The acquisition and lease negotiation of laboratory and manufacturing facilities for life science companies is much different than for traditional corporate users of space. Securing the wrong type of facility, or failing to recognize the cost implications of various lease clauses, can have a significant economic impact on overall business operations for these companies. Consequently, it is imperative that life science companies understand the potential pitfalls and unique challenges they face when striving to create functional and cost-effective facilities to address their scientific needs.
Biopharmaceutical companies require highly specialized facilities to conduct their scientific activities, and many traditional buildings are not suitable and cannot be economically retrofitted to meet the intensive infrastructure needs that are required. A building that does not meet these specialized requirements may force a life science company to make compromises in its laboratory/manufacturing design that can significantly increase the upfront design and build-out costs, along with the ongoing life cycle utility and operating expenses throughout the holding period of the facility.
Life science companies should be diligent in their efforts to identify and focus in on properties that have the necessary basic building attributes to accommodate laboratory or manufacturing use. It is not uncommon for a typical lab user to require an average of 1,000 square feet of rented space for only 500 square feet of actual usable lab area. The additional 500 square feet is necessary to satisfy the associated lab support, core and circulation required. Given the enormous expense of facilities, the following are several general areas that should be studied when identifying potential buildings:
• The building must be capable of handling the required laboratory and associated support functions, such as the HVAC (chillers, air handlers and exhaust systems), water systems (RO, pharmaceutical grade, etc.), boilers, autoclaves, cold rooms, warm rooms, dark rooms, etc.
• The facility should have higher ceiling heights (minimum 16 feet) to accommodate the extensive mechanical/electrical systems, ducting, conduit, building chases, water/steam supply, exhausting for hoods and other lab support functions.
• Heavier roof and floor loading is necessary to accommodate specialized equipment.
• Exterior building pad space for back-up uninterrupted power generation and external tanks (oxygen, carbon-dioxide, liquid nitrogen, etc.) is also required.
• Flex/R&D building design bays lend themselves well for incremental growth of laboratory, manufacturing, packaging and storage space over time.
• Proper zoning for current and future anticipated use must be in place. For example, if an organization is planning to integrate a vivarium as part of the overall facility, then the permitted uses within the zoning must be carefully reviewed.
Improper structuring of the lease escalation clause can have a negative compounding effect on the overall rent expense. It is not uncommon for landlords to fund a large portion of a life science company’s tenant improvement allowance. In return, the landlord requires the monies to be paid back with an interest component (usually 8-12 percent per annum). The payback of the borrowed funds is then added into the overall base rent; it then becomes a component of the annual fixed rent escalation (usually 2-5 percent), which results in a significant compounding effect on the overall rent that the tenant is required to pay the landlord. This compounding effect represents an economic windfall to the landlord. An astute tenant will do his/her best to separate the “tenant improvement” portion out of the rent, which will result in a lower overall economic obligation over the term of the lease.
Careful Negotiation
Careful negotiation of the renewal option is required to save money. Laboratory build-outs will significantly exceed the allowance that a landlord will fund, requiring the life science tenant to contribute the additional dollars. This results in a significantly improved property to the landlord upon the tenant’s vacating the facility or at the end of the tenant’s lease term. The landlord will then be in a position to capitalize on this highly improved facility by commanding a “premium rent” based on the capital investment that has been made. Oftentimes life science tenants do not carefully negotiate their renewal options to reflect “fair market but net of the investment that they have personally funded,” resulting in renewal rents to them that reflect the overall improvements and additional investment that the tenant has actually made. Biopharmaceutical tenants need to carefully structure the renewal option language so they are not paying for their laboratory infrastructure investments again as part of the premium rent that the landlord can now command.
Follow-up on municipal incentives is necessary to collect on monies that may be owed to the life science company. Life science companies attract higher-paying jobs with substantial benefits that increase the tax base for a particular state. As a result, the life science industry has become a “targeted” industry for many states. These states have created lucrative financial and nonfinancial incentives to attract and retain biopharmaceutical companies.
Unfortunately, life science companies often expend considerable time and resources negotiating meaningful packages but then do not put the proper internal systems in place to actually receive the incentives. Since many incentives are based on the verifiable capital investment into the facility, as well as employee headcount and growth over time, the states require these companies to provide annual follow-up documentation in order to benefit from the incentives. This follow-up, however, does not always take place, and these companies relinquish their rights to the incentives. It is important that the proper procedures are put in place to guard against lost incentives.
Utilizing a knowledgeable and experienced real estate advisor can be beneficial to a life science company. Due to the unique needs of biopharmaceutical companies, many commercial real estate brokers are not properly equipped to understand the required building types and mission-critical lease terms that must be negotiated in order to ensure a functional and cost-effective real estate outcome. Life science companies must identify a real estate advisor who understands the specific real estate needs of the life science industry. A good real estate advisor will have a focused and fine-tuned approach to representing only the life science company’s interests – not the landlord’s interests – and have relationships with “best-in-class” consultants, such as laboratory construction experts, process engineering and validation professionals and others who will be part of the overall real estate acquisition process.
Operational control of the facility is a must for biopharmaceutical users. Unlike traditional tenants that occupy space, life science companies require daily operational control of their building and environment. They will require access to the roof, and they will need the ability to control every aspect of their environment without having to go to the landlord every time for required and time-consuming landlord approvals. Clauses in the lease that address the building (access to the mechanical/electrical rooms, etc.), along with restrictions on alterations (those requiring landlord approval), must be carefully negotiated to provide maximum flexibility to the tenant. Also, many leases have clauses that require tenants to pay the landlord costly review or oversight fees each and every time the tenant requires changes or modifications to its facilities. These fees can become a significant overhead expense to a life science company. However, they can often be negotiated out of the lease, resulting in reduced expense obligations for the tenant.
Expansion flexibility is key to preserving the financial investment made by the tenant. Many biopharmaceutical companies invest hundreds of dollars per square foot into laboratory/R&D space, and thousands of dollars per square foot in GMP pilot and manufacturing space. Given these significant capital investments, it is important for life science companies to structure the proper expansion flexibility into the lease to guard against the inability to expand over time.
If a life science tenant outgrows its mission-critical laboratory or manufacturing space, it may be forced to relocate into a larger facility. A relocation may then require the company to write off infrastructure investments that it has made in its current facility, and to relocate sensitive scientific experiments and transfer existing state-regulated licenses to the larger facility at a great expense. A relocation may also require the tenant to incur dual rent obligations as it builds out and commissions the newly expanded facility. A biopharmaceutical company can avoid this scenario by identifying a building that will allow for contiguous growth over time, and then carefully negotiate liberal expansion options and lease terms that would require a landlord to relocate an existing contiguous tenant into another area of the building or complex to allow the life science company to expand.
Life science companies face many unique challenges when identifying and securing functional and cost-effective facilities, and unlike other organizations that lease space, biopharmaceutical companies must be cognizant of the potential pitfalls within certain aspects of the real estate transaction. It should be noted that favorable concessions might be difficult to achieve; the success within each individual area of the negotiation is often highly dependent upon a biopharmaceutical company’s credit, particular facility use, existing market-driven dynamics during the time of the negotiation and sophistication in dealing with landlords, among other factors. However, developing a thoughtful strategy and securing proper professional guidance in the areas of particular risk will help biopharmaceutical companies secure functionally efficient facilities on more favorable economic terms.
