In April 2022, San Francisco’s Mission Bay neighborhood, known for its low lab vacancy rates, saw a notable real estate acquisition. DivcoWest secured the former headquarters of Old Navy, a 320,000-square-foot office space, at a premium exceeding $1,100 per square foot. Located near prominent institutions such as the University of California San Francisco and Kaiser Permanente, the building at 550 Terry Francois was on the brink of a transformation. A planned $30 million overhaul, supported by city permits, was set to convert the office into a state-of-the-art life sciences facility.
However, the investment landscape has since shifted. Venture capitalists, once captivated by the potential of life sciences amid the pandemic, have turned their attention towards the burgeoning field of artificial intelligence (AI). This pivot has left developers and owners of newly converted life science properties facing uncertainty. Despite DivcoWest’s enhancements to the building’s infrastructure, including a modern lobby and collaborative outdoor spaces, a full conversion to a lab has been paused. The property is now being marketed to both life science and tech tenants by CBRE representatives.
The strategic hesitation could prove advantageous. Speculations arose in April that a high-profile potential tenant, OpenAI, which already leases nearby properties, might be interested in the space. Such market dynamics illustrate the chase for the next innovation while commercial owners scramble to adapt.
Not all developers can afford the flexibility demonstrated by DivcoWest. The extensive investments needed to cater to life sciences, which may not be required by AI companies, put smaller players at risk, according to William O’Daly of Avison Young. He suggests those unable to renegotiate financial terms could face property losses.
The Bay Area, second only to Boston, has been a stronghold for life science companies thanks to its prestigious universities and medical centers. The onset of Covid-19 propelled investor interest, with funding for regional life sciences companies soaring from $8.9 billion in 2019 to a peak of $20 billion in 2021. Office owners, aware of the less than 5% lab space vacancy and the need for life sciences workers to operate on-site, capitalized on this demand. The cost of converting properties into lab spaces was steep, with estimates from Kyle Hipple of Colliers indicating an additional $400 to $500 per square foot on top of acquisition costs.
Landlords anticipated high returns on their investments, given the scarcity of lab space and the clustering tendency of life sciences companies, which drove further development of specialized campuses. However, the gamble on life sciences spaces always carried inherent risks due to the high costs of development and the uncertain outcomes of research and development endeavors.
As investor interest in life sciences waned, AI emerged as the new investment darling. Venture funding for Bay Area AI companies reached $10.6 billion over 15 months beginning in early 2023, according to Avison Young. With more than 2 million square feet leased in both San Francisco and Silicon Valley, these markets became hotspots for AI. OpenAI’s CEO, Sam Altman, has even declared the end of the remote work experiment, emphasizing the importance of in-office collaboration.
Following suit, 90% of AI companies are now opting for in-office work, with venture capital backers often enforcing this preference. This shift poses a question for life sciences developers: Can their spaces, designed for specific research needs, accommodate AI companies that generally require traditional office setups?
Colin Yasukochi of CBRE’s Tech Insights Center points out that while some AI companies may need R&D space, most are looking for standard offices, rendering the specialized infrastructure of life sciences developments potentially redundant and cost-ineffective.
The real estate market’s future now hinges on whether AI can fill the gap left by life sciences. With an oversupply of life sciences spaces anticipated, the Peninsula region might be most affected. Yet, the Bay Area’s proximity to innovation hubs suggests a potential resurgence for life sciences real estate. Tim Hogan of Avison Young remains optimistic about the market’s long-term viability, which is bolstered by new company formations and acquisitions by large pharmaceutical firms.
Ultimately, the ability to weather the market’s fluctuations will determine the fate of life sciences property owners. Those capable of enduring the downturn may emerge successfully, while those who cannot must seek alternative strategies. As for whether venture capitalists will abandon AI as swiftly as they did life sciences, industry professionals can only speculate. According to Kyle Hipple, the allure of new technology will continue to drive investment decisions, rewarding those who place their bets wisely.
