Commercial Buildings Finding New Purpose
Many developers of commercial properties thought that the pandemic had supercharged demand for the life sciences and that the demand would be sustainable. Unfortunately, for these developers, they were wrong.
Biotech and pharmaceutical buildings became one of the hottest investments in commercial property at the start of the pandemic. Now, the glut of life-science properties has gotten so bad that some developers are exploring the unthinkable: marketing the space for traditional office use.
In the Boston region, for example, owners of at least 10 life-sciences locations are now offering those buildings for office space instead of lab space, according to brokers and other real-estate professionals. The building owners are willing to lease it for office use even though they can face a 30% loss of rent when leasing regular commercial space rather than for life-sciences use.
The U.S. office market is downsizing (for ex., people working from home). Owners of life science buildings in areas as widespread as Boston, San Diego, the Bay Area, are dealing with an overabundance of inventory of life science properties that took off during the pandemic. But as the virus abated, so did the need for these specialized properties., leaving these property owners in a financial bind.
Since the first quarter of 2020, more than 59 million square feet of new life-science space has been added with an additional 19.1 million square feet in the pipeline in the U.S., according to real-estate services firm JLL.
By comparison, an average of 3.7 million was added annually in the five years leading up to the pandemic.
Contributing to the problem, demand for life-sciences space has fallen sharply from its pandemic peaks as biotech, pharmaceutical and other life-sciences companies have lost their appetites for rapid expansion because of high interest rates, weak venture-capital financing and an uncertain economy.
In September 2020, a developer named IQHQ broke ground on what would be downtown San Diego’s first major life-sciences campus on 10 acres of waterfront property. Four years later, the nearly $2 billion five-building project is close to opening without any life-sciences tenants announced, at all.
In the Boston area, with over 49 million square feet, vacancies have soared to 27.7% in the sector compared with less than 6.2% in late 2020, according to JLL. An additional 5 million square feet are under construction, which could push vacancies higher. The outlook for this real estate sector is bleak.
One developer of a nine-story project in Boston’s Somerville suburb, a venture of Leggat McCall Properties and DLJ Real Estate Capital Partners, has halted construction. “Construction has paused until market conditions improve,” the developer said.
The value of even high-quality life-sciences property is down about 15% to 20% from its peak in 2022, because of supply and demand pressures as well as high interest rates, according to Dylan Burzinski, analyst at real-estate analytics firm Green Street.
In May, Citigroup downgraded bank OZK K which provided close to $915 million in construction financing to IQHQ, partly citing weak life-sciences demand for the 1.7 million-square-foot San Diego project. The report sent the bank’s shares down sharply.
Travis Mcready, head of the life sciences division of JLL said, “We cannot withstand this level of supply-demand imbalance for too long,” he said. “At some point the arithmetic just doesn’t work.”
So, what is the lesson here? Even the most sharp, knowledgeable, and savvy developers (and believe me these top-of-the-line developers are all of that) make serious mistakes.
When the next hot thing comes along, it must be met with caution. There is no sure thing.