As investors’ demand for life sciences real estate grows at a rapid pace, lenders are actively seeking to lend in this space. A Goodwin partner spoke with Eric Juster, Vice President, Investments at Square Mile Capital, about the outlook of the propsci industry, potential risks facing lenders and how best to mitigate them.
What are the most important factors to consider when lending on life sciences real estate?
Eric: Location is always important, especially within the life sciences market. We consider what city you are in and whether the property is part of a life sciences hub. We also analyze population size and proximity to universities.
For example, in Boston, you're near Harvard and MIT, which is one of the reasons why Cambridge is ground zero for life sciences research and development. On the West Coast, you have great universities in areas where people want to work.
Life sciences is a very collaborative industry. Larger companies invest in smaller startups, and companies of all sizes are looking to work in the same building or the same vicinity as other companies.
So those are some of the main touchpoints and factors we evaluate on each deal.
What challenges does New York face in coaxing tenants away from more established life sciences hubs like San Diego, San Francisco and Boston?
Eric: As we move past COVID-19, the market in New York is at or above where it was pre-pandemic. New York has an excellent employment base, great universities and a vast hospital network. However, it is tougher for new development in New York versus other major markets and, as such, attracting the 500,000-square-foot banner pharmaceutical tenants has been more challenging.
Nevertheless, long-term, we’re bullish on New York as a life sciences destination rivaling other more established locations due to its dense concentration of hospitals and universities and the growing demand, VC and government funding for life sciences real estate.
We see a much more competitive landscape for lenders in the life sciences real estate space, and finding assets to lend on is tricky; where are you seeing opportunity and winning deals?
Eric: Redevelopment presents more opportunities right now. But when there is a more complicated business plan, such as redevelopment, it is crucial to partner with experienced developers able to identify and solve various deficiencies. You have to know what works and doesn't and what's been successfully leased in the past.
We have a network of consultants we can consult with on particular transactions, and this is an invaluable resource.
Another advantage is our relationship with USAA. They have an equity platform in life sciences in multiple markets, and understanding their analysis of an asset as a developer helps. For example, sometimes they will look at the specs of a building and say, "you're going to be fine here," or "this is a challenge, but here is how you can mitigate it." It is beneficial to have this perspective when analyzing potential debt investments. If they feel good about it through an equity lens, this provides us with a certain comfort level.
Have you noticed any other shifts in the industry that might be indicative of future trends? Anything to keep an eye on in the space?
Eric: In general, there are a lot of positives. There's more funding. You mentioned New York earlier, but there's more government funding occurring in many cities, particularly Washington, D.C.
One trend we cannot overlook is technology – the ability to share data and work with other companies and to be able to send data across the world in seconds for other people to analyze. And we haven't touched on artificial intelligence, which will have a tremendous impact on the life sciences industry. The pandemic has been an accelerant for the adoption of technology.
One potential negative is that, given the experimental and fast-moving nature of the life sciences industry, many ideas fail. Where there's a lot of funding in a sector such as there is now in life sciences, we tend to see more instances where companies receive funding but cannot execute their business plan.
There is a silver lining to this trend, however. Two or three companies may fail in a particular space, but there could be one company that started in the same building with 5,000 square feet and now needs 50,000 square feet. While there are some negatives, they are mitigated by more positives in the long term.
How are you structuring transactions to mitigate the risks inherent in life sciences real estate new construction and redevelopment?
Eric: You have to understand the market and the types of tenants in the space. As tenants get larger, they have more specific space requirements, while smaller startup/early-venture tenants need space period.
In addition, where you have experienced developers, we will fund them a portion of the loan to build out speculative space and then once leasing happens, we will fund what we call "good news" money for tenant improvements. It is a give and take; as a lender, you want to balance loan dollars advanced on speculative development versus amounts tied to expected cash flow from signed leases.