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What Blackstone’s $3.45bn deal says about life science pricing

At 2.3m square feet, the research lab and office portfolio purchased from Brookfield is the largest to trade hands this year. But is it worth the price?

After orchestrating the biggest transaction of the year – a $14.6 billion recapitalization of its life science portfolio – Blackstone has closed 2020 by doubling down on its commitment to the property type.

The firm acquired a $3.45 billion portfolio from Brookfield last week, becoming the largest owner of life science real estate in the booming Cambridge, Massachusetts market. Combined with its BioMed platform, which was spun out into an open-end core-plus fund in October, Blackstone now has $20 billion of research lab and office assets globally, two-thirds of which are in the Boston area.

At $1,500 per square foot, the transaction closed for a higher-than-expected price after a competitive bidding process that one source familiar with the market described as a “feeding frenzy.” In October, Bloomberg reported that the 2.3 million-square-foot portfolio was expected to trade hands for around $3 billion. At $3.45 billion, the portfolio has a capitalization rate in the high 4s, someone familiar with the transaction told PERE.

“The price seemed frothy, but on the other hand, Blackstone is building a business, they’ve raised billions of dollars and I don’t think they were going to be left behind,” Ronald Dickerman, president and founder of New York-based manager Madison International Realty, said.

Nadeem Meghji, Blackstone’s head of real estate Americas, said the trends in the life science sector – rising demand for properties catering to life science and the influx of capital flowing into the space – helped to justify the price paid by the core-plus Blackstone Property Partners Life Sciences fund.

Meghji: Unique insights give Blackstone a market edge

“We’re seeing increased interest in the sector amongst institutions,” said Nadeem Meghji, head of Americas real estate for Blackstone. “There’s a recognition that life sciences office space benefits from really strong demand tailwinds, and so, in a world where there are fewer sectors that are producing outsized growth, this sector is gaining more traction, receiving more attention.”

Rising tide

From the start of the year into early November, $10 billion of life science transactions were executed globally, according to the data firm Real Capital Analytics, accounting for 1.9 percent of the total investment in income-producing real estate. Through all of last year, $14 billion of transactions closed, accounting for 1.4 percent of the market.

The final month of 2020 has seen several large transactions take place, mostly in and around Boston. Three deals alone – Brookfield’s sale to Blackstone; a $720 million portfolio sale by Harrison Street, Bullfinch Companies and National Real Estate Advisors to Healthpeak Properties REIT; and a $151 million sale by The Carlyle Group and King Street Properties to Oxford Properties – push the year’s total beyond that of 2019.

“Life science is the darling of the commercial real estate business now and the reason is because it’s extremely undersupplied,” Dickerman said. “And just as September 11 was to cybersecurity, covid is to biotech and lab research,” with pharmaceutical companies taking center stage in the race to develop tests, treatments and, ultimately, vaccines for covid-19.

The strength of life science real estate goes beyond the needs of the pandemic, said Dickerman, whose company recently committed $200 million to an upstart firm in the space. “When you’re working on lab experiments, you can’t work from home,” he said.

Blackstone’s acquisition was the largest of the year in life science real estate, both by total volume and price per square foot. The next closest was Chicago-based REIT Ventas’s purchase of a three-property portfolio in South San Francisco from Bain Capital and the investment firm Phase 3 Real Estate Partners for a little more than $1 billion, or $1,200 per square foot.

But Blackstone’s price was comparable to other recent prominent sales in Cambridge. In fact, two transactions in the city in 2019 were more expensive on a per-square-foot basis, according to the brokerage Cushman & Wakefield; Ventas paid $1,700 a square foot for a 78,000-square-foot lab building while Harrison Street and Bullfinch paid $1,600 for a three-property complex. Those had cap rates of 4.5 percent and 4.3 percent, respectively.

A unique opportunity

For months, interested parties have monitored Brookfield’s life science portfolio, PERE understands, with the expectation that its sale would serve as a bellwether for a sector that has seen its standing with institutional capital rise dramatically amid the pandemic. Meghji, however, noted that the deal also reflects the unique characteristics of the Cambridge market and the portfolio itself.

