Life Sciences: The Code Breaker?
It would be impossible not to acknowledge the sad news that changed the world last week. The Queen, who personified British stoicism, integrity, generosity and even mischief, lived a life of selfless devotion to the country and conducted herself, always, with poise. Many faith groups, including ourselves, pray for the Queen and Royal Family, and will continue to have her family in our thoughts and prayers.?
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It is with great sadness that we mark the passing of the world's oldest head of state and longest serving UK monarch, Queen Elizabeth II, who died at the age of 96. The sheer longevity of the House of Windsor is remarkable, Prince Philip is one of only about 10,000 UK residents who have reached their late 90s, the Queen Mother reached 101. So, in recognition, not just of her remarkable service to the country, but the more mundane longevity of her life, this note takes a look at the Life Science sector.
From the Human Genome Projects formal launch in 1990, gene editing has become one the great hopes for humanity. Back in 2012, Nobel Prize winners Jennifer Doudna and Emmanuelle Charpentier published a scientific paper proving a key part of the bacterial immune system could be used to cut DNA: disrupting, deleting or correcting genetic errors. Ten years later and Crispr Therapeutics, in partnership with biotech group Vertex, expects to seek approval for its treatment for the inherited blood diseases sickle cell anaemia and beta thalassaemia to EU and UK regulators. Vijay Pande, a general partner at venture capital firm Andreessen Horowitz, compares Crispr to the invention of the transistor, which revolutionised computer design. “We are just at the very earliest stages. I think where we are now is maybe akin to the 1960s in computers,” he said. Indeed, Walter Isaacson in his book The Code Breaker, Jennifer Doudna, Gene Editing, and the Future of the Human Race phrased it similarly “we have entered a third and even more momentous era, a life science revolution. Children who study digital coding will be joined by those who study genetic code.” The technology is not cheap to develop and there have been several setbacks in clinical trials along the way. The rash of early start-ups have seen recent heavy share price falls with the Nasdaq biotechnology index fell by 21% in the past year. Crispr Therapeutics has lost about 40% of its market capitalisation.
Capital is still flowing however into the wider biotech sector; McKinsey estimates that VC companies invested in 3,100 start-ups worldwide in 2021. They also found that biotech companies raised more than $34bn globally in the same year, more than doubling the 2020 total of $16bn. The big pharma companies, with huge cash piles, may also be ready to start investing. Pfizer has partnered with base editing company Beam Therapeutics in a deal worth up to $1.35bn.
From a real estate perspective, Life Science is a new sector with growth potential and a diverse tenant base which will add diversification to portfolios. Investment needs to be highly concentrated, as life science companies often prefer to set up near public and private research institutions creating agglomerations in particular locations. A flexible leasing approach will also be required for at least some stock as new companies prefer to lease and take flexible space to meet their growth requirements. The space requirements will be specialist and often expensive to fit out, including a mix of lab and office space as well as specialist production facilities such as clean rooms plus R&D facilities. In addition to higher long-term net operating income growth, the sector has lower ongoing landlord capital expenditure needs, as most investment is reusable and there are high retention rates for tenants.
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According to Swiss Life, companies in continental Europe are more reluctant to rent than they are in the UK which offers the opportunity for sale-and-lease-back agreements to companies with strong credit ratings. In contrast to the US, the European life science real estate investment market is less mature and more difficult to measure. According to the Urban Land Institute, transaction volumes in life sciences in 2020 were less than 1% of the overall €275bn invested. According to JLL the majority of venture capital investment is focused on the US, with around $56bn raised in the year to date. That is more than triple the $16bn raised in China, the second-largest market in the world. A total of $12.3bn has been raised in Europe, where the UK is by far the largest target for investors. The UK government has also thrown its weight behind the sector, raising its commitment to research and development spending from ￡15bn by 2027 to ￡22bn. The investment includes a stake in the ￡1bn Francis Crick (co-discoverer of the structure of DNA) Institute, a biomedical research centre at King’s Cross in central London. The institute has 1,500 staff, including 1,250 scientists, and an annual budget of over ￡100m, making it the biggest single biomedical laboratory in Europe. Business Secretary (now Chancellor) Kwasi Kwarteng said: “From the invention of penicillin and the first successful blood transfusion to the ground-breaking coronavirus vaccination developed by Oxford scientists, the UK has an impressive legacy in the life sciences.”
Savills estimate that every $1bn of Series A venture capital funding into life sciences equates to approximately 140,000 sq ft of demand. Based on the 2021 totals of $18.9 bn, the market should anticipate approximately 2.6m sq ft of new life sciences requirements across the major life sciences hubs globally. “Venture capital growth equates to company growth, which equates to real estate need,” said Chris Walters, who heads JLL’s UK life sciences practice. With location and clustering key there has been huge focus on the Oxford-Cambridge ‘arc’. In the Savills ranking for science cities (Boston sits top), Oxford and Cambridge are in 9th and 10th place and London 13th, the highest-ranking European locations. A shortage of space may drive companies to the US, with Bidwells reporting availability close to zero in June in the arc after demand surged by almost a quarter in the first half of this year. JLL is currently tracking 3.2 m sq ft of active ‘wet-lab’ demand, up 400,000 ft2 on nine months ago, but that just 1.1 m sq ft of lab space is set to be delivered in the next 18 months.
Life sciences is high on the agenda of many investors, and has become one of Blackstone’s highest-conviction investment themes. Blackstone are taking a “building to beaker to bedside” approach: investing in the real estate where research occurs, in promising treatments and technology, and in logistics solutions that help these products reach patients. Blackstone portfolio company BioMed Realty, one of the leading providers of life sciences real estate in the US, acquired 42 acres of land in Cambridge with a view to investing an estimated ￡850m in 800,000 sq ft of purpose-built accommodation.
The development requirements mean that lenders are having to educate themselves about the sector, fast. KKR Real Estate Finance Trust in the U.S. for example recorded 6% of their debt portfolio as allocation to the Life Science sector at the end of Q2 2022. Looking back through previous filings, at the same time last year, it didn’t appear as they had any loans outstanding to the sector. The specialist nature of the buildings is a risk to lenders however, as Chris Swarbrick, senior director for debt finance at OakNorth, describes it: “It’s a broad sector, and ‘life sciences’ is an umbrella term for many uses. For example, one of the buildings we financed will have a digital-focused use, so it is more like a traditional office, whereas the other is for a medical use, so is traditional lab space.” So, the first thing a lender should ask is, ‘What is this building actually going to be?’ Will an alternative use be difficult – for instance, if it is a wet lab that is expensive to fit out or strip out?”
Lenders should certainly be looking ensure that any project without planning consent is underpinned by the existing use value of the site. Possibilities include shell and core fitout with an option for the tenant to personalise their own space. Future proofing is key as many tenants will take short leases, thus longevity in design is crucial. Developers would be wise to seek feedback from a prospective tenant base.
Not all life sciences projects attract equal lender attention. Those in which lenders can find the greatest similarity with an office asset are most popular among financiers. When it comes to funding life sciences parks that have leases rather than just operating companies, that’s where most people start thinking, ‘Hang on, is this a bit closer to normal commercial real estate compared with operating real estate?’
Despite its popularity, improved research and investment intent, the sector is still relatively specialist and opaque. This creates both threats and opportunities for investors and lenders. Any sector experiencing rapid demand growth that is stimulating a rapid supply response is at risk of a demand slowdown meeting a supply glut. Throw in the specialist nature of some of the assets and lenders are demonstrating a positively cautious attitude to the long-term risks.?