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August 22, 2018

What’s Driving California Life Sciences Markets

Lack of Space, Increased Demand Drive California Life Science Markets

California has been firmly cemented as a fixture in the national Life Sciences industry ever since companies like Edwards Lifesciences established a presence in Irvine in 1958, Hybritech launched San Diego’s biotech industry in 1978, and Genentech planted its flag in South San Francisco in 1976. Today, there are nearly 300,000 Californians working in the life sciences, according to the California Life Sciences Association (CLSA).

That includes more than 3,200 life sciences companies in the state striving to find innovative solutions to human health, agriculture, biofuels and numerous other areas. Those firms have more than 1,200 medicines, along with even more diagnostics and devices, in the pipeline designed to improve patient care.

The life sciences industry has also proven to be a powerful economic engine for the state. In fact, the CLSA reports direct, indirect and induced employment exceeds 900,000, and those life sciences jobs generate an average annual salary of $113,000. The sector’s revenue exceeded $169 billion in 2016, and exports topped $22 billion, notes CLSA.

California is also a favorite of venture capital, which poured more than $6.6 billion in life sciences investment in 2017. The next closest state, Massachusetts, drew less than half that amount, notes CLSA.

Let's take a look at how all that activity is affecting the commercial real estate side of the equation. We'll explore California's main life sciences markets, the Bay Area and San Diego, through the expertise of Kidder Mathews' life sciences experts. They share what trends are worth following, what companies are producing innovation and growth, which clusters are hot, as well as why they may remain so into the future.

Northern California's Bay Area Life Science Cluster Overview

Kidder Mathews' James Bennett, managing partner and executive vice president, Life Sciences in San Francisco says, "At the macro level, the life sciences market has obviously been extremely dynamic over the past four to five years. It was lagging tech at one point, but caught up and now is on par with the high level of activity the Bay Area markets are experiencing overall, which brings challenges as space becomes tight and continues to grow."

The bigger tenants and pharmaceutical companies traditionally tended to supplement growth via acquisitions and partnerships, Bennett notes. But more frequently they seek to have a physical presence in the Bay Area in order to be part of an increasingly dynamic community. He pointed to Merck and Astra Zeneca setting up major operations in South San Francisco as examples of that trend.

Another interesting dynamic Bennett is monitoring is longtime companies up and down the state roaring along with success in the pipeline. "Unlike past cycles that were driven by big pharma and M&A activity, we are seeing venture capital drive the low end, and that’s pushed the middle of the market to tremendous growth," said Bennett.

Kidder Mathews' Eric Bluestein, CCIM, executive vice president and partner, said, "Medium-sized companies are moving from startup to IPO and all of a sudden they’re mature." He’s seeing examples of companies taking 40,000 square feet and then two years later needing 100,000 square feet. Among the mid-stage companies' experiencing such growth include Grail in Menlo Park, which came out of the gate taking 72,000 square feet, and now is looking for more space to accommodate growth. Some of these life sciences firms have been around awhile, and others are experiencing rapid accents, points out Bluestein.

There's competition for space with more traditional tech firms, too. A prime example of that was Kilroy Realty's The Exchange, which was originally marketed as 400,000 square feet of life science space. Dropbox made a surprise move by taking the whole complex. "That's not the norm," says Bennett, "but the space in Mission Bay was originally conceived as a life science hub around the UC Life Science campus, but the market matured." In addition to Dropbox, Uber also took two buildings from Alexandria that were planned as life science, and the Warriors new basketball arena space also claimed sites envisioned for Life Science uses.

Finding and keeping talent is one of the key issues affecting all real estate. For life sciences facilities, recruitment is at the top of everyone's list, whether it be a small or large company, but it is especially acute in a region where demand for workers is high, and tech companies are continuing to experience significant expansion.

"That's driving tenants to make decisions on facilities that they see maximize their ability to attract and retain people," said Bennett. "The location and quality of buildings choices are getting more and more challenging, as space gets tighter and tighter, it is harder to get ideal space, especially for small firms," he said.

Bluestein points out that attracting talent and retaining employees are critical. "We are seeing collaboration dictate decisions. If a company is doing something with a mothership or big partner, that becomes a part of it, too, since companies want to be close to where they can attract talent from another company," said Bluestein.

A way start-ups and small companies can mitigate some of the challenging market conditions that exist within the Bay Area's life sciences markets is to prepare early. "My advice from a tenant rep perspective," said Bluestein, "is to get way out ahead of the requirement, and look for space as soon possible. That could be as much as nine to 12 months out."

He notes it is a more extensive process to educate a client on the market to see how challenging it may be to find existing lab spaces now. Bluestein said, "You have to prepare a client for the possibility of not being able to take occupancy of a warm shell for four to six months. Then, they must consider design and construction delay time, plus another factor is the upfront cost outlay."

