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An overall marketplace review indicates that several key influencing factors continue to drive corporate real estate decisions in the biotech sector. These factors have resulted in different corporate decisions that seem to be a direct correlation to the size of the business. Furthermore, the overall approach to utilized real estate holdings within this specific industry mirrors the trends and decision making found in the location selection process itself. Simply stated, there is a difference in approach between embryonic early-stage companies and mature late-stage organizations that are well-capitalized.

Segmenting the industry in the following manner reveals the differences in real estate approach as it relates to recent strategies and decisions:

• Early-stage companies/products: tend to be high on idea and technology promise, low on profit, generally privately held, or, if publicly traded, categorized as low (“small”) market capitalization value.

• Mid-stage companies/products: tend to be in late early- to mid-stage product development, product patents in place, beginning to show profit, publicly traded, categorized as middle (“mid”) market capitalization value.

• Late-stage companies/products: tend to be mature companies with multiple products and successful patents, profitable, and categorized as large market value capitalization.

The early-stage organizations continue to seek ways to have third-party entities — such as the landlord — provide the upfront, nonrecurring costs involved with building construction, tenant improvements, and ancillary expenses such as design fees and moving expenses. Also, they want increased flexibility, including termination rights, in the lease agreement — demands greater than those of the standard tenant. The mid- and late-stage organizations are driven by “product-to-market” time constraints, necessitating full control of both financing and real property. These organizations are continuing to choose to own their core operating assets (R&D and manufacturing facilities) and not become subservient to the real estate lending community.

After reviewing current real estate and location decisions being made within the industry, it appears that the best way to provide for location and space varies based on the size of the biotech company making the decision.

Location Drivers and Trends
The needs of biotech organizations change in direct proportion to their life-cycle maturity level, size, and capital value in the marketplace. At first, smaller cap companies are looking for quick access to ideas, venture capital, and short-term commitments. Communities with research-oriented universities — complete with ideas and talent — and access to venture capital financiers looking for creative ideas continue to serve as extremely powerful magnets to the early-stage organization. In most instances, the smaller startup biotech company will forgo the in-depth, lengthy analysis — utilized by more established companies — as a tradeoff to achieve quicker results. For example, certain states do not offer favorable tax programs such as credits for net operating losses (NOLs), but that fact alone has not stopped smaller biotech companies — surely facing an operating loss position — from starting or locating in those states. The smaller companies are making a conscious decision to worry about those issues at a point in the future. Therefore, the early-on losses expected and incurred by the typical startup biotech organization will not factor into future net corporate income taxes levied by those states — compared with the favorable treatment and credit offered by competing states.

In terms of location selection trends of the more mature large-cap companies, these biotech organizations have fallen in line with other industry groups as far as what is important in the decision criteria and where these organizations are choosing to invest. The traditional criteria — including overall business environment, operating costs, labor availability, travel convenience, quality of life, and available land — are considered and analyzed in the same manner. The speed in which these biotech projects are conducted and time frames of expected occupancy, however, are longer, and the need to design and create for very specialized needs are taken into account.

In terms of popular location destinations, both historically and currently, early-stage companies continue to be located close to research-oriented universities. Once products become successful and business growth follows, the mid- and large-cap companies utilize the more traditional methods for determining location. Among those criteria examined are the presence of similar industries and organizations. This is important to be able to tap into an existing labor pool with appropriate skill sets, and to assist in recruiting and relocating personnel. What several large-cap biotech organizations have mentioned, when asked, is that skilled professionals resist relocating (either by transfer or new position) if the new location does not have other employment opportunities — just in case the new job does work out. As a result, location clusters continue to occur through out the United States as well as globally.

Real Estate and Financing Drivers and Trends
Each real estate transaction must incorporate the preferences of the user, the desires of the landlord, and the influence and demands of the lender. Ultimately, the lender’s interests prevail. Because of the amount of specialized construction required in the biotech world, this dynamic continues to drive the financing and real estate decisions within the industry, more so than in other industries. Across the board, for all facility types — including administration, R&D, manufacturing, and distribution — the mid- and large-cap companies are taking equity positions in their utilized properties and controlling both the asset and the financing. The costs of specialized construction for biotech requirements are substantially higher than a typical construction project — tenant improvements alone typically fall in the range of $200–350 per square foot, equating to an incremental rent increase of $32–$64 per square foot per year. Therefore, the user does not want to sink unrecoverable improvements into the landlord’s asset. As a result, most U.S.-based biotech core operations are owned by the user.

Conversely, landlords are not willing to finance and build improvements that are so specialized that they would have limited use for other tenants. The typical landlord sees the biotech tenant improvements as a throwaway expense with a very limited reuse — causing the high costs to be amortized over a relatively short lifetime and reflecting enormous rental rates. Thus, in most cases, the landlord (and the landlord’s lender) insists that the tenant bear full responsibility for specialized improvements beyond the typical tenant improvement allowance.

For mid- and large-cap companies, a clear trend exists in the highest and best use strategy being pursued. Biotech organizations that wish to expand (quick product-to-market scenario) will first relocate administrative functions, which involve relatively low-cost tenant improvement facilities, to leased facilities — and preserve capital and owned space for the more expensive R&D and manufacturing properties. Additionally, a secondary trend still growing in the manufacturing sector, particularly in the late-stage companies, is the continuing interest to consolidate or offshore manufacturing for stabilized products — some of which may be coming off patent protection. This results in biotech manufacturing facilities being readily available for resale in virtually all markets across the United States — and in many instances, these facilities come complete with necessary FDA approvals, greatly contributing to the speed of implementation and commissioning.

In terms of preferred financing approaches, due to the special nature and limited reuse of the property improvements, biotech organizations continue to be very limited in their accounting approaches. Off-balance sheet financing — including synthetic and operating leases — is proving to be unacceptable. Additionally, most specialized (R&D and manufacturing) properties offered for sale are not recapturing their current book value for the corporate owner/user, resulting in material accounting adjustments and write-downs.

Small-cap companies, including startups and early-stage organizations, continue to focus on more creative ways to accommodate their facility needs. Theses approaches include shared space with research-driven educational institutions, incubator space provisions, and utilizing low-end construction in flex and manufacturing buildings. The idea of the “garage” giving birth to new ideas and companies still exists.

Lessons Learned
When one analyzes the current trends, several implications become increasingly clear for both corporate decision makers and economic development efforts. From the perspective of the corporate biotech user, it is apparent that differing strategies are being pursued depending upon the current life-cycle situation of the enterprise. In many cases, for the early-stage company, it appears to be more beneficial to seek the closeness of venture capital and the services that come with incubator-type facility arrangements. This approach will help the younger company preserve capital and provide for needed flexibility requirements. Mid- to large-cap companies are utilizing their own capital for the purchase and construction of their core operating facilities, including R&D and manufacturing. Those companies with excess production capacity — due to expiring patent rights or other reasons — are recognizing that the undepreciated investments in their specialized real property are legitimate “sunk” and unrecoverable costs. Generally, most companies that are selling their underutilized specialized facilities are accepting the book loss as a reality and spreading the unrecoverable investment across the cost structure of the specific product, as opposed to trying to recapture the investment through the real estate sale.

From an economic development outlook, many of the communities focusing on early-stage companies must continue to market themselves to a well-targeted audience and clearly understand the value to they are providing to the biotech community. However, the programs instituted to attract early-stage biotech companies will not be the programs that attract well-established, mature, large-cap companies. The enlightened economic development effort will provide both types of assistance programs and position their communities accordingly.