be taken as a sign of investment activity, then encouraging signs are beginning to emerge. Eight biotech IPOs raised a combined $1.1B in the third quarter — double the number of companies that went public in Q2, and nearly twice as much capital raised between them, BioPharma Dive reports. Though an improvement, it was still well off the pace set in early 2022, when 17 IPOs were held in Q1, Reuters reported earlier this year.
Whether on the public market or through additional rounds of private fundraising, new infusions of capital typically come with a delay of several months before a company is ready to commit to physical expansion, Wang said. However, few panelists expressed optimism that the recovery will resemble previous cycles.
“It’s going to take a little bit longer this time, but we are seeing good platforms with good management and great data get funded,” Vault Advisors Managing Partner Sava Kobilarov said.
Considering the unprecedented scale of capital raising in 2021, some of the speculative development that started in response will not absorb at the speed or rent levels their developers anticipated, King Street Properties Chief Investment Officer Robert Albro said. The most likely candidates are buildings at sites that wouldn’t have been considered in 2019.
“We’re starting to see real winners and losers, which we really didn’t see for many years when almost everything was leasing,” Albro said. “Now, tenants have choice, so site selection will be critical. There will be some projects that aren’t going to be successful, but it comes down to the original site selection.”
At properties with the right combination of location and debt-burdened or otherwise distressed owners, this time is the best opportunity for those with equity at hand to provide rescue capital and position themselves to take over a property if the initial sponsor can’t hang on, Reynolds said.
“There is going to be some shakeout; some people chased the market late,” he said. “Nobody has any idea, as far as I can tell, of how everything is going to play out. And that’s painful, but people who say they want to be in distressed markets never have a good time when they’re in them.”
See below for more photos from Bisnow's International Life Sciences & Biotech Conference, held at the Pennsylvania Convention Center in Philadelphia on Oct. 11 and 12.