Life sciences have taken off since Crick and Watson unravelled the double helix structure of DNA and cleared the way for genetic research, opening up the field to tackling an ever wider range of medical issues, attracting a broad spectrum of scientists and turning lab, manufacturing, testing and research-and-development space into a multi-billion real estate market for developers and investors.
More than 60 years on, the lab space occupied by the ground-breaking Cambridge researchers may still be similar to that of the modern-day scientists, but the field of life sciences has now broadened out to biotechnology, pharmaceuticals and medical devices. The top clusters are typically in the US and characteristically involve concentrations of life sciences researchers, adding in specialists in related fields, all using a stock of suitable lab space, and importantly – with access to venture capital funding.
With impressive amounts currently being spent on life sciences, the prospects for the real estate end of the industry look favourable, including from an investor perspective. As global health spending grows inexorably, demand for lab space should continue to benefit. (As an offshoot, the broader local real estate market stands to prosper too, for example, as highly paid scientists look for homes, retail and leisure.)
And while a limited set of public real estate companies are exposed to this segment, a significant number of US real estate investment trusts (REITs) are trying to increase their presence in lab space or office segments linked to lab space.
The meaning of life
Life science research may have been around for several decades, but in the key market clusters in the US, available space is scarce. This often leads to new construction to meet tenants’ expanding needs.
The requirements of biotech and life science tenants differ from those in other sectors of the economy. These tenants often expand or move when they make a research breakthrough or raise new research monies. Lab space is undoubtedly a niche property type, but it enjoys favourable dynamics and lease terms. It tends to cluster in a handful of areas close to universities and other research institutions. The rapid growth of this sector is driving demand for lab space, which means rents have risen to historical highs in markets such as Boston, San Francisco and San Diego.
That has helped make investing in life science property an increasingly attractive proposition for real estate and REIT investors. A present, there are only a handful of public office and healthcare REITs that own lab space, with labs making up just 10% of the total asset value of these sectors.
Familiar public companies present in life science are Alexandria REIT, Health Care Properties Inc., Kilroy Realty, Ventas Inc. which is all registered and active in the US. These companies have increasingly focused on the life science industry markets and while one cannot draw many concrete conclusions from their historic performance, companies with exposure to lab space and life science markets have done well in recent years as Exhibit 1 illustrates.
Exhibit 1: Annual returns of healthcare REITs, office REITs, and REITs with significant lab space exposure (USD, in %)
Annual total returns to 31/5/2019; year-to-date returns are not annualised; *average for Alexandria REIT, Health Care Properties Inc., Kilroy Realty, Ventas Inc.; source: Bloomberg
The value of your investments may fluctuate. Past performance is no guarantee for future returns. As a result of currency fluctuations, returns can increase or decrease.
“To know what life is worth you have to risk it once in a while”
Impressive amounts are being spent in the life science sector as a consequence of the inexorable growth of global health spending. The increase in venture capital funding for US life sciences companies highlights the robust expansion of the industry. Deloitte’s 2019 global life sciences outlook reported that the number of research jobs in US biotechnology increased by 27.1%, compared to 7.2% for overall employment, between 2013 and 2017, stimulating demand for laboratory space in markets like San Francisco, San Jose, and Boston (December 2019, Deloitte).
The lab space real estate sector is not without risk, however, not least because it involves exposure to a single, specialist industry. US healthcare regulation presents another risk, particularly efforts aimed at limiting drug pricing. Finally, a lot of the companies active in the industry are start-ups or relatively new and there has been considerable consolidation and M&A activity in the life science sector as well as more broadly in the drug industry.
Life goes on
The combination of population aging driving healthcare spending and more pharmaceutical research provides a solid platform for the continued growth in demand for life science and lab office space over coming decade. Global pharmaceutical spending should outpace overall healthcare spending, according to the Deloitte 2019 outlook.
More than USD 66 billion in venture capital was invested in bioscience companies between 2014 and 2017, benefiting commercial real estate demand. This is becoming a key component of collaborative property environments. Indeed, life science start-ups and established companies prefer to cluster in specialist office campuses so they can access talent and share ideas. This favours real estate companies that can offer specialist property in the main life science markets.
Clearly, this is a niche space to invest in with only a handful of companies providing meaningful exposure. But it is an example of an opportunity that the smarter real estate managers in the REIT segment identified correctly. They spotted an innovation at an early stage and took significant steps to exploit it.
It also reminds us that technological advances may harm businesses. Just think of the effect of e-commerce on physical shopping centres. However, progress need not always have a negative impact on property. E-commerce boosted warehousing and datacentres. Similarly, rapid advances in science can open up meaningful investment opportunities. That includes the listed real estate sector.
Written 19 June 2019
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