By Andrew McIntyre

Law360 (May 13, 2021, 5:06 PM EDT) -- While the rapid growth of e-commerce has generated much buzz around a robust logistics property market as retailers gobble up distribution space, life sciences real estate is also booming, and experts say the sector has the potential to outlast logistics and remain attractive for some time.

Logistics and life sciences were strong before the pandemic, and both have received increased interest from investors in the past year. But the life sciences boom is in part being fueled by advances in technology as well as races to discover new therapies and treatments for cancer and other diseases, and lawyers say such races could mean demand for life sciences space will remain high for some time.

"We are a long ways away from stopping our love for life science," said Tony Natsis, a partner and chair of global real estate at Allen Matkins Leck Gamble Mallory & Natsis LLP. "The pandemic I think increased the love for life science. People think that logistics has less runway."

"Life science is the complete darling of real estate," he added. "Logistics is second."

The surging demand for life sciences space is also playing out as office tenants scramble to figure out their needs and landlords strategize about the future of their spaces. Some office space is likely to be converted to life sciences use, and demand for the latter is expected to remain high given that doing lab work from home is not viable, experts say.

Here, Law360 looks at three things to watch amid the life sciences boom.

Demand Continues To Skyrocket

The demand for life sciences space is partly being driven by increased attention to the sector over the past year amid the race to develop COVID-19 vaccines, but there's more to the story. New technologies are also driving research more broadly, and companies are looking to get in the game early.

Experts say the surge in demand for space continues to be concentrated in a handful of U.S. biotech hubs, including the Bay Area, San Diego, the Boston area and, to a lesser extent, Seattle and Austin.

"Boston and the Bay Area are hotbeds for life sciences," said Mike Liever, senior counsel at Orrick Herrington & Sutcliffe LLP, who said he just completed a life sciences deal in the Bay Area. "Prices for deals right now in good areas of San Francisco … are very hot, and prices are going up dramatically."

"Prices are higher than people would have anticipated. There's enormous demand," Liever added.

Liever said that in response, Orrick has recently hired lawyers who have experience in the life sciences and venture capital spaces. He said increased attention to genome editing as well as mRNA research are part of what's driving the demand.

"You can pinpoint therapies, tumor treatments in a way you weren't able to do before," Liever said. "We see the [VC-backed companies] expanding rapidly in that area. There's a lot of money."

And the massive amounts of capital chasing such real estate deals are pushing up purchase prices and making it harder for smaller companies to do acquisitions as larger players seek to outbid the competition, lawyers say.

"If you're lucky that the big guys aren't competing with you, then you have a shot," Natsis said. "Everybody wants to be in life science. People look at a gas station and wonder how they can convert it to a life science building."

Landlords and Developers Face Hurdles

While demand is stiff on the acquisition front, the boom is also pushing up rental prices. Although landlords and developers of such properties see opportunities on the one hand, they also face a variety of challenges operating in the space, experts say.

For one, many would-be tenants are little-known, have little credit history and are making massive bets on new drugs taking off. That can be daunting to landlords who are concerned about next month's rent coming in.

"The downside … is they are often newly funded companies with no track record, many of which are not going to make it in the long term," said Steve Berkman, a partner at Paul Hastings LLP. "It's more akin to leasing office space to venture-backed startups rather than to Google or Facebook."

Natsis said credit isn't much of an issue with mega companies, and when it comes to public companies, landlords are "still feeling pretty good." For small, little-known private companies, landlords generally ask for a letter of credit, he said.

Another issue, though, is cost. Developers typically have to commit large amounts of capital to build out and customize spaces, and given the uncertainty of the results of the research that may happen in the space and the viability of the tenant, upfront cost can be a concern.

"It's very expensive to build out this space. It's not without its pitfalls," Berkman said. "You've got to put more money in, but you get more money back on rent as long as your tenant succeeds."

Banks, though, have been "pretty bullish" on the sector, so access to debt financing is generally not an issue, Berkman said.

Developers' experience is yet another potential stumbling block. While it's one thing to have the capital and another to have a tenant lined up, developers also have to understand how to build such properties. Often, the institutional players who have the capital lack the experience, and that's meant more companies are now doing joint ventures.

"Alexandria [Real Estate Equities Inc.] has been doing [life sciences deals] for 25 years. More owners are now looking to try to capitalize on this, but at the same time may not have the experience," Berkman said. "Office space is more hands-off. It's going to be interesting to see if there are problems in the future."

Companies May Convert Office Space for Life Sciences Use

As the pandemic has put the future of the office sector in flux, owners of office space are increasingly thinking about repurposing some of their space for life sciences use if it means they can land a tenant that will pay top dollar.

"Life sciences companies are basically settling for not-perfect space because they need it," Berkman said. "In the Bay Area, there's a lot of [office] sublease space. There's an influx of companies looking for [life sciences] space, and being willing to take less-perfect space."

As one example of a potential office-to-life-sciences conversion, KKR earlier this year bought The Exchange, a 750,000-square-foot office property in San Francisco, from Kilroy Realty Corp. While the property is fully leased to Dropbox, KKR has hinted that it could reposition the asset for life sciences use, particularly if Dropbox decides it doesn't need or want as much space going forward.

"That's a typical sound bite that's now being attached to various transactions," Natsis said, referring to owners and investors increasingly talking about creating life sciences uses at their properties.

During the pandemic, tech companies have been able to operate with most of their employees working from home, which is not the case by and large in the biotech space, since lab work is required. That reality is likely to fuel conversions by office owners.

Natsis said buildings that have sophisticated HVAC systems can be good candidates for conversion. Cooling is particularly important, as are electrical systems and high ceilings, he said.

And as office owners are scrambling to predict the future of demand for their spaces, they are now increasingly also looking at the bones of their buildings to see if there may be a potential life sciences use.

"You've definitely got a lot of new entrants, landlord or owner entrants into the space," Berkman said. "There are traditional office companies who are looking to get into the space, or sell their space to life sciences users, which wasn't happening before."

--Editing by Aaron Pelc.

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