The supply and demand dynamics of the lab market 2015 created a crazy year. We started the year with almost 1,000,000 square feet of lab space on the market and saw that cut in half by December. The market demand was driven by a variety of factors including some new partnerships, lots of funding, and the need to scale up manufacturing operations to move through clinical trials.
The challenge this market faces is that the supply of existing, 2nd generation lab space has been depleted to the point where there are very few options available for lab users in their respective size ranges or functionalities.
Starting off 2016, we are now at a 6.6% vacancy rate with several transactions poised to close in the 1st quarter. That doesn’t tell the whole story though…the existing supply has 2 big blocks of space at 14200 Shady Grove Road (GSK) and 1201 Clopper Road (QIAGEN). Those two blocks make up over 4% of the market and are not easily divisible. Factor in the upcoming transactions and the functional obsolescence of a few blocks in the market, and the “real vacancy rate” quickly drops to 1%. Factor in that in any given year the market demand is approximately 80,000 to 150,000 of new space, it seems likely certain in 2016 there will be surplus unmet demand in the region’s lab market.
We have reached a point in the market that new lab space needs to be built, which presents both a challenge and potentially an opportunity. The challenge is that lab space is expensive to build and has some specific requirements with regard to functionality…you can’t just build it in any building. Most landlords budget $40 to $60 per square foot to contribute to tenant improvements, but the average, general wet lab costs between $120 and $160 per square foot to build. Landlords that will provide this level of tenant improvements are few and far between. So the big question is how do we create new lab space to meet the demand?
Therein lies the opportunity–needed financing for the tenant improvements can open new opportunities for real estate investors to repurpose languishing flex, industrial, and in some cases office buildings to fulfil the demand. This financing will come with a premium rental rate and potentially faster lease up time than if the property is marketed as a commodity office, flex, or industrial space. Economic development may play a role by helping to close the gap with a contribution of public money or some sort of risk mitigation on the needed tenant improvements for conversions.
Looking to the future, we see very little if any new supply coming available on the market. Also, we see rental rates growing from the mid to high $20 range and will likely see the market break the $30, NNN mark in the near-term horizon.