March 31, 2002

Lab Space Is Bright Spot in Dim Cambridge Market

By SUSAN DIESENHOUSE

CAMBRIDGE, Mass.

Over the last 18 months, as Internet and telecommunications tenants have evaporated, the vacancy rate in this small, high-priced office market has been soaring. But as vacancies in office buildings increased, the market for laboratories — the most expensive space of all — tightened. As a result, several new commercial projects are being repositioned from offices, telecommunications facilities or industrial sites to laboratories for life science companies engaged in biotechnological and biopharmaceutical research, product development and manufacture.

At the end of 2001, the overall vacancy rate for the 17.5 million square feet of commercial space here was 18.5 percent, compared with 1.2 percent at the end of 1999. In East Cambridge, a neighborhood fronting on the Charles River that is flush with new development, vacancies have reached 21 percent.

But for the 7.3 million square feet of existing biotechnology space, which is about 70 percent laboratories and 30 percent offices, the citywide vacancy rate is 0.25 percent as of the end of last year. When 11 commercial conversion projects (shell buildings that landlords are marketing or converting for laboratories), are included, the rate rises to 8.3 percent, according to Joseph P. Flaherty, senior vice president at Meredith & Grew Inc./Oncor, a full service real estate firm.

In 2000, when the first signs of weakness appeared in the office market, some property owners who were designing offices scrapped those plans to build laboratories instead. The relative demand was so strong that in one case last year plans to build a rental apartment building — in a city with a chronic housing shortage — were replaced by blueprints for a more costly lab.

Now, other owners who find themselves with empty telecommunications, industrial or office building shells are trying to convert them into laboratories.

At University Park, a mixed-use project near the Massachusetts Institute of Technology that is to have 1.6 million square feet of commercial space and 420 units of housing when completed, two buildings now under construction that had been planned as offices were redesigned in 2000 for biotechnology tenants, according to Peter Calkins, senior vice president of development for Forest City Enterprises, the project's developer. It owns the buildings at University Park, and M.I.T. owns the 27 acres of land.

The two buildings that became labs have 345,000 square feet of space and were converted to respond to space demands of expanding University Park biotechnology tenants. Another building at University Park was going to be the 235-apartment rental building, but last year Forest City decided to put a 241,000-square-foot biotechnology laboratory there.

M.I.T. currently owns 10 million square feet of buildings for academic use, 3 million square feet of commercial property and the land at University Park. A year ago, the university purchased Technology Square, a complex that has 872,000 square feet in six buildings, of which 254,000 square feet is vacant.

Of the vacant space, only 36,000 square feet are laboratories, which M.I.T. may use itself. If not, "whatever lab space we bring to market we can lease," said Joseph T. McGuire Jr., M.I.T.'s director of real estate.

A significant portion of the empty space at Technology Square involves a single building. Completed last fall, it had been 90 percent preleased to the Internet company Akamai Technologies, which never occupied its 114,000 square feet of space. Instead, last month, Akamai paid M.I.T. $15 million to dissolve the lease.

In total, 11 Cambridge buildings have recently been or soon may be repositioned for use by life science tenants: the three at University Park, one at Technology Square, four in East Cambridge (two owned by Lyme Properties, one by the Beal Companies and one by Laverty & Lohnes L.L.C.), a former candy factory near M.I.T. (owned by DSF Advisers) and two on Memorial Drive, which runs along the river (owned by Alexandria Real Estate Equities Inc., a biotechnology real estate investment trust).

These property owners' preference for biotechnology is simply explained: demand is strong and rents are high.

"Biotechnology is expanding, so the demand is there," said Mr. Calkins of Forest City. "With rising construction costs, the economics for offices isn't that great, but the return on investment for biotech is better, and they're always 100 percent preleased."

Current rents for labs are clearly more attractive. Offices here are now leasing for $25 to $40 a square foot annually, compared with $60 for labs. But the property owner who invests in developing laboratories must be prepared to make a big investment.

To construct the shell of an office building here costs about $125 a square foot. For the landlord to fit it out for office tenants costs about another $25 a square foot.

The shell for a laboratory costs about $200 a square foot. The landlord must then invest another $75 a square foot to build out the space for a biotechnology tenant. The tenant will then invest an additional $150 to $300 a square foot to equip the space, said David L. Pergola, executive vice president of Meredith & Grew Inc./Oncor.

To convert an office building shell to a building that could serve the needs of life science tenants — who require higher ceilings, sturdier floors and more intensive climate control, ventilation and electrical power — calls for an investment of an additional $75 to $100 a square foot, Mr. Pergola estimated.

"Basically the major Cambridge developers — M.I.T., the Beal Companies, the Lyme Company — are attempting to recapture general purpose buildings for biotech use," he said. "While demand for offices has diminished, biotech is expanding, fueled by an increase in venture capital funding, the drive by pharmaceutical firms to develop new products and substantial National Institute of Health funds funneled to Massachusetts."

Of approximately 200 biotechnology companies in New England, about 85 percent, with 20,000 workers, are in Cambridge and Boston.

In the six-state region as a whole, perhaps 50 of the biotechnology companies are publicly traded. As a group, from June 2000 to June 2001, the revenues of the publicly traded companies totaled $3.6 billion, up 50 percent from a year earlier. Their losses that year were $1 billion, up 25 percent from the previous year, said Stephen Buckley, New England director of the life science practice for Ernst & Young, the accounting and consulting firm.

Much of the space designated for conversion in Cambridge has not been leased yet, but brokers estimate that it will be absorbed in 9 to 12 months compared with an estimated 24 months to fill all the vacant office space.

However, they caution against considering biotech tenants to be the cure for all that ails the office market. "Biotech isn't the savior of the office market," said Gregory P. Lucas, senior managing director at Insignia/ESG Inc. "Cambridge has always been the East Coast center for the biotech industry. But, for the past decade or so, its growth here as an industry has been very steady and will continue to be so."

Furthermore, the investment in biotech space is so high that it is appropriate only for investors with deep pockets who plan to hold the property for a long time.

In addition, few properties designed for office use can be converted into biotech laboratories. Mr. Maguire at M.I.T. said, "Most office buildings can't be converted." Biotech laboratories require 30 watts of electrical power per square foot compared with 15 watts per square foot for offices; they also need floors that can hold more weight, and air control systems that recirculate 100 percent of the air versus 20 percent recirculated in offices. With more equipment in the building, floor to ceiling heights need to be higher and the penthouse that contains mechanical systems is larger.

The biotechnology sector may help bolster the Cambridge market until a resurgent economy revives the office market. But, over time, it is likely that the Cambridge commercial property market will continue to experience drastic swings in vacancies and rental rates. As the home of high-powered academic institutions, Cambridge is a center of innovation.

"We deal with a lot of new, technology oriented industries that rely on venture capital funding," Mr. Maguire said. "As some companies move from research to product development, they leave for less expensive locations; others, like the dot-coms and telecom, just tank."