That's because there's no existing inventory. "In the last couple years, the new norm shifted. It used to be for new start-ups needing new space they'd build a new building and then they'd need to build out space for a Life Science use. They would wait six months for the space to be ready. It is a different animal now," said Bluestein.

Bennett said, "across spectrum, there’s just no space and that’s a change for small companies," who need bio and wet lab space, hoods, animal research and some outsourcing. Mid to large companies are starting to convert space similar to the tech model with office space open plans.

"We're also seeing densification, as scientists are seated with DNA staff in an open environment, which seems to be the trend. Some of the "big guys" are hot desking and even hot benching, and are doing more outsourcing of some functions such as animal research," said Bennett.

Another trend that warrants mention, says Bennett, is as mid-sized companies' hit milestones such as FDA approvals, their space needs change dramatically from R&D to needing a larger percentage of office space for functions such as clinical regulation, and administrative office functions to service those products. Examples of those types of growth phases include 23andme, which took 145,000 square feet of office in Sunnyvale; and Nektar Therapeutics, which took 136,000 square feet in SoMa.

Bluestein notes the layout of spaces are trending away from labs, as companies seek a more creative office feel to appeal to Millennials, in particular, the engineers to help with data analysis. The shift has resulted in a new moniker called the Medivation effect. Essentially, that refers to companies rethinking their space models. When they need more lab space in a life science setting, they shift people typically doing more office-type jobs into more traditional office buildings.

As far as what the future may hold for the Bay Area life science market, Bennett believes, one trend is big pharma continues to desire to be in the market so he sees more of that expansion ahead and demand remains high. He's even heard a few rumblings of several firms expected to make moves that he's closely watching.

Due to the "absolute lack of space for small companies," Bennett expects that will impact several companies who will elect to move outside the Bay Area to other markets in order to get space and find talent. That may result in moves to San Diego, though Bennett does not envision a "wholesale flight out of the Bay Area, but he finds it interesting that about a half dozen start-ups and incubator firms have moved to space in San Diego," said Bennett.

Southern California's San Diego Life Science Cluster Overview

In Southern California, landlords continue to invest in Life Science real estate in the San Diego cluster through acquisitions, industrial/office to lab conversions, and ground-up development. Kidder Mathews' John Hundley, senior vice president, notes a prime example of this is Alexandria Real Estate's acquisition of the 247,000-square-foot Quidel (formerly Alere) campus in Sorrento Mesa for $146.65 million. Alexandria, BioMed Realty, and HCP all have new product that is market-ready or will be brought to market in the next 12 to 36 months, notes Hundley, who specializes in Life Science, healthcare, and technology industries.

Several San Diego based companies have also significantly expanded in 2018. Among the growth companies were Tocagen, which expanded into 38,000 square feet at Phase 3's Genesis project in UTC; Gossamer Bio successfully raised $70 million and subsequently leased 32,000 square feet in Torrey Pines; AnaptysBio was one of the best performing IPO’s of 2017, and that led to an expansion into additional office space in early 2018; and Crinetics raised $60 million and moved into a new facility as it plans for an IPO later this year.

All of the national Life Science landlords own property in San Diego, including Alexandria, BioMed Realty/Blackstone, and HCP, in addition to several regional companies, Phase 3, City Office REIT, and Bollert Labeau, own lab buildings in San Diego, points out Kidder Mathews' Jon Engle, who focuses on the life science, tech and healthcare real estate solutions. "One trend that we are seeing is the increased appetite for these landlords to go 'spec' and build out various lab and office suites before identifying a tenant. This certainly isn't a one-size fits all strategy, and not every space/building is a good candidate, but landlords are not shy about building spec spaces particularly in the 5,000- to 15,000-square-foot range. And more importantly, the demand among tenants is there," said Engle.

The continued emergence of the San Diego Life Science hub is being driven by many factors. "We have several world-class research institutes and a University that continue to discover and develop new technology, " said Engle. "Our talent pool is top-notch, and we have a steady flow of funding through grants and venture capital money. "

That's added up to strong venture funding. San Diego had the strongest Q2 for venture funding since 2001. More than 30 companies raised nearly $600 million in funding (according to the MoneyTree Survey), and one of the most exciting aspects of Q2 is that San Diego had eight companies raise more than $25 million.

Looking ahead, the region is poised for continued growth. "With well over a million square feet of demand, I see the life science real estate footprint continuing to grow," said Engle. "San Diego is approaching a base of 15 million square feet of purpose-built life science real estate in Torrey Pines, UTC, Sorrento Valley, and Sorrento Mesa. I see the base continuing to grow, with an emphasis on cGMP space as the industry matures. The big question is what will this growth look like? Further, how will the marketplace accommodate future growth for lab product?"

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