Nearly 20M SF Of Spec Lab Construction Is Available As Demand Is Set To Drop
Life sciences real estate has been growing so fast that experts have often described it as akin to a car speeding down the highway. But as markets digest a cascade of bad news, from a pullback in venture capital investment to concerns over stagflation and fears of a recession, speed bumps are starting to emerge for lab developers.
Of the 29.1M SF of lab space expected to be under construction in the next two years, 26.2M SF is being built speculatively, according to CBRE. Just 26% of that space is pre-leased, showing how aggressively developers have built for an industry that has long been considered a risky bet.
While analysts and experts in the life sciences don't expect a crash landing — too much money has been raised by companies that need lab space — the mood in the industry has darkened in the last six months as valuations of biotech companies have fallen.
“Is this going to affect spec construction? Yes, and it’s going to make demand for certain projects less robust,” CBRE Senior Director of Research Ian Anderson said. “It’ll be a pullback, but not significant.”
Biotech startups will slow their burn rates, funding levels will be more measured, and spec construction will take longer to pay off than it otherwise would have, experts said. Some firms will slow down and delay lease signings for half a year or so, Colliers Director of Research Aaron Jodka said, and that’s to be expected. But he doesn’t see a “major challenge” coming.
Fundamentally, the industry, and the science behind it, are sound, said Matt Gardner, head of CBRE’s U.S. Advisory Life Sciences practice. The industry has always moved in longer cycles than the rest of the economy, due to the decade-plus it typically takes to create and approve a new drug, and lab space tends to get built in great bursts.
“The reality is, most of the stuff in the pipeline will get built as planned,” said Gardner, who was previously CEO of MarylandBio, BayBio and Innovation Counsellors. “It’ll just take longer to fill.”
Gardner also hinted at a larger financial issue impacting the industry that will likely get more attention in a softening market: the average cost to develop a drug (recently estimated at roughly $1B). The figure has been rising significantly, especially in a more overheated market with skyrocketing labor costs fueled by record venture capital investments. Larger firms will be tasked with lowering that figure, which means a more conservative financial picture, and likely pressure to avoid taking on too much new real estate.
The predictions of a muted slowdown also contain more serious implications for specific markets and sectors within biotech. Up-and-coming cities and regions will likely see plans to expand and build out their life sciences infrastructure slow and be postponed, said Anderson, with the “overheated” markets going by the wayside first.
Cities like Houston, Atlanta and Los Angeles, which have seemed on the verge of building out larger ecosystems for talent development and commercialization, will likely see that growth delayed — a generation of new projects and expansions that would be plotted and planned in coming years would likely be shelved or slowed down, delaying regional growth.
The space needs of new firms and startups are also expected to shrink considerably. Many midsized firms have been deliberately taking larger leases so they have space to grow, and subleasing between 6K SF and 10K SF of excess space to startups, a practice likely to cease for the immediate future.
Newmark Executive Managing Director Eric Bluestein, based in the Bay Area, says no developer he can think of is slowing down or stopping, with several big regional projects powering ahead: IQHQ is going forward with 580 Dubuque, a 350K SF project in South San Francisco, as well as the 600K SF Elco Yards in Redwood City; BioMed realty broke ground on a new phase of Gateway of Pacific, a 36-acre megacampus; and Longfellow picked up the 250K SF San Mateo Bay Center last summer for a planned conversion.
CBRE’s Anderson is preparing the firm’s second-quarter report, and in discussions with professionals around the country said he hasn’t yet heard any talk of pullbacks or canceling projects.
Bluestein foresees this economic uncertainty leading to a lot of “musical chairs” in the portfolio of big players like Alexandria, which often develop and expand space with specific market intelligence and insights into the expansion needs of specific firms in hand; biotech firms may delay expansions or lease less square footage, and there could be a race to backfill open lab space by other clients within the portfolio.
“If it does go on for years, by the time we fully realize it’s a significant downturn, everything in the spec pipeline will be built,” Bluestein said. “Overall, it won’t have a significant impact on currently planned construction.”
A potential silver lining could emerge. The industry has long suffered from a talent shortage, and fewer expansions and slower growth may give the biotech labor market time to catch up to demand. In 2020, when the rest of the economy saw a 13.4% year-over-year drop in employment, biotech registered zero change, Anderson said.
What might a more serious downturn begin to look like? Right now, there are roughly 11,000 drugs in Stage 2 or Stage 3 clinical trials, Gardner said, a record number suggesting significant optimism in the underlying science behind this technology. Real doubt will set in if a trial is pulled, which suggests a funding environment where even well-capitalized firms with cures that have cleared numerous hurdles can’t raise capital. This could have serious real estate implications.
Gardner also has his eye on conversion projects in urban centers. Newmark is tracking 3.6M SF of planned conversions nationally, with another 1.3M SF in proposal stage. These projects have some flexibility in their end use, and any pullback from planned lab projects would be another key sign of market softness leading to something more significant.
If a downturn transforms into a recession, there would be particular danger in the long-term health of the life sciences market. This is an industry where startups need product when they need it and can’t plan too far ahead — if the industry hits the brakes, Jodka said, that could create a situation where “we can't grow the industry quick enough coming out of a recession.”
In a prolonged downturn, capital tends to shift to less risky assets, businesses and companies, which may not necessarily be a life sciences firm with untested drugs at the beginning of a years-long development cycle. But Jodka and others said there are myriad secular reasons to doubt the sector's long-term future.
“I’m in the 'blip on the radar screen' camp,” Jodka said. “Look at the billions invested in life sciences over the last couple of years. Not all of that money has been spent, so there’s a tremendous demand pipeline, waiting to essentially find open space. Is the sky falling? I do not foresee that.”