Market analysis by our public securities expert, Geoff Shaver
April 17, 2020
Why Demand for Lab Space REITs Will Continue to Grow
by Geoff Shaver
Director of Public Securities
As the Coronavirus pandemic continues to affect all our lives, we are frequently asked what types of properties can thrive after this pandemic subsides. One type of property we think will succeed is lab space that supports the life science industry. We mentioned this recently in one of our webinars and thought it might be a good time to go into more detail.
We believe that lab space will be in greater demand going forward, as there will be an almost certain push in virologic research. We expect this research will transcend the current virus and look to better our understanding in all areas of virology including detection, transmission, vaccination, and even potential cures. This research will almost certainly be performed in a lab environment.
If you’re looking for ownership exposure to this type of lab space and life science real estate assets, there are a handful of publicly listed real estate investment trusts (or “REITs”) that focus on this area. The greatest concentration of lab space can be found in Alexandria Real Estate Equities (ARE) but can also be found at Healthpeak Properties (PEAK), Ventas (VTR), and Kilroy Realty (KRC).
Lab Space Clustered in Four Main U.S. Markets
Lab space can be found all over the U.S., but there are four markets that tend to dominate: Cambridge, Mass., South San Francisco, Seattle; and San Diego. You can also find clusters of lab space near major universities that focus on life science research. It’s easy to see why Cambridge tops this list with its close proximity to the academic institutions of Harvard and M.I.T. along with the concentration of pharmaceuticals companies in the greater Boston area, but lab space can also be found near other universities such as Duke in Durham, NC, or the University of Pennsylvania in Philadelphia. These universities have even been known to partner with REITs for on-campus development, where the university gives the REIT a long-term land lease for ground space, the REIT develops a facility on this ground and then leases the new facility back to the university.
Aside from the universities, tenants can include the traditional pharmaceutical companies, newer companies that specialize in biologics, companies that focus on genome research and genetics testing, as well as any venture-backed startup that focuses on life science and needs lab space. While many of the larger pharmaceutical companies can self-fund research and development from existing revenue streams, the smaller players are often backed by venture capital firms or rely on research grants, which can come from government sponsored entities, such as the National Institute of Health (NIH), which is the largest public funder of biomedical research in the world, or private entities such as the Bill and Melinda Gates Foundation.
Let’s take a look at some of the key players in lab space, starting with Alexandria Real Estate Equities.
Alexandria Real Estate Equities (ARE)
Alexandria was founded in 1994, and their first asset was a lab/office building in the Torrey Pines neighborhood of San Diego, with proximity to UC San Diego. Today ARE has an equity market cap of over $19B and owns over 27 million square feet of space in 269 properties across North America. They have major asset concentration in the four dominant markets mentioned earlier, as well as other markets that have intense life science research abilities, such as New York City, the greater D.C. metro area, and the Research Triangle in North Carolina.
ARE caters to these lab space users; in fact, biotech, pharmaceutical, and other life science-related entities make up the vast majority of their tenant mix. ARE does have exposure to tech tenants as those major markets mentioned earlier also are heavy in tech, and in many cases the line between tech and life science can be blurred depending on the tenant’s product or application.
A review of ARE’s top twenty tenants shows some familiar names in the pharmaceutical and biotech space. While leasing to a biotech startup that has no source of revenue sounds like it could be a risky proposition, 53% of ARE’s revenue comes from tenants with investment grade ratings or who are large cap publicly listed companies1.
