Mission Street CEO interviewed by IPE Real Assets for “In the UK, life sciences real estate is still playing catch-up”

30.08.2024

Mission Street CEO interviewed by IPE Real Assets for “In the UK, life sciences real estate is still playing catch-up”

Investors aiming for UK life sciences real estate must prepare for a distinct set of assumptions, writes Artem Korolev

There is no doubt that the trends shaping real estate investment in the UK are, at least in part, inspired by the US.

Take life sciences as a recent example.

The success of early-movers, such as Alexandria Real Estate Equities and Biomed Realty, has enticed capital to consider other opportunities overseas where investors could buy-in early and build critical mass in underserved R&D ecosystems, beginning with the Golden Triangle of Cambridge, Oxford and London.

But is it true that when the US sneezes, everyone else catches a cold?

While key innovation clusters in the US are experiencing a material slowdown in new development and oversaturation has dampened asset pricing from a fever pitch in 2022, our view is that – for several reasons – the fate of life sciences real estate in the UK will be guided, but not governed, by the US experience.

I say ‘guided’, because while the UK’s desire to rival the US through the creation of a global ‘science superpower’ implies a similar investment rationale, each side of the Atlantic has its own unique market idiosyncrasies that will dictate the pace at which the needs of R&D ecosystems are met.

In turn, investors hoping to introduce UK life sciences real estate into their portfolios and exploit its catch-up potential, must be prepared to apply a very different set of assumptions to – what is – an inherently complex asset class.

Consider the process of planning and permitting in the US and UK and its effect on supply.

In the US, a more flexible planning system and softer infrastructure constraints have operated to expand inventories, to the extent that the 38m sqft of new lab and R&D space under construction has outpaced a reversion of life sciences venture capital to pre-Covid levels.

That directly contrasts with the UK, where the challenges of construction in compact and highly constrained R&D locations have minimised the risk of overdevelopment.

Demand-side, the less mature capital markets funding European innovation has meant start-ups, scaleups and even established multinationals have needed to be more disciplined with capital.

In the UK, this prudence has had a direct knock-on effect on real estate decisions as expressed by prospective occupiers taking up smaller footprints, avoiding the subletting currently occurring in major US markets.

The above results in vastly different real estate fundamentals. In the UK, life sciences employees occupy 129 sq ft per person vs 328 sq ft per person in the US. In the Golden Triangle, vacancy is still sub-5% vs 12 to 16% in the top US markets.

Total UK construction pipeline is a fraction of the top 10 US cities. This creates a highly attractive property market as demand grows in response to recovery of venture capital and government support, and as big pharma seeks to replace its estimated 46 percent revenue loss due to upcoming patent expirations.

The nuances of investing and developing life sciences real estate in the UK should not dissuade institutional capital from introducing the asset class into their portfolios. The nascency of life sciences real estate in Oxford, Cambridge and London – despite being concentrated hubs combining world-class academia with commercially applied R&D – offers a compelling catch-up dividend.

And while the US experience of over-delivery is not an issue in the UK’s most productive R&D clusters, it does offer useful insights for investors in UK life sciences real estate looking forward.

In particular, where rental levels in prime locations such as Kendall Square in Boston have remained resilient in a ‘flight to quality’, investors and their development partners should examine how to replicate the characteristics that keep returns attractive and consistent.

Embryonic markets provide a degree of control over rents, but where there are ‘lemons’ mixed in with ‘plum’ assets, investors can easily fall on the wrong side of market segmentation.

An asset’s tenant base, location and integration with the wider ecosystem are critical factors beyond the quality of the built asset. Identifying ways to retain companies within the investor’s portfolio as their needs evolve as well as delivering flexible specifications that can accommodate diverse customers is critical to minimising void periods and leasing costs.

Similarly, from an occupier perspective, customers need proven real estate partners who understand their business models, accommodate their technical and operational needs and offer the scale of platform to grow into.

The key for any institutional investor is to have a degree of comfort that they have a capability that understands the granular. In the UK, local innovation ecosystems are born out of ancient historic centres of knowledge and commerce, with a very dominant academic core, overlaid by emerging commercial ecosystems.

Embracing what makes an R&D ecosystem successful, and offering a genuinely accretive addition to its built environment, will be the surest way to benefit from a structural mismatch between supply and demand that continues to define the advantages of investing in UK life sciences real estate.