As its office sectors remain depressed, California is home to numerous underway and proposed conversions to life sciences real estate, but the task is far from a sure bet and much easier said than done, experts told Bisnow.
Conversions to life sciences properties aren't new, with South San Francisco's Genesis Towers a large-scale example, but the diverging fates of office and life sciences properties this year have culminated in a "notable increase" in conversions of other property types to labs, CBRE said in a new national report.
Most pronounced in the Bay Area and San Diego, interest in the trend might outpace demand and lead to a market correction in the coming years, experts said.
"Everyone is thinking about it," Longfellow Real Estate Partners Managing Director Evan Schwimmer said. "My concern is we could potentially have an oversupply problem if this trend continues unchecked.”
Courtesy of Longfellow Real Estate Partners
A rendering of Longfellow's newly renamed Redwood LIFE project, a 1M SF redevelopment of Bayshore Technology Park in Redwood City, California.
The trend makes up larger portions of California markets' pipelines. In Q3, the Bay Area's life sciences lab space pipeline consisted of just over 4M SF, about 1M SF of which took the form of conversions. Over half of San Diego's 1.5M SF pipeline is conversions, according to CBRE's report. In the Boston-Cambridge market, about 10% of the lab space pipeline is conversions.
California's markets are seeing conversion interest because of wariness over the office sector elicited by coronavirus pandemic-induced remote work, especially in the Bay Area, experts said. In a separate report, CBRE identified San Francisco as the U.S. office market most at risk from the nationwide trend of rising sublease space. The Peninsula office market vacancy rate, meanwhile, has risen from about 6% to 10.2%, according to the brokerage.
“The real estate capital markets are looking for places to invest their resources, and from our perspective, it’s harder for real estate companies to get their arms around traditional office buildings," Schwimmer said.
Even so, much of the interest in life sciences properties indeed has to do with an apparent undersupply, both in existing properties and ground-up development opportunities. CBRE Executive Vice President Dino Perazzo said S.F. and the Peninsula have consistently had about 2M SF of active demand in recent quarters and that the vacancy rate is under 1%, by far the lowest in the nation.
But Perazzo and others say conversions aren't the surefire solutions many owners and developers are hoping them to be.
“When you look at the market today and you look at the office market, and it’s at best on pause as a result of this work-from-home, COVID environment, there is a tremendous amount of office space that conceivably should be able to curb that inventory issue, with conversions being able to be delivered faster," Perazzo said. “It’s unfortunately not quite that simple.”
Aside from a potential oversupply issue, conversions also pose often prohibitive skills, scaling and cost challenges, according to Schwimmer, whose company is working on two conversions: one at the former Bayshore Technology Park in Redwood City, California, and the other at a Palo Alto property
Amrit Chaudhuri, CEO of SmartLabs, a laboratory-as-a-service company, said base-building work and tenant improvements for a life sciences project come in at around 50% more costly than an office project in a competitive life sciences market.
One challenge is the need for 15- to 18-foot floor-to-floor heights to attract big companies like Pfizer and Novartis, which don't accept the lower ceilings accompanying most office buildings. Others include the need for floors that carry more weight.
“It is also really, really difficult to build labs in depressed-ceiling-height buildings," Chaudhuri said. "There are only a handful of real experts globally who know how to do that well. [Phase 3 Real Estate Partners], Longfellow, [Alexandria Real Estate Equities] are all competent, experienced landlords who have done that very well, but there actually aren’t that many.”
Some owners opt to accept lower ceilings and attract some startups and growth companies still interested in lower-ceiling buildings, but Chaudhuri said a more limited client base, and one with generally less creditworthiness, can hinder the valuation of the building.
In addition, many owners are unaware of major differences between the needs of an average office tenant compared to those of the average life sciences tenant, Perazzo said. Large, specialized ones like Healthpeak and Alexandria tend to be able to accommodate the oft-changing space needs of life sciences tenants in ways other owners can't.
“These are companies that might commit to a mid- or longer-term lease, but they rarely can actually predict where they’re going to be within 24 months," he said. "There’s dynamic growth, and as a result of that, they really do need a partnership with their space provider.”
Chaudhuri, meanwhile, said he has had about 20 different developers of large projects around the country approach him in the last six months asking about converting office or retail mixed-use projects to life sciences real estate. He is anticipating a correction in several years, he said.
“The real question is, is there going to be a massive correction in five or six years? Potentially," he said. "By the time entitlements and new projects come online, probably.”
Hughes Marino Executive Vice President David Marino, who is based in San Diego, said one could come sooner.
"If the market cools in 2021, there’s going to be a lot of very disappointed landlords," Marino told Bisnow in an email.
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October 26, 2020 at 08:55AM
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Too Low, Too Fragile, Too Short-Term: Life Sciences Conversions Are Popular But Hard To Pull Off - Bisnow
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