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After the housing bubble: Medical and life science properties

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As the housing market weakens, real estate investors' attention will increasingly turn to other real estate assets. Given the strong contribution of life science and health care companies to San Diego's economy, it's worth considering how medical office and life science research and development properties are distinct from other real estate assets generally and office properties in particular, and how they share similar requirements.

Lower correlation with broader economy

If the housing market downturn spreads to the larger economy, general office and industrial space demand will likely weaken. It's less clear how a recession will affect medical office and life science research and development space demand.

Medical office and life science R&D space serve different health care constituencies - health care consumers and health care innovators. However, they are similar in that demand is largely a function of increasing health care needs from an aging U.S. population, rather than short-term economic fluctuations. In our own practices, we have not seen any recent downturn in health care-related real estate activity. However, we anticipate that the broader economy will have some impact on medical and life science markets, as discretionary spending for elective medical procedures and health care technologies is directly impacted by consumer confidence.

Location, location, location

While a cliché in real estate, location is key for medical office and life science properties. In the United States, research in the life sciences is clustered largely around San Diego, Boston and the Silicon Valley. Within cities, medical office and life science users require proximity to research centers and health care providers.

Higher construction, tenant improvement costs

Medical office and life science uses place greater demands on a building's structure and systems, and construction costs for such space are considerably higher than general office space. Likewise, tenant improvements for leased medical office and life science space are generally more extensive than in typical office space, and associated costs are generally higher than for general office uses.

More planning, negotiation, due diligence

In light of the higher cost of preparing medical office and life science space, negotiations between property owners and tenants or purchasers concerning design, construction financing, delivery schedules and property management are much more critical to the overall transaction than in the typical office lease.

Yet most non-institutional medical office and life science users commit little, if any, internal resources toward strategically planning for their future facilities requirements. From the real estate investor or landlord's perspective, a medical office or life science development must be thoroughly planned to meet the specific needs of occupants.

Similarly, a prudent medical office or life sciences tenant should perform more title and entitlements due diligence than the typical office tenant to avoid costly errors in the design and extent of improvements to its space, to control the costs of its initial out-of-pocket investment in its space, and to ensure flexibility to accommodate changes in its use and occupancy requirements over its lease term. Also, by negotiating nondisturbance agreements with project lenders during lease negotiations, a life sciences tenant can better protect its out-of-pocket investment.

Medical office and life science properties are a more complex, costly and less fungible asset than general office properties. Such properties are also geographically constrained by their need to be near existing health care and life science uses. These barriers to entry may limit real estate investors' ability to successfully redirect dollars to this sector from other asset classes. However, for those able to navigate the development and operation of medical office and life science projects, such properties may provide an attractive investment and a hedge against a recession.

Biel is a partner and Schnitzler is an associate with Mintz, Levin, Cohn, Ferris, Glovsky and Popeo PC. Both practice in the firm's Real Estate section.

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