Can Philly's Developers Shepherd Cell And Gene Therapy Startups Through The 'Valley Of Death'?
The life sciences real estate market in Philadelphia is coming into its own just as its cell and gene therapy industries stare down their first economic cycle with high inflation and spiking federal interest rates.
Despite the success of Spark Therapeutics, the vast majority of cell and gene therapy candidates remain in early stages of testing, with relatively few in clinical trials and only a handful commercially available. So much of the public and private sector in the area is focused on sustaining the growth of the past few years, but both are being called on to shepherd startups through the “valley of death,” or the period between early stage trials and commercialization when funding is hardest to come by and most desperately needed.
One of the costs that balloon during that period is real estate, as the space a biotech startup requires for advancing a therapy through testing phases is often what takes it from a couple of stations at an incubator to its first proper lease. But that graduation space, as the industry calls it, is in extremely short supply across the Philadelphia region, Longfellow Real Estate Partners Managing Director of Research Lauren Gilchrist said at Bisnow’s Philadelphia Life Sciences Summit on June 28.
“Our incubator spaces and our [life sciences] coworking spaces are filling up with companies that are probably ready for their graduation spaces, and in other markets would be in graduation space,” Gilchrist said. “But we have not yet provided that space and the right continuum of services in Philadelphia.”
While several ground-up construction projects are underway, the two most significant adaptive reuse projects in and around Center City — 401 North Broad St. and The Curtis — are filling up space virtually as soon as they can convert it.
To meet the timeline specific to life sciences tenants, Philadelphia developers have had to get comfortable with starting buildings on speculation, with multiple such projects underway in University City and the Philadelphia Navy Yard. One uCity Square, set to deliver this fall, is up to 80% leased, said Wexford Science + Technology Director of Development Pete Cramer, whose company is developing the building in partnership with the University City Science Center and Ventas. But the upfront cost and risk associated with speculative development keep rising.
With financing costs rising precipitously amid higher interest rates, capital markets activity is cooling in commercial real estate, all while inflation and supply chain snags persist to make projects more expensive and more unpredictable in terms of cost. But if a company has the money, spending it now seems to be the order of the day, panelists at the event agreed. Even if specialized equipment is more expensive than it has been for years, future price hikes and surprise inventory disruptions are being treated as a virtual certainty across the industry.
The joint venture of Ensemble Real Estate Investments and Mosaic Development Partners tasked with leading the Navy Yard’s next wave of development, which has one spec lab building under construction, plans on front-loading more of its capital expenditures for its next building, which is planned for Current Good Manufacturing Practices-compliant biomanufacturing, Mosaic founder and co-owner Greg Reaves said at the event.
“The GMP that you knew before Covid is not the same GMP [as today],” Reaves said. “Purchasing materials upfront is a requirement today, and I don’t think you can avoid that. If you expect to be open anytime in 2023 or 2024, you have to be thinking seriously about moving forward on risk.”
To build on speculation is to rely on the Field of Dreams line oft-quoted in real estate, “If you build it, they will come.” But in a sector where the majority of tenants are pre-revenue, selecting a tenant from a pool of interested parties is an exercise in risk assessment. Multiple landlords and brokers at the full-day event stressed the importance of believing in a tenant’s research or, more importantly, its leadership.
“A lot of these early stage companies can't scale because they don't have the expertise, they don't have the network and they don't know what they don't know,” HDR Managing Principal Elizabeth Mahon said. “In the cell and gene therapy world, there's not enough leadership talent to go around. So when you're dealing with a lot of technical founders, scientific founders, first-time CEOs and [chief science officers], you're really limited because they're learning on the fly.”
Having a leader with deep experience or a wide network is crucial for a life sciences startup’s appeal to landlords, not least because it gives those startups an edge in recruiting venture capital investors. In situations when a landlord may believe in a tenant even if the latter lacks its own access to capital, some landlords are tapping their own capabilities or partnerships.
University Place Associates has connected potential tenants with its capital partners, the joint venture of Cantor Fitzgerald and Silverstein Properties that has financed 3.0 University Place, set to deliver next year, and with which UPA is negotiating financing terms for the following 4.0 University Place next door, UPA President Anthony Maher said.
“My guess is that [a startup’s] investors are not looking at this as a ‘gulp’ moment of hyper-leverage,” Maher said. “They're looking at it as a serious way to get these companies into occupancy and production by paying rent and other fees and moving along in the life cycles of their businesses.”
The Center for Breakthrough Medicines, which operates both an accelerator and a contract development and manufacturing organization at the Discovery Labs complex in King of Prussia, uses a “milestone-based” lease structure with some promising companies, CBM co-founder Audrey Greenberg said. Under that system, CBM initially leases space at cost to startups, and leases grow in cost commensurate with the funding and/or revenue those startups wind up bringing in.
CBM announced in late June that it plans to expand its facility by 1M SF, including 90K SF of cGMP space, with a focus on cell therapy. That expansion, as well as CBM’s leasing model, is made possible by a $350M equity investment the facility received at the start of the year from SK Inc., the investment arm of South Korean conglomerate SK Group. That investment was announced only a few weeks before the Russian invasion of Ukraine, which the Federal Reserve cited as an inflationary factor in raising its interest rate, which in turn has made capital more expensive.
“We have to acknowledge that pricing has changed,” Greenberg said. “I think that more can be done in terms of taking risk on the tenant base and underwriting credit in a creative way. But it's a challenging time to do that. So you know if it was last year or the year before, it might be different.”
Panelists throughout the day pleaded for more assistance from state government. The commonwealth of Pennsylvania’s Redevelopment Assistance Capital Program served as a small-yet-key financing piece for tenant space at 3.0 University Place and 401 North Broad, Maher said. A RACP-type program specific to life sciences, or private capital deployed in a similar way, would go a long way toward stabilizing many companies slogging through the biotech valley of death.
“A backstop for a non-credit tenant that you believe in, or [funding] an incubator, could go a long way,” Maher said. “I can show you [potential tenants] that could stabilize on revenue. But you have a blip in the first six months, then you have a blip again at month 18, someone needs to fill that void. And the ask would not be $50M, it would be $5M.”
Massachusetts and California created programs that filled crucial financing gaps in the past couple of decades, and their life sciences hubs are better for it, Mahon said. But part of the difficulty facing the Philadelphia market is that its suburbs are split across multiple states, introducing a competitive factor that ultimately works against the region on the whole, Delaware Innovation Space founder and CEO Bill Provine said. But New Jersey Gov. Phil Murphy has not let the presence of New York in the north and Philly in the south get in the way of offering economic incentives to companies through the New Jersey Economic Development Authority.
“It's not just the state, every level has to be engaged in this,” Philadelphia Department of Commerce Senior Director of Business Development Sam Woods-Thomas said. “And that's why you see places like Massachusetts, New York and California eating our lunches, frankly. We hope that won't continue. We're going to work hard to make sure that doesn't continue.”
Though it only represents a part of the region’s ecosystem and has a much smaller budget, the city of Philadelphia is working on a way to address the problem of institutional support, Woods-Thomas said.
“In the next year or so you're going to see policies and incentives coming from us that begin to make a lot more sense than what we have right now,” he said.