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Life science market bright spot in local economy

Demand for lab space growing as early- to mid-stage companies gain momentum

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At a time when many commercial real estate sectors are slowing, the San Diego County life sciences market continues to grow as biotechnology and market research rank among the region's top performing industry sectors. As a result, the Cushman & Wakefield Global Life Sciences Practice reports steadily declining vacancy and an increasingly limited supply of space, particularly for users looking for options 20,000 square feet and smaller.

The recent Cushman & Wakefield life science market study shows that the San Diego County life science vacancy rate of 6.7 percent is nearly half of the 11.7 percent rate just three years ago.

"San Diego County is a hotbed for startup and entrepreneurial companies, which is driving demand for smaller space options," said Brent Jacobs, senior director with Cushman & Wakefield's Global Life Sciences Practice. "With a number of credible transactions in process, we expect vacancy to dip to less than 6 percent by mid-year and potentially even further by 2009."

According to Jacobs, nearly 80 percent of San Diego County's 13.8 million square feet of inventory exists in blocks over 20,000 square feet in size, leaving a shortage of attractive and usable space under the 20,000-square-foot threshold.

"This has been a dominant trend in the market for six consecutive quarters," he said. "The resulting 'flight to quality' in the smaller size ranges has created a glut of poor quality Class C options. It has also caused a pronounced pricing disparity between quality space that can be occupied immediately and substandard product that requires a substantial investment in renovation."

Landlords and developers are responding to the opportunity created by this space shortage by improving larger underutilized facilities and dividing the floor plates to capture growing demand in the 5,000- to 10,000-square-foot range. For larger requirements, San Diego County will see continued interest in custom-designed lab space, ideally within a first- or second-generation lab building.

Greg Bisconti, also a senior director with Cushman & Wakefield's Global Life Science Practice Group, added that while the market is tightening, the typical ebb and flow of sublease space may also add some fluctuation to the life science market.

"As rental rates trend north of $3-per-square-foot/per-month triple net, we expect most tenant demand to focus on sublease opportunities and landlord-assisted R&D conversions," said Bisconti. "In 2008, the best opportunities will appear in form of 'off-market' and/or design-build options."

Changing industry trends are also supporting the growth of San Diego's life science market. Big Pharma, which once drove outsource chemistry businesses and validated chemistry-based research, has switched its focus to biologics -- a move that has resulted in massive chemistry layoffs. While this has contributed to a growing glut of chemistry space on the East Coast, the impact in San Diego thus far has been nominal. According to Cushman & Wakefield, there is growing speculation and evidence that Big Pharma will divert even more of its substantial balance sheet to early- and mid-stage biotechs, and San Diego would be a likely beneficiary.

"We continue to see exciting talent land in San Diego to meet the demand for intellectual capital being generated by the growth of early- to mid-stage companies here," said Brian Cooper, an associate director with Cushman & Wakefield's Global Life Science Practice Group. "The majority of this growth is by biology and/or light chemistry users, a less intensive use than seen in recent years."

As evidence, Cushman & Wakefield research shows the San Diego County lab to office space ratio has declined from an average of 70-30 to about 50-50 or 60-40. Additionally, Cushman & Wakefield reports that more companies are outsourcing manufacturing, chemistry, small and large molecule work and vivarium needs.

"These growth-oriented companies, entrepreneurial by nature, continue to explore ways to off-set capital intensive research. This trend is leading to less intensive laboratory use and further driving the demand for lab conversion and sublease space," Cooper said. San Diego County saw several major real estate ownership changes led by Health Care Property (HCP) and Arden Realty Inc. in 2007.

In a $3 billion move last summer, HCP acquired Slough USA's 5 million square feet of existing laboratory and R&D space and several-million-square-foot development pipeline. Arden Realty bought CarrAmerica's West Coast portfolio for $2 billion and subsequently spun out over one-half million square feet of life science product to Alexandria Real Estate Equities.

While property acquisitions have slowed in response to the tighter credit market, Jacobs noted that San Diego is still reporting noteworthy activity.

Earlier this year, San Diego-based Veralliance Properties acquired the Neurocrine Bioscience (Nasdaq: NBIX) campus in Del Mar Heights for $109 million and secured a 12-year leaseback with Neurocrine for one of two existing buildings in the 220,000-square-foot campus. The acquisition included a 4.2-acre parcel, upon which Veralliance plans to build a 93,000-square-foot Class A facility.

Veralliance Properties preceded this acquisition with its purchase of Campus Point Technology Center in UTC for $72 million. The company is repositioning a former R&D building in the project for lease to both office and laboratory tenants. At about the same time, Biomed Realty Trust continued its aggressive pace by purchasing quality lab product in Torrey Pines and Sorrento Mesa.

"It is important for the life science tenant to fully understand the landlord and its team and capabilities," said Jacobs. "These transactions are complex and not all laboratories are built alike. There can be huge cost and operational implications for issues not properly addressed."

Cushman & Wakefield's Global Life Science Practice recommends life science companies consider the following when reviewing their space needs in San Diego over the next couple of years:

1. Options for quality lab space are becoming slim. As a result, it is important to plan at least six to 18 months ahead. Since much of the quality space has disappeared, almost every facility needs major changes to the functional layout, which takes time.

2. Specialty lab functions are scarce and specific uses such as manufacturing, clean room and vivarium space are almost impossible to find. Companies requiring this kind of space should plan to undertake either a full or partial conversion from an existing lab facility or shell. This will take approximately 12 to 18 months to bring on line from lease signing and costs $200-per-square-foot to $500-per-square-foot to build.

3. A good hedge against the risks posed by relocation in this environment is to use a qualified life sciences broker. This is particularly important at a time when many office and industrial brokers are trying to shift their focus in response to a slowdown in those sectors. Brokers should be asked to provide a list of laboratory transactions in which they personally (not their company) have represented the tenant. Make sure the transactions they list are not virtual pharma (office). Anyone with less than six such representations over the recent two-year period may lack the relevant experience needed to maximize the tenant's position in the market.

Grove is president of The Grove Agency.

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