80% of Top 20 Annual Rental Revenue From Investment-Grade or Publicly Trade Cap Tenants
|Tenant||Remaining Lease Term(1) (in years)||Aggregate RSF||Annual Rental Revenue(1)||Percentage of Aggregrate Annual Rental Revenue||Investment-Grade Credit Ratings||Average Market Cap(1)(in billions)|
|1. Bristol-Meyer Squibb Company||8.7||900,050||$52,174||4.1%||A2||A+||$86.9|
|2. Takeda Pharamceutical Company Ltd.||9.6||606,249||$39,251||3.1%||Baa2||BBB+||$57.9|
|3. Facebook, Inc.||12.0||903,786||$38,873||3.0%||---||---||$518.1|
|4. Illumina, Inc.||10.6||891,495||$35,907||2.8%||---||BBB||$45.6|
|5. Eli Lilly and Company||9.4||554,089||$34,096||2.7%||A2||A+||$115.9|
|7. Novartis AG||8.3||378,894||$27,849||2.2%||A1||AA-||$224.8|
|8. Uber Technologies, Inc.||62.8(3)||378,894||$27,849||2.2%||---||---||$60.3|
|9. Merck & Co., Inc.||11.4||421,623||$24,290||1.9%||A1||AA||$211.4|
|10. bluebird bio, Inc.||7.4||312,805||$23,076||1.8%||---||---||$6.5|
|11. Moderna, Inc.||9.9||382,388||$22,665||1.8%||---||---||$6.0|
|12. Maxar Technologies(2)||5.5||478,000||$21,577||1.7%||---||---||$0.5|
|13. New York University||11.7||201,284||$19,011||1.5%||Aa2||AA-||---|
|15. Pfizer Inc.||5.2||416,976||$17,754||1.4%||A1||AA-||223.3|
|16. Stripe, Inc.||7.8||295,333||$17,736||1.4%||---||---||---|
|17. athenahealth, Inc.(2)||12.5||409,710||$17,632||1.4%||---||---||5.6|
|18. Massachusetts Institute of Technology||5.7||257,626||$17,306||1.4%||Aaa||AAA||---|
|19. Amgen Inc.||4.3||407,369||$16,838||1.4%||Baa1||A-||119.3|
|20. United States Government||8.0||284,998||$16,384||1.3%||Aaa||AA+||---|
1 Based on aggregate annual revenue in effect as of December 31, 2019. Referto "Annual Rental Revenue" and "Investment-Grade or Publicly Traded Large Cap Tenants" in the "Definitions and Reconciliations" of this Supplemental Information for additional details on our methodology on annual rental revenue from unconsolidated real estate joint ventures and average daily market capitalizations.
2 Annual rental revenue from investment-grade or publicly traded large cap tenants includes two tenants, Maxar Technologies and athenahealth, Inc., located at properties acquired during 4Q19. Excluding these two tenants, our annual rental revenue from investment-grade or publicly traded large cap tenants within our top 20 tenants was 87%.
3 Includes a ground lease for land at 1455 and 1515 Third Street (two buildings aggregating 422,980 RSF) and a lease at 1655 and 1725 Third Street (two buildings aggregating 593,765 RSF) owned by our unconsolidated joint venture in which we have an ownership interest of 10%. Annual rental revenue is presented using 100% of the annual rental revenue of our consolidated properties and our share of annual rental revenue for our unconsolidated real estate joint ventures. Refer to footnote 1 for additional details. Excluding the ground lease, the weighted-average remaining lease term for our top 20 tenants was 8.9 years as of December 31, 2019.
Alexandria isn’t just an owner of lab space assets; they are also a prolific developer, and we believe the U.S. is going to need more lab space. Some of the lab-heavy markets have almost no vacancy. For instance, a recent CBRE report showed the Cambridge lab market with less than 3% vacancy in lab and rents approaching $100 per square foot. As of December 31, 2019, ARE had eleven development projects underway2 consisting of over two million square feet to be delivered, and these projects are exclusively in the Boston, Northern California, San Diego, NYC, and greater D.C. metro regions.
If you want exposure to lab space real estate and only want to buy one REIT stock, then ARE is the way to go. However, if you want to shop the field or see what else is out there, then there are a few other ways to get lab exposure, though none are as concentrated as ARE.
Let’s take a look at a few of the smaller players in lab space.
