Could VC Investment Spike In Life Sciences Become Too Much Of A Good Thing?
At first blush, things are looking great in the life sciences real estate market. In particular, venture capital funding is exploding, supporting new companies or expansion from existing ones that should keep demand high for properties and continue to support larger rents. But this could lead to some overheating in the property market and to a shift in the way life sciences investors want to handle real estate.
This year has already set a record-breaking pace in venture capital investment in the life sciences. Per analysis of VC activity by Pitchbook, $20.3B was invested in firms in the U.S. in just the first half of the year, a rate that will shatter 2020’s record haul of $28.5B.
The increasing influx of investor dollars was due in large part to the tailwinds of coronavirus vaccine development and the continued emergence of well-funded, specialist VCs focused on the life sciences. ARCH Venture Partners closed a $1.9B fund focused on life sciences in January, while Flagship Pioneering closed the largest-ever biotech venture fund for $3.4B in June. Potential federal investments, including proposals for an Innovation and Competition Act and large increases in federal grants for research, stand to further supercharge investor interest in the sector.
“There are a lot of factors that contribute to these raises,” Biocom Los Angeles Executive Director Stephanie Hsieh said. “You see these valuations go up exponentially, driven both by the competition for technologies, and people finally starting to dig in and understand how to value gene editing and CRISPR technology.”
As the amount of money being invested in life sciences startups increases, including larger Series A rounds for younger firms, according to Pitchbook Biotech Analyst and venture capital investor Joshua Chao, it is also coming earlier in a firm’s life cycle. A JP Morgan Chase report also found increasing activity in Series A, the first opportunity for significant VC funding for a new venture, including more investment from nontraditional investors such as individuals, angels, family offices, corporates and hedge funds. In 2020, life sciences Series A rounds raised $5.4M median and $23.8M on average, per Pitchbook; in the first half of 2021, those figures increased to $10M and $31.1M.
All this money in search of the next big innovation has led to increased demand for life sciences real estate and lab space. Newmark’s midyear report found the going price for space nationally was $585 per SF, a 50% jump from the same time last year. Even with $28B in funding targeting life sciences real estate, and 27M SF of lab space in the pipeline in the country’s top 14 markets, the rate of construction can barely keep up (vacancy in San Diego has hit an all-time low).
While this sounds like good news, this could lead to pain.
Cushman & Wakefield Life Sciences Real Estate expert Shaun Stiles said that there’s “absolutely a concern and possibility” of overheating the market with so much investment. Right now, in many cases, companies that need space need to build it, and he said more VC investment will create either an overflow of firms that must look to move to secondary markets, delays in companies finding space and starting additional research or trials, or increased necessity to depend on contract research and manufacturing. Time equals money, but more VC money could lead to more startups looking for space and being unable to find it and thus unable to fulfill their missions.
“Money is flowing into all these companies and they all need space and it’s basically impossible,” he said. “You need to get in line, that’s how I think it’s playing out.”
Another thing to watch is the relationship between rents and funding, and if the latter will keep pace with the former. Analysts suggest that there’s a tight correlation between rent and fundraising in the industry — rents are rising because life sciences companies are doing well, but the market may have reached a point that funding is increasing to support life sciences firms' need to pay high rents — but that the relationship isn’t exactly straightforward.
“Are VCs factoring in the cost of lab space? I don’t think it’s explicit,” Chao said. “It’s not like they bring out a term sheet and say, I’m going to multiply this amount for a Series A by a certain factor because you’re in a market like Cambridge. That said, real estate prices aren’t a lagging indicator. There definitely seems to be correlation with the VC dollars coming in.”
Chao believes that real estate costs are an underlying factor for investment firms and VCs looking to invest in a new life sciences company. The market was already growing when Covid-19 and the validation of mRNA technology added even more excitement to find the next blockbuster cure or therapeutic. Today’s competition is causing more VCs to invest earlier and earlier in biotech firms, since more and more are going public early, stymieing the strategy of many investors who tend to wait for later funding rounds.
Competition inflates prices, but so does the price of talent. Especially in the big three markets of Boston, San Francisco and San Diego, local real estate prices for housing, as well as rising costs for lab space, mean that to extend the runway, or time a firm has to develop its technology or obtain regulatory approval, requires additional funding.
“For traditional office tenants, talent is usually the No. 1 cost, followed by real estate,” JLL Senior Director for Research Amber Schiada said. “For life sciences lab users I’d imagine that’s the case, too, but cost factors less in the decision compared to many more important elements of the local ecosystem. Is there talent, access to partners and room to scale?”
Funding for life sciences firms works slightly differently than traditional tech firms, which tend to be valued on potential future earnings, however theoretical. Funding rounds, as well as going public, are more often seen as fundraising for future clinical trials — that’s why so many have opted to go public early. These types of studies, including the materials and animal testing, can be incredibly expensive and often make up the bulk of a startup’s budget. Drug discovery and pre-clinical research, which comes before trials, costs an average of $6.5M and typically lasts 35 months, per Pitchbook; Phase 1 trials cost an average of $4M and take around 18 months.
“Rats are really expensive, unfortunately,” Hsieh said.
Increasingly, according to Hsieh and Chao, investors see the value in their own real estate acquisitions and development as a way to control costs and make sure the firms they invest in have lab space (delays finding a home can be costly). Cambridge-based investment firms Atlas Ventures and Flagship Pioneering lease out buildings they own to their own stables of startups. In Los Angeles, Westlake Biopartners announced it had launched a $500M fund to invest in local startups, eight of which would be tenants in an incubator space in suburban Thousand Oaks, part of a partnership with Alexandria Real Estate Equities.
“It’s a win-win for everybody by boosting needed lab space in the area,” Chao said. “It’s an interesting proposition.”