Investors surf the life sciences wave in the Bay Area

KKR’s record-setting purchase of Dropbox’s base highlights one of the nation’s real estate darlings

National Issue /
Nov.November 03, 2021 07:30 AM

The Exchange complex at 1800 Owens Street in San Francisco

You might think San Francisco’s priciest per-square-foot commercial deal was about tech. You’d be wrong: It was KKR’s $1.1 billion purchase of a life science complex in Mission Bay, among the last available lab spaces in the area.

In August, BioMed Realty paid Oracle $160 million for offices and vacant land at the border of Belmont and Redwood City, giving it over 200,000 square feet of existing space with life science conversion potential and the opportunity to build a new campus next door. About a month later, Longfellow Real Estate Partners said it bought a storage facility in Millbrae for $80 million as a life science redevelopment play.

The Bay Area’s life science real estate sector has hit a fever pitch. The region has the second-largest life science cluster in the U.S. after Boston, according to JLL and Newmark. While the pandemic suppressed the area’s office market, asking rents for life science properties jumped 90 percent from 2016, according to Newmark data, which also shows that vacancy rates dropped to 5.6 percent in the first half of this year from 8 percent at the end of 2020.

Life science development hasn’t been uniform throughout the region. While San Mateo County and the East Bay have been hot, Silicon Valley has lagged behind.

Still, a market dominated by Alexandria Real Estate Equities, Healthpeak Properties and BioMed Realty could put the tech epicenter on track to become a life science hub to rival South San Francisco or Emeryville.

“We see that demand not only in the existing core clusters but also growing into additional locations in the Bay Area,” said Managing Director Nick Frasco of Longfellow, which is managing KKR’s Mission Bay project and is the nation’s fifth-largest owner of life science real estate.

The public health crisis supercharged interest in vaccines and associated products, propelling demand for laboratory space. It doesn’t hurt that the industry is largely immune from stay-at-home pressure — one can’t exactly conduct sensitive scientific experiments from a spare bedroom.

Chain reactions

Leasing volume in the first half of the year more than doubled the trailing five-year average, while investment sales volume jumped 27 percent in the 12 months preceding the second quarter, driving record pricing in many markets, according to data from JLL. All told, 2021 looks set to be a record year for venture capital funding in life sciences, topping the high that was set in 2020.

In 2020, venture capital directed to California life sciences rose more than 60 percent year-over-year to a record $15 billion, according to Biocom California. The state also got $6.2 billion in federal research funding last year, about 40 percent of which went to the Bay Area.

KKR’s Mission Bay purchase, which closed about a year after officials issued the first shelter-in-place orders, illustrates how the pandemic has transformed the region’s commercial real estate market. It also highlights the bigger role played by Wall Street firms — the deal was financed with a $600 million loan from JPMorgan Chase and Goldman Sachs — as investors place long-term bets on the industry, even if it means paying top dollar, as KKR did in its $1,440-per-square-foot deal.

The 750,000-square-foot property, called The Exchange, has a 50:50 lab-to-office ratio and is in a part of San Francisco that didn’t have any available lab real estate at the end of last year, according to JLL. Dropbox, which leases almost all of the campus, is seeking to sublease the lion’s share and is targeting biotech firms.

The Exchange wasn’t the only recent 10-figure transaction. A year ago, Chicago-based health care REIT Ventas paid $1 billion for a three-building, 800,000-square-foot complex in South San Francisco.

Even foreign companies are making a splash. Oxford Properties Group, the real estate subsidiary of Canadian pension fund OMERS, acquired the Emeryville Public Market with City Center Realty Partners in January for $119 million. The partners plan to convert 60,000 square feet of space within the 148,000-square-foot structure to lab use, and may develop new lab product on the surrounding parcels.

Silicon Valley lags behind

The nation’s tech mecca is a bit of an outlier.

San Mateo County, which stretches from Redwood City to Daly City, had more than 300,000 square feet of life science leases in the second quarter, including renewals and new deals, according to commercial brokerage Kidder Mathews. Companies in Santa Clara County, which makes up almost all of Silicon Valley, leased less than 40,000 square feet.

One reason: There just isn’t much life science space south of Sunnyvale.

“Tech is going to continue to be a mainstay in the market,” said Amber Schiada, a research director at JLL. “If you’ve got a big tech company that you know is going to need space, as a developer or an investor, you’re going to go with the sure bet.”

Landlords also haven’t provided enough perks to attract life science firms, said Gregg Domanico of Kidder Mathews. A typical tenant improvement allowance for a life science company in the Bay Area was $150 a square foot last year, according to Newmark. Silicon Valley landlords don’t offer adequate allowances to attract them, Domanico said.

That said, the Valley is home to Stanford University, among the world’s leading biotech institutions. In 2019, it designated an 85-acre portion of the 700-acre Stanford Research Park as a life science district. Anchoring it is a 92,000-square-foot life science incubator that opened in September, a collaboration between Stanford and Alexandria Real Estate Equities.

Stanford has had success in attracting prominent investment firms. Chicago-based Harrison Street Real Estate Capital made its first life science bet in the Valley last year and has since committed nearly $1 billion to similar projects in the Bay Area, according to Michael Borchetta, who’s on Harrison’s transactions team.

The firm has so far focused its investments on Palo Alto and Mountain View because those cities are closely tied to Stanford’s ecosystem, Borchetta said. However, it expects that lab and biotech companies will push into submarkets south of those two cities over time, creating opportunities to convert vacant buildings into lab space — particularly if the tech office market continues to take a hit from remote work.

The East Bay and San Mateo County boom

Go north of Silicon Valley, and the pipeline for new life science projects gets busier.

When Alexandria delivered a more-than-520,000-square-foot office/lab project in the city of San Carlos late last year, about 90 percent of the development’s space had already been pre-leased to several companies. The project is now fully leased.

All newly built life science property in San Mateo County was pre-leased, while more than two-thirds of the space slated to come online in late 2021 is already pre-leased, said Newmark’s Eric Bluestein, who specializes in life science leasing.

Since September, developers have filed plans for three life science projects in Alameda and San Mateo counties that would collectively add about 1.25 million square feet. The largest of them, by Healthpeak, calls for two new towers in Brisbane collectively offering over 850,000 square feet.

As more life science companies pile in, capitalizing on local talent and an established startup culture, investors who still see the industry as an alternative asset class will have a harder time justifying that perception.

“What’s great about life sciences is there’s a huge runway for industry growth,” JLL’s Schiada said. “Life sciences is becoming much more tech-enabled than ever before. That’s really what’s driving the growth.” 





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