Healthpeak Properties (PEAK)
Healthpeak Properties (formerly known as HCP) is a healthcare REIT whose portfolio has about 30% of their assets dedicated to the life science space, with the balance mostly split between medical office and senior housing. Most of their life science assets can be found in the San Francisco area, but they also have exposure to Boston and San Diego along with some minimal exposure to secondary life science markets. PEAK remains active and intends to grow their life science business, as they acquired over $1B of life science assets in 2019 and currently have two life science development projects underway, one in Boston and one in San Francisco3.
Ventas, which we’ve written about before here, primarily owns senior housing assets, but about 8% of their portfolio by investment dollar is in assets they call “research & innovation.” These are largely through partnerships with major universities. Additionally, VTR has a $1.5B near-term development pipeline in these research & innovation assets and over half this amount is already in signed commitment. So, while it’s currently a smaller piece of Ventas’ overall portfolio, it is an important and growing area of business for them.
Kilroy Realty (KRC)
Kilroy is an owner, operator and developer of office and mixed-use assets on the West Coast. One thing to note right away is the markets that KRC is in; San Francisco, Seattle, and San Diego are all present, along with Los Angeles. While KRC typically caters to tech and creative offices, investors will still get some exposure to life science users, even if it is in more traditional office space. Furthermore, KRC has and is developing life science specific assets inclusive of lab space. They have demonstrated this in the San Diego market for decades, but more recently they have a marquee development project underway in South San Francisco named Kilroy Oyster Point. This project will be built in four phases and consists of eleven buildings totaling 2.6 million square feet of lab and office space. KRC will likely have in excess of $2B invested at Oyster Point when it is fully built out.
We believe that lab space, already a hot property type, will have stable demand during the current pandemic as we seek faster testing and a vaccination for COVID-19. This demand will likely increase after the pandemic as steps are taken to prevent future outbreaks. In addition, the search for cures for other medical ailments, diagnostic testing, invention of medical devices, and genetics sequencing also show no sign of slowing down, and much of this requires lab space. These all involve secular demand. While there may be natural cycles in business and economic growth, the desire to cure disease or expand the natural age expectancy of humans will never end. Lab space is a critical component of these desires.
Investors can find ARE, PEAK, and VTR in the Path Healthcare Block. Our Healthcare REIT Block invests in REITs that predominantly generate their revenue from healthcare-related properties and is designed for a primary objective of capital appreciation, with a secondary objective of current income. Download the Path app to learn more about this REIT Block and see if it might be a good fit for your portfolio.
1 Company presentation dated December 3, 2019 (https://www.are.com/fs/ARE2019InvestorDay.pdf)
2 Company earnings supplemental dated 4Q 2019 (https://www.are.com/fs/ARE2019InvestorDay.pdf)
3 Company presentation dated February 2020 (https://ir.healthpeak.com/investor-presentations)
Director of Public Securities
Geoff leads the construction and monitoring of the public real estate securities portfolios available in our Path by Origin app. Prior to Origin, Geoff spent the last 12+ years researching and investing in public REIT securities at both Duff & Phelps Investment Management Co. and J.P Morgan Asset Management.
Geoff Shaver and clients of Path by Origin, LLC own ARE, PEAK, VTR, and KRC. Neither Mr. Shaver nor Path have a business relationship with any company whose stock is mentioned in this article.
Path by Origin, LLC (“Path”) is an SEC registered investment adviser. Mr. Shaver is the Director of Public Securities of Path. The views expressed herein are subject to change, and no forecasts can be guaranteed. The comments provided are for educational purposes only and may not be relied upon as recommendations, investment advice or an indication of trading intent. In preparing this document, the author has relied upon and assumed, without independent verification, the accuracy and completeness of information available from public sources. The stocks mentioned in this article have been highlighted based on some reported news, quality or characteristic and do not necessarily represent all of the securities recommended for a particular portfolio. Path is not soliciting any action based on this communication. Investments involve risk, including the possible loss of principal and fluctuation of value. Past performance is not indicative of future results. Mr. Shaver and Path disclaim responsibility for updating any information herein. In addition, Mr. Shaver and Path disclaim responsibility for any third-party content.