In 2021, the life sciences sector had one of its best years on record. Already growing rapidly before the pandemic hit, the race to develop vaccines helped further bolster the niche sector, leading to a record number of IPOs formed last year. But 2022 has been different. The COVID-19 boost the industry benefited from has ended, and numbers are coming back down to Earth, looking more like they did pre-pandemic. Investment activity and venture capital funding have dropped significantly, and overall sales in the life sciences sector have cooled off. But while the numbers may look alarming, the industry has a lot of reasons to be optimistic.
A return to normal
Few sectors in commercial real estate have been performing like the life sciences industry has been performing over the last few years. Money has poured into the biotech sector from venture capital, major brokerage firms have been beefing up their life science divisions, and demand for space has gone through the roof. Last year, the amount of investment into the sector hit an all-time high, with volume reaching $18.4 billion, according to Newmark. But earlier this year, things started to change. Mid-year market reports showed that life science investment activity had fallen significantly. One of the largest publicly-traded life sciences REITs, Alexandria Real Estate Equities, saw its stock value fall more than 35 percent. And the number of IPOs formed in the industry, which hit a high in 2021 with 124, is on pace for only 30 to be created in 2022. “It’s been an odd year in some ways and a return to normal in others,” said Travis McCready, JLL’s Head of Life Sciences for North America.
The pandemic had a big impact on the life sciences sector in the U.S. It sent numbers soaring in several areas. The amount of capital being deployed in the industry, the number of IPOs being formed, and the number of federal research dollars being invested all contributed to the seller year that the industry had. With traditional asset classes like office, hotel, and retail hit hard by the health crisis, institutional capital shifted away from those core sectors and looked at niche segments like life sciences, data centers, and self-storage, areas where there was still upward growth. But that story is over. Based on the number of IPOs formed within life sciences, 2022 is on pace to be the worst IPO year for life sciences in a decade. “If you look back at every metric, we have returned to pre-COVID levels,” McCready said. However, a closer look at what’s behind the numbers shows it’s not all doom and gloom.
While it’s true that companies going public has nearly come to a stop and private capital investment in the sector this year has fallen 38 percent since last year, investment volume is still historically high and already above what was a record-high in 2020. Venture capital from high-profile companies has also continued to draw healthy amounts of capital. For example, four firms (Atlas Venture, Third Rock Ventures, 5AM Ventures and Andreessen Horowitz) have raised nearly $4 billion of life sciences–focused funds this year alone, and “the spigot is still open,” JLL wrote in a recent life sciences report. The major drop in IPO formation is a result of a period of overexuberance, when companies started with venture capital during last year’s boom may have formed too quickly, with not a lot of great data and just an idea. That led to a bursting IPO market, or as McCready called it, “a python swallowing a pig,” where the market is still digesting hundreds of companies that went public that are not producing great results. As a result, the IPO market cooled off significantly. Now, venture capital firms are retooling, and there’s been an uptick in investment in the earliest-stage companies and a return to focus on the fundamentals: strong science and good data.
In terms of supply and demand, major markets have had a dip in demand, in part because companies have less money to spend on expansion and due to the market correcting over the last few years and bringing more and more lab space online. Demand has dropped about 35 percent in the third quarter of 2022 compared to the same period last year, from about 21 million square feet to about 14 million square feet, according to McCready. The good news is rent prices have not dropped at all. In fact, direct asking rents across major markets are still up 14 percent year-over-year.
The life sciences segment is all about clusters. The three biggest markets, Boston/Cambridge, San Diego, and the San Francisco Bay Area, all command the highest rents and have the largest footprints of any market in the U.S. They are markets that have been steadily growing for years and building reputations in the industry. While there are a lot of emerging life sciences markets around the country, including Pittsburgh, Minneapolis-St. Paul, and Houston, there’s still a big divide between the top markets and the rest of the life science hubs. One of the biggest is cost. In the three biggest markets, as well as Raleigh/Durham and Philadelphia, the cost to build life science projects and rent space within them are incredibly expensive.
Asking rents average $90 per square foot in the top markets, while other markets average $40 per square foot, according to McCready. It’s a huge difference, but there’s an important reason why. The priciest markets are also the most efficient, where companies can more easily find venture capital, talent, can advance their program and, get into clinical trials, and get their product into manufacturing. In 2015, a JLL study looking at Boston’s life sciences hub found that, on average, companies in the greater Boston area went to IPO two-and-a-half years faster than anywhere else in the U.S. “Companies are constantly evaluating this tension between do you pay more and go to market faster, or pay less and go to market less efficiently,” McCready said. “That’s why those top three continue to overperform and be desirable.”
Among other things, the biggest markets have a dense concentration of expertise and more access to life sciences space. It makes it hard for other markets to compete, but efforts are being made to turn that around. JLL is seeing second and third-tier markets continuing to improve on the fundamentals that make a life sciences hub attractive for tenants and investors. Good quality of life, a growing amount of life sciences real estate, and universities becoming more active within the hubs are leading to venture capital firms starting to look around markets outside the big three. “Non-traditional risk capital is starting to enter the picture, like family office money and others,” McCready said. “It’s starting to become really attractive at a smaller scale.”
Experts expect the life sciences segment to still be impacted by the same headwinds that are affecting real estate markets now, and that will continue to temper demand for space into 2023. The industry will continue to keep a close eye on the important metric of IPO formation, which many anticipate could turn around next year, but it’s hard to predict. Construction is also expected to pick up next year after some developments were put on hold. Therapies that continue to be strong include cell and gene therapy, particularly CRISPR and CAR T-cell, which will continue to grow, and as the science improves, more companies will follow. Additionally, oncology is an area that has attracted the highest number of companies and FDA approvals, while infectious diseases have seen somewhat of a rebirth since the names COVID-19 and Monkeypox entered the lexicon.
The pandemic led to a boom in investment and funding for the life sciences that has since tapered off since last year’s high but is still on a steady pace, despite some worries earlier this year about the state of the sector. Emerging markets around the country are starting to generate more interest and could eventually rival the big three life sciences hubs of Boston, San Diego, and San Francisco that dominate the industry. While 2023 is expected to be a more muted year for life sciences as economic headwinds continue to impact markets, there is a lot of reason to continue to be optimistic about life science real estate. Continued scientific advances and research will help power the growth and expansion of the sector for the foreseeable future, so despite the strange year it’s been for the sector, all signs are pointing to more normal times ahead.