Acquired in 2018 as part of Brookfield’s takeover of Forest City Realty Trust, the portfolio has 90 percent of its properties in East Cambridge, next to the Massachusetts Institute of Technology campus. Dickerman said it is likely the largest contiguous portfolio of life science real estate ever sold.

East Cambridge has the highest average asking rent for research space in North America at $97.97 per square foot net of taxes, insurance and maintenance charges, according to Cushman & Wakefield’s 2020 life science report. One Massachusetts-based investor that has acquired 400,000 square feet of life science space in the past two years said the Kendall Square district, near MIT and just across the river from Massachusetts General Hospital, has rents upwards of $120 per square foot. And, with the Brookfield portfolio alone comprising nearly a third of the square footage in the Cambridge market, Blackstone will have significant pricing power.

Construction costs for speculative life science space in and around Boston can range from $200 to upwards of $1,000 per square foot, the Massachusetts investor said, adding that several prominent firms have committed that kind of capital to convert traditional office buildings. “Real estate pricing is founded on the rents people are paying and the reality is these companies can afford to pay for world class space,” he said. “They’re paying for extensive HVAC, mechanical, electrical and plumbing infrastructure to conduct research. This is not just generic office space; this is a tangible product that an end user requires, and they need it to be best in class. So, while there is a lot of capital chasing it, we’re seeing cap rates compress a bit, but not dramatically.”

Meghji said Blackstone came into the transaction with a strong understanding of rent growth potential not only from its existing real estate platform, but also from its Blackstone Life Sciences arm, which invests directly into pharmaceutical, biotech and medical technology companies. “We believe we have unique insights and an information advantage that enables us to capitalize on these types of acquisition and development opportunities,” he said. “We also have scale capital and perpetual capital, which is a really significant advantage in these types of situations.”

Funding the future

Funding: on the rise for life science research

In the past, life science-based strategies have been a hard sell for real estate owners because of the cost of outfitting the properties and the risks associated with the tenants, PERE understands. Upstart firms in this space typically burn through cash in hopes of developing a paradigm-shifting drug or treatment regime. With no revenue coming in, their funding was liable to dry up overnight.

While the life science sector has attracted increased investor awareness and demonstrated its outsized resilience compared to traditional office, retail and hospitality, it is the capital markets support – which has increased steadily in recent years – that has won over real estate investors.

Through the second quarter of this year, $17.8 billion of venture capital had been raised on a rolling four-quarter basis for life sciences strategies, according to the brokerage CBRE. Similarly, federal funding for medical research from the US National Institutes of Health rose 6.7 percent annually from 2015 to 2019, nearing $40 billion last year. And finally, life sciences firms saw unprecedented support in the public markets this year, raising $6.7 billion between 37 initial public offerings as of mid-August, according to the website Crunchbase. Through all of 2019, life sciences firms raised $5 billion across 51 IPOs.

Much of this funding can be attributed to research breakthroughs in the field of genetics that have opened the door to more specialized diagnostic tests and therapeutics. But Michael Gershenson, a managing director at Carlyle, said the real demand driver is an aging US population. With the number of people age 65 or older expected to grow by 75 percent over the next four decades, the amount spent on medical expenses is expected to balloon in unison. Investing in drug research and development space presents an opportunity to capture some of the spending.

Carlyle has made 11 life science investments since 2013. In addition to a more secure capital market backing the sector, Gershenson said the growth in key markets has bolstered the firm’s confidence in research and development real estate.

“If you have a best-in-class asset in a market that has shown a depth of demand for life science company creation, such as Boston, San Francisco or San Diego, even if your tenant has to move, that space is reusable and re-leasable to another tenant that is likely to come along given the demand in those markets,” he said.

Meghji said Blackstone has pursued a similar strategy. After it acquired BioMed Realty Trust in 2016, it sold off all assets that were not in Boston/Cambridge, the San Francisco Bay Area, San Diego, Seattle or Cambridge, UK. As more investors and managers clamor for exposure to the sector, he said his firm plans to stick to that strategy for its Blackstone Property Partners Life Science platform.

“There is more capital heading into the sector, and one would expect to see more competition in this space over time,” Meghji said. “That’s why it’s really important to have a differentiated approach, a strong operating platform, to have the insights and information and to focus in on the best markets and the right pool of capital. All of those things are important in a world that’s competitive.”