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Innovators Face Shortage of Real Estate for Hatching New Ideas

blog 12-10-2019

By David Klein

The life sciences industry relies on a constant flow of innovation to power its progress to commercialize its discoveries for consumer use. But many budding entrepreneurs leading these discoveries need specialized environments to conduct their experiments, build management teams, collaborate with colleagues and cohorts, and have ready access to supporting services and resources.

Enter the incubator: a highly specialized facility that offers life sciences entrepreneurs and their fledgling companies a working space and resources to advance their ideas and dreams. It’s similar to what coworking providers bring to traditional office buildings but in a more technical way. While incubators are the ideal innovation portal for the life sciences industry, there simply is not enough lab-ready real estate to support the exploding growth of scientific innovation.

Supply and Demand

During the last three years, life sciences funding in the San Francisco Bay Area alone has completed more than 300 early-stage and seed-round deals totaling over $9 billion. To translate this to square footage, we’ll use a common benchmark of $225,000 per employee for a two-year growth runway and a lab/office average of 300 square feet per employee. That equates to demand for nearly 6 million square feet of real estate for startups.

In the San Francisco Bay Area, there are 24 life sciences incubators totaling approximately 730,000 square feet of space. These spaces range from a simple 3-foot wide workbench, called a “kneehole,” to fully outfitted suites combining labs and offices. Monthly rents range from $3 to $11 per square foot on a full-service basis; the lower end of the rent range for unpolished spaces with fewer amenities, and the higher end for global-standard, institutional-quality space. Lease terms tend to be short, with month-to-month to one-year terms in prevalence.

The most common elements have the landlord providing common areas, chemistry or biology labs, culture, virus and bacteria rooms, bioassay areas, labware, chemical storage, refrigeration, cleaning, all essential services, utilities and access to equipment for experiments. The more modern incubators also include specialized HVAC, back-up emergency generators, conference rooms, shower/locker rooms, extensive kitchen facilities and outdoor areas.

The Incubator Submarket

The life sciences incubator is of recent origin. Recognizing that startups were a source for new business opportunities, Johnson & Johnson began the life sciences incubator market with its first JLABS concept in San Diego in 2012. Many other life sciences companies have followed Johnson & Johnson’s lead, including Novartis AG’s Biome, Bayer’s Colaborator, Illumina, Amgen, and the recently opened Eli Lilly’s Lilly Gateway Labs in South San Francisco, all of which have a “captive” incubator program.

Incubators are also ripe for established life sciences companies to acquire young companies with promising products and services. And incubators have proven to be fertile hunting ground indeed: Recently, Roche Molecular Systems, a subsidiary of pharmaceutical giant Roche, acquired three young companies out of San Jose bioCube – Ariosa Diagnostics, Geneweave and Genia Technologies – in transactions totaling $1.4 billion.

The Bay Area life sciences industry is one of the world’s most coveted places to conduct science, with three major universities and scores of global companies attracting the best scientists and technicians worldwide. As such, space has not kept up with demand, and there is currently a functional zero vacancy in the incubator submarket. However, the inventory of incubator space is set to increase about 50{ff66251fa959225ec0415bec498104472c710c05756e34120ff9c6ac4cef9161} in the next two years. Even with the projected supply growth, there is expected to be continued limited supply, and startups will remain on long waiting lists or in a mad scramble to lease available lab space.

The incubator submarket of the Bay Area is the most supply-constrained of any commercial real estate type. The space shortage is fundamentally due to land scarcity, NIMBY-based zoning constraints, entitlement delays, the highly specialized nature of the facilities, and the economic barrier of constructing a modern life-science incubator. Excluding land and build shell, an incubator fit-up in the Bay Area’s feverish construction-cost environment can exceed $400 per square foot.

Types of Incubators

Today, incubators fall into the following four main categories:

  • Accelerators, such as Y Combinator, condense two years of business development into a six-month program prior to mandatory graduation and often require an equity stake in their clients.
  • Agnostic incubators, such as San Jose bioCube, provide basic services and other features as needed in exchange only for rent and fees and have no set graduation timetable. Most notably, agnostic incubators take no equity in their clients.
  • University-sponsored incubators connect academic research to the private sector, such as University of California-led QB3.
  • Captive incubators are typically housed on the sponsor’s campus to acculturate their clients and require the sponsor company to have a first option on a client’s promising science developed there. Company-captive incubators are the most significant in terms of size and scale, with JLABS, the industry leader, operating 12 facilities globally.

Incubators may focus on one or more specific industry segments, such as medical device, oncology, cleantech, genomics or digital health, to name a few. However, the most sought-after (and expensive to rent) incubators in the Bay Area have two key amenities in common. First, they offer proximity to one of the three major sources of life sciences innovation: University of California – San Francisco, University of California – Berkeley and Stanford University. Second, they must provide the ability for a young company to grow in-place, from the single kneehole-workbench to fully outfitted suites, without having to incur the disruption of construction or an expensive relocation, either of which could contaminate on-going experiments.

Incubators support their young clients by providing valuable, established vendor relationships in a variety of fields, including human resources, banking, legal, accounting, insurance, environmental, health and safety, labware, design, construction, and biowaste. And, given the long hours of intensive work in the initial phase, the startup depends on the on-site incubator team to solve the myriad day-to-day logistics and tactical issues that beset startups, such that the incubator personnel become embedded in the client’s team.

Real Estate Strategy

Landlords will soon recognize that incubators can grow future tenants for their life sciences developments. We may even see a fifth incubator category, that of the developer-sponsored incubator. Alexandria Real Estate Equities is currently developing such a project in the Bay Area that will include an on-site incubator with available lab-ready spaces for expansion. For startups on a strong financial footing and growth track, this type of development offers the convenience of an incubator with ready-made contiguous growth space available under the same operating and lease structure.

Start-ups typically want to avoid the drain of human and financial capital needed to own and operate a brick-and-mortar facility, making them likely candidates for leasing as opposed to owning real estate. In a similar vein, incubator tenants are unlikely to move, due to expensive buildouts and the need to operate in a highly controlled, consistent and secure environment. That, taken together with dynamic and at times uncertain growth, guides a facility strategy towards shorter-term leases – from two to three years – in substantially built-out spaces with life-sciences-savvy landlords. As the startups grow, landlords can address their evolving space requirements.

The best incubator operators are sensitive to the needs of their clients that, by design, share common laboratories, kitchens, support areas and equipment. This produces a number of issues that need to be considered before leasing in an incubator, including competitive client programs, cultural fit, intellectual property protection, storage, waste disposal, restoration, site security and environmental needs.

This partnership allows startups to stay focused on innovation and science, while landlords can supply expansion space as needed and enjoy consistent occupancy and steady rent growth. In all, the synergy between life sciences entrepreneurs and facility operators grows bigger and stronger by the day and will continue to do so for the foreseeable future.

David Klein is a Senior Vice President in Transwestern’s San Francisco office, where he specializes in tenant advisory and landlord representation in the life sciences sector.

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