The lack of laboratory space, which is essential for life science companies to conduct research and development, has been a common problem in many cities across the country over the past year. However, in California, the situation seems even worse. Recent reports show that vacancy rates for lab space in the Bay Area and San Diego are around 3 percent; while in Los Angeles, they are as low as 1.5 percent. What are the implications for the life science industry when space is scarce? What should companies, especially startups, be aware of? We asked our members who are experts in life science spaces and commercial real estate for some answers in this three-part Q&A series. Next up in the series is the Bay Area, where we spoke with Scott W. Miller, Executive Managing Director of Life Sciences at JLL.
What is the current state of lab space availability in the Bay Area?
The current vacancy rate for genuine laboratory office space, which is synonymous with life sciences, is definitely below four percent for direct spaces and probably three percent is a realistic figure for where we are currently tracking on direct vacancy. Sublease vacancy, while also relatively low, is actually increasing from where it was three quarters ago.
It’s always better to have more balance between supply and demand in the ecosystem. Before COVID, and then during COVID, it’s increasingly been a market where demand exceeds supply–more tenants, more occupants looking for a limited amount of inventory and space. Ideally, you always want there to be more alignment and harmony within that paradigm of supply meets demand. What’s happening in the world around us with inflationary conditions and the rising cost of construction is it’s providing a relief valve for the occupiers and tenants as developers are having to provide more improvement capital.
With that said, in the Bay Area, there has also been a weakening of demand and an increase in sublease inventory (although not as much as in other marketplaces nationally). There’s been new direct inventory hitting the market, both in office-to-lab conversions and new development. I see vacancy rate numbers rising to a number [in the future] where it’s more harmonious from an occupier’s perspective and healthier on the supply-demand ecosystem.
How does the current vacancy rate affect the local life science industry? Are new companies coming into the Bay Area? If so, are they looking for space outside of the primary life science hubs?
A lot of the big pharma and big biotech groups that come to the Bay Area either come through a merger or acquisition event, or they establish a presence here by putting their metaphorical flag into the marketplace. However, many of the big pharma and big biotech organizations have already arrived here invariably over the past decade. We did see Astellas sign a large deal with Healthpeak Properties recently—a very large publicly traded life sciences developer—in our market, but we’re not seeing that big wave of large biotech or large pharma companies as we did in prior years as they have already arrived.
A considerable amount of the organic growth in our market is well-funded, mid-cap, and mid-emerging biotech companies that are looking for progression. They’re having to plan ahead in advance to accommodate and host their growth because of how limited the options [for space] have been for the past many quarters. Returning to new developments coming online, conversions, and ground-up development, there will be more options. More opportunity for those companies that are organically expanding in our market to find a headquarters location that makes sense for their operation.
There are also landlords entering the Bay Area life sciences market, with King Street Properties bringing their expertise from the East Coast, as well as IQHQ expanding operations from Southern California. Established developers and new entrants are already planning the next major clusters outside of the primary life sciences submarkets. One example is Millbrae, where Alexandria has secured Eikon Therapeutics for 285,000 square feet.
The Bay Area had the second-largest percentage gain for office-to-lab conversions this year. Will this help the current situation—especially since employees at several tech companies in the region have gone to permanent remote or hybrid work models?
The work-from-home trend that emerged from COVID has been beneficial for office occupiers in the technology and financial services sectors. However, life sciences users cannot work from home because they need laboratory workers who are essential. They have to be in buildings that are either built or converted specifically for life sciences.
This has led to a paradigm shift where office developers—who might be worried about facing long periods of vacancy—are considering converting their space to the laboratory, life sciences space. But if a conversion is done poorly, it will not be well received by the life sciences community—it’s crucial that the right developers execute that task effectively and efficiently. It’s not a simple feat. It’s a very complex and challenging operational conversion: converting an office building to a laboratory is not as easy as it sounds, it has to be done correctly. There are some developers who do it well and accurately. And unfortunately, there are some developers who do it badly and cut corners. The developers who actually know how to convert offices to laboratories/offices effectively and accurately are the ones who will succeed in the end. There is a significant reputation risk associated with any office-to-lab conversion and the good conversions are being noticed and appreciated. The same can be said about the bad conversions, they can damage a developer’s reputation.
I think the conversions will provide more options for tenants who are looking for space, but it will be clear which assets have been converted well and which assets have not been converted well.
Is there a factor that makes building more lab space in the Bay Area uniquely challenging?
There’s always a clustering effect with where these life sciences companies want to be located. First, they want to be where there’s existing talent, which is related to where existing life sciences companies already have their home. Second, being close to research institutions and venture capital is essential. You’ve seen a combination of existing locations being the beneficiary of all these attributes—this is why South San Francisco, Mission Bay, Emeryville, Berkeley, Alameda, Redwood City, Foster City, and Hayward are growing life sciences markets.
Also, you’re land-limited in the Bay Area Peninsula because you’re surrounded by a bay, existing residential neighborhoods, and the foothills on the peninsula. There are not a lot of other land opportunities to expand a life science cluster which is why so much existing real estate is re-used to create adequate laboratories to support the growth. You’d have to really expand south into Silicon Valley or farther east if you’re on the east side of the bay, up and down the 880 corridor. What we’re finding is life sciences occupiers and tenants mostly want to be where there’s already an established cluster in the Bay Area.