In the last few years, and very much following in the footsteps of the US, the UK's life sciences sector has grown exponentially. This growth has been accelerated by Governmental support for the scientific community in the wake of Brexit, as well as the increased spotlight on life sciences and pharma following the COVID-19 pandemic. From a real estate perspective, recent research from Jones Lang LaSalle has estimated that there is up to £15bn of capital which has been allocated by funds and various other real estate investors for the sector, of which only approximately 10% has been deployed to date. Investors are attracted from both the UK and internationally into the UK's "Golden Triangle" of London, Oxford and Cambridge. But what are the key requirements for the legal documentation that are specific to this asset class?
Start-up and Early-Stage – v Mid-Stage and Scale Up
In order to answer this question, we first need to consider that there are two distinct phases of development for a life sciences occupier – firstly, there is start-up, or early stage, and secondly, there is mid-stage, or scale-up. Typically, a start-up / early stage occupier is not going to have the appetite, or the capital, to invest in a long-term lease, or other long-term occupational arrangement. In fact, a start-up / early stage occupier will very much want (and expect) to partner with a real estate investor who can provide ready-to-use laboratory and office space, often via an incubator facility, providing access to the latest technologies, and allowing proximity to eminent scientists and experts in technology. Often, in these incubator facilities (such as those provided by Imperial College Thinkspace), there is day-to-day support provided by a technology commercialisation partner, often affiliated to the landlord. Incubator laboratories need to be well-equipped and versatile, and offices / write-up suites will often encompass hot-desking, flexible offices, meeting rooms, business support services and training. By contrast, at the mid-stage / scale up end of the market, occupiers will likely look for a longer term solution to their laboratory and office space needs, and may be prepared to invest more capital upfront on fit-out costs and ensuring appropriate longer-term service standards.
Start-up and Early-Stage – Flexibility is Key
Much like the space itself, the occupational terms for start-up / early stage occupiers need to be flexible, with short-term and short-notice occupancy, and instant access to the most innovative laboratory equipment, a business imperative. Therefore, life sciences investors for this phase of the market cannot simply passively collect rent, in the way that a landlord might do for a longer-term occupier under a lease with an upward-only rent review. The investor will need to provide attractive, collaborative, working solutions to a larger number of occupiers. They, and in particular their lenders, will need to be comfortable with a business plan which envisages occupancy on an ad-hoc basis, albeit that the occupier will need to pay a premium for that state-of-the-art laboratory equipment, access to commercialisation partners, and support.
Mid-Stage and Scale-Up – A more permanent occupancy approach
In contrast, for the mid-stage / scale up end of the market, where occupiers will not be in need of, and will not wish to pay for, the flexibility, support and innovation described by the incubator solution set down above, a longer term leasing solution will likely be required. So, what are the most important terms to consider in respect of such leases? Seven options are described below:
- Lease Lengths – Unlike other asset classes, where lease lengths are shortening, for life sciences it is not uncommon to find 15/20 year lease terms. This is due to the needs of occupiers to be in a particular geographic location, which is frequently driven by the availability of a talent pool of staff, or the importance of being in close proximity to universities / seats of learning. Coupled with the significant capital outlay made by the tenant in fitting out the premises to be suitable for its needs, the result is that longer term leases tend to be desirable. Provided the covenant strength of the tenant is attractive, this will in turn be attractive to investors and their lenders, which goes someway to explaining the increased investor focus in the life sciences sector.
- Lease Renewals – For the same reason as a long-lease length is attractive to an occupier in this sector (see immediately above), so too is a statutory right-of-lease renewal.
- Services and Service Standards – The availability of power, data and other utilities will be business critical for the occupier. Therefore, landlords will need to provide exemplary services and service standards. Whilst not prevalent in the market at this point, there is a move towards penalties for landlords who fail to provide 24 hours access to utilities at specified service standards, due to the significant losses that may be faced by an occupier as a result of utilities failures. In addition, it is common to see tenants taking responsibility for the repair and maintenance of landlord's plant and equipment, in order to have the peace of mind that it will always be fit for their business purposes. If a landlord is to permit this in a multi-tenanted building, careful consideration needs to be given where that plant and equipment may be communal – whilst a tenant may be prepared to take responsibility for plant and equipment which services their own demise, they will almost certainly be less willing to support another occupier's requirements.
- Sharing Occupation – The needs of both parties here need to be carefully balanced – the landlord will want to keep their pre-approved and vetted tenant entity on the hook for the lease obligations, and a typical lease will restrict assignment and underletting, with Landlord's prior approval being required in both cases. There is no difference here in the life sciences world, with market participants (and their lenders) currently being unwilling to offer little leeway here. However, restricting occupation sharing to group companies only, as is seen with so many asset classes, is not popular in the life sciences space. Whilst the mid-stage / scale-up phase of the market is typically no longer in need of the support and collaboration provided by an incubator / co-working environment, sharing innovative ideas and research is crucial to the scientific community, and permitting shared occupation with a wider group of entities than affiliated corporate vehicles is commonly seen. The landlord and their lenders will be keen to ensure that no legal relationship of landlord and tenant is created by such sharing arrangements, but in practice this should be entirely avoidable.
- Mortgagee Protection Provisions – Whilst not often seen in rack rent leases, mortgagee protection provisions in leases of life sciences space are common. Lenders to the life sciences business will not wish to risk a lease being forfeited, or indeed a landlord exercising commercial rent arrears recovery in respect of valuable laboratory equipment, without having an opportunity to step in to the tenant's shoes / to otherwise cure the lease breaches. This will also be attractive to the Landlord's lenders – as it helps preserve the rental income stream which is no doubt servicing the Landlord's debt obligations.
- Landlord Access – Due to the nature of the premises and the operations of a life sciences occupier, the typical lease clause which allows a landlord a right of access to the demise is unlikely to be appropriate. Certain areas of the demise are likely only suitable for access by highly skilled operatives wearing appropriate protective equipment.
- Confidentiality – Many members of the scientific community are sensitive around advertising their business or their operations from a particular location. This needs to be balanced against the Landlord's wish to enhance its own market profile by advertising the presence of a particular tenant. This will need to be considered on a case-by-case basis, but is important to agree at the Heads of Terms stage of any transaction, as it is likely to be a key point on both sides.
Conclusion
The real estate industry certainly has its part to play with the UK's increasing focus on life sciences and pharma. Coupled with the materially reduced appetite from market participants for investment in physical retail, hotels and leisure, and even offices, and with significant equity and debt capital to deploy, a move to this alternative asset class is not surprising. There is increased industry and government support for scientific research and development, and the "work from home" solution is simply not an option for laboratory-based research and development professionals. When this is combined with the broad array of start-up / early stage opportunities, together with the (quite different) mid-stage / scale-up prospects, not least attractive lease lengths, it is our view that investment in real estate for life sciences is here to stay in the medium to long term.
See also:
Victoria Landsbert is a real estate partner at White & Case and a graduate in Chemistry and Biochemistry from Imperial College